The New Jersey Supreme Court in a recent decision in E. Dickerson & Son, Inc. v. Ernst & Young, LLP, 179NJ500 (2004), dealt a significant blow to third parties seeking damages from accounting firms for negligence. Dickerson provided the New Jersey Supreme Court with its first opportunity to interpret New Jersey’s accountants liability statute, N.J.S.A. 2A:53A-25, which was enacted for the purpose of overruling the New Jersey Supreme Court decision in H. Rosenblum, Inc. v. Adler, 93 NJ 324 (1983). The Rosenblum decision greatly expanded the scope of accountant liability by adopting a “foreseeability” standard for cases involving accountant negligence. Rosenblum placed New Jersey law in direct conflict with the position taken by the New York Court of Appeals in the seminal case of Ultramares Corp. v. Touche Niven & Co. 255N.Y.170 (1931), which position was followed by the vast majority of other jurisdictions. The Uitramares decision rejected negligence claims brought by third parties due to the lack of privity of contract between the plaintiff and the accountants. The New York Rule has long stood for the proposition that a plaintiff’s failure to allege privity or in the alternative a nexus between it and the accountant was fatal to any negligence claim against the accountant.

The New Jersey Supreme Court in Rosenblum rejected the New York Rule and allowed a recovery without a lack of privity, by finding that an independent auditor owes a duty to all parties who the auditor could reasonably foresee would be recipients of and rely upon from the financial statements prepared.

The Rosenblum decision has generally not been followed by other jurisdictions. Many of these jurisdictions have adopted a middle ground which is embodied in the Restatement (Second) of Torts 552, which limits accountant’s liability for negligence for losses to (a) the person or one of a limited group of persons, for whose benefit and guidance the accountant intends to supply the information or knows that the client intends to supply it, and (b) through reliance on it in a transaction that the accountant intends the information to influence or knows the recipient so intends or in a substantially similar transaction.

In 1994 The New Jersey Legislature passed the accountants liability statute (N.J.S.A. 2A:53A-25 which limits accountants liability for negligence, and effectively overruled Rosenblum. The statute adopted the New York Rule and was for the most part based upon a model statute promoted by the American Institute of Certified Public Accountants.

The Dickerson case represented the New Jersey Supreme Court’s first opportunity to interpret the New Jersey Accountants Liability Statute. The facts in Dickerson were that the plaintiffs were corporations who were owned and operated supermarkets that were members and shareholders of Twin County Grocers, Inc., a corporation functioning as a cooperative of supermarkets for marketing and purchasing purposes. Twin County filed a bankruptcy petition after it was discovered that its upper management had engaged in an ongoing scheme to misappropriate funds and defraud the Twin County members. The plaintiffs’ claimed that Ernst and Young negligently performed several annual audits at Twin County, by failing to discover the ongoing fraud. The plaintiffs first sued Ernst and Young for negligence and other related claims. These claims were dismissed by the Trial Court and the Appellate Division affirmed that decision. Undaunted the plaintiffs applied for Certification to the New Jersey Supreme Court. Before the Supreme Court, the plaintiffs argued that the Court should construe the statute broadly so as to deem Twin County Grocers Ernst and Young’s “clients.”

This argument would have given the Court an opportunity to minimize the Statute’s effect. However, the Court declined the invitation. The Court held that Twin County’s cooperative purpose leant it no special status and consequently the plaintiffs were indistinguishable from any other shareholder of an accountant’s corporate client. As such, they were required to satisfy requirements for third parties to bring a negligence claim, which the court held they did not do.

In denying the plaintiff’s negligence claims, the Court did shed light on how a potential plaintiff might satisfy the statute’s requirement. This may prove indispensable to potential claimants seeking to protect themselves from potential losses attributable to accountant negligence. The guidelines set forth in the Dickerson decision were as follows. First a non party to the contract must demonstrate that the auditor knew at the time of the engagement (1) that its report would be given to the claimant in connection with a specified transaction, and (2) that the claimant intended to rely upon the report. This follows the New York Rule and the New York Rule line of cases. The plaintiff must demonstrate that the accountant knew from the inception of the transaction that his or her services were rendered either wholly or in part for the benefit of another. In order to satisfy the second requirement it must be shown some “linkage” between the accountant and the third party claimant. The linkage requirement could be satisfied if the plaintiff secures an engagement letter or another understanding to that effect. This may create an obstacle to any such suit being brought as it is highly unlikely that an engagement letter would be provided to a third party. The only way to satisfy these requirements would be for the plaintiff to show that (1) the accountant knew that the results of the audit would be transmitted to the plaintiffs for use in a specific transaction and with that purpose known to it (2) the auditor conducted the audit.

An interesting question was raised whether or not shareholders of a corporation , who is the client, might recover by way of a derivative action brought on behalf of the client corporation. In the Dickerson case this was not available to the plaintiffs due to the fact that the bankruptcy proceeding had already occurred. However, it does appear that if shareholders of the corporate client were to bring such a derivative claim on behalf of a client that they would be able to bring such an action.

In closing, while the New Jersey Supreme Court in Dickerson has left the door open to some third party plaintiffs, it has closed the door to many other potential clients. As a result, going forward third party lawsuits against accountants for negligence may constitute the exception rather than the rule.