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Defeating the "deep pocket" syndrome through Tort reform.

In the last several issues of the National Public Accountant, we have commented on the Uniform Accountancy Act (the UAA) and the exposure draft of the proposed rules to implement the UAA. Some of my comments may have been harsh and, in my judgment, deservedly so considering the subject matter involved and its adverse effect on the scope of practice and conduct of unlicensed accountants.

This lead to an inquiry of me: "Is there anything in the UAA that you like?" The answer is "yes." Speaking for myself and at the risk of offending my brother and sister members of the bar, there are three things in the UAA that I do like. They are Section 20 on privity of contract; Section 21 on uniform statute of limitations; and Section 22 on proportionate liability. These three sections were carefully considered and included unchanged in the 1993 revisions to the NSPA Model Accountancy Law (MAL) so, obviously, the NSPA Board of Governors likes them, too.


These three sections on legal liability were added to the 1992 UAA. These were not in the 1984 joint AICPA/NASBA Model Accountancy Bill nor in the 1987 NSPA MAL. The legal liability sections were included in the UAA and the MAL because of increasing litigation against accounting firms which resulted in substantial judgments based on alleged audit negligence in the case of the big accounting firms and alleged negligence in compilation and review work of non-public clients by small accounting firms.


UAA Section 20 on privity of contract represents the common law rule that only persons who have a direct contractual relationship with the accountant, or a relationship so close as to approach privity, may sue the accountant for negligence. The contractual privity rule is derived from Chief Justice Cardozo of the New York Court of Appeals in his decision in Ultramares Corp. v. Touche, 255 NY 170, decided in 1931 and reaffirmed by the New York court in Credit Alliance v. Arthur Andenon & Co., 65 NY 2d 536, 1985.

However, state courts have abandoned or eroded the strict Ultramares doctrine. A proposed position paper on tort reform prepared by the Legal Liability Task Force of the National Association of State Boards of Accountancy (NASBA) would recommend adoption of a moderate position illustrated in the Restatement of Torts, a reputable legal treatise in the field of tort law. The Restatement rule would extend the accountant's liability not only to those persons with whom the accountant is in privity or near privity but also to those third parties who were foreseen and intended--that is, who were known by the accountant to be intended users or beneficiaries of the information presented in the accountant's report. Thus, the accountant's liability is extended to those persons or classes of persons whom the accountant knows will rely on his/her opinion, or whom the accountant knows that the client intends will so rely.

The narrow Ultramares rule is favored by the big accounting firms and this is the rule set forth in UAA Section 20. However, the accounting industry is pragmatic and recognizes opposition of the legal profession and the state legislatures (consisting mainly of lawyers) to enact a restrictive interpretation of privity as suggested in UAA Section 20.

The Restatement rule seems to be a better rule to follow because it identifies a group of known and intended beneficiaries of the accountant's attestation while at the same time protecting the accountant from negligence claims by individuals not known or identified to be users of the accountant's work product. Accordingly, the NASBA Legal Liability Task Force would recommend the moderate Restatement rule. The fact that the UAA is bold enough to suggest the restrictive Ultramares privity rule to protect the profession is worthy of note.


UAA Section 21 on a uniform statute of limitation sets out the time frame within which a legal action for negligence or breach of contract may be brought against an accountant. It provides that no suit may be commenced against an accountant unless it is begun on or before the earlier of: (1) one year from the date the alleged negligence is discovered or should have been discovered by exercise of reasonable diligence; (2) three years after completion of the accountant's work; or (3) three years after the date of the initial issuance of the accountant's report on the financial statements. The purpose of UAA section 21 is to reduce the uncertainty attending potential liability exposure under different types of state statutes of limitation.

We have previously criticized proposed statutes of limitations in specific state laws, such as accountancy laws, on the grounds that all limitations statutes should be contained in one place in the state codes. Lawyers, regardless of their alleged high remuneration, should not be put to the burden to research each title and chapter of the state code to ascertain the statute of limitation. We still think all statutes of limitations should be contained in one title, but there's nothing wrong with cross-references.

To approach the subject more substantively, state laws and judicial decisions differ widely on the subject of limitations of actions. Generally, most statutes of limitations on a breach of contract action begin to run on the date of the breach.

The next question in some cases is: When is there a breach? What course of conduct gave rise to a breach and how is it defined within a time frame? In a negligence action statutes of limitations generally begin to run on the date of discovery of the wrongdoing, or the date the wrongdoing could have been discovered. Limitations statutes are diverse and because of the factual situation involved, it is difficult to determine when the limitations actually began to run. A uniform statute of limitations serves a useful purpose by establishing a rule of consistency.

Boone et al v. Weaver, Inc. (S. Ct. of VA, decided March 4, 1988, 365 SE 2d 764) is one of those cases where the dispositive question on appeal concerns the time when the statute of limitations begins to run on a claim for damages caused by negligence in the furnishing of accountancy and tax services. If the provisions of UAA section 21 were codified in the Virginia law, the accountant in the case would have prevailed.

However, the Court decided that the client's claim against the accountant for erroneous tax advice did not begin to accrue until four years after the tax returns in question were filed, when the IRS audit proceedings were completed. The Court held that the client did not accrue any right of action until it suffered harm as a result of the breach, and no harm was suffered until the IRS assessed additional taxes. Then, and only then, did the statute of limitations begin to toll. The Court decline to follow the rule that the statute began to run when the erroneous advice was given.

A clear and unambiguous standard that is consistent among the states for filing a legal action against the accountant is plainly desired. However, its place in the statute books belongs in the title on statutes of limitations, along with all other limitations on actions.


UAA Section 22 concerns the principle of proportionate liability in actions (except fraud actions) for money damages against accountants. This is a controversial issue and vigorously opposed by the plaintiffs' trial bar. Under proportionate liability an accountant would be liable for the portion of the plaintiffs injury caused by the accountant's conduct. The accountant would not be required to compensate the plaintiff for damages caused by others--e.g., the partner of the firm who performed the allegedly negligent audit--when the other partner had nothing to do with the audit or the alleged negligence.

Joint and several liability, which is now the law in two-thirds of the states, may be criticized because it assumes that compensation to the claimant is more deserving than an equitable apportionment of liability. A defendant accountant (or accounting firm) would be required to bear the burden of the entire money damages awarded (the "deep pocket") even though the harm was caused by others who don't have a "deep pocket." Proportionate liability avoids that result. The individual defendant accountant is held liable only for his/her share or proportion of fault.

The inclusion of a proportionate liability standard in the UAA is, in my judgment, a step in the right direction. My fellow members of the bar, particularly those who represent plaintiff claimants, will vigorously disagree and will lobby with all the strength and vigor of the trial lawyers association when the provision comes up for legislative consideration. However, an excellent case can be made for proportionate liability.

While accountants have a public responsibility, it does not extend to literally stripping an accountant partner of all partnership and personal assets to satisfy a money judgment against the firm, when the accountant partner was not involved in the activity that gave rise to the alleged negligence. Even innocent partners in the "big six" firms deserve better!

Several states have now recognized the unfairness of joint and several liability as applied to the accounting profession. Twelve states have abolished joint and several liability in favor of proportionate liability, and 14 states have adopted some form of modification of joint and several liability for the awarding of economic damages, according to G.W. Tonkin, CPA, in his paper, The Regulators Perspective on Accountant's Legal Liability, presented at NASBA's 86th Annual Meeting, San Diego, October 4, 1993.

In three states (Colorado, Delaware and Pennsylvania) the law provides that accounting firms who wish to avail themselves of the proportionate liability standard are required, at the time of registration with the state accountancy board, to demonstrate and agree to maintain a minimum level of liability insurance, capital reserves or some other form of surety as specified by the board. If the firm fails to meet that requirement, it would be subject to the provisions of joint and several liability.

The unfairness of joint and several liability has also attracted the attention of Congress. H.R. 417 introduced by Rep. Billy Tauzin (D-LA) includes a proportionate liability provision. Although H.R. 417 under the Securities Exchange Act of 1934, the enactment of the provision would be a powerful stimulant to amend state liability statutes. At the least, it would establish a Federal precedent.

The popularity of the limited liability company structure (LLCs, now permitted in about 36 states) is its provision for limited liability. Unless otherwise provided in the articles of organization, no member, manger or other agent of an LLC shall have any personal obligation for any liabilities of an LLC, whether the liabilities arise in contract, tort or otherwise, solely because the individual is a member, manager or agent of the LLC.

In some states the damages assessed against an LLC member or manager arising out of a single transaction or occurrence may not exceed certain statutory limitations. Since no LLC member is personally liable for the obligations of the entity, the question of proportionate liability versus joint and several liability may be on its way to becoming an academic discussion so far as the licensed professions are concerned.


The three sections under discussion were added to the 1992 UAA and the 1993 MAL to clarify the legal liability of the accounting profession. Whether you call these sections liability reform measures or efforts to put accountants on a level playing field with their litigant opponents does not matter. What does matter is that the present legal environment for licensed and unlicensed accountants can be improved.

Some of the liability awards in recent years against licensed accountants are unconscionable. Accountants--who by training are independent and objective and seek to serve the public interest--deserve better than to be exposed to excessive liability in the practice of their chosen profession.
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Author:Sager, William H.
Publication:The National Public Accountant
Date:Jun 1, 1994
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