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Contributors:

D.J. Sartorio Jeffrey M. Alperin

August 2007

Bolingbrook

Chicago

Los Angeles

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Tressler, Soderstrom, Maloney & Priess, LLP Attorneys At Law www.tsmp.com

50 State Survey: Accountants’ Liability to Third Parties

Please note that statutes and case law vary from state to state and from time to time. This survey does not encompass all possible exceptions to statutes and it does not discuss all possible case law variations. In addition, choice of law rules may impact the result in certain cases.

may be reached at [email protected] or 312‐627‐4172 1

ACCOUNTANTS’ LIABILITY TO THIRD PARTIES

Public accountants owe their clients a legal and contractual duty of due care. Accountants may also owe a duty of due care to third parties who rely on their work. The courts have adopted different standards for determining when such a duty exists. Below is a description of each standard, followed by appendices identifying the standard applied by each state.1

1. Privity:

a. Traditionally an accountant could not be held liable in contract or tort (e.g. negligence) to a third party with whom accountant was not in privity of contract.

b. Accountant’s duty of care only extends to parties in contractual privity with

accountant. 2. Near Privity:

a. Modifies the privity doctrine to include others whose relationship with the

accountant approaches privity. b. Requirements:

(1) Accountant knew the financial statements were to be used for a particular purpose;

(2) Accountant intended that a known third party rely; and

(3) Accountant’s actions were connected to the third party, demonstrating

accountants’ knowledge of that party’s reliance.2

c. Demanding standard because a casual connection is insufficient to link accountant to third party as required.3

1 Accountants may also be liable to third parties for fraud, regardless of the standards described herein, if there is fraudulent intent and detrimental reliance. See e.g., Joel v. Weber, 569 N.Y.S.2d 955 (N.Y. App. Div. 1991); Aetna Cas. & Sur. Co. v. Leahey Const. Co., 219 F.3d 519 (Ohio Ct. App. 2000); Dougherty v. Zimbler, 922 F. Supp. 110 (N.D. Ill. 1996); Curiale v. Peat, Marwick, Mitchell & Co., 630 N.Y.S.2d 996 (N.Y. App. Div. 1995); Howard v. Dun & Bradstreet, Inc., 220 S.E.2d 702 (Ga. Ct. App. 1975); Stephens Indus., Inc. v. Haskins & Sells, 438 F.2d 357 (Colo. Ct. App. 1971). 2 Credit Alliance Corp. v. Arthur Andersen & Co., 438 N.E.2d 110 (N.Y. 1985). 3 William Iselin & Co. v. Mann Judd Landau, 522 N.E.2d 21 (N.Y. 1988)

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(1) Most parties not in actual privity of contract with the accountant will not meet the standard because it requires proof that:

(a) Accountant’s words or actions were directed towards the third

party; or (b) Something in the client’s employment itself established a nexus

approaching privity with the third party.4

(2) In most cases the accountant will not have communicated directly with the third party and thus the employment will, at best, be only incidentally for the purpose of inducing the third party to extend credit to, invest in, or transact business with the client.5

d. Third party must establish that it is an intended beneficiary of the accountant’s

employment by the client. This can be established by evidence that the primary purpose of the accountant’s engagement was:

(1) To prepare financial statements, reports, or opinions for the use of the

third party; or (2) To be available on an ongoing basis to answer third party’s questions

regarding the client’s financial statements or condition or regarding the accountant’s opinion.6

e. A complaint alleging the following states a cause of action under this standard:

(1) Accountant was aware the financial statements would be used in connection with a particular transaction;

(2) Accountant was a key advisor to the client regarding the transaction; and (3) Accountant has repeated direct communications with the third party

regarding the client’s financial position.7

3. Restatement § 552:8

a. Currently represents the majority view. b. Provides that “one who supplied information during the course of his business,

profession, employment, or in any transaction in which he has a pecuniary interest 4 Westpac Banking Corp. v. Deschamps, 484 N.E.2d 1351 (N.Y. 1985) 5 Dan L. Goldwasser and M. Thomas Arnold, Accountants’ Liability, (Prac. Law Inst. 2001). 6 Sec. Pacific Bus. Credit, Inc. v. Peat Marwick Main & Co., 597 N.E.2d 1080 (N.Y. 1992). 7 Dept. of Econ Dev. v. Arthur Andersen & Co., 924 F. Supp. 449 (S.D.N.Y. 1996). 8 Restatement of Torts 2d, § 552 (1977).

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has a duty of reasonable care and competence to parties who rely upon the information in circumstances in which the maker was manifestly aware of the use to which the information was to be put and intended that it be so used.”9

c. Accountant’s liability extends to a foreseeable person or limited class of persons

for whom the information was intended, either directly or indirectly, even if the identity of the person is unknown.10

d. Reliance must be actually foreseen.11

(1) For example, accountant supplies information to a third party or limited

class of third parties; or (2) Accountant knows the recipient of the information intends to supply it to

the third party or limited class of third parties.12

e. Courts look to the purpose for which the accountant’s financial statement was made to determine whether the third party’s reliance is justifiable.

(1) Accountant must have made the statement to induce the third party to

rely upon it.13 (2) Accountant is not liable absent actual knowledge of the use of the

statement.14 (3) Liability to third party is more likely if accountant supplied information

directly to the third party.15

(4) Third party must rely on the actual statement and not a secondhand report of the same.16

f. Accountant may limit liability by disclaimer alerting parties not in privity that

they rely at their peril.

9 Id. 10 Id. 11 Goldwasser and Arnold, supra note 5. 12 Id. 13 Id. If this cannot be shown there will be no liability in the absence of privity, willfulness, physical harm or property damage 14 Nycal Corp. v. KPMG Peat Marwick LLP, 688 N.E. 2d 1368 (Mass. 1998); But cf. Arthur Andersen LLP v. Superior Court, 79 Cal. Rptr. 2d 879 (Cal. App. 1998) (accountants, in the business of auditing insurance companies, charged with knowledge of law pertaining to insurance company audits and, thus, that financial statements would be furnished to Insurance Commissioner). 15 First Fla. Bank, N.A. v. Max Mitchell & Co., 558 So. 2d. 9 (Fla. 1990). 16 Raritan River Steel Co. v. Cherry, Bekaert & Holland, 367 S.E.2d 609 (N.C. 1988).

may be reached at [email protected] or 312‐627‐4172 4

g. Accountant has a duty to those whose reliance is actually foreseen, even if the specific identity of the person(s) is not known.

4. Foreseeability:

a. Accountant is liable to all third parties whose reliance upon accountant’s negligently prepared financial statement is reasonably foreseeable.17

b. Unlike the Restatement standard, the third party need not be a person or one of a

class of persons whose reliance was actually foreseen by the accountant. c. Creates broad potential liability and thus several courts have established limits.

For example: Accountant not liable for a foreseeable injury if there is a strong public policy reason for denying recovery.18

5. Statute:

a. Several states have enacted statutes limiting the civil liability of accountants resulting from the negligent preparation of financial reports or statements.19

b. For example, legislation in Illinois, Arkansas, Michigan, and Utah provides that

an accountant will not be held liable in negligence to persons not in privity if the accountant sends a letter to the client identifying only those persons he or she intends to rely on the services; the accountant will only be liable to the identified persons and to those in privity.20

17 H. Rosenblum, Inc. v. Adler, 461 A.2d 138 (N.J. 1983). 18 Citizens Nat’l Bank v. Timm, Schmidt & Co., 335 N.W.2d 361 (Wis. 1983); See also, Rosenblum, supra note 17 at 153 (institutional investor who does not obtain audited statements directly from company may not recover from its accountant); Touche Ross & Co. v. Commercial Union Ins. Co., 514 So. 2d 315, 322-23 (Miss. 1987) (accountant “remains free to limit the dissemination of his or her opinion through a separate agreement with the audited entity.”). 19 See Appendices I and II. 20 See Appendix I for citations of statutes.

APPENDIX I

MATRIX OF STANDARDS APPLIED BY EACH STATE (Alphabetically by State)

STATE STANDARD APPLIED AUTHORITY

Alabama Restatement § 522 Boykin v. Arthur Andersen & Co., 639 So. 2d 504 Ala. 1994).

Alaska Restatement § 522 Selden v. Burnett, 754 P. 2d 256 (Alaska 1988).

Arizona Restatement § 552 Standard Chartered PLC v. Price Waterhouse, 945 P.2d 317 (Ariz. Ct. App. 1996).

Arkansas Statute similar to near privity (accountant can limit liability by letter)

Swink v. Ernst & Young, 988 S.W.2d 660 (Ark 1995); Ark. Stat. Ann. §§16-114-302,17-12-701.

California Restatement § 552 Bily v. Arthur Young & Co., 834 P.2d 745 (Cal. 1992).

Colorado Privity Stephens Indus., Inc. v. Haskins & Sells, 438 F.2d 357 (Colo. Ct. App. 1971).

Connecticut Near Privity Twin Mfg. Co. v. Blum, Shapiro & Co., 602 A. 2d 1079 (Conn. Super. Ct. 1991).

Delaware None specified to date

District of Columbia

None specified to date

Florida Restatement § 552 First Fla. Bank, N.A. v. Max Mitchell & Co., 558 So. 2d 9 (Fla. 1990). NationsBank, N. A. v. KPMG Peat Marwick LLP, 813 So. 2d 964 (Fla.App. 2002)

Georgia Restatement § 552 Badische Corp. v. Caylor, 356 S.E.2d 198 (Ga. 1987).

Hawaii Restatement § 552 Kohala Agric. V. Deloitte & Touche, 949 P.2d 141 (Haw. Ct. App. 1997).

Idaho Near Privity Idaho Bank & Trust Co. v. First Bancorp, 772 P.2d 720 (Idaho 1989).

Illinois Statute (accountant can limit liability by letter)

Ill. Comp. Stat. Ann. Chap. 225, § 450/30.1.

Indiana Near Privity Toro Co. v. Krouse, Kern & Co., 827 F.2d 155 (7th Cir. 1987).

Iowa Restatement § 552 Eldred v. McGladrey, Hendrickson & Pullen, 468 N.W.2d 217 (Iowa 1991).

Kansas Statute (similar to near privity)

Kan. Stat. Ann § 1-402.

Kentucky Restatement §552 Ingram Indus., Inc. v. Nowicki, 527 F. Supp. 683 (E.D. Ky. 1981).

Louisiana Restatement § 552 First Nat’l Bank of Commerce v. Monco Agency Inc., 911 F.2d 1053 (5th Cir.1990).

Maine Restatement § 552 Bowers v. Allied Inv. Corp., 822 F. Supp. 835 (D. Me. 1993).

Massachusetts Restatement § 552 Nycal Corp. v. KPMG Peat Marwick LLP, 688 N.E. 2d 1368 (Mass. 1998).

Maryland Near Privity PPM America, Inc. v. Marriott Corp., 820 F. Supp. 970 (D. Md. 1993). Walpert, Smullian & Blumenthal, P.A. v. Katz, 762 A.2d 582 (Md. 2000)

Michigan Statute (accountant can limit liability by letter) Restatement § 552

M.C.L.A. § 600.2962. Law Offices of Lawrence J. Stockler, P.C. v. Rose, 436 N.W. 2d 70 (Mich. App. 1989).

Minnesota Restatement § 552 NorAm Inv. Servs., Inc., v. Stirtz, Bernards, Boyden, Surdel & Larter, 611 N.W.2d 372 (Minn. App. 2000).

Mississippi Foreseeability MidAmerican Bank & Trust Co. v. Harrison, 851 S.W.2d 563 (Mo. Ct. App. 1993) Touche Ross &

iii

Co. v. Commercial Union Ins. Co., 514 So. 2d 315 (Miss. 1987).

Missouri Restatement § 552 Mark Twain Plaza Bank v. Lowell H. Listrom & Co., 714 S.W. 2d 859 (Mo. App. 1986). MidAmerican Bank & Trust Co. v. Harrison, 851 S.W.2d 563 (Mo. Ct. App. 1993)

Montana Near Privity Thayer v. Hicks, 793 P.2d 784 (Mont. 1990).

Nebraska Restatement §552 Privity

St. Paul Fire & Marine Ins. Co. v. Touche Ross & Co., 507 N.W.2d 275 (Neb. 1993). Citizens Nat. Bank of Wisner v. Kennedy and Coe, 441 N.W.2d 180 (Neb. 1989).

Nevada Privity Eikelberger v. Rogers, 549 P.2d 748 (Nev. 1976).

New Hampshire Restatement § 552 Spherex, Inc. v. Alexander Grant & Co., 451 A.2d 1308 (N.H. 1982). Demetracopoulos v. Wilson, 640 A.2d 279 (N.H. 1994)

New Jersey Statute similar to near privity Foreseeability

N.J. Stat. Ann. § 2A: 53A-25. H. Rosenblum, Inc. v. Adler, 461 A.2d 138 (N.J. 1983).

New Mexico None specified to date

New York Near Privity

Parrott v. Coopers & Lybrand, 741 N.E.2d 506 (N.Y. 2000).

North Carolina Restatement § 552 Raritan River Steel Co. v. Cherry, Bekaert & Holland, 367 S.E. 2d 609 (N.C. 1988). Marcus Bros. Textiles, Inc. v. Price Waterhouse, LLP, 513 S.E.2d 320 (N.C. 1999)

North Dakota None specified to date

Ohio Restatement § 552 Haddon View Inv. Co. v. Coopers & Lybrand, 436 N.E.2d 212 (Ohio 1982). Fed. Mgt. Co. v. Coopers & Lybrand, 738 N.E.2d

842 (Ohio Ct. App. 2000)

Oklahoma Foreseeability Stroud v. Arthur Andersen, 37 P.3d 783 (Okla. 2001).

Oregon Restatement §552 U.S. Nat’l Bank of Oregon v. Fought, 630 P. 2d 337 (Or. 1981).

Pennsylvania Privity Pell v. Weinstein, 759 F. Supp. 1107 (M.D. Pa. 1991).

Rhode Island Restatement § 552 Forcier v. Cardello, 173 B.R. 973 (D. R.I. 1994).

South Carolina Restatement § 552 ML-Lee Acquisition Fund, L.P. v. Deloitte & Touche, 489 S.E. 2d 470 (S.C. 1997).

South Dakota None specified to date

Tennessee Restatement § 552 Bethlehem Steel Corp. v. Ernst & Whinney, 822 S.W.2d 592 (Tenn. 1991).

Texas Restatement § 552 Scottish Heritable Trust v. Peat Marwick Main & Co., 81 F.3d 606 (5th Cir.1996).

Utah Statute (accountant can limit liability by letter) Restatement §552

Utah Code Ann. § 58-26-12. Milliner v. Elmer Fox & Co., 529 P.2d 806 (Utah 1974).

Vermont Restatement § 552 Nordica USA, Inc. v. Deloitte & Touche, 839 F. Supp. 1082 (D. Vt. 1993).

Virginia Privity Ward v. Ernst & Young, 435 S.E.2d 628 (Va. 1993).

Washington Restatement §552 ESCA Corp. v. KPMG Peat Marwick, 959 P.2d 651 (Wash. 1998).

West Virginia Restatement § 552 Costa v. Neimon, 366 N.W.2d 896 (Wis. Ct. App.

1985) First Nat’l Bank v. Crawford, 386 S.E.2d 310 (W. Va. 1989).

Wisconsin Foreseeability Citizens Nat’l Bank v. Timm, Schmidt & Co., 335 N.W.2d 361 (Wis. 1983). Costa v. Neimon, 366 N.W.2d 896 (Wis. Ct. App. 1985)

Wyoming Statute similar to near privity

Wyo. Stat. § 33-3-201.

APPENDIX II

MATRIX OF STATES APPLYING EACH STANDARD (Organized by Standard)

PRIVITY

Colorado Nevada

Pennsylvania Virginia

NEAR PRIVITY

Connecticut Idaho

Indiana Maryland Montana

New York

RESTATEMENT §522

Alabama Alaska Arizona

California Florida Georgia Hawaii Iowa

Kentucky Louisiana

Massachusetts Maine

Michigan* Minnesota

Missouri Nebraska

New Hampshire North Carolina

Ohio Oregon

Rhode Island South Carolina

Tennessee Texas Utah*

Vermont Washington

West Virginia

FORESEEABILITY

Mississippi

New Jersey* Oklahoma Wisconsin

STATUTE

Arkansas Illinois Kansas

Michigan New Jersey

Utah Wyoming

NO STANDARD SPECIFIED TO DATE

Delaware District of Columbia

New Mexico North Dakota South Dakota

* State governed also by statute.

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