Third-party reliance on audit curtailed.

The U.S. District Court for the eastern district of North Carolina granted summary judgment in favor of Deloitte Haskins & Sells on claims brought by venture capitalists who allegedly relied on Deloitte's audit work in making investments.

During the years 1981 to 1988, the venture capitalists invested in a company called Learning Resources, Inc. (LRI), which prepared and marketed educational audiovisual tapes. LRI needed several supplemental cash infusions from the investors during this period in addition to initial capital investments. The venture capitalists refused to invest further in 1988 and LRI's assets were sold. The investors then brought action against Deloitte for their lost funds.

The investors alleged LRI's financial statements for the years 1982 to 1986 contained material misrepresentations. They specifically alleged Deloitte allowed LRI to accelerate income recognition on contingent contracts and failed to obtain management representation letters for the audit years 1985 and 1986. Deloitte moved for summary judgment.

The court noted the investors were never designated as thirdparty beneficiaries of the contracts between LRI and Deloitte. Moreover, the investors never received any annual audit reports directly from Deloitte and, with the exception of the 1982 audit, there was no evidence Deloitte knew the financial statements would be distributed to or used by investors.

Consequently, the court ruled the investors were not intended beneficiaries of the audit engagements and could not maintain an action against Deloitte. (Venturtech H v. Deloitte Haskins & Sells, 790 F.Supp. 576)

Editor's note: Thanks to John D. Hughes of the Hutchins & Wheeler law firm for providing the Security Pacific and Venturtech cases.