Academic journal article Journal of Accountancy

Shareholders May Sue Firm for Constructive Fraud

Academic journal article Journal of Accountancy

Shareholders May Sue Firm for Constructive Fraud

Article excerpt

A North Carolina court of appeals ruled that shareholders of a corporation could maintain a constructive fraud action against an accounting firm.

Fraud claims are not covered in most professional liability policies. This case was significant because it established that an accounting firm could be liable for a claim outside the scope of it's professional liability policy.

This case began when the corporation employed the accounting firm McCoy, Hillard and Parks to provide it with accounting services and advice. In the process of rendering these services, the firm allegedly committed an error that resulted in understatement of the corporation's liabilities and overstatement of sales.

The company had wanted to expand its operations and the firm had advised it that debt incurred to finance this expansion would have to be guaranteed personally by the shareholders. The firm also had advised that this debt could be amortized if projected revenue targets were achieved. In their suit in a North Carolina circuit court, the plaintiffs, shareholders in the corporation, alleged that they had relied on this advice in assuming personal guarantees for the debt.

Despite reported sales that exceeded projections, the corporation experienced severe cash flow problems, which the firm said were temporary. The shareholders claimed they had relied on this advice in deciding to guarantee a further line of credit to alleviate the company's cash flow problems. …

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