May 06, 2004
E. DICKERSON & SON, INC., ESTEVEZ GROUP, INC., FOOD CIRCUS SUPER MARKETS, INC., FOOD KING, INC., FRANELEN, INC., CHARLANN, INC., 444 FULTON MANAGEMENT CORP., HARP MARKETING CORPORATION, LJV, INC., MANYFOODS, INC., NICHOLAS MARKETS, INC., NORKUS ENTERPRISES, INC., RAMLAC CORPORATION/BELL BEEF CO., SIDNEY CHARLES MARKETS, INC., SUPERMARKET ACQUISITION CO., LLC, V & V SUPERMARKETS, INC., OLIVA SUPERMARKETS, LLC AND FOODTOWN, PLAINTIFFS-APPELLANTS,
ERNST & YOUNG, LLP, DEFENDANT-RESPONDENT.
On certification to the Superior Court, Appellate Division, whose opinion is reported at 361 N.J. Super. 362 (2003).
SYLLABUS BY THE COURT
(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized).
Plaintiffs, seventeen corporations owning and operating supermarkets, are members or stockholders of Twin County Grocers, Inc. (Twin County), a wholesale distributor of supermarket products, described as "a cooperative organization serving the mutual need of supermarket members..." Most of the individual owners of the corporations were also members of Twin County Cooperative's Board of Directors. Twin County hired Ernst & Young, a public accounting firm, to conduct audits of its financial statements. The annual audits were performed negligently for four years and, as a result, failed to disclose that one of the directors had perpetrated numerous frauds adversely affecting Twin County and its members, including plaintiffs.
Plaintiffs sued Ernst & Young, alleging that its negligence in performing audits for Twin County caused them damages. In their complaint, plaintiffs allege that Ernst & Young knew that the members of Twin County's Board of Directors, including the plaintiffs, relied on Ernst & Young's audits in connection with their individual store operations, including but not limited to, their individual decisions concerning the nature and extent of their continued participation in the cooperative. Plaintiffs further allege that Ernst and Young breached a fiduciary duty to inform them about the fraudulent acts and that, as beneficiaries of the engagement agreement hiring the accounting firm, Ernst and Young had a written obligation to report directly to the Twin City Board of Directors and their respective operating entities.
Ernst & Young filed a motion to dismiss for failure to state a claim upon which relief can be granted, which the trial court granted. On appeal, the Appellate Division affirmed the decision of the trial court to dismiss the complaint, finding that the allegations of the complaint do not meet the requirements of N.J.S.A. 2A:53A-25 (the statute), which governs the negligence liability of accountants to third parties for all transactions entered into after March 17, 1995. After reviewing the statutory language and legislative history, the Appellate Division concluded that the claims of the seventeen corporate plaintiffs arising from allegedly inaccurate annual audits did not satisfy the requirements for accountant third-party liability pursuant to the statute.
The Supreme Court granted certification.
HELD: Plaintiff corporations were not the client of Ernst & Young within the statutory definition of N.J.S.A. 2A:53A-25 and general reliance by these individual corporate shareholders of Twin County on annual audits was not sufficient to satisfy the statutory conditions for liability and confer a cause of action for accounting negligence.
1. Ernst & Young's accounting services were rendered to Twin City as the "client," which was driven into bankruptcy and liquidation by the fraudulent conduct of its management. Thus, plaintiffs must satisfy subsections 2(a), (b), and (c) of the statute for Ernst & Young to be liable to them as third parties. As noted by the Appellate Division, none of those conditions was satisfied by the claims pleaded in the complaint. Thus, the Court affirms the decision of the Appellate Division substantially for the reasons stated in its opinion. (Pp. 2-4)
2. The complaint does not allege a transaction between the client, Twin County, and the claimants, the plaintiffs; therefore, subsection 2(a) is not satisfied. In addition, the complaint does not allege that plaintiffs were specifically identified as possible claimants. The assertion that plaintiffs' relied on audit services in connection with their individual decisions to continue participating in the cooperative fails to allege any specific transaction in which plaintiffs were going to engage with the client. Thus, subsections 2 (a) and (b) are not satisfied. Lastly, the complaint fails to satisfy subsection2(c) because it contains no language suggesting that Ernst & Young provided any expression directly to plaintiffs or any expression reflecting an understanding that plaintiffs intended to rely on the audits. (P. 4)
3. The manifest legislative intent in adopting N.J.S.A. 2A:53A-25 was to limit the impact of the Court's decision in H. Rosenblum v.Adler, which expanded the scope of accountants' liability to all reasonably foreseeable claimants, including stockholders and public investors. As noted in the sponsor statement of the bill, the statute would restore the concept of privity to accountants' liability toward third parties. (Pp. 5-6)
4. Most of the individual owners of plaintiff corporations were members of the "Twin County Cooperative;" however, Twin County was not formally organized as a buying cooperative under New Jersey law. Rather, Twin County was a New Jersey general corporation in which these plaintiffs were shareholders. Thus, there is no special status that plaintiffs achieved by virtue of their announced cooperative purpose that would distinguish them from the individual shareholders of an accountant's corporate client. Plaintiffs were not clients of Ernst & Young within the statutory definition and plaintiffs' reliance on annual audit report alone does not satisfy the "specified transaction" definition in the statute, that is, "a particular transaction between a client and a claimant." (Pp. 6-9)
Judgment of the Appellate Division is AFFIRMED.
CHIEF JUSTICE PORITZ and JUSTICES LONG, VERNIERO, and ZAZZALI and JUDGES SKILLMAN and KESTIN (temporarily assigned) join in JUDGE KING's opinion. JUSTICES LaVECCHIA, ALBIN and WALLACE did not participate.
The opinion of the court was delivered by: Judge King (temporarily assigned)
Argued March 1, 2004
We granted certification in this matter to consider for the first time L. 1995, c. 49, now codified at N.J.S.A. 2A:53A-25, which governs an accountant's liability to third parties for negligence. 178 N.J. 249 (2004). We affirm the decision of the Appellate Division substantially for the reasons stated in Judge Coburn's opinion, E. Dickerson & Son v. Ernst & Young, 361 N.J. Super. 362 (App. Div. 2003).
The procedural history and factual underpinnings of the case are recounted in the opinion of the Appellate Division. See E. Dickerson & Son, 361 N.J. Super. at 364-65. After considering statutory language and legislative history, the panel concluded that the claims by the seventeen corporate plaintiffs arising from allegedly inaccurate annual audits did not satisfy the requirements for accountant third-party liability at N.J.S.A. 2A:53A-25b(2)(a), (b) and (c). The panel affirmed the Law Division's R. 4:6-2(e) dismissal with prejudice.
All parties agree that defendant Ernst & Young's accounting services were rendered to Twin County Grocers, Inc. as the"client," which was driven into bankruptcy and liquidation by the fraudulent conduct of its management. Thus, the plaintiff had to satisfy the conditions of subsections (2)(a),(b) and (c):
b. Notwithstanding the provisions of any other law, no accountant shall be liable for damages for negligence arising out of and in the course of rendering any professional accounting service unless:
(2) The accountant:
(a) knew at the time of the engagement by the client, or agreed with the client after the time of the engagement, that the professional accounting service rendered to the client would be made available to the claimant, who was specifically identified to the accountant in connection with a specified transaction made by the claimant;
(b) knew that the claimant intended to rely upon the professional accounting service in connection with that specified transaction; and
(c) directly expressed to the claimant, by words or conduct, the accountant's understanding of the claimant's intended reliance on the professional accounting service[.]
[N.J.S.A. 2A:53A-25b(2)(a), (b) and (c).]
As Judge Coburn observed, none of those conditions was satisfied by the plaintiff corporations' pleaded claims. 361 N.J. Super. at 368. The Appellate Division precisely and correctly ruled:
The complaint neither alleges expressly, nor implies, satisfaction of any of the elements of this statute. Consider first its description of plaintiffs' transactions giving rise to damages:"individual store operations" and"the nature and extent of their continued participation in the Twin County cooperative." Since the first category does not allege a transaction between the client, Twin County, and the claimant, subsection a(5) is not satisfied. While the second category is suggestive of a transaction between each plaintiff and client, it hardly describes, or suggests, a particular transaction, which is fatal under this section.
Although the complaint alleges defendant's knowledge respecting the private business interests of plaintiffs, it does not allege that plaintiffs were specifically identified as possible claimants. Moreover, the assertion that [plaintiffs] relied on the audit services in connection"with their individual decisions regarding the nature and extent of their continued participation" in Twin [County], quite obviously fails to allege any specific transaction in which plaintiffs were going to engage with the client. Therefore, the complaint fails to satisfy subsection b(2)(a) and (b). Finally the complaint does not contain any language even suggesting that defendant provided any expression directly to plaintiffs, let alone one reflecting an understanding that they intended to rely on the audits. Therefore, subsection b(2)(c) has not been satisfied.
[Id. at 368-69.]
Professor Feinman has recently and comprehensively reviewed the subject of auditor's liability for professional negligence. Jay M. Feinman, Liability of Accountants for Negligent Auditing:
Doctrine, Policy and Ideology, 31 Fla. St. U. L. Rev. 17 (2003).
As to the national picture, he states:
Auditor liability is a particularly interesting doctrinal problem because of the diversity of approaches to liability. A few states still require that a third party be in privity or a similarly close relationship with the auditor to recover. Several others allow any foreseeably injured party to recover. Most states have taken a middle ground by adopting the negligent misrepresentation standard of the Restatement (Second) of Torts, section 552. That standard, however, is notably diffuse, so courts applying it still range from a near privity requirement to a foreseeability test.
[Id. at 20.]
As to New Jersey's approach upon the statute's modification of the common-law forseeability rule previously adopted in our state by H. Rosenblaum, Inc. v. Adler, 93 N.J. 324 (1983),
Professor Feinman states:
Of the jurisdictions that have adopted the requirement that there be a relationship approaching privity, nearly all have done so by using the [test in Credit Alliance Corp. v. Arthur Andersen & Co., 483 N.E.2d 110, 118-19 (N.Y. 1985)] as an appropriate standard.
A few states have adopted the rule of privity or a near substitute by statute. The American Institute of Certified Public Accountants has promoted legislation of this type in a model statute that closely resembles the Credit Alliance test. New Jersey has adopted a modified version of this statute that has some changes in the language and a special exception for bank plaintiffs.
[Jay M. Feinman, Professional Liability to Third Parties, § 8.4.1 at 128 (American Bar Association 2000).]
We find that the manifest legislative intent in adopting N.J.S.A. 2A:53A-25 was to limit the impact of our 1983 Rosenblum decision that greatly expanded the scope of accountants' liability to all reasonably foreseeable claimants, including stockholders and public investors. As the sponsor's statement expressed,"This bill would restore the concept of privity to accountants' liability towards third parties." See E. Dickerson & Son, 361 N.J. Super. at 367 (quoting in full Statement attached to S. 826 (March 10, 1994)); see also Finderne Management Co. v. Barrett, 355 N.J. Super. 197, 205 (App. Div. 2002).
Plaintiff corporations appear to invoke a special status to escape the rigors of the accountants' liability statute. They owned and operated over 100 supermarkets. These corporations were stockholders in Twin County Grocers, Inc., which they describe as"a cooperative organization serving the mutual needs of its supermarket representatives." Most of the individual owners of the plaintiff corporations were also members of the board of directors of the self-styled"Twin County Cooperative." However, Twin County was a regular business corporation and the plaintiff corporations were its individual stockholders. Twin County was not formally organized as a buying cooperative under any New Jersey law, but was a New Jersey general corporation in which these plaintiffs were shareholders.
Specific types of cooperative business enterprises are addressed in our statutes to varying degrees. These include milk producer cooperatives (N.J.S.A. 4:12-1), agricultural cooperatives (N.J.S.A. 4:13-1 to 13-50), library cooperatives (N.J.S.A. 18A:73-35b), cooperatives of veterinarians, doctors, or dentists (N.J.S.A. 45:16-1.1), electricity cooperatives (N.J.S.A. 48:2-13.1), water cooperatives (N.J.S.A. 48:2-13.2), limousine cooperatives (N.J.S.A. 48:16-22.4), fuel cooperatives (N.J.S.A. 52:27F-39), and telecommunications service provider cooperatives (N.J.S.A. 56:8-86). Some of these cooperative statutes are specific on how the cooperative is formed, as with agricultural cooperatives. Other statutes simply allude to"cooperatives" generally.
We perceive no special status which plaintiffs achieved by reason of their announced cooperative purpose that could distinguish them from the individual shareholders of an accountant's corporate client. They are still required to meet the qualifying conditions of N.J.S.A. 2A:53A-25, notwithstanding their collective endeavor to enhance their market position. We conclude that the plaintiff corporations were not the"clients" of defendant Ernst & Young within the statutory definition, i.e."[parties] directly engaging an accountant to perform a professional accounting services." N.J.S.A. 2A:53A-25(a)(1).
Twin County alone was Ernst & Young's client. And, for the reasons Judge Coburn carefully explained, E. Dickerson & Son, 361 N.J. Super. at 368-69, the plaintiffs' reliance on annual audit reports alone cannot satisfy the"specified transaction" definition in the statute, that is,"a particular transaction between a client and a claimant." N.J.S.A. 2A:53A-25(a)(5).
At oral argument, counsel for Ernst & Young explained how conditions for liability to third parties, like the plaintiffs, could have been met in a commercially reasonable manner. Twin County and a potential creditor or investor specifically could have indicated to the accountant reliance on an annual audit for a particular loan or investment transaction and secured an engagement letter or other understanding to that effect. This acknowledgement of third-party reliance would alert the accountant who could then calculate the risk and exposure from the transaction.
General reliance by these individual corporate stockholders of Twin County on annual audits was not sufficient to satisfy the statutory conditions for liability and confer a cause of action for accounting negligence. Nor is this a stockholders' derivative action for the benefit of the accountants'"client," Twin County. See In re PSE&G Shareholder Litigation, 173 N.J.
258 (2002). This is an action for the benefit of the plaintiff corporations and their shareholders. Twin County itself never sued Ernst & Young for damages. Twin County did sue its culpable management, which perpetrated the fraud, in an action, we are told, that was settled and dismissed.
Moreover, the seventeen corporate plaintiffs did not tender any supplementary proffer of facts to the Law Division judge or on appeal which could suggest that their individual claims for consequential negligence damages, generously construed, would fall within the statute's conditions for liability. See Printing Mart v. Sharp Electronics, 116 N.J. 739, 746, 771-72 (1989) (addressing R. 4:6-2(e)).
CHIEF JUSTICE PORITZ and JUSTICES LONG, VERNIERO and ZAZZALI and JUDGES SKILLMAN and KESTIN, temporarily assigned, join in JUDGE KING'S opinion. JUSTICES LaVECCHIA, ALBIN, and WALLACE did not participate.
Chief Justice Poritz PRESIDING
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