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Accountant Cannot be Held Liable to Third Parties Without Specific Knowledge That Third Parties Will
Accountant Cannot be Held Liable to Third Parties Without Specific Knowledge That Third Parties Will
By Thomas Paschos, Esq. of Thomas Paschos & Associates, P.C.
In Cast Art Industries, LLC v. KPMG LLP, --- A.3d ----, 2012 WL 489229 (N.J. February 16, 2012), plaintiff, Cast Art Industries (Cast Art), was a producer and seller of collectible figurines and giftware. Papel Giftware (Papel) was in the same line of business as Cast Art, and in the spring of 2000 Cast Art became interested in acquiring Papel. Eventually, Cast Art decided that a merger, rather than an acquisition, would be the preferable format for such a transaction. Cast Art lacked the financial ability to complete such a transaction on its own. As a result, it negotiated a loan agreement with PNC Bank (PNC) for $22 million to fund the venture. One of PNC's conditions to advancing the $22 million loan, however, was that it receive audited financial statements of Papel.
Defendant KPMG had audited Papel's financial statements since 1997, when Papel's principal had acquired it from a prior owner. KPMG was already in the process of auditing Papel's 1998 and 1999 financial statements when Cast Art and Papel began their merger discussions. Cast Art obtained copies of the completed 1998 and 1999 audits and provided copies to PNC in satisfaction of its obligation under the loan agreement. Three months later, in December 2000, Cast Art and Papel consummated the merger. Shortly after the merger was finalized, Cast Art began to experience difficulty in collecting some of the accounts receivable that it had believed Papel had had outstanding prior to the merger. Cast Art began its own investigation and learned that the 1998 and 1999 financial statements prepared by Papel were inaccurate and that Papel evidently had engaged regularly in the practice of accelerating revenue.
Plaintiffs commenced this litigation seeking damages for the losses they said they incurred following its bankruptcy and subsequent liquidation. Cast Art alleged that KPMG negligently audited Papel because its audit had not revealed Papel's accounting irregularities and sought to recover for the loss of its business. It contended that if KPMG had performed a proper audit, it would have uncovered the fraudulent accounting activity that was taking place at Papel. Cast Art further maintained that it never would have proceeded with the merger if it had been alerted to this fraud. Thus, Cast Art asserted that its losses were caused by KPMG's negligence, and it argued that KPMG should be responsible to make it whole.
KPMG defended this litigation arguing that because Cast Art had not retained it to audit Papel, Cast Art was not its client, and Cast Art's claim was consequently barred by the Accountant Liability Act, N.J.S.A. 2A:53A–25. Prior to trial, KPMG unsuccessfully sought summary judgment on that basis. Cast Art prevailed in the trial court. On appeal, KPMG argued that, among other things, Cast Art's action was precluded by N.J.S.A. 2A:53A–25. The Appellate Division rejected KPMG's statutory argument, as well as the bulk of KPMG's other arguments. It did concur, however, that Cast Art's proofs with respect to its damages were insufficient, and it thus set aside the judgment entered by the trial court and remanded the matter for a new trial on damages only. Defendant petitioned for certification, and plaintiffs submitted a cross-petition, both of which were granted.
KPMG presented a number of arguments in support of its position. It contended that the construction placed on N.J.S.A. 2A:53A–25 by the trial court and the Appellate Division was incorrect and had the effect of reinstating foreseeability as the test to determine the scope of accountant liability to third parties. KPMG asserted that under the proper construction of the Accountant Liability Act, it could not be held liable to Cast Art because KPMG did not know at the time it agreed to perform these audits that Papel and Cast Art were contemplating a merger and that Cast Art would be relying on its auditing work. Cast Art, on the other hand, rejected KPMG's construction of N.J .S.A. 2A:53A–25. It contended that an accountant may be held liable to a third party if the accountant, at any time prior to the completion of its work, knows that its work will be made available to, and will be relied on by, that nonclient third party.
The New Jersey Supreme Court analyzed the statute and the historical development of the manner in which courts have addressed the issue of an auditor's potential liability to nonclient third parties. The court’s conclusion with respect to the proper construction of the Accountant Liability Act was that an auditor's “liability must be defined by the scope of the engagement it entered.” The court provided that an auditor is entitled to know at the outset the scope of the work it is being requested to perform and the concomitant risk it is being asked to assume. The court noted that the pertinent language of KPMG's engagement letter with Papel with respect to the audits was silent as to Cast Art. Thus, at the outset of its engagement with Papel, KPMG was not told that a nonclient would be relying on its work.
Cast Art contended that its cause of action nonetheless fits within that portion of the statute permitting a third party to seek recovery from an accountant if the accountant “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.” N .J.S.A. 2A:53A–25(b)(2)(a). The court did not agree and held that because Cast Art failed to establish that KPMG “knew at the time of the engagement by the client” or thereafter agreed that Cast Art could rely on its work in proceeding with this merger, Cast Art failed to satisfy the requisite elements of N.J.S.A. 2A:53A–25(b)(2), and KPMG was entitled to judgment.
