Parrott v. Coopers & Lybrand, L. L. P.

OPINION OF THE COURT

Tom, J.

Plaintiff Harold Tod Parrott was employed as Vice-President of Sales by nonparty Pasadena Capital Corporation, a privately held investment advisor firm located in California. A majority of the company’s shares were held by its CEO, with employees, including plaintiff, holding various minority interests. Under a January 1, 1992 stock purchase agreement, plaintiff purchased 40,500 shares at $28.22 per share. The purchase agreement provided that, upon termination of plaintiffs employment, the company would purchase back these shares at fair market value to be determined on a minority basis by an independent third-party analysis conducted in accordance with the company’s employee stock ownership plan.

Defendant accounting firm had provided accounting reports to the company twice annually, on December 31 and June 30, for several years. The accountants were retained by the company and reported only to the company. As per the December 20, 1993 letter of continuing engagement, the accountants valued the company on a minority interest basis, exclusive of added value or premiums in connection with the sale or proposed sale of the company. Each biannual report was based on two methodologies: a discounted cash flow method, and a market comparable method relying on the stock values of similar companies publicly traded. Under the terms of engagement, the company’s management was required to keep the accountants informed of any material changes in operation, management or financing, and the company was required to review draft reports prior to issuance to verify accuracy of the analysis and conclusions.

Plaintiff was terminated on May 31, 1996. When it appeared that the repurchase provision of the stock purchase agreement would be invoked after his termination, plaintiff initially resisted the repurchase. His initial recourse, understandably, was against his former employer. Plaintiff commenced a Federal action in the Southern District of New York in August 1996 to enjoin Pasadena from exercising its right to buy back plaintiff’s stock under the stock purchase agreement. He challenged the legality of his termination as well as what he expected to be defendant’s valuation, and contended that the repurchase could not be triggered by a wrongful termination. In that action, in which he also sought an independent valuation, he estimated the value at $120 per share, arising in part from an anticipated sale of the company. However, plaintiff did not allege that an identified purchaser or a pending offer for the company existed.

By letter dated September 26, 1996, the company gave notice that it was exercising its right to repurchase the stock, and explained that the value it relied on was established by defendant accounting firm in the most recent biannual report. The accountants set a value of $78.21 per share as of June 30, 1996. This represented a total company value of $117,000,000, divided by the number of shares. The result was that plaintiff was offered $3,069,208.50 payable over five years, plus interest, for stock that he had purchased for $1,143,035 in 1992.

On or about January 14, 1997, the Federal court denied plaintiffs motion for a preliminary injunction on the basis that recovery of a monetary award provided an adequate remedy at law and that he had failed to demonstrate irreparable injury. In March 1997, plaintiff entered a so-ordered stipulation with his employer providing for a repurchase price of $3.9 million without prejudice to plaintiff seeking a higher price in litigation against the employer. Subsequently, the Federal District Court directed that the dispute was to be arbitrated pursuant to the arbitration provisions of the stock purchase agreement and an arbitration proceeding was commenced in California against the company.

Plaintiff next sought recourse against the accountants, and commenced the present action in 1997. The complaint sounded in professional negligence, negligent misrepresentation and aiding and abetting the employer’s breach of fiduciary duty. Under the negligence and misrepresentation claims, plaintiff argued that he had reasonably relied on the accountants’ misrepresentations and omissions when he stipulated to the sale of the shares. Under the breach of fiduciary duty claim, he argued that the accountants had changed the valuation methodology, at the employer’s insistence, in order to reduce the price of plaintiff’s shares, and that plaintiff was thereby induced to accept a lesser value for his stock. We, as well as the dissent, agree that this latter claim, which rests solely on conclusory allegations, cannot be sustained.

Defendant then moved for summary judgment. The motion court, finding that there were factual issues regarding, inter alia, whether defendant negligently prepared the valuation in failing to account for the company’s marketability, the extent to which defendant knew plaintiff was bound by the results of its valuation, and whether defendant knew of the company’s alleged breach of fiduciary duty, denied summary judgment as to all claims.

Initially, we find that New York law, rather than California law, applies. Although the claim arose from conduct occurring in California, New York is the common domicile of plaintiff and defendant, which maintains its principal place of business here. New York has the greater interest in extending the protection of its own laws to its own domiciliaries (First Interstate Credit Alliance v Arthur Andersen & Co., 150 AD2d 291, 293-294). However, even under New York law, plaintiff cannot prevail.

The analysis of the malpractice claim starts from the general proposition that under New York common law, accountants do not have a duty to the public at large (Westpac Banking Corp. v Deschamps, 66 NY2d 16). Rather, traditionally, as noted by Chief Judge Cardozo in Ultramares Corp. v Touche (255 NY 170) in dismissing a cause of action against an accounting firm for inaccurately prepared financial statements relied on by a plaintiff having no contractual privity with the accountants, privity was the necessary predicate for accounting liability. The duty of care arose from the relationship. Among Cardozo’s concerns, still applicable decades later, was that any mistake by an accountant otherwise might expose that accountant, or any accountant, to liability by a limitless class of aggrieved parties. In Ultramares, Chief Judge Cardozo addressed and distinguished his prior ruling in Glanzer v Shepard (233 NY 236), upon which the dissent presently relies for the proposition that liability may arise when the third party must rely on a bean counter’s report. The distinction was that in Glanzer, a bean counter had affirmatively assumed a duty of care to the specified third party for a specific purpose, to wit, give accurate weight of a quantity of beans, which was not specifically a contractual obligation, and, hence, privity did not strictly apply. Those factors are not present in the case before us. These different traditional approaches to third-party liability were joined and analyzed in the Court of Appeals landmark Credit Alliance ruling. Credit Alliance Corp. v Arthur Andersen & Co. (65 NY2d 536) did not overturn the common-law rule, but only expanded it modestly, reflecting the modern ubiquity of financial statements, to allow for the liability of an accountant who provides advice to a third party with whom the accountant is not in privity, but with whom a close relationship nevertheless exists. At most, Credit Alliance resolved the tension, if any, between these two lines of Cardozo jurisprudence.

Credit Alliance sets forth three criteria for establishing the liability of accountants on the basis of advice or services to clients when noncontracting third parties claim injury as a consequence of that advice: the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes, upon which a known party or parties were intended to rely, and there must have been some conduct on the part of the accountants linking them to that party or parties’ reliance (supra, at 551). These “indicia, while distinct, are interrelated and collectively require a third party claiming harm to demonstrate a relationship or bond with the once-removed accountants” (Security Pac. Bus. Credit v Peat Marwick Main & Co., 79 NY2d 695, 702-703). Hence, although there is some conceptual overlap among the showings necessary to establish these requirements, the Court of Appeals has nevertheless set forth three discrete criteria. Evidentiary proof, in admissible form, must be offered in support of all three criteria in order to warrant trial (Security Pac. Bus. Credit v Peat Marwick Main & Co., at 704). As with a three-legged table, remove one prop, and the entire structure must fall. So, too, here, where I conclude that the inadequacy of the linkage between the accountants and plaintiff is fatal to plaintiff’s theory of liability.

The Court of Appeals policy-based expansion of an accountant’s common-law liability to a third party, with whom the accountant has no contractual or direct relationship, turns in part on whether that plaintiff can establish the correlates of a contractual or direct relationship. This expansion, though it “permitís] some flexibility in the application of the doctrine of privity to accountants’ liability,” as noted above, does not represent a departure from traditional modes of analyzing such privity-based liability (Credit Alliance Corp. v Arthur Andersen & Co., at 551). Rather, the analytical model is whether there is a “relationship sufficiently approaching privity” between plaintiff and the accountants (William Iselin & Co. v Mann Judd Landau, 71 NY2d 420, 423) or a direct “nexus” (European Am. Bank & Trust Co. v Strauhs & Kaye, 65 NY2d 536, 554 [decided with Credit Alliance]) or, as we have characterized it, “the functional equivalent of privity” (John Blair Communications v Reliance Capital Group, 157 AD2d 490, 491). The factors utilized in demonstrating the requisite relationship depend not only on the number of contacts but also on the substantive nature of the contacts. While the dissent characterizes nexus as being multifactored, there still must be a demonstrably direct relationship, which is absent in this case.

For instance, in European American Bank (supra), the Court found a direct nexus between the parties based on the fact that the accountants had multiple, direct and substantive meetings with the third parties. The Security Pacific Court found the facts of European American Bank to be a “cogent contrasting illustration” since the plaintiff’s claimed relationship to the accounting firm in Security Pacific, “rises or falls essentially on the single unsolicited phone call * * * ‘limited to generalities’ ” coupled with an assurance by the accountant to the third party that an audit of the client had uncovered nothing wrong (supra, at 705). The limited nexus in Security Pacific did not “ ‘sufficiently approach!] privity”’ (Security Pac. Bus. Credit v Peat Marwick Main & Co., supra, at 705). The Court of Appeals in Westpac Banking Corp. v Deschamps (66 NY2d 16, supra), analyzing the “relationship” criterion, found no direct nexus under the facts of that case in the absence of any allegation that the accountants had any dealings with the plaintiff, or had agreed with the client to prepare the report for plaintiffs use or according to plaintiffs requirement, or had agreed with the client to provide that plaintiff with a copy and had actually done so. “Indeed, there is simply no allegation of any word or action on the part of [the accountants] directed to [plaintiff] or anything contained in [the accountants’] retainer agreement with [the client] which provided the necessary link between them” {supra, at 19). The record before us indicates there was never any similar contact between plaintiff and the accountants.

By contrast, in John Blair Communications {supra), we found the requirement satisfied by the numerous meetings between the parties, and in excess of 20 specific allegations in the complaint establishing the relationship. Similarly, we found “the requisite nexus” present in Cherry v Herbert & Co. (212 AD2d 203) where there were personal meetings between the parties, the accountants’ personnel were aware of the purposes of their actions vis-a-vis the nonclient plaintiffs, and assurances were personally communicated to the plaintiffs by the accountants. Although those facts are not a necessary baseline for evaluating whether a relationship exists, they are certainly illustrative, and the omission of any relevant substantive allegations in the present case is a telling defect. In Security Pacific, at least there was an alleged telephone communication between plaintiffs vice-president and an audit partner at the accounting firm, who provided verbal assurances. But that plaintiffs “efforts to elevate these facts to the critical rank and linking relationship akin to privity * * * [were] unavailing” (Security Pac. Bus. Credit v Peat Marwick Main & Co., supra, at 705), requiring rejection of liability under the Credit Alliance criteria.

In some respects, the dissent conflates these separate requirements, in support of which it cites cases for general propositions that are not on point with the specific accounting liability issue before us. However, even broadly speaking, the overlap of these requirements does not create a privity-like context where none is to be found in the unadorned facts. The dissent contends that plaintiff might have been “known” in the sense that he fit within a class of persons — employees — that was “known” to the accountants {but see, Westpac Banking Corp. v Deschamps, supra) and for whose benefit the report establishing annual value was issued. Since there is no such evidence of the accountants’ knowledge of the particular use to which the report would be put vis-á-vis plaintiffs particular situation, I also respectfully question the dissent’s conclusion that plaintiff passes muster under Credit Alliance as to this criterion. The dissent also suggests that the requisite “knowledge” may be imputed to defendant accountants insofar as this was purportedly a “small” company — although that characterization is not clear — in which plaintiff held a high position. This remains sheer surmise. However, if the basic requirement of a relationship approaching privity cannot be established, the point remains academic. Even if we stretch the “specific purposes” requirement to accommodate an employer’s buyback of stock from an employee, and even if we deem plaintiff’s reliance as arising under the coercive circumstances of the buyback, as the dissent would do, there still must have been conduct by the accountants linking them to plaintiff “approaching privity.” That is simply absent in this case. As the Court of Appeals has noted, whether or not the plaintiff may be deemed to have “relied” on the “advice” is not dispositive: a third-party plaintiff “cannot unilaterally create such an extraordinary obligation, imposing negligence liability of significant commercial dimension and consequences by merely interposing and announcing its reliance in this fashion” (Security Pac. Bus. Credit v Peat Marwick Main & Co., supra, at 705). Absent “sufficient conduct * * * evidencing a relationship between [plaintiff] and the accountants * * * [t]his plainly is not what Credit Alliance and its related precedents effected” (supra,, at 705-706).

The dissent also cites to White v Guarente (43 NY2d 356), decided the decade preceding Credit Alliance, for the proposition that the requisite relationship may be found between the accountants and the class of persons in which a plaintiff has membership. However, that general proposition, accurate under the facts of that case, has no application here. The accounting firm in White prepared tax returns for the partnership, including the 40 limited partners, who, naturally, relied on the partnership tax returns in preparing their own annual tax returns. As noted in Judge Cooke’s opinion (White v Guarente, supra, at 362), “[t]his was within the contemplation of the parties to the accounting retainer.” The retainer contract imposed the specific duty on the accountants and created the limited partners’ rights to an accurate accounting. That particular service was one of the “ends and aims of the transaction,” rather than being “ ‘merely one possibility among many” ” (supra, at 362). Hence, the question of privity was beside the point. In the present case, the “end and aim” of the service was to provide an annual accounting for employee pension plan purposes. A potentially different use, such as that herein, was too remote to be foreseeable. In any event, with the subsequent Credit Alliance ruling, the Court of Appeals refined the analysis, superseding White.

In the case before us, there is no indication that plaintiff ever met or even communicated with the accountants, or that the accountants were even aware that plaintiff owned company stock, or that the stock would be repurchased by the employer-client at a value fixed by the accountants. There were no written or verbal communications between plaintiff and the accountants on the subject matter of the stock values prior to the report being issued. At best, the accountants acted pursuant to an ongoing engagement with their client — the employer — to simply appraise the stock twice yearly for employee stock ownership plan purposes generally, and this is an insufficient basis upon which to ground a relationship approaching privity with this plaintiff.

Plaintiff concededly never read nor even received the accountants’ report, and none had been provided to him. The accountants did not prepare the June 1996 report with any regard to plaintiffs termination. Nor did the accountants have a copy, or even knowledge of, any stock purchase agreement between plaintiff and the company. In sum, the accountants’ discharge of their routine responsibilities was completely unrelated to Pasadena’s purchase of plaintiffs stock under the stock purchase agreement.

Credit Alliance’s expansion of the common-law doctrine that relied on privity was never intended to create the expedient of new liability grounded merely on the fact that a third party utilizes an accountant’s report. Returning to the point first illustrated in Ultramares (supra), such open-ended liability would have unintended and far-reaching consequences, effectively creating remedies that were never necessary to address the tort in question. The dissent notes the arguably small size of this company of less than 100 employees to conclude that widening the scope of accountant liability to the facts of this case sets reasonable and predictable limits to this defendant’s liability to third parties. However, it does not follow, whatever the practical consequences as among these particular parties, that the proposed expansion of the theory of third-party liability will retain practical limitations in other cases. Once we establish the principle, it will likely detach from these facts. One may reasonably ask under different facts how we would apply such a principle to limit liability to third parties. If the company has 200 employee-shareholders, do we still dispatch with the requirement that there must be a demonstrable linkage? What if there are hundreds or thousands of nonemployee shareholders? Where does one draw the line? Parsimony in extending Credit Alliance would, I think, provide better guidance for accountants and those in relationships with them that fall short of privity. It would be better to adhere to the actual requirement of Credit Alliance and our own prior case law that a close linkage between the accountants and the nonclient be established.

Since we are dismissing the complaint, the remaining issues are rendered academic.

Accordingly, the order of Supreme Court, New York County (Beatrice Shainswit, J.), entered January 13, 1999, denying defendant’s motion for summary judgment dismissing the complaint, and for costs and attorneys’ fees, should be modified, on the law, to the extent of granting the motion to dismiss the complaint, and otherwise affirmed, without costs. Appeal from order, same court and Justice, entered February 17, 1999, granting defendant’s motion to quash a subpoena directed to a third-party witness, should be dismissed, without costs, as academic.