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Lender suit against accountants barred.

A California appellate court ruled that in a case alleging both breach of contract and negligence, the negligence action predominates for determining the statute of limitations.

This case involved the Spitzer family, which controlled various partnerships and "alternative lender" companies that made loans to parties that might not qualify for bank loans. The companies allegedly made unconectible loans and loans unjustified by appropriate lending criteria, and generally engaged in unsound lending practices.

Arthur Andersen & Co. audited the financial statements of the partnerships and companies from 1981 to 1988, allegedly failed to disclose these practices in its audit reports and concluded the "loan portfolio was adequately collateralized." On March 28, 1989, the city of Los Angeles and others sued various defendants, including the Spitzer companies, to redress their practice of maintaining and operating slum buildings through a complex set of financial transactions.

Following the filing of this lawsuit, banks refused to extend any further credit to the Spitzer partnerships and companies. On November 24, 1989, the companies and partnerships filed for protection under Chapter 1 1 of the U.S. Bankruptcy Code. On October 15, 1993, investors in the Spitzer companies and partnerships filed an action for professional negligence and breach of contract against the firm. On May 24, 1994, the trial court dismissed the investors' complaint, stating that the two-year statute of limitations for negligence claims governed the entire complaint. The plaintiffs then appealed.

In upholding the trial court's dismissal, the appellate court noted that in a malpractice action against an accountant, the statute of limitations does not run until the negligent act is discovered or, with reasonable diligence, could have been discovered. The appellate court quoted the California Supreme Court on an auditor's responsibility: An auditor is a watchdog, not a bloodhound. As a matter of commercial reality, audits are performed in a client-controlled environment.

The client typically prepares its own financial statements; it has direct control over and assumes primary responsibility for their contents."

In this case, the city's 134-page lawsuit described in detail the poor condition of the slum properties. This 1989 description would have alerted any reasonable person, and certainly a professional lender, to the properties' worthlessness. The appellate court noted that the plaintiffs-appellants who had made the unsecured, uncollectible and inflated loans already knew what they claimed the accounting firm should have discovered. (Danning v. Arthur Andersen & Co., 95 Daily journal D.A.R. 9488, july 17, 1995.
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Article Details
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Title Annotation:California; Danning v. Arthur Andersen & Co.
Author:Baliga, Wayne
Publication:Journal of Accountancy
Article Type:Brief Article
Date:Oct 1, 1995
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