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NCP Litigation Trust v. KPMG LLP

187 N.J. 353, 901 A.2d 871 (2006)

ACCOUNTANTS; IMPUTATION DOCTRINE—The imputation doctrine does not bar corporate shareholders, through a litigation trust, from recovering from the corporation’s auditor if the auditor can be shown to have negligently failed to uncover or report fraud by the corporation’s officers or directors.

Two officers of a corporation intentionally misrepresented to an independent auditing firm details concerning the corporation’s financial status. That firm, in turn, failed to detect those misrepresentations for several years. After subsequent audits revealed the officers’ fraud, the corporation was forced to acknowledge previously unreported losses of tens of millions of dollars and to declare bankruptcy. A litigation trust, acting as the corporation’s successor-in-interest and representing the corporation’s shareholders, filed suit against the auditor for negligently conducting the audit. The lower court granted the auditor’s motion to dismiss the action based on the imputation doctrine, which holds that knowledge of an agent generally is attributed to its principal. It concluded that the fraud was imputable to the litigation trust, as the corporation’s successor. Therefore, the litigation trust could not sue the auditor unless the auditor intentionally and materially participated in the fraud. On appeal, the Appellate Division reversed, concluding that the trust’s complaint alleged sufficient facts to support an equitable fraud claim against the auditor.

On further appeal, the New Jersey Supreme Court explained that the imputation doctrine is a rule that a principal is deemed to know facts that are known to its agent. Under the doctrine, a third party may invoke imputation as a defense against a principal seeking to enforce an agreement when the principal’s agent fraudulently induced the third party to enter into that agreement. To the Supreme Court, the issue presented by these facts was whether the imputation doctrine barred the litigation trust from bringing suit against the corporation’s auditor for its alleged negligence in failing to detect the fraud of the corporations directors and officers. To answer that question, the Supreme Court needed to determine whether New Jersey’s jurisprudence permitted the litigation trust to maintain an action for negligence. It held that the litigation trust’s suit was not barred because one who contributes to the misconduct cannot invoke imputation. Therefore, the Court concluded that a claim for negligence could be brought on behalf of a corporation against the corporation’s allegedly negligent third-party auditors for damages proximately caused by that negligence. The Court addressed whether the imputation doctrine barred a suit on behalf of shareholders. It held that, in this case, the litigation trust, as the representative of the corporation’s shareholders, could bring this action.

Accordingly, the Court held that the imputation doctrine did not bar the corporate shareholders from recovering through their litigation trust against the auditor, if the auditor were shown to be negligent within the scope of its engagement by failing to uncover or report the fraud of the corporate officers and directors.


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