Becker, Inc., purchased the assets of Bell Corporation. A condition of the purchase agreement was that Bell retain a CPA to audit its financial statements. The purpose of the audit was to determine whether the unaudited financial statements furnished to Becker fairly presented Bell’s financial position. Bell retained Salam & Company, CPAs, to perform the audit.
While performing the audit, Salam discovered that Bell’s bookkeeper had embezzled $ 500. Salam had some evidence of other embezzlements by the bookkeeper. However, Salam decided that the $ 500 was immaterial and that the other suspected embezzlements did not require further investigation. Salam did not discuss the matter with Bell’s management. Unknown to Salam, the bookkeeper had, in fact, embezzled large sums of cash from Bell. In addition, the accounts receivable were significantly overstated. Salam did not detect the overstatement because of Salam’s failure to follow its audit program.
Despite the foregoing, Salam issued an unqualified opinion on Bell’s financial statements and furnished a copy of the audited financial statements to Becker. Unknown to Salam, Becker required financing to purchase Bell’s assets and furnished a copy of Bell’s audited financial statements to City Bank to obtain approval of the loan. Based on Bell’s audited financial statements, City loaned
Becker $ 600,000. Becker paid Bell $ 750,000 to purchase Bell’s assets. Within six months, Becker began experiencing financial difficulties resulting from the undiscovered embezzlements and overstated accounts receivable. Becker later defaulted on the City loan.
City has commenced a lawsuit against Salam based on the following causes of action:
• Ordinary negligence.
• Constructive fraud (gross negligence).
In separate paragraphs, discuss whether City is likely to prevail on the causes of action it has raised. Set forth reasons for each conclusion.