Read Case 40.3, Johnson Bank v. George Korbakes Company, LLP. 472F.3d 439. Web 2006 U.S. App.Lexis 31058 (2006) United States Court of Appeals for the Seventh Circuit. Using the IRAC Method of briefing cases found below, and prepare a document that outlines the legal aspects of this case.
Case 40. 3 Accountants’ Liability to a Third Party
Johnson Bank v. George Korbakes & Company, LLP.
472 F.3d 439, Web 2006 U.S. App. Lexis 31058 (2006)
United States Court of Appeals for the Seventh Circuit
“The audit report might flunk Accounting 101, but if the report didn’t mislead anyone toward whom the auditor had a duty of care, the auditor would not have committed a tort.” – Judge Posner
Facts: Brandon Apparel Group, Inc. (Brandon), made and sold clothing and licensed the making and selling of clothing in exchange for a percentage of the licensees’ sales revenues. Brandon began borrowing money from Johnson Bank and in 2 years owed the bank $10 million. George Korbakes & Company, LLP (GKCO), was the auditor of Brandon during the period at issue in the case. When Brandon was seeking an additional loan from the bank, Brandon instructed GKCO to give the bank the audit report that GKCO had just competed, which GKCO gave to Johnson Bank.
The audit report summarized Brandon’s financial results for the year and revealed that Brandon had serious problems. But the audit report contained several errors. First, the audit report classified a $1 million lawsuit Brandon had brought against a third party as an asset, but it was in fact only a contingency that should not have been listed as an asset. Second, Brandon’s sales were inflated by 50 percent because sales of a licensee were inflated by 50 percent because sales of a licensee were treated as if they were Brandon’s sales. However, footnotes in the audit report indicated that Brandon might not prevail in the lawsuit and that Brandon’s sales included those of a licensee.
After receiving the audit report, Johnson Bank made further loans to Brandon. Brandon did not repay Johnson Bank the new money it borrowed. Johnson Bank sued GKCO, alleging that GKCO committed the tort of negligent misrepresentation and was therefore liable for the money lost by the bank as a result of the errors in the audit report prepared by GKCO. The U.S. District Court entered judgment in GKCO’s favor. Johnson Bank appealed.
Issue: Is GKCO, the auditor of Brandon, liable to Johnson Bank for negligent misrepresentation?
Language of the Court: Under Illinois law an auditor is liable to a third party, that is, to someone different from the firm that hired it to audit its books, only if the auditor knew that the firm wanted to use the audit report to influence a third party. The audit report might flunk Accounting 101, but if the report didn’t mislead anyone toward whom the auditor had a duty of care, the auditor would not have committed a tort.
At root the bank’s argument for liability is that it was entitled to look no farther than the bottom-line numbers in the audit report. That is incorrect; it had no right to ignore the footnotes in the report, which together with the numbers in it gave the reader an accurate picture of Brandon’s financial situation. The bank cannot base a claim for damages on a refusal to read. The audit report even says that “the notes on the accompanying pages are an integral part of these financial statements.”
The losses the bank incurred as a result of the additional loans that it made could not be recovered as damages even if GKCO had been guilty of negligent misrepresentation. GKCO could not have predicted how much money the bank would lend to Brandon in reliance on the audit and with what consequences. Damages so speculative are not recoverable in a lawsuit.
Decision: The U.S. Court of Appeals held that GKCO, the auditor of Brandon, was not liable to Johnson Bank for negligent misrepresentation. The Court of Appeals upheld the District Court’s judgement in favor of GKCO.
Case Questions: Critical Legal Thinking – Which of the following three legal theories did the Court apply in making its decision in this case?
Section 552 of the Restatement (Second) of Tort
Ethics: Should GKCO have listed the lawsuit as a contingency rather than an asset? Was the footnote sufficient disclosure of this information? Should GKCO have included the licensees’ sales in Brandon’s sales? Was the footnote sufficient disclosure of this information?
Contemporary Business: How could Johnson Bank have better protected itself rather than rely on the audited reports of Brandon Apparel that were prepared by GKCO?
Many lawsuits against accountants involve liability of accountants to Third Parties. The plaintiffs are Third Parties (e.g., shareholders, bondholders, trade creditors, and banks) who relied on information supplied by the auditor. There are three (3) major rules of liability that a state can adopt in determining whether an accountant is liable in negligence to third parties.
1. The Ultramares doctrine.
2. Section 552 of The Restatement (Second) of Torts.
3. The foreseeability standard.
Write an eight to twelve (10-12) page paper in which you:
1. Summarize the facts associated with Johnson Bank v. George Korbaken Company.
2. Identity the primary and secondary legal question(s) that are under consideration.
3. Prioritize the rules of law that the court will consider in this case.
4. Compile the court’s decision and opinions on the case.
5. Prepare a conclusion for the outcome of the case.
6. Determine how this case may have been treated differently if it had been decided in 2012 instead of 2006.
Your assignment must follow these formatting requirements:
- Be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides; citations and references must follow APA or school-specific format. Check with your professor for any additional instructions.
- Include a cover page containing the title of the assignment, the student’s name, the professor’s name, the course title, and the date. The cover page and the reference page are not included in the required assignment page length.
The specific course learning outcomes associated with this assignment are:
Given a business situation, evaluate the various options for resolving a business dispute from a legal perspective and develop an optimal course of action to resolve the dispute.
Analyze company policies to ensure compliance with key provisions of the major federal laws related to investor protection, equal employment opportunity, consumer protection, and environmental protection.
Use technology and information resources to research issues in commercial law.
Write clearly and concisely about commercial law using proper writing mechanics.