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Marcus Brothers Textiles, Inc. v. Price Waterhouse

April 07, 1998


Appeal by plaintiff from order dated 6 December 1996 and filed 9 December 1996 by Judge William H. Freeman in Forsyth County Superior Court. Heard in the Court of Appeals 27 January 1998. The plaintiff, Marcus Brothers Textiles, Inc. ("Marcus Brothers"), is a converter in the business of supplying fabric to retail vendors. The defendant, Price Waterhouse, LLP ("Price Waterhouse") is an independent certified public accounting firm. On 11 August 1995 Marcus Brothers filed a complaint against Price Waterhouse alleging negligent misrepresentation and gross negligence. Plaintiff seeks damages from Price Waterhouse and individual certified public accountants with Price Waterhouse resulting from plaintiff's claimed reliance on financial statements Price Waterhouse audited for its client, Piece Goods Shops Company, L.P. ("Piece Goods"). Plaintiff claims that "1992 audited financial statements materially misrepresented Piece Goods' financial condition and that Price [Waterhouse] knew that Piece Goods intended that [plaintiff] would rely on them in making its decision whether to extend credit to Piece Goods and in what amount." Plaintiff states that the audited financial statements "included [Price Waterhouse's] unqualified opinion that the financial statements `fairly' and `in all material respects' accurately presented Piece Goods' financial position, the results of its operations, and its cash flows for the relevant years." Plaintiff claims that it made several extensions of credit to Piece Goods between 30 December 1992 and 5 April 1993 based on those audited financial statements. On 19 April 1993, with a $288,440.63 debt owed to plaintiff, Piece Goods filed for bankruptcy. Plaintiff alleges that the 1992 financial statements audited by Price Waterhouse contained several material misrepresentations and reflected numerous departures from Generally Accepted Accounting Principles ("GAAP"), and that Price Waterhouse's failure to alert readers of the financial statements to those departures violated Generally Accepted Auditing Standards ("GAAS"). First, plaintiff claims that the 1992 financial statements indicated a "Receivable from General Partner" in the amount of $30,332,000.00 but that the receivable was worthless because the General Partner did not have the ability to pay the amount due. Piece Goods did not write off this receivable and Price Waterhouse took no exception to this departure from GAAP, an omission which plaintiff claims violated GAAS. Second, Piece Goods also erroneously increased the reported value of this receivable by recording accrued interest on the balance sheets, although Piece Goods knew it was not collectible. Piece Goods reported the uncollectible interest as income and offset it against actual interest expense paid in cash. Price Waterhouse was aware but took no exception to this departure from GAAP in its audit report, another omission which plaintiff claims violated GAAS. Finally, the financial statements reflected nearly all payables for certain pattern inventories as non-current, long term liabilities, but reflected the inventories for those pattern inventories as current assets. Plaintiff claims the result was to overstate Piece Goods' working capital and distort Piece Goods' current working capital ratio. Defendant moved for summary judgment on 5 June 1995. Following a hearing on 14 October 1996, the trial court allowed summary judgment for defendant on 9 December 1996. Plaintiff appeals.

The opinion of the court was delivered by: Eagles, Judge.


We first consider whether the trial court erred in granting defendant's motion for summary judgment on the claim of negligent misrepresentation because plaintiff's evidence was sufficiently "substantial" to entitle plaintiff to have a jury consider the question of defendant's knowledge that Piece Goods intended that plaintiff would rely on the financial statements in plaintiff's decision to extend credit.

Plaintiff argues that genuine issues of material fact remain regarding the requisite knowledge element and that summary judgment should be reversed. Plaintiff contends that their evidence, and the reasonable inferences to which it gives rise, show that plaintiff was a member of "a limited group of persons" whom defendant knew, at the time Price Waterhouse audited Piece Goods' 1992 financial statements, that Piece Goods intended to provide copies of those statements for the purpose of "influenc[ing]" plaintiff in its decision to extend credit. Restatement (Second) of Torts § 552 at 2(a). Plaintiff argues that the actual identity of plaintiff need not have been known by defendant when the defendant prepared the information. It is sufficient that the "maker supplies the information for repetition to a certain group or class of persons and that the plaintiff proves to be one of them, even though the maker never had heard of him by name when the information was given." Restatement (Second) of Torts § 552 cmt. h (1977).

Plaintiff first cites as evidence an internal memorandum of defendant dated 25 September 1989 and initialed by Robert A. Smith, a partner at Price Waterhouse who worked on the 1992 audit. The memorandum states: "[Price Waterhouse] has historically reported on the financial statements of [Piece Goods] and . . . vendors and factors are accustomed to receiving [Piece Goods] financial statements . . . ." Plaintiff contends that this memorandum shows that defendant knew that Piece Goods regularly furnished its vendors and creditors with financial statements. Accordingly, plaintiff contends that since Piece Goods was in a business where acquiring inventory on credit is standard operating procedure, and since by 1992 defendant had been Piece Goods' accountant and financial adviser for six years, a factfinder could logically conclude that defendant knew why Piece Goods regularly gave creditors its financial statements, namely, to influence their decisions to extend credit.

Plaintiff next cites deposition testimony from Karen Frazier, the Price Waterhouse employee who was manager of the 1992 audit. Frazier testified that audited financial statements are "to be used by the management of the company and possibly outsiders," that trade creditors like plaintiff "could" be included among the "outsiders," and that in Piece Goods' situation, the outsiders "could" include "suppliers of material and inventory patterns."

Plaintiff next cites Piece Goods' 1993 bankruptcy filing which indicated that 43 trade creditors received copies of audited financial reports within the two years immediately preceding the bankruptcy filing. Plaintiff contends that this supports "the common sense inference that as Piece Goods' accountant since 1986, Price [Waterhouse] could not have been unaware" that Piece Goods furnished its audited financial statements to creditors in the regular course of its business.

Finally, plaintiff cites evidence that the sixth largest check on a list of 50 "held checks" in the 1992 Piece Goods' audit file was a check on Piece Goods' account payable to plaintiff in the amount of $291,337.78. Plaintiff contends that this evidence supports the inference that defendant knew that plaintiff was a member of the group identifiable as Piece Goods' major creditors.

Plaintiff argues that the evidence, when viewed in the light most favorable to plaintiff, creates a genuine issue of fact regarding the requisite element of knowledge as required by the Restatement and Raritan River Steel Co. v. Cherry, Bekaert & Holland, 322 N.C. 200, 367 S.E.2d 609 (1988), appeal after remand, 101 N.C. App. 1, 398 S.E.2d 889 (1990), rev'd on other grounds, 329 N.C. 646, 407 S.E.2d 178 (1991). Accordingly, plaintiff argues that the summary judgment order should be reversed.

Defendant first argues that North Carolina law limits an accountant's liability for negligent misrepresentation to those persons the accountant intends to be able to rely on the information, or those persons the accountant knows his client intends to be able to rely on the information. Defendant maintains that our Supreme Court has specifically rejected the "reasonably foreseeable" test in Raritan. Accordingly, defendant argues that it is not enough for plaintiff to show that defendant "should have known" that Piece Goods "might" provide the financial statements to trade creditors like plaintiff. Instead, defendant contends that plaintiff must show that defendant "knew" that Piece Goods intended for trade creditors to rely on the 1992 financial statements in extending credit.

Defendant maintains that plaintiff has not forecast sufficient evidence to show that defendant had the requisite knowledge at the time of the audit. Defendant argues that the memorandum cited by plaintiff "establishes, at most, that Price Waterhouse knew that Piece Goods' audited financial statements were customarily used in a variety of financial transactions by the company and that the financial statements may have been relied upon by lenders, creditors and others in a variety of transactions." Defendant maintains that this evidence is not sufficient to satisfy the requisite element of knowledge and to extend liability for negligent misrepresentation to defendant. See Raritan, 322 N.C. at 215 n.2 (citing Restatement (Second) of Torts § 552 cmt. h Example 10).

We hold that there is a genuine issue of material fact concerning whether Price Waterhouse knew that Piece Goods supplied the audited financial statements to its creditors in order to buy on credit, and whether Price Waterhouse knew that plaintiff would be included in a limited group to whom the audited financial statement would be supplied. In Raritan, our Supreme Court adopted the standard set forth in the Restatement (Second) of Torts § 552 (1977) for determining the scope of accountant's liability to persons other than the client for whom an audit was prepared. Our Supreme Court recognized "that liability should extend not only to those with whom the accountant is in privity or near privity, but also to those persons, or classes of persons, whom he knows and intends will rely on his opinion, or whom he knows his client intends will so rely." Raritan, 322 N.C. at 214, 367 S.E.2d at 617. The Court further determined that:

[t]he Restatement's text does not demand that the accountant be informed by the client himself of the audit report's intended use. The text requires only that the auditor know that his client intends to supply information to another person or limited group of persons. Whether the auditor acquires this knowledge from his client or elsewhere should make no difference. If he knows at the time he prepares his report that specific persons, or a limited group of persons, will rely on his work, and intends or knows that his client intends such reliance, his duty of care should extend to them.

Id. at 215, 367 S.E.2d at 618 (emphasis added).

Plaintiff's evidence creates a genuine issue of material fact regarding Price Waterhouse's knowledge. First, the 25 September 1989 internal memorandum cited by plaintiff creates a genuine issue of material fact concerning Price Waterhouse's knowledge of the intended use of the audited financial statements and whether they were given to creditors to influence decisions on whether to extend credit. Second, plaintiff's inclusion on a list of 50 "held checks" contributes at least to a reasonable inference that Price Waterhouse knew plaintiff was a member of a group identifiable as Piece Goods' major creditors. Third, Price Waterhouse had been retained as Piece Good's accountant and financial adviser for the preceding six years. Accordingly, there is a genuine issue of material fact concerning whether Price Waterhouse knew that Piece Goods supplied the ...

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