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British high court rules on privity.

In news from overseas, the British House of Lords, in Caparo Industries PLC v. Dickman and Others, limited the right of third parties to sustain a negligence claim against an accounting firm.

Touche Ross audited the financial statements of a publicly held company, Fidelity PLC. The audited statements for the year ended March 31, 1984, revealed Fidelity's actual income for the year fell well below anticipated income. Based on this result, Fidelity's shares fell from 143 pence on March 1, 1984, to 63 pence by the beginning of June 1984.

Sensing an opportunity to take over Fidelity at a bartain price, Caparo Industries PLC began to purchase shares of Fidelity and subsequently acquired 100% of the company.

Caparo alleged at trial that its purchases of Fidelity shares were made in reliance on the audited financial statements that indicated income of 1,300,000 pounds when, in fact, Fidelity had suffered a loss of 400,000 pounds for the year.

The House of Lords stated the following tests apply in determining to whom the accountant owes a duty of care:

1. Is there a sufficient relationship of proximity between the alleged wrongdoer (the accountant) and the person suffering damage such that the wrongdoer reasonably can anticipate that carelessness on his part may be likely to cause harm to the damaged party?

2. If the first test is met, are there any considerations to reduce or limit the scope of duty or the class of persons to whom the duty is owed?

In this case, the court distinguished the situation at hand, in which a financial statement is put into general circulation and relied on by strangers to the auditor, from a situation in which the auditor knew his statement would be communicated to a third party, specifically in connection with a particular transaction. Only in the latter case would the plaintiff's reliance on the statements be sufficient to sustain an action against the auditor. Judgment consequently was made in favor of Touche Ross. (Caparo Industries PLC v. Dickman and Others. See The Times (London), February 12, 1990)
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Author:Baliga, Wayne J.
Publication:Journal of Accountancy
Date:Jul 1, 1990
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