Opinion
Civil Action No. 3:01-CV-2028-N
September 5, 2003
MEMORANDUM OPINION AND ORDER
Before the Court is Defendants King Griffin Adamson P.C. and Laurence D. King's (collectively, "KGA") motion for summary judgment. The Court holds that under Texas law, section 552 of the Restatement (Second) of Torts imposes liability for negligent misrepresentation only if the defendant actually knew a party would rely on the statement in question in an identified transaction. Because KGA here had no such knowledge, the Court grants KGA's motion for summary judgment.
I. BACKGROUND
This lawsuit arises out of KGA's audits of the December 31, 1998 and 1999 financial statements of Webb Cooley Company ("Webb Cooley"). KGA is a public accounting firm. Because KGA's audits were performed after the calendar year in question, KGA performed its audit of the 1998 financial statement in 1999 and performed its audit of the 1999 financial statement in 2000. Thus, KGA issued its report on the 1998 financial statement in May 1999; KGA issued its report on the 1999 financial statement in April 2000.
Plaintiff Compass Bank ("Compass") was Webb Cooley's lender. In April 1999, before KGA completed the 1998 audit, Compass loaned Webb Cooley $1.5 million pursuant to a term loan and extended Webb Cooley an additional $3.5 million revolving credit line. Compass increased Webb Cooley's credit line by $1 million in March 2000 and an additional $500,000 in May 2000. What KGA knew about Compass and when is a matter the Court will discuss at greater length below.
Shortly after the May 2000 credit line increase, Webb Cooley defaulted on its loans, and it eventually filed for bankruptcy. Compass then filed this action against KGA, claiming that KGA negligently misrepresented Webb Cooley's finances in the 1998 and 1999 audits, causing Compass to extend additional credit to Webb Cooley.
II. SECTION 552 OF THE RESTATEMENT OF TORTS
The central issue in KGA's motion for summary judgment is how section 552 of the Restatement (Second) of Torts is applied to accountants under Texas law. That section provides, in pertinent part:
Sitting in diversity, the Court applies Texas substantive law. Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938). The Court also applies the customary summary judgment standard. See, e.g., Chiu v. Piano Indep. Sch. Dist., 339 F.3d 273 (5th Cir. 2003).
§ 552. Information Negligently Supplied for the Guidance of Others
(1) One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.
(2) Except as stated in Subsection (3), the liability stated in Subsection (1) is limited to loss suffered
(a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and
(b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.
RESTATEMENT (SECOND) OF TORTS § 552(1), (2) (1977).
The historical context of the Restatement is an expansion of liability for providers of information. See generally First Nat. Bank of Commerce v. Monco Agency, Inc., 911 F.2d 1053, 1057-60 (5th Cir. 1990). Courts initially restricted liability to parties in privity of contract with the information provider. Over time, different courts broadened the scope of liability from "near-privity" all the way to any person whose use of the information was foreseeable. "The Restatement represents the moderate view, allowing only a restricted group of third parties to recover for pecuniary losses attributable to inaccurate financial statements. Significantly, the accountants retain control over their liability exposure." Id. at 1059.
III. MCCAMISH AND BLUE BELL
The crucial question the Court must answer is whether the application of section 552 in Blue Bell, Inc. v. Peat, Marwick, Mitchell Co., 7 15 S.W.2d 408 (Tex.App.-Dallas 1986, writ ref'd n.r.e.), survives the Texas Supreme Court's decision in McCamish, Martin, Brown Loeffler v. F.E. Appling Interests, 991 S.W.2d 787 (Tex. 1999). In Blue Bell, the Dallas Court of Appeals considered whether to apply section 552 to accountants and extend the accountant's legal duty beyond those in strict privity. The court first noted that section 552 had been applied to accountants already in Shatterproof Glass Corp. v. James, 466 S.W.2d 873 (Tex.Civ.App.-Fort Worth 1971, writ ref d n.r.e.). Blue Bell, 715 S.W.2d at 411. Presaging its own analysis, the Dallas court commented: "Initially, we note that, although the court in Shatterproof Glass relied upon adoption of the quoted section of the Restatement, it also quoted extensively from one commentator who advocates even broader liability than that set forth in Section 552." Id. The Dallas court then cited a lengthy list of authority advocating a foreseeability standard, and, while noting that reasoning was persuasive, determined it need not decide whether to adopt a foreseeability standing in that case. Id. at 411-12. The Dallas court then held:
Instead, we look to section 552 of the Restatement (Second) and decide that, as we construe this section, a fact issue exists as to whether Blue Bell falls within the "limited class" as used in that section. Although we need not go so far today as to adopt the broad standard of foreseeability advocated by some of the commentators, we conclude that the apparent attempt in comment h. under this section to limit the class of third parties who may recover to those actually and specifically known by the defendant is too artificial a distinction. Consequently, we adopt a less restrictive interpretation of section 552 than would be indicated by the comments thereunder, particularly Comment h., illustration 10. To allow liability to turn on the fortuitous occurrence that the accountant's client specifically mentioned a person or class of persons who are to receive the reports, when the accountant may have that same knowledge as a matter of business practice, is too tenuous a distinction for us to adopt it as a rule of law. Instead, we hold that if, under current business practices and the circumstances of that case, an accountant preparing audited financial statements knows or should know that such statements will be relied on by a limited class of persons, the accountant may be liable for injuries to members of that class relying on his certification of the audited reports.Id. at 412 (citations omitted, emphasis in original).
This analysis is a remarkable bit of doublespeak. First, the court declines to adopt the broad standard of foreseeability, but then the court extends an accountant's liability to those the accountant should know would rely upon his or her statements. Other than a difference in verbiage, this Court has difficulty ascertaining much difference between the "foreseeability" and "should have known" standards. Second, the court purports to apply section 552 to accountants, but it makes just one teensy change from comment h in how the court construes section 552. But perhaps the central point of section 552 is how it defines the universe of parties to whom a speaker owes a legal duty. The drafters of section 552 considered the various policy arguments and extended a legal duty only to those parties the speaker actually knows may rely upon his or her statements, expressly rejecting a foreseeability approach. See, e.g., RESTATEMENT (SECOND) OF TORTS § 552 cmt. a. By expanding the scope of the duty to "should know," the Blue Bell court in truth rejected section 552.
SeeNycal Corp. v. KPMG Peat Marwick, LLP, 688 N.E.2d 1368, 1373 n. 5 (Mass. 1998) (discussing Blue Bell and another case applying a foreseeability standard purportedly pursuant to section 552: "These cases apply such an expansive interpretation to § 552 that they effectively eliminate all of the restrictions that the Restatement sought to impose.")
The Texas Supreme Court in McCamish, in contrast, followed section 552 in word and deed. The McCamish court was addressing "one precise question: Whether the absence of an attorney-client relationship precludes a third party from suing an attorney for negligent misrepresentation under the RESTATEMENT (SECOND) OF TORTS § 552." McCamish, 991 S.W.2d at 791. The court first noted that it had applied section 552 to define the scope of a lender's duty to prospective borrowers in Federal Land Bank Ass'n of Tyler v. Sloane, 825 S.W.2d 439, 442 (Tex. 1991). McCamish, 991 S.W.2d at 791. The court then cited various courts applying Texas law that applied section 552 to other professionals. Id. In that string cite, the court cited Blue Bell as applying section 552 to accountants. The court then stated: "We perceive no reason why section 552 should not apply to attorneys. First, nothing in the language of section 552 or in the reasoning of Sloane warrants such an exception." Id. Thus, a central part of the reasoning in McCamish was that section 552 should be applied uniformly across professional lines.
This citation of Blue Bell thus is not an endorsement by the Texas Supreme Court of how Blue Bell applied section 552 to accountants, but only of the proposition that section 552 should apply to accountants.
Blue Bell also recognized this idea. See Blue Bell, 715 S.W.2d at 412 n. 3 ("we doubt the wisdom of distinguishing among various professionals in determining their scope of liability for negligent misrepresentation"); id. at 413 ("We doubt the wisdom of continuing to apply different standards for determining the liability of different professionals to third parties, but conclude that we need not eliminate these distinctions in this case.").
The McCamish court then discussed various other policy implications of permitting nonclients to sue lawyers. In that context, the court noted:
Nor does section 552 threaten lawyers with "almost unlimited liability." In fact, section 552 adequately addresses this threat by narrowing the class of potential claimants and requiring that any claimant justifiably rely on the alleged negligent misrepresentation. Under section 552(2), liability is limited to loss suffered:
(a) by the person or one of a limited group of persons for whose benefit and guidance [one] intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that [one] intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.
This formulation limits liability to situations in which the attorney who provides the information is aware of the nonclient and intends that the nonclient rely on the information. In other words, a section 552 cause of action is available only when information is transferred by an attorney to a known party and for a known purpose. A lawyer may also avoid or minimize the risk of liability to a nonclient by setting forth (1) limitations as to whom the representation is directed and who should rely on it, or (2) disclaimers as to the scope and accuracy of the factual investigation or assumptions forming the basis of the representation or the representation itself.Id. at 794. The Texas Supreme Court in McCamish thus walked the walk of section 552, and did not just talk the talk, as in Blue Bell.
The Court must next decide whether Blue Bell' revisionist application of section 552 to accountants survives McCamish. The Court concludes it does not. A central aspect of the Texas Supreme Court's analysis in McCamish was the view that section 552 should apply uniformly across professional lines. Although much of the discussion in McCamish dealt specifically with attorneys, that was in the context of discussing whether there was anything special about attorneys that would justify excluding them from the scope of section 552; the Texas Supreme Court determined section 552 should apply to attorneys as it did to other professions. Nothing in the Texas Supreme Court's application of section 552 quoted above indicates it is a construction of section 552 applicable only to attorneys. Thus, if section 552 is to be applied uniformly across professional boundaries, the McCamish construction of section 552 also applies to accountants.
A view shared by the Dallas Court of Appeals in Blue Bell, 715 S.W.2d at 412 n. 3, 413.
Moreover, while Blue Bell purported to apply section 552 to accountants, it in fact rejected the heart of section 552. McCamish, with its view that section 552 should apply across professional boundaries, inherently stands for the proposition that section 552, as written, should apply to accountants. To the extent Blue Bell rejected application of section 552, as written, to accountants, it is inconsistent with McCamish. Accordingly, the Court holds that the Texas Supreme Court in McCamish overruled by implication the portion of the Blue Bell opinion extending accountant liability to those parties the accountants should know would rely on their opinions.
The Court notes it is not making an Erie guess about whether the Texas Supreme Court would change Texas law if it were faced with this question. In view of McCamish there is no need to guess; Texas law has already changed since Blue Bell. The Court likewise notes it is not making a policy decision about whether society would be better served by imposing accountant liability broadly, as in Blue Bell, or more narrowly, as in section 552. The Court, rather, is following Texas law as articulated by the Texas Supreme Court in McCamish. The Court's view of Blue Bell after McCamish is not altered by Averitt v. PriceWaterhouseCoopers L.L.P., 89 S.W.3d 330 (Tex.App. — Fort Worth 2002, no pet. h.). That opinion cites Blue Bell for how to apply section 552 to accountants. Id. at 335. First, the citation to Blue Bell is dicta, as the issue before the court was "whether an accounting firm can use a declaratory judgment action to obtain a declaration of nonliability for an alleged breach of an oral contract for accounting services pertaining to the formation of a trust." Id. at 331. (The court held it could not.) Second, the opinion does consider any impact McCamish might have on Blue Bell. Third, sitting in diversity this Court must follow the Texas Supreme Court, rather than an intermediate Texas court of appeals.
IV. KGA Is NOT LIABLE TO COMPASS FOR NEGLIGENT MISREPRESENTATIONS FROM THE 1998 AND 1999 AUDITS
Compass primarily opposes summary judgment with its legal argument relying on Blue Bell. Alternatively, it argues fact issues preclude summary judgment, even under the standards of section 552. Having resolved the legal question in favor of section 552, the Court now turns to the question whether on this record Compass can raise a fact issue regarding whether KGA knew Compass would receive either of its audits and would rely on either to extend additional credit to Webb Cooley. Recapping some of the chronology:• April 1999 — Compass extends $5 million credit to Webb Cooley
• May 1999 — KGA issues 1998 audit
• March 2000 — Compass increases Webb Cooley credit line by $1 million
• April 2000 — KGA issues 1999 audit
• May 2000 — Compass increases Webb Cooley credit line by additional $500,000
The issues around the 1998 audit are simpler. The summary judgment evidence establishes that Webb Cooley never told KGA that its 1998 audit would be provided to Compass, or that almost a year later Compass would rely on the 1998 audit to increase Webb Cooley's credit line by $1 million. Compass argues that KGA marketed its services to clients on the basis that KGA's services would give its clients greater credibility with their lenders; thus, Compass argues, KGA should have known Webb Cooley would use the 1998 audit to obtain credit. But "should have known" is not the standard under section 552, and further, there is no evidence that KGA actually marketed its services to Webb Cooley on the basis that KGA would enhance Webb Cooley's credibility with Compass. Compass also argues that KGA knew about Compass because when KGA partner King learned there was a potential problem with the 1999 audit in June 2000, he told Compass not to rely on the 1999 audit. This argument suffers from a timing problem; KGA's awareness in June 2000 that Compass would rely on the 1999 audit does not show that KGA knew in the spring of 1999 that Compass would rely on the 1998 audit. Accordingly, KGA is entitled to summary judgment on Compass' claims arising out of the 1998 audit.
To the extent Compass argues that KGA could be liable for the $1 million credit line increase under the 1998 audit because that increase was substantially similar to prior extensions of credit, pursuant to section 552(2)(b), the analysis of that position is identical to the following discussion of the 1999 audit.
The issues around the 1999 audit are somewhat more complicated, because by that time KGA was aware of Webb Cooley's relationship with Compass and was aware of the original $5 million credit facility and of the $1 million credit line increase in March 2000, both of which occurred before the 1999 audit was issued in April 2000. The question is whether that knowledge precludes summary judgment in connection with the $500,000 credit line increase in May 2000, following the issuance of the 1999 audit. The summary judgment record shows that during the course of the 1999 audit, KGA did not know about the possibility of the $500,000 increase in Webb Cooley's credit line in May 2000, and indeed, that Webb Cooley did not approach Compass about that increase until after the 1999 audit was issued. KGA knew that Webb Cooley had drawn down all available credit, including the March 2000 $1 million increase, and was negotiating with Compass to make that increase permanent. The question before the Court is whether knowledge of those other transactions makes the May 2000 $500,000 increase actionable under section 552.
Section 552 does not require knowledge of the actual transaction in order to impose liability, but it does require knowledge of "a substantially similar transaction." RESTATEMENT (SECOND) OF TORTS § 552(2)(b). The comments addressing that point follow:
j. Transactions for guidance in which the information is supplied. The rule stated in Clause (2)(b) is somewhat more narrowly restricted than in the case of the liability of the maker of a fraudulent representation stated in § 531, Clause (b). The liability of the maker of the fraudulent representation extends to all transactions of the type or kind that the maker intends or has reason to expect. Under this Section, the liability of the maker of a negligent misrepresentation is limited to the transaction that he intends, or knows that the recipient intends, to influence, or to a substantially similar transaction.
Thus independent public accountants who negligently make an audit of books of a corporation, which they are told is to be used only for the purpose of obtaining a particular line of banking credit, are not subject to liability to a wholesale merchant whom the corporation induces to supply it with goods on credit by showing him the financial statements and the accountant's opinion. On the other hand, it is not necessary that the transaction in which the opinion is relied on shall be identical in all of its minute details with the one intended. It is enough that it is substantially the same transaction or one substantially similar. Thus, in the situation above stated, if the corporation, finding that at the moment it does not need the credit to obtain which the audit was procured, uses it a month later to obtain the same credit from the same bank, the accountants will remain subject to liability to the bank for the loss resulting from its extension of credit, unless the financial condition of the corporation has materially changed in the interim or so much time has elapsed that the bank cannot justifiably rely upon the audit.
There may be many minor differences that do not affect the essential character of the transaction. The question may be one of the extent of the departure that the maker of the representation understands is to be expected. If he is told that the information that he supplies is to be used in applying to a particular bank for a loan of $10,000, the fact that the loan is made by that bank for $15,000 will not necessarily mean that the transaction is a different one. But if the loan is for $500,000, the very difference in amount would lead the ordinary borrower or lender to regard it as a different kind of transaction. The ordinary practices and attitudes of the business world are to be taken into account, and the question becomes one of whether the departure from the contemplated transaction is so major and so significant that it cannot be regarded as essentially the same transaction. It is also possible, of course, that more than one kind of transaction may be understood as intended.
Illustrations:
13. A negligently furnishes to a title insurance company a letter praising its facilities and operation, for the purpose of aiding it in selling title insurance. The company exhibits the letter to B, who relies on it in taking out title insurance with the company, and is also induced by the letter to purchase stock in the company. The company proves to be insolvent and B suffers pecuniary loss. A is subject to liability to B for his loss on the title insurance but not for his loss on the purchase of the stock.
14. A, an independent public accountant, negligently conducts an audit for B Corporation, and issues an unqualified favorable opinion on its financial statements, although it is in fact insolvent. A knows that B Corporation intends to exhibit the balance sheet to C Corporation, as a basis for applying for credit for the purchase of goods. In reliance upon the balance sheet, C Corporation buys the controlling interest in the stock of B Corporation and as a result suffers pecuniary loss. A is not liable to C Corporation.
15. The same facts as in Illustration 14, except that A is informed that C Corporation will be asked to extend credit for the purchase of washing machines, and credit is extended instead for the purchase of electric refrigerators. A is subject to liability to C Corporation.Id. cmt. j.
Few cases address substantially similar transactions. The First Circuit recently considered substantially similar transactions in North American Specialty Ins. Co. v. LaPalme, 258 F.3d 35 (1st Cir. 2001). After considering the comment to the Restatement quoted above, the court concluded:
Quite plainly, this definition is fact-sensitive and requires case-by-case development. We think that, under it, an accountant's liability for substantially similar transactions must be determined in two steps. First, the rule implicitly recognizes that the risk perceived by the accountant at the time of the engagement cabins the extent of the duty that he owes to known third parties. Thus, an inquiring court initially must consider, from the preparer's standpoint, what risks he reasonably perceived he was undertaking when he delivered the challenged report or financial statement.
Second, the court must undertake an objective comparison between the transaction of which the accountant had actual knowledge and the transaction that in fact occurred. This comparison cannot be hypertechnical, but, rather, must be conducted in light of "[t]he ordinary practices and attitudes of the business world." Restatement (Second) of Torts § 552 cmt. j. The goal of this inquiry is to determine whether the two transactions share essentially the same character. If so, the actual transaction is substantially similar to the contemplated transaction (and, therefore, liability-inducing). Elsewise, the third party has no recourse against the accountant for negligent misrepresentation.Id. at 41 (citations omitted).
The court then applied its definition of "substantially similar" to the facts before it. CRS was in the business of installation and repair of roofs. D L provided accounting services to CRS. CRS worked on public projects in Massachusetts, and was therefore required to be bonded. NASI provided bonding to CRS and required audited financial statements. CRS changed ownership. Shortly thereafter, D L generated financial statements which were provided to NASI and omitted information about the change of ownership. CRS then obtained new contracts for public buildings, which NASI bonded, relying on D L's financial statements. CRS failed under its new owners, causing NASI to pay nearly $2,000,000 on its bonds. NASI sued D L for negligent misrepresentation. Id. at 36-37.
NASI argued that the new projects were part of an ongoing bonding program and thus D L knew that new projects were possible. The court held that an objectively reasonable accountant would not have thought he was assuming a year's worth of open-ended bonding risk on all possible new projects. Id. at 43. The court then considered NASI's claim that the new bonds were substantially similar to existing bonds. After considering various hypothetical transactions of differing degrees of similarity, the court held:
There is an obvious difference between these examples and the case at hand. The examples presume that the accountants knew the general nature of the risk they were taking and the approximate dollar amount of their potential liability. In this case, however, D L accepted potential liability only for the ongoing work — known projects in various stages of completion — but NASI seeks to hold the firm liable for unknown future projects not yet begun (or even bid) when the financial statement was delivered. The increased degree of risk is patent. By like token, D L accepted potential liability only for bonds previously issued — bonds with fixed, easily ascertainable dollar limits — but NASI seeks to hold D L liable for bonds which, at the relevant time, were not yet issued(and which, therefore, had no monetary limit). Those bonds would be written for whatever sums the contract documents might require. Once again, the increased degree of risk is patent. Consequently, the liability that NASI wishes us to impose on the defendants is well beyond the outermost frontier of Massachusetts law. It is not liability for transactions substantially similar to the ones which D L knowingly undertook to influence, but for new transactions that differ in their essential character and entail a new, unanticipated level of risk.
That ends this aspect of the matter. Without some evidence that the defendants knew that they were undertaking additional, open-ended liability with respect to future bonds by releasing the financial statement, NASI's second argument founders. Simply because transactions are of the same general nature (e.g., "bonds") is not enough to render them substantially similar for purposes of the Restatement rule. Any other conclusion would make a mockery of a basic premise that underbraces the Restatement rule: that an acquiescent accountant is only deemed to accept the risks of specific transactions that were made known to him in advance (or substantially similar ones).Id. at 44. It is worth noting that the First Circuit made its determination of lack of substantial similarity in the context of affirming a district court grant of summary judgment in favor of the accountants.
The Court has quoted extensively from the North American Specialty Ins. Co., opinion in part because it is factually substantially similar to this case. The salient point is that in the context of section 552(2)(b), the issue is not whether a new, undisclosed transaction is substantially similar to transactions the accountant's client had previously consummated; rather the issue is whether a new undisclosed transaction is substantially similar to a contemplated, disclosed transaction that it replaced. Otherwise, the accountant would be subjected to risks he or she could not have assessed or taken into account in the course of the engagement.
Of course, the analysis might be different if the possibility of future transactions was expressly disclosed to the accountant with the understanding that the financial statements would influence those transactions. That is not this case, however.
In this case, at the time of the 1999 audit, KG A was aware of the risk of the original $5 million credit facility and the first $1 million extension. It was not aware of any possibility of an additional $500,000 extension. There was no proposed $490,000 extension, for example, to which the actual $500,000 could be substantially similar. The mere fact that Webb Cooley had undertaken similar lending transactions with Compass in the past does not make an undisclosed future $500,000 increase substantially similar to the past transactions within the meaning of section 552(2)(b). Accordingly, KGA is not subject to liability based on the 1999 audit in connection with Compass' $500,000 credit line extension in May 2000.
CONCLUSION
In summary, the Court holds that in McCamish Texas adopted section 552 of the Restatement, as drafted, and thereby overruled by implication the modifications to section 552 invented by Blue Bell. Accordingly, because KGA had no notice of proposed future transactions between Webb Cooley and Compass, it did not undertake the risk associated with those undisclosed transactions. Regardless whether subsequent undisclosed credit line increases were similar to prior credit dealings between Webb Cooley and Compass, those subsequent undisclosed transactions were not "substantially similar" to disclosed risks that KGA knowingly undertook to influence with its audits. Therefore, KGA's motion for summary judgment is GRANTED.
Accordingly, all other pending motions in this action are denied as moot.