## Facts

- Osborne Computer Corporation retained Arthur Young & Company to perform independent audits of its fiscal-year 1981 and 1982 financial statements.
- Arthur Young issued unqualified audit opinions that allegedly overstated Osborne’s financial condition and understated liabilities and losses.
- Robert R. Bily (an investor) and J.F. Shea Co., Inc., et al. (lenders and trade creditors) alleged they relied on Arthur Young’s audit reports when making investment and credit decisions.
- After Osborne’s financial problems became known and the company failed, the plaintiffs claimed substantial economic losses.
- The plaintiffs sued Arthur Young asserting, among other theories, negligence and negligent misrepresentation based on the audit reports.
- The case was tried to a jury under general negligence instructions imposing a broad duty to nonclient third parties; the jury found Arthur Young liable.
- The Court of Appeal affirmed in part under an expansive view of duty to foreseeable third parties.
- The California Supreme Court granted review to determine whether, and to what extent, an auditor’s duty of care extends beyond the client.

## Issues

1. Whether an independent auditor owes nonclient third parties a general negligence duty of ordinary care for purely economic losses based on foreseeable reliance on an audit report.
2. Whether, and under what limits, nonclient third parties may recover from an auditor for negligent misrepresentation based on reliance on audit reports.

## Decision

- The California Supreme Court reversed the judgment to the extent it imposed broad negligence liability to nonclients based on general negligence instructions.
- The Court held an auditor owes no general duty of care in negligence to persons other than the client regarding the conduct of an audit.
- The Court recognized a narrower cause of action for negligent misrepresentation to a limited class of third parties, consistent with Restatement (Second) of Torts § 552.
- Because the case was tried under an overly broad negligence theory rather than the restricted negligent-misrepresentation standard, the Court remanded for further proceedings consistent with its limits on third-party liability.

## Legal Principles

- Foreseeability of third-party reliance, standing alone, is insufficient to impose a negligence duty on an auditor to nonclient users of an audit report seeking purely economic damages.
- An auditor’s negligence liability to nonclients is limited by policy concerns about indeterminate and potentially disproportionate exposure relative to the auditor’s fault.
- For negligent misrepresentation, an auditor may be liable only to a limited group of persons for whose benefit and guidance the auditor intends to supply the information, or knows the recipient intends to supply it, and who justifiably rely in a transaction the auditor intends to influence or knows will be influenced.
- Broad tort recovery for economic loss is generally disfavored where contract and related risk-allocation mechanisms are better positioned to define scope, price, and responsibility for audit-related risk.

## Conclusion

The court rejected general negligence liability by auditors to all foreseeable nonclient users of audit reports for economic loss, but allowed a restricted negligent-misrepresentation claim limited to intended or known third-party recipients and intended or known transaction types under a § 552 framework.


Bily v. Arthur Young & Co., 3 Cal. 4th 370 (Cal. 1992)