Bily v. Arthur Young & Co., Supreme Court of California
3 Cal. 4th 370; 834 P.2d 745; 11 Cal. Rptr. 2d 51; 1992 Cal. LEXIS 3971; 48 A.L.R.5th 835

Key Facts
Plaintiffs, an individual investor, a corporate investor, and associated individuals, invested in a computer company that went bankrupt. Plaintiffs brought an action against defendant accounting firm, Arthur Young, alleging intentional fraud and negligent misrepresentation. Plaintiffs contended that their investments were made in reliance on defendant's unqualified audit opinion on the company's financial statements.
Issue
Whether and to what extent an accountant's duty of care in the preparation of an independent audit of a client's financial statements extends to persons other than the client.
Rule
An auditor could be held liable for negligent misrepresentations in an audit report to those people who acted in reliance upon those misrepresentations in a transaction that the auditor intended to influence, in accordance with the rule of Restatement Second of Torts section 552.
Analysis
An auditor's liability for general negligence in the conduct of an audit of its client financial statements was confined to the client. Other people could not recover on a pure negligence theory.
Although intended beneficiaries of an audit report could recover on a theory of negligent misrepresentation, they could not recover on a general negligence theory.
One who made a fraudulent misrepresentation was subject to liability to the people or class of people whom one intended or had reason to expect to act or to refrain from action in reliance upon the misrepresentation.
Non-clients of the auditor were connected with the audit only through receipt of and express reliance on the audit report. Without such reliance, there was no recovery regardless of the manner in which the audit itself was conducted.
Conclusion
The court reversed and remanded the judgment in favor of plaintiffs, an individual investor, a corporate investor, and associated individuals. Because plaintiffs were not defendant accounting firm's clients, they were not entitled to recover on a general negligence theory. The appellate court was instructed to enter judgment in favor of defendant against plaintiff individual investor, and to decide plaintiff corporate investor's cross-appeal.