Twomey  Jennings
Anderson’s Business Law and the Legal Environment, Comprehensive 20e
Anderson’s Business Law and the Legal Environment, Standard 20e
Business Law: Principles for Today’s Commercial Environment 2e
Chapter 47
Accountant’s Liability
and Malpractice
Copyright © 2008 by West Legal Studies in Business
A Division of Thomson Learning
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.
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Malpractice
Malpractice
consists
of both:
Breach of
Contract
Accountant (party
to contract) fails to
fulfill duties.
Malpractice
Tort
Plaintiff must show
that defendant’s
breach was negligent
or willful.
Accountant is
negligent or
commits fraud.
Plaintiff bringing suit for malpractice may choose
which action to pursue:
Breach of
Contract
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Tort
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Differences
In choosing which action to pursue,
a plaintiff may consider:
BREACH OF CONTRACT
Limited by Contract
Runs from Date When
Contract Was Broken
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TORT LIABILITY
Damages
Statue of
Limitations
Can Be Greater Than
Contract Law Damages
Runs from Date When
Harm Was Discovered
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Liability to Third Parties
• No privity of contract: third persons may
also sue the accountant 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.
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Liability to Third Parties
• Liability is evaluated by one of these
rules:
–
–
–
–
–
–
The Privity Rule
The Contact Rule
The Known User Rule
The Foreseeable User Rule
The Intended User Rule
The Unknown User Rule
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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.
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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.
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Theories of Liability (cont’d)
• A few courts use a FLEXIBLE
approach, deciding each case as it
arises.
• Finally, an accountant is not liable to a
non-privity UNKNOWN user when the
accountant has no knowledge of any
way the party could be affected.
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Liabilities
Malpractice (Tort)
Liability
for
Statutory Violations
Breach of Contract
Anyone in Privity of Contract
Client
Beneficiaries of Statutory Protection
(Section 11-1933 Act
Section 10b-1034 Act)
Liability to
- Differing Decisions
Known-User
Contacts
Foreseeable User
No liability to
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Interloper
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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.
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Fraud Malpractice
• When an accountant is guilty of fraud, the
intended victim of the fraud may sue the
accountant even though privity of
contract is lacking.
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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).
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Sarbanes-Oxley Act of 2002
• Accountants must register with
Accounting Oversight Board.
• Corporate audit committees.
• Records retention (Arthur Anderson).
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