## Facts

- A corporate borrower (Smith) sought financing from Credit Alliance and related entities, which required audited financial statements as a condition of lending.
- Smith provided audited consolidated financial statements for 1976–77 and later for 1978, each accompanied by audit reports issued by Arthur Andersen & Co.
- The audit reports stated the audits were performed under professional standards and that the statements fairly presented Smith’s financial position under generally accepted accounting principles.
- Credit Alliance extended substantial financing in reliance on the audited statements.
- Smith later collapsed financially, and Credit Alliance alleged the audits materially misstated Smith’s financial condition due to negligent audit work.
- Credit Alliance sued Andersen for negligence and fraud, alleging Andersen knew or should have known the audit reports would be used to obtain lender financing.
- In a companion appeal (European American Bank & Trust Co. v. Strauhs & Kaye), a bank alleged it relied on an auditor’s work where the auditor allegedly knew the audit’s primary purpose was to support the bank’s lending and had direct communications with the bank.

## Issues

1. Under what conditions, absent contractual privity, may an accountant be liable in negligence to a third party who relied on a negligently prepared audit report?
2. Whether Credit Alliance adequately alleged a relationship with Andersen “sufficiently approaching privity” to support a negligence claim.
3. Whether the bank in the companion case adequately alleged such a near-privity relationship based on the auditor’s knowledge and linking conduct.

## Decision

- The court reaffirmed that accountant negligence liability to nonclients is limited to situations involving a relationship “sufficiently approaching privity.”
- The court adopted a three-part test requiring allegations that:
  - the accountant knew the report would be used for a particular purpose;
  - a known party (or parties) was intended to rely; and
  - the accountant engaged in conduct linking it to that known party, showing the accountant’s understanding of reliance.
- Credit Alliance: the order denying dismissal was reversed; the negligence claim was dismissed for failure to plead the required near-privity relationship.
- Companion case: the order reinstating the bank’s complaint was affirmed because the allegations of specific knowledge, identified reliance, and direct communications were sufficient at the pleading stage.

## Legal Principles

- General foreseeability that lenders or investors may rely on an audit is insufficient to create a duty of care to nonclients.
- A nonclient negligence claim against an accountant requires a relationship “sufficiently approaching privity,” shown by the accountant’s awareness of a particular purpose, reliance by a known party, and linking conduct evidencing understanding of that reliance.
- The rule reflects a policy choice to prevent indeterminate liability while allowing recovery where the accountant’s work is directed to an identified third party in a defined transaction.

## Conclusion

The court held that accountants generally owe no negligence duty to third parties who merely foreseeably rely on audit reports; liability arises only where the plaintiff pleads a near-privity relationship defined by specific intended reliance and linking conduct, a standard Credit Alliance failed to meet but the bank in the companion case plausibly alleged.


Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536 (N.Y. 1985)