Accountant's Duty of Care Towards Third Parties in California
In Bily v. Arthur Young & Co. (1992) 3 Cal.4th 370, the Supreme Court considered whether an accounting professional's duty of care in preparing an independent audit of a client's financial statements extended to persons other than the client, in the context of the client's public stock offering.
A jury returned a verdict in favor of the investor plaintiffs on a claim of professional negligence. The jury was instructed that " 'an accountant owes a further duty of care to those third parties who reasonably and foreseeably rely on an audited financial tatement prepared by the accountant. A failure to fulfill any such duty is negligence.' " (Bily, at p. 379.)
The court reversed the judgment, employing the "checklist of factors" articulated in Biakanja to "assess legal duty in the absence of privity of contract between a plaintiff and a defendant." (Bily, at p. 397; see id. at pp. 407, 416.)
The Bily court again emphasized the important role of policy factors in determining negligence, observing that "mere presence of a foreseeable risk of injury to third persons is not sufficient, standing alone, to impose liability for negligent conduct" and that " 'policy considerations may dictate a cause of action should not be sanctioned no matter how foreseeable the risk ... for the sound reason that the consequences of a negligent act must be limited in order to avoid an intolerable burden on society.' " (Id. at p. 399.)
Additional considerations the court found pertinent in limiting the auditor's liability in Bily were (1) potential imposition of liability out of proportion to fault, "raising the spectre of vast numbers of suits and limitless financial exposure" (id. at p. 400); (2) the ability of third parties in an audit negligence case to " 'privately order' " the risk of inaccurate financial reporting through alternative contractual arrangements (id. at p. 403); and (3) the effect on auditors of third party liability, in light of the relative sophistication of third parties who lend and invest based on audit reports--i.e., "whether auditors are the most efficient absorbers of the losses from inaccuracies in financial information" (id. at p. 405).
In limiting general negligence liability to the direct clients of the auditor, the Supreme Court observed that "judicial endorsement of third party negligence suits against auditors limited only by the concept of forseeability raises the spectre of multibillion-dollar professional liability that is distinctly out of proportion to: (1) the fault of the auditor (which is necessarily secondary and may be based on complex differences of professional opinion); and (2) the connection between the auditor's conduct and the third party's injury (which will often be attenuated by unrelated business factors that underlie investment and credit decisions). As other courts and commentators have noted, such disproportionate liability cannot fairly be justified on moral, ethical, or economic grounds. ." (Id. at pp. 401-402.)
In Bily, the court distinguished the class of third party investors, creditors, and others who read and rely on audit reports and financial statements from ordinary consumers. (Bily, supra, 3 Cal.4th at p. 403.)
The court noted that, unlike the " 'presumptively powerless consumer' " in product liability cases, generally more sophisticated investor/creditor plaintiffs have the ability to " 'privately order' the risk of inaccurate financial reporting," either through their own investigation or audit, or by contractual arrangements with the client. (Ibid.)
"As a matter of economic and social policy, third parties should be encouraged to rely on their own prudence, diligence, and contracting power, as well as other informational tools. This kind of self-reliance promotes sound investment and credit practices and discourages the careless use of monetary resources. If, instead, third parties are simply permitted to recover from the auditor for mistakes in the client's financial statements, the auditor becomes, in effect, an insurer of not only the financial statements, but of bad loans and investments in general." (Ibid.)