© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. Twomey & Jennings BUSINESS LAW Chapter 46 Accountant’s Liability and Malpractice Chapter 46 Accountant’s Liability and Malpractice

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 2 What is Malpractice? When a contract requires a party to perform services, the party must perform with the care exercised by persons performing similar services within the same community. If the party negligently fails to observe those standards, there is both a breach of contract and a tort. When a contract requires a party to perform services, the party must perform with the care exercised by persons performing similar services within the same community. If the party negligently fails to observe those standards, there is both a breach of contract and a tort. Ronson v Talesnick (1999) Was the accountant negligent?

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 3 MalpracticeMalpractice Breach of Contract Accountant (party to contract) fails to fulfill duties. Tort Accountant is negligent or commits fraud. Plaintiff must show that defendant’s breach was negligent or willful. Malpractice Breach of Contract Tort Malpractice consists of both: Plaintiff bringing suit for malpractice may choose which action to pursue:

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 4 DifferencesDifferences Can Be Greater Than Contract Law Damages Runs from Date When Harm Was Discovered Limited by Contract Runs from Date When Contract Was Broken BREACH OF CONTRACT In choosing which action to pursue, a plaintiff may consider: TORT LIABILITY Damages Statue of Limitations

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 5 Liability to Third Parties No privity of contract: third persons may also sue the wrongdoer for malpractice. When the malpractice suit is brought against an accountant for negligence, courts differ as to when a third person may sue and what the plaintiff must show to bring such a suit. No privity of contract: third persons may also sue the wrongdoer for malpractice. When the malpractice suit is brought against an accountant for negligence, courts differ as to when a third person may sue and what the plaintiff must show to bring such a suit. AUSA Life Insurance Co. v Ernst & Young (2000) Is the firm liable when the company goes belly up?

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 6 Liability to Third Parties Liability is evaluated by one of these rules: PrivityContact Known UserForeseeable User Intended UserFlexible Unknown User Liability is evaluated by one of these rules: PrivityContact Known UserForeseeable User Intended UserFlexible Unknown User Williams Controls v Parente, Randolph, Orlando & Assoc. (1999) Is the firm liable to the buyer of the business?

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 7 Theories of Liability Some courts refuse to let the third person sue; these courts require PRIVITY between the parties. In New York, sufficient CONTACT with the third party can make the accountant liable just as if there was privity. In some states, it is sufficient that the third person was a KNOWN USER of the accountant’s information. Some courts refuse to let the third person sue; these courts require PRIVITY between the parties. In New York, sufficient CONTACT with the third party can make the accountant liable just as if there was privity. In some states, it is sufficient that the third person was a KNOWN USER of the accountant’s information.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 8 Theories of Liability (cont’d) Some courts go allow third parties to sue if it was REASONABLE TO FORESEE that the third party use the accountant’s information. Some courts limit suit to those nonprivity plaintiffs who were INTENDED to rely on the accounting work. A few courts use a FLEXIBLE approach, deciding each case as it arises. Finally, an accountant is not liable to a non-privity UNKNOWN party when the accountant has no knowledge of any way the party could be affected. Some courts go allow third parties to sue if it was REASONABLE TO FORESEE that the third party use the accountant’s information. Some courts limit suit to those nonprivity plaintiffs who were INTENDED to rely on the accounting work. A few courts use a FLEXIBLE approach, deciding each case as it arises. Finally, an accountant is not liable to a non-privity UNKNOWN party when the accountant has no knowledge of any way the party could be affected.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 9 LiabilitiesLiabilities Liability for Malpractice (Tort) Statutory Violations Breach of Contract Interloper No liability to Contacts Foreseeable User - Differing Decisions Known-User Beneficiaries of Statutory Protection (Section Act Section 10b-1034 Act) Liability to Anyone in Privity of Contract Client

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 10 Defenses To Liability To a limited degree, an accountant is protected from malpractice liability by: –A clear, conspicuous disclaimer of liability, or –The contributory or comparative negligence of the plaintiff. To a limited degree, an accountant is protected from malpractice liability by: –A clear, conspicuous disclaimer of liability, or –The contributory or comparative negligence of the plaintiff.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 11 FraudFraud When an accountant is guilty of fraud, the intended victim of the fraud may sue the accountant even though privity of contract is lacking.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW Twomey Jennings 1 st Ed. 12 Sarbanes-Oxley Act of 2002 Imposes significant liability on auditing firms for fraud, securities violations and obstruction of justice. Auditor Independence. –Public Company Accounting Oversight Board. –Auditors must remain independent (no conflicts of interest). Imposes significant liability on auditing firms for fraud, securities violations and obstruction of justice. Auditor Independence. –Public Company Accounting Oversight Board. –Auditors must remain independent (no conflicts of interest).