No one questions a client’s right to sue his or her accountant if the accountant erred in providing professional services to the client. If a mistake was made or something was overlooked and the client was harmed, then the client has the right to sue the accountant. However, depending to some extent on where you practice, the potential list of plaintiffs that might be able to sue for negligence could include people and companies that are not clients, such as third parties that are in some fashion related to the client or the services provided. Knowing the law in the jurisdictions where you practice and understanding how third parties might gain the right to sue you can provide valuable insight into practices that could help avoid potential liability to non-clients.
At one time, the law of most jurisdictions limited the right to sue an accountant to the accountant’s clients.
A legal concept known as “privity of contract” was used to justify this limitation, which some courts reasoned was necessary to help ensure that claims against accountants remained predictable, thereby avoiding an avalanche of unforeseeable claims. There are a few states that still follow this strict privity approach, allowing only clients to sue accountants for negligence. However, many states, either through statute or case law, have arrived at less-stringent standards, resulting in claims against accountants being permitted by people and companies that are not clients.
An approach adopted by many states is the “near privity” standard, which was first articulated by the courts in New York in European American Bank and Trust Company v. Strauhs & Kaye et al., 65 N.Y.2d 536, 546 (1985). Under Strauhs, a non-client can sue an accountant in a “near privity” jurisdiction if the following elements can be established: “the accountants must have been aware that the financial reports [or other written communication prepared by the accountants] were to be used (1) for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants’ understanding of that party or parties’ reliance.”
Accordingly, the non-client must have been known to the accountant (at least as a class if not individually), the accountant must have been aware the non-client was going to use the accountant’s work for a particular purpose (such as a particular transaction), and there must be some objective conduct by the accountant linking the accountant to the non-party in such a way that it demonstrates the accountant’s understanding that the non-client was going to rely on the accountant’s work.
The “linking conduct” element of the near privity standard is probably the most important for the practitioner to keep in mind. While you should always pay attention to any indication that a client is going to share your work product with a third party as part of a transaction or business relationship, it is even more important in a near privity jurisdiction to carefully limit your contact with any such third party. No contact is best since even limited contact may raise a question as to whether there is sufficient linking conduct. Moreover, many lenders are well aware of the near privity limitation and may ask that you send copies of your work product directly to them or provide some type of representation concerning the information they received from your client. These requests are traps for the unwary accountant. A better practice is to insist that the client provide all information to the lender and carefully limit responses to requests for “comfort letters” with the assistance of an attorney or risk management professional.
Other states are said to be “Restatement jurisdictions,” referring to their adherence to the approach spelled out in section 552 of the Restatement (Second) of Torts. Under this approach, liability extends beyond clients, but only to the limited group of entities that will receive the information directly from the accountant or that the accountant knows will receive it from the client, and who justifiably rely on the information. In Restatement jurisdictions, it is important to avoid providing reports, tax returns and other information to anyone other than the client, and to the greatest extent possible limit the client’s ability to pass such information along to third parties. While you cannot entirely control who a client may share its information with, you can incorporate provisions into your engagement letters stating that you are not aware of any other recipients and that your client must obtain your consent prior to sharing your work product with any third party.
Additionally, if you provide paper copies of your work product to the client, you should only provide as many copies as the client reasonably needs for its own purposes, thereby avoiding the appearance that you knew the client would be sharing the information because you provided extra copies.
Still other jurisdictions adhere to the “foreseeability” approach, which extends liability to anyone who might foreseeably rely on the accountant’s work product. This approach essentially abandons the concept of privity and opens the accountant up to claims by just about anyone. Defending a claim based on the absence of a relationship with the plaintiffs is very difficult and there are no meaningful risk management steps that can be taken to limit liability to third parties.
Finally, some jurisdictions have adopted statutes and regulations that specifically address when non-clients can sue an accountant. In New Jersey, for example, if the non-client third party is a bank, the bank, in addition to meeting the elements applicable to all other non-client third parties, also must obtain a letter from the accountant in which the accountant acknowledges the bank’s intended reliance. This is an important protection for accountants in New Jersey since banks pursuing claims against their defaulting borrowers’ accountants is one of the most commonly encountered third-party claims against accountants.
What is a prudent accountant to do?
- First, know your state’s rules regarding who can sue accountants for negligence. Make sure your partners and staff are aware of these rules and act accordingly.
- Second, to the greatest extent possible limit communications and distributions of reports or tax returns to the client.
- Third, avoid oral communications that could give any credibility whatsoever to any claim of reliance by the non-client. If compelled to discuss a client with the client’s lenders, creditors or investors, be sure to document what was said to confirm that there were no representations and that the non- clients were informed that they should not rely on anything conveyed during that discussion.
These considerations do not directly impact other claims that are often brought against accountants, which have their own elements and own legal analysis, such as breach of fiduciary duty or fraud. Moreover, auditors of publicly traded companies also are governed by federal securities laws, which have their own rules for who can and cannot sue accountants.
When in doubt, contact a knowledgeable attorney or risk management professional.