On appeal from the Superior Court, Appellate Division, whose opinion is reported at 183 N.J. Super. 417 (1982) (A-39). On appeal from the Superior Court, Appellate Division (A-85).
For reversal and remandment -- Chief Justice Wilentz and Justices Clifford, Schreiber, Handler, Pollock, O'Hern and Garibaldi. For affirmance -- None. The opinion of the Court was delivered by Schreiber, J.
This case focuses upon the issue of whether accountants should be responsible for their negligence in auditing financial statements. If so, we must decide whether a duty is owed to those with whom the auditor is in privity, to third persons known and intended by the auditor to be the recipients of the audit, and to those who foreseeably might rely on the audit. Subsumed within these questions is a more fundamental one: to what extent does public policy justify imposition of a duty to any of these classes?
The issues herein arose on defendants' motion for partial summary judgment. The facts that follow were, therefore, adduced from the record in a light most favorable to the plaintiffs. The plaintiffs Harry and Barry Rosenblum brought this action against Touche Ross & Co. (Touche), a partnership, and the individual partners. Touche, a prominent accounting firm, had audited the financial statements of Giant Stores Corporation (Giant). These plaintiffs, allegedly relying on the correctness of the audits, acquired Giant common stock in conjunction with the sale of their business to Giant. That stock subsequently proved to be worthless, after the financial statements were found to be fraudulent. Plaintiffs claim that Touche negligently conducted the audits and that Touche's negligence was a proximate cause of their loss.
Giant, a Massachusetts corporation, operated discount department stores, retail catalog showrooms and art and gift shops. Its common stock was publicly traded, its initial public offering having been made pursuant to a registration statement filed
with the Securities and Exchange Commission (SEC) in 1969. Giant was required to file audited financial statements with the SEC as part of its annual report to stockholders and Touche conducted those audit examinations during the fiscal years 1969 through 1972. Giant's fiscal year was the twelve months ending January 30.
In November 1971 Giant commenced negotiations with the plaintiffs for the acquisition of their businesses in New Jersey (H. Rosenblum, Inc. and Summit Promotions, Inc.). These enterprises had retail catalog showrooms in Summit and Wayne. The merger negotiations culminated in an agreement executed on March 9, 1972. During the discussions two significant events occurred. First, on December 14, 1971, Giant made a public offering of 360,000 shares of its common stock. The financial statements included in the prospectus of that offering contained statements of annual earnings for four years ending January 30, 1971, as well as balance sheets as of January 30 for each of those years, which had been audited by Touche. Touche's opinion affixed to those financials stated that it had examined the statements of earnings and balance sheets "in accordance with generally accepted auditing standards" and that the financial statements "present[ed] fairly" Giant's financial position. Similar data had been incorporated in Giant's annual report for the year ending January 30, 1971. Second, Touche began its audit of Giant's financials for the year ending January 29, 1972. This audit was completed on April 18, 1972. The attached Touche opinion bore the same language affixed to the 1971 statements.
One of the Touche partners, Armin Frankel, was present at some of the merger discussions. It does not appear that he participated in the negotiations, though the plaintiffs assert that they received the January 1971 audited statements during a meeting at which Frankel was present. Although he denies making the projection, Frankel is also alleged to have stated during one meeting that the preliminary figures of the 1972 audit then under way indicated it was going to be "a very
strong year for Giant Stores, it is probably going to be the best in history . . . ."
The merger agreement provided that the Rosenblums would receive an amount of Giant stock, up to a maximum of 86,075 shares, depending upon the net income of their enterprises for their fiscal year ending December 31, 1971. The closing was to be scheduled between May 15 and May 31, 1972. Giant agreed that as of the closing it would represent and warrant that there had "been no material adverse change in the business, properties or assets of Giant and its Subsidiaries since July 31, 1971." The plaintiffs claim they relied upon the 1972 audited statements before closing the transaction on June 12, 1972. The Rosenblums received Giant common stock, which had been listed on the American Stock Exchange in February 1972 and was being traded on that Exchange when the merger was effected. After the Rosenblum closing, Giant made another public offering of common stock in August 1972. Touche furnished for this Giant registration statement the audited financial statements for each of the five fiscal years ending January 29, 1972, to which was affixed Touche's unqualified opinion.
Giant had manipulated its books by falsely recording assets that it did not own and omitting substantial amounts of accounts payable so that the financial information that Touche had certified in the 1971 and 1972 statements was incorrect.*fn1 The fraud was uncovered in the early months of 1973. Trading in Giant stock on the American Stock Exchange was suspended in April 1973 and never resumed. On May 22, 1973, Touche withdrew its audit for the year ending January 29, 1972. Giant filed a bankruptcy petition in September 1973. The Giant stock received by the plaintiffs in the merger had become worthless.
The plaintiffs' four-count complaint, predicated on the audited financials for the years ending January 30, 1971 and January 29, 1972, charged fraudulent misrepresentation, gross negligence, negligence and breach of warranty. Touche moved for partial summary judgment. It sought to have the court dismiss the claims based on alleged negligence in making the audit for the year ending January 30, 1971 and on alleged negligence, gross negligence and fraud in making the audit for the year ending January 29, 1972. The trial court granted the motion with respect to the 1971 financials and denied it as to the 1972 financials.
The Appellate Division granted plaintiffs' motion for leave to appeal, but affirmed the trial court's dismissal of the negligence claim based on the 1971 audit. 183 N.J. Super. 417 (1982). We granted plaintiffs' motion for leave to appeal. 91 N.J. 191 (1982). The defendants had also moved for leave to appeal from the denial of their motion for partial summary judgment addressed to claims predicated on the 1972 financials. The Appellate Division had denied that motion. The defendants subsequently moved before us for leave to appeal from the Appellate Division's denial. We acceded to that motion after we had granted plaintiffs' motion for leave to appeal. Thus the propriety of the trial court's disposition of Touche's entire motion for partial summary judgment is now before us.
An independent auditor is engaged to review and examine a company's financial statements and then to issue an opinion with respect to the fairness of that presentation. That report is customarily attached to the financial statements and then distributed by the company for various purposes. Recipients may be stockholders, potential investors, creditors and potential creditors. When these parties rely upon a negligently prepared auditor's report and suffer damages as a result, the question arises whether they may look to the auditor for compensation.
In other words, to whom does the auditor owe a duty? The traditional rule is that the auditor's duty is owed only to those with whom he is in privity or to those who are known beneficiaries at the time of the auditor's undertaking. This rule is commonly attributed to an opinion of Chief Judge Cardozo in Ultramares v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931). A second rule has been expressed in Section 552 of the Restatement (Second) of Torts. Under the Restatement, liability is extended to a known and intended class of beneficiaries. For example, if the auditor knows that the report is to be prepared for bank borrowing, then his duty would run to the bank to whom the company delivered the opinion. A third rule is that the auditor's duty is owed to those whom the auditor should reasonably foresee as recipients from the company of the financial statements for authorized business purposes. See JEB Fasteners v. Marks, Bloom & Co.  3 All E.R. 289, 296.
A claim against the auditor is realistically one predicated upon his representations. Though the theory advanced here by the plaintiffs is directed to the service performed by accountants and thus is in the nature of malpractice, their claim can be viewed as grounded in negligent misrepresentation. In the complaint the plaintiffs seek recompense for economic loss from a negligent supplier of a service with whom the claimants are not in privity. It has generally been held with respect to accountants that imposition of liability requires a privity or privity-like relationship between the claimant and the negligent actor. We must examine a number of issues in order to determine whether we should so limit such actions in New Jersey.
First, we shall consider whether, in the absence of privity, an action for negligent misrepresentation may be maintained for economic loss against the provider of a service. This involves (1) a negligent misrepresentation, (2) in furnishing a service, (3) that results in economic loss, (4) to a person not in privity with the declarant.
Second, we shall determine what duty the auditor should bear to best serve the public interest in light of the role of the auditor in today's economy.
Negligent misrepresentation is a legally sound concept. An incorrect statement, negligently made and justifiably relied upon, may be the basis for recovery of damages for economic loss or injury sustained as a consequence of that reliance. Pabon v. Hackensack Auto Sales, Inc., 63 N.J. Super. 476 (App.Div.1960), presents an example of a valid physical damage claim predicated upon misrepresentation. The driver of an automobile sued the automobile dealer and manufacturer for damages sustained when his steering wheel locked and the automobile went out of control and struck a pole. A judgment of involuntary dismissal at the close of the plaintiff's case was reversed. One theory advanced by the plaintiff was based on the negligent representation made by the dealer that the steering characteristic plaintiff had encountered prior to the accident was not the result of any deficiency, but rather was normal. The Appellate Division observed that negligence might be inferred from the falsity of the representation. It commented:
A false statement negligently made, and on which justifiable reliance is placed, may be the basis for the recovery of damages for injury sustained as a consequence of such reliance. Russell v. First National Stores, 96 N.H. 471, 79 A.2d 573 (Sup.Ct. 1951); Restatement, Torts, § 552, especially Illustration 2; 1 Harper & James, supra, § 7.6, pp. 545-51; Prosser, supra, § 88, pp. 541-45; 23 Am.Jur., Fraud and Deceit, § 126, p. 917; 65 C.J.S. Negligence § 20, p. 427. The statement need not be a factual report, but may consist of an expert opinion. Justification for the imposition of a duty of care upon the speaker is found in the respective positions of the one making the representation and the relying party, the former purporting to exercise the skill and competency compatible with his profession or calling, the latter openly placing his faith on such reputed skill. There must be knowledge, or reason to know, on the part of the speaker that the information is desired for a serious purpose, that the seeker of the information intends to rely upon it, and that if the information or opinion is false or erroneous, the relying party will be injured in person or property. [ Id. at 497]
Recovery of economic loss, due to negligent misrepresentation by one furnishing a service, has long been permitted when
there existed a direct contractual relationship between the parties or when the injured third party was a known beneficiary of the defendant's undertaking. Thus, for example, in Economy B. & L. Ass'n v. West Jersey Title Co., 64 N.J.L. 27 (Sup.Ct.1899), the plaintiff agreed to loan $3,000 to one Moore secured by a first mortgage on Moore's property, title to which was to be certified by a title insurance company. Moore advised the defendant title insurance company of his agreement and retained the defendant to make the search and certificate. Moore delivered the certificate to and obtained the loan from the plaintiff. The plaintiff was held to have a good cause of action against the certifying title company when it was discovered that the carelessly made title search had not disclosed a prior recorded mortgage.
Our case law, however, has been split on whether privity or a similar relationship is necessary in a suit against the supplier of a service for negligent misrepresentation causing economic loss.
Kahl v. Love, 37 N.J.L. 5 (Sup.Ct.1873), is probably the first reported New Jersey negligent misrepresentation case concerned with a service resulting in economic loss. Defendant was the Jersey City collector of taxes. Upon receiving the check of a landowner in payment of taxes, defendant gave the landowner a receipt in full. The land, the subject of these taxes, was sold to the plaintiff, who relied on the receipt as proof of payment of the taxes. The check was later dishonored and taxes were levied on the lands after the plaintiff acquired title. The plaintiff sued the collector for the damages suffered and obtained a judgment. The Supreme Court reversed, citing both the absence of a duty and the unreasonableness of the plaintiff's reliance. The Court assumed that the defendant knew that these receipts were used on the sale of land to establish that taxes were paid up. It held that a duty, arising from contract or otherwise, had to exist before liability could ensue. Chief Justice Beasley, writing on behalf of the Court, stated:
Such a restriction on the right to sue for a want of care in the exercise of employments or the transaction of business, is plainly necessary to restrain the
remedy from being pushed to an impracticable extreme. There would be no bounds to actions and litigious intricacies, if the ill effects of the negligences of men could be followed down the chain of results to the final effect.*fn2 [ Id. at 8]
A more recent lower court decision has held to the contrary. In Immerman v. Ostertag, 83 N.J. Super. 364 (Law Div.1964), the court stated that a notary public owes a duty to third persons who rely on his acknowledgment to refrain from acts or omissions that constitute negligence. Immerman accepted the proposition that "an acknowledgment-taking officer has a duty to refrain from acts or omissions which constitute negligence, a duty which he owes not only to persons with whom he has privity, but also to any member of the public who, in reasonable contemplation, might rely upon the officer's certification." 83 N.J. Super. at 369. This Court has approvingly cited Immerman as articulating the general rule with respect to notaries. Commercial Union Ins. Co. v. Thomas-Aitken Constr. Co., 54 N.J. 76, 81 (1969).
Similarly, lack of privity has been held not to bar the liability of an independent contractor engaged to perform services for his negligent nonfeasance. Gold Mills, Inc. v. Orbit Processing Corp., 121 N.J. Super. 370 (Law Div.1972). The court there observed:
Such liability should exist when the contractor has undertaken performance, whether his negligent performance results from the doing of something which a reasonably prudent person would not have done or from the failure to do something which a reasonably prudent person would have done. So long as the privity rule is no longer viable in the area of tort liability there is no reason why a contractor should not have the same duties toward a stranger to the contract as any member of society to another, i.e., to exercise due care to avoid injury to another's person or property. [ Id. at 376]
We have never passed upon the problem of an accountant's liability to third persons who have relied ...