Downriver community federal credit union

The U.S. District Court for the District of Massachusetts ruled that the trustee of a failed bank may bring a direct action against the bank's former auditors.

This case arose from the failure of a bank holding company, the Bank of New England, and several subsidiary banks. On January 6, 1991, the subsidiaries were declared insolvent and the Federal Deposit Insurance Corporation was appointed as receiver. The following day BNEC filed Chapter 7 bankruptcy. The plaintiff, Ben Branch, was appointed bankruptcy trustee.

In 1982 Ernst & Young was hired as auditor of BNEC and the subsidiaries. In September 1989 BNEC raised capital through a $250 million debt offering. Between September and December of that year, BNEC transferred to its subsidiaries $183 million, which had been raised by the debt offering. The plaintiff alleged that BNEC had received nothing in exchange for these transfers. BNEC claimed that the money "was lost at the moment the transfers were made," because the subsidiaries were already insolvent.

BNEC said that it was unaware of its own and the subsidiaries' financial condition because the firm had failed to perform its duties competently. Specifically, BNEC alleged that the firm was negligent in not reporting BNEC's insolvency and that of its subsidiaries.

The firm made a motion to dismiss BNEC's claim, arguing that the shareholder's injury due to the failed banks' deterioration in value did not give rise to a direct claim against the auditor. The trustee-plainfiff responded that the firm's alleged failure to inform BNEC of BNEC's precarious financial condition, as well as that of the subsidiaries, gave rise to a direct claim against the firm. This claim arose from the alleged breach of duty owed directly to Branch, independent of his status as a shareholder, investor or creditor of the corporation. The court agreed and denied the firm's motion to dismiss the claim.

This ruling is important because it allowed the trustee of a failed financial institution to maintain a direct action against an auditor. This is a change from previous cases, such as In re Sunrise Sec. Litig., 916 E2d 874, and Downriver Community Fed. Credit Union v. Penn Square Bank, 879 E 2d 754, which viewed such actions as derivative and dismissed such cases against the accounting firms. (Branch v. Ernst & Young, 93-10024-RGS, December 22, 1995)