Damage Control for Professional Liability

Article excerpt

The increasing number and severity of liability claims against CPAs intensifies the need to consider the format of accounting firms and personal assets in the event that claims exceed available liability coverage. The author presents an update of material published in December 1986 which is even more pertinent now. This article includes information about recent changes in the states' professional corporation laws and, most importantly, advice for protection of individual assets. The current liability climate requires all practitioners to reconsider their defenses against ruinous professional liability claims.

The threat of professional liability has become more ominous to CPAs with the recent downturn in the U.S. economy, as the number of suits brought each year against accountants is largely a function of the health of the national economy. Equally distressing is that such suits, on average, are resulting in larger monetary awards. These trends mean that in the next few years, many CPAs will likely be defendants in professional liability suits. The significance of these developments was recently underscored by the sudden demise of Laventhol & Horwath.

In the past, the accounting profession has sought to avoid litigation by adopting detailed written practice standards and quality control procedures. Although these measures have helped to improve the overall quality of practice among CPAs, they have done little to eliminate the nightmare of professional liability litigation, as the public's expectation of CPA performance has either kept pace or has increased at the same time.

The accountant's second line of defense traditionally has been to purchase professional liability insurance. Such insurance has been generally available in virtually unlimited amounts, covering every type of claim, save only those in which there were findings of intentional or fraudulent misconduct. Unfortunately, the cost of such insurance is currently four times higher than it was 10 years ago, with the result that many firms have decided to reduce, or even forego insurance coverage. Moreover, accountants are now forced to accept policies with sharply curtailed coverage. In addition, most professional liability policies provide that legal fees and other related costs of defending a claim are charged against the policy limits. Thus, accountants are not only faced with a rapidly increasing liability exposure, but also with diminished insurance protection.

Many CPA societies have sought to have their state legislatures adopt "privity" legislation limiting the scope of persons who can sue an accountant on a negligence standard. To date, Illinois, Kansas, Arkansas, and Utah have adopted such legislation. Others have sought similar protection from the courts. At present there are eight states that have adopted privity or near privity rules via the courts: New York, Colorado, Delaware, Idaho, Indiana, Nebraska, Nevada, and Pennsylvania. More recently, the AICPA has embarked upon a campaign to have states permit the practice of accountancy in "limited liability" corporations to further protect the assets of accounting firm owners from vicarious liability. These efforts alone, even if successful, will not completely remove the threat of personal liability and financial ruin that CPAs currently face.

The AICPA's Council has approved an amendment to Rule 505 of the Institute's Code of Professional Conduct, which, if adopted by the membership, will permit the practice of accountancy in business corporations. Typically, under state law shareholders of business corporations are shielded from personal liability resulting from the actions of others. The laws of most states, however, currently require professional firms to conduct their practices through either a partnership or a professional corporation. In contrast to shareholders in a business corporation, each member of a partnership is personally responsible for the liabilities of the partnership, regardless of their cause. …