Ultramares Corporation v Touche 174 N.E. 441 (1932)

Case Summary of Ultramares Corporation v Touche 174 N.E. 441 (1932)

Introduction

The case of Ultramares Corporation v Touche 174 N.E. 441 (1932)was a tort law case in the United States on the question of indeterminate liability and privity. The case involved the reliance of one party (the plaintiff) on the financial statements prepared by another (the defendant) in providing a third party, the defendant’s client, with a loan. Shortly thereafter, the defendant’s client was declared bankrupt and the plaintiff brought a case against the defendant, alleging that the accountants had been negligent in their financial reporting duty and ought therefore to be liable for the loss suffered by the plaintiff. Fraud was also alleged. The case was therefore about the liability of accountants to third parties where an audit is relied upon by the third party.

Issues Raised by the Case:

The pertinent issue raised in this case was whether auditors or a firm of accountants could be held liable for negligence by a third party who on the strength of the audited reports or financial statement makes an investment from which loss is later incurred. Issues which had to be considered by the court included whether a contractual relationship could possibly be inferred between the plaintiff and the defendant. This raised the issue or question of privity and whether there was indeed a relationship so close to privity between Ultramares and Touche as to imply privity(Miller & Jentz, 2012). One of the main questions which the New York Court of Appeals deliberated upon in reaching its decision was in whose primary benefit the statements forming the crux of the negligent claim had been prepared in the first instance. In addition to the negligence claim, Ultramares Corporation had also alleged fraud against the firm of accountants. Ultimately, Ultramares Corporation v Touche raised the issue of potential liability “in an indeterminate amount for an indeterminate time to an indeterminate class” (174 NE 441 (1931) per Cardozo CJ).

Facts of the Case:

Fred Stern & Company had falsified their accounts and was actually insolvent. On application for a loan to the Ultramares, a condition was imposed that Fred Stern would need to provide its audited accounts. While Touche, Niven & Co., the defendants, had no knowledge of who these financial statements would be given to, they were nonetheless aware that a number of creditors were going to be approached by their client. Relying on Touche’s report about the viability of Fred Stern, Ultramares Corporation decided to invest significantly in the company. Shortly thereafter Fred Stern went bankrupt having fabricated their financial statements in the first instance to reflect a false credit of $700,000. Based on the fact that Touche certified Fred Stern’s balance sheet and produced 32 copies for their client to show to suppliers and lenders, of which Ultramares was one, the plaintiff sought to hold Touche liable.

The main contention in the case was the accountants’ disclosure obligations and the nature of the relationship, if any, between both parties to the extent to which such obligation or a duty of care is owed to Ultramares. Given that the loss suffered was purely economic, recognition of such obligation on Touche’s part would have exposed the firm of accountants to a potentially indeterminate liability. It therefore fell on the court to regulate the indeterminacy of Touche’s liability(Cockburn & Wiseman, 1996).

Outcome of the case:

The fraud claim against Touche was dismissed by the court of first instance for the plaintiff’s failure to evidence to the court that it had deliberately been misled by Touche or indeed that the defendant had knowingly covered up the irregularity in Fred Stern’s audited accounts. Although the audit was initially found to have been negligent, the negligence claim was also dismissed when a verdict of $186,000 was returned by the jury. According to the trial judge, the existence of negligence on the accountants’ part notwithstanding, the jury must retain focus of the fact that in order to successfully bring a negligence claim for damages, there must be privity between the parties where the defendant would have owed a duty of care to the plaintiff. On appeal to the appellant division of the New York Supreme Court, there were dissenting views by the judges as to whether Touche owed a duty of care to Ultramares despite what seemed to be the lack of privity in their relationship (Ultramares Corporation v Touche et al., 229 App Div. 581, 243 NYS 179 (1930).

The case proceeded to the New York Court of Appeals (255 N.Y. 170, 174 N.E. 441 (1931). Unlike Glanzer v Sheppard (135 N.E. 275 (N.Y. 1922) in which it was decided that the bond between the defendant and the third party was of such proximity as to be or at least to infer privity, the New York Court of Appeals saw Ultramares as a case involving misrepresentation rather than a service(Feinman, 2007). In the words of Cardozo CJ, the court was expected to assert that “liability attaches to the circulation of a thought or a release of the explosive power resident in words” (at 445). Cardozo queried as follows that even if evidence supported the finding that the audit had been negligently made, the bigger question remained whether such negligence constituted a wrong to the plaintiff. The court found that Touche had not been negligent because of the lack of privity.

The Impact of the Ultramares Rule:

Traditionally, the liability of accountants or auditors was limited to the existence of privity or to those with who they have a proximity of relationship and as such owe a duty of care. (Miller & Jentz, 2012). Cardozo CJ felt that to extend this liability to third parties would open accountants and other professionals to indeterminate liability. The requirement of privity in the Ultramares case meant that such extension may not readily be applied by the court. This rule was rigidly applied in the case of Duro Sportswear v. Cogen (131 N.Y.S.2d 20 (Sup. Ct. 1954). The Ultramares rule has however been heavily criticised for the court’s failure to recognise that the accountants were aware that Fred Stern intended for prospective investors to rely on the accounts and as such liability was owed to the end user of the financial statements(White, 2003). Modifications have thus been applied to create a new requirement of ‘near privity’ in the case of Credit Alliance Corp v Arthur Andersen & Co (65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110 (1985). The court decided in this case that sufficient intimacy with which privity may be equated means that a third party can sue another’s accountants for negligence (at 115).

References:

Cockburn, T. & Wiseman, L., 1996. Disclosure Obligations in Business Relationships. Annandale: The Federation Press.

Feinman, J. M., 2007. Professional Liability to Third Parties. 2nd ed. Chicago: ABA.

Miller, R. L. & Jentz, G. A., 2012. Business Law Today. 9th ed. Mason: Cengage Learning.

White, G. E., 2003. Tort Law in America: An Intellectual History. Oxford: Oxford University Press.

Case Law:

Credit Alliance Corp v Arthur Andersen & Co (65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110 (1985)

Duro Sportswear v. Cogen (131 N.Y.S.2d 20 (Sup. Ct. 1954)

Glanzer v Sheppard (135 N.E. 275 (N.Y. 1922)

Ultramares Corporation v. Touche 174 N.E. 441 (1932)