Credit Alliance Corporation. v. Arthur Andersen & Co. Ct. Of App. Of N.Y.,

65 N.Y.2d 536, 483 N.E.2d ll0, 493 N.Y.S.2d 435 (1985).

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Nature of the Case

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Facts

P is a major financial service company engaged in financing the purchase of capital equipment through installment sales or leasing agreements. Arthur Andersen (D) is a national accounting firm. P provided financing to L. B. Smith, Inc. of Virginia ('Smith'), a capital-intensive enterprise that regularly required financing. P advised Smith that as a condition to extending additional major financing, they would insist upon examining an audited financial statement. Smith provided P with a consolidated financial statement, covering both itself and its subsidiaries. It contained an auditor's report prepared by D stating that it had examined the statements in accordance with generally accepted auditing standards ('GAAS') and found them to reflect fairly the financial position of Smith in conformity with generally accepted accounting principles ('GAAP'). In reliance upon the statements, P provided substantial amounts in financing to Smith through various extensions of credit. The same procedure occurred the next year with Smith providing a report by D as to current conditions. In reliance upon the reports, P provided additional substantial financing to Smith. P sued D for damages lost on the loans to Smith. P claimed both negligence and fraud by D in the preparation of its audit reports. P alleges that D knew, should have known or was on notice that the 1977 and 1979 certified statements were being utilized by Smith to induce companies such as P to make credit available to Smith. P also alleges that D knew or recklessly disregarded facts which indicated that the 1977 and 1979 statements were misleading. D motioned to dismiss. The court eventually denied the motion. On appeal the court ruled that P fell within the exception to the general rule that requires privity to maintain an action against an accountant for negligence. Two Justices dissented on the ground that the rule requiring privity has been repeatedly reaffirmed. In the second case, European American Bank and Trust Company (P1), made substantial loans to Majestic Electro Industries and certain of its subsidiaries in March 1979 pursuant to their written agreements. Majestic Electro retained Strauhs & Kaye (D1), an accounting partnership rendering services in accordance with GAAS and to report its findings in conformity with GAAP. During the course of its lending relationship with Majestic Electro, P relied upon the interim and year-end financial reports prepared by D1 to determine the maximum amount it was willing to lend. From 1979 through 1982, D1 allegedly overstated Majestic Electro's inventory and accounts receivable, and failed to disclose the inadequacy of Majestic Electro's internal recordkeeping and inventory control. P1 discovered the problems when Majestic defaulted. P1 sought damages for its reliance upon D1's reports. P1 specifically alleges negligence in that D1, in performing auditing and accounting services for Majestic Electro, at all relevant times knew that P1 was Majestic Electro's principal lender, was familiar with the terms of the lending relationship, and was fully aware that P1 was relying on the financial statements and inventory valuations certified by D1. The trial court dismissed the complaint holding that, absent a contractual relationship between the parties or an allegation of fraud, the complaint failed to state a cause of action. On appeal, the Appellate Division unanimously reversed and reinstated the complaint in its entirety.