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Cast Art Industries, LLC v. KPMG LLP

416 N.J. Super. 76, 3 A.3d 562 (App. Div. 2010)

ACCOUNTANT LIABILITY ACT — When an accounting firm knows that its audit work will be made available to an acquiring company for a merger transaction, and the work will be relied upon by the acquirer, and would be a precondition to the proposed merger, the accounting firm may be liable to the acquiring party under New Jersey’s Accountant Liability Act.

A giftware manufacturer discussed a merger with a rival distributor. A year later, these discussions resulted in a merger. To be able to enter into the transaction, the manufacturer had to borrow $22 million to refinance the rival’s debt. Within a year of the merger, the manufacturer learned that the rival had significantly misrepresented its accounts receivable in the years before the merger. The merged company experienced substantial financial losses, and three years later went out of business and liquidated its assets.

At the time of the merger, and for a number of years before then, an accounting firm had been the rival’s auditor. It had prepared audited financial statements for the rival, specifically the one for the fiscal year while the merger was being negotiated. After the merged company’s demise, the manufacturer and its principals filed an accounting malpractice action against the accounting firm under the New Jersey Accountant Liability Act. A jury awarded $30 million plus prejudgment interest. The accounting firm appealed, raising issues regarding interpretation of the Act as applied to an accountant’s liability for accounting malpractice to a party other than the accountant’s client.

In the appeal, the Appellate Division held that the evidence presented by the manufacturer was sufficient to impose a duty of care upon the accounting firm. The record contained substantial evidence that the accounting firm knew the most recent audited financial statement would be made available to the manufacturer during merger negotiations, would be relied upon by the manufacturer, and was a precondition of the proposed merger going forward. The record also indicated that the accounting firm breached its duty of care to faithfully audit the rival’s financial records and this breach was a substantial factor in causing the failure of the merged company. Former employees of the rival company testified their company had engaged in a pervasive scheme of premature reporting of revenue and this had continued right up until it entered into the merger agreement. Testimony indicated the merger would not have taken place if this fact had been discovered in a properly conducted audit. The Court rejected the accounting firm’s argument that expert testimony was required to make these statements. It held that the manufacturer’s principals were extremely knowledgeable about the business’s operations.

Nonetheless, the Court reversed and remanded as to the amount of the jury award, finding that the manufacturer had failed to present sufficient competent evidence of the company’s value as of the date of the merger so as to support the jury’s damages award. It held the value of the manufacturer on the date of the merger was an appropriate measure of damages because the harm suffered as a result of the accounting firm’s malpractice was the financial failure and subsequent loss of all value of the company after the failure. The manufacturer did not present testimony, at trial, from a business valuation expert it had retained; rather it submitted the testimony of its president and an investment banking consultant, and presented a valuation report prepared by the accounting firm. The Court said that even if the valuation report was credible, its valuation of the manufacturer’s worth at merger was $9 million less than the jury verdict. It concluded the evidence did not establish a sufficient foundation for the jury’s damages award and remanded for a new trial on damages.

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