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Legislative modifications to the issue of privity.

Legislative Modifications to the Issue of Privity

The public accountant is unique among all professionals. Other professionals work for and are paid by the client. Where there is negligence on the part of the professional, privity is easily established. The accountant, on the other hand, is paid by the client but works for the "public good." Where there is negligence on the part of the accountant the issue of privity is clouded.

Privity

Privity is the relationship that is establishea between two or more contracting parties. In the 1931 definitive Ultramares case [255 N.Y. 170, 174 N.E. 441], the court established that only those in privity could recover damages from an accountant and only when those damages resulted from gross negligence on the part of the accountant. Since that case, various courts have expanded the concept as to who is in privity and have diluted the construct of gross negligence to ordinary negligence. Since 1931, both the breadth (privity) and depth (negligence) of the accountant's legal liability have grown larger.

Judicial Decisions

Becker and Kim (1989) reviewed the conundrums concerning accountants in public practice with respect to the issue of privity. their discussion, however, was limited to judicial decisions from the State of New York. They observed that the Credit Alliance case [65 N.Y. 2nd 536,483 N.E. 2d 110] reversed the trend towards widening the scope of privity by establishing three criteria to define the concept of "sufficiently approaching privity." Privity, or now, sufficiently approaching privity, is a condition that a plaintiff must establish in order to collect damages from an independent accountant in New York.

It is interesting to observe that, in 1988, the Supreme Court of North Carolina in the Raritan River Steel Company case declined to apply the near privity criteria of the Credit Alliance case. Instead it chose the less strict privity criteria of the Restatement (Second) of torts [para.] 552 (1977), that defines privity as the client or any person or group of persons that the client intends the information to benefit or influence--not necessarily in writing. However, the North Carolina court did observe that the Credit Alliance doctrine had been followed in four other jurisdictions: Indiana, Toro Co. v. Krouse, Kern & Co., Inc. [1827 F.2d 155 (7th Cir. 1987)]; Arkansas, Robertson v. White [1633 F.Supp. 954 (W.D.Ark.1986)]; Iowa, Briggs v. Sterner [529 F.Supp.1155 (S.D.Iowa 1981)]; and Illinois, Shofstall v. Allied Van Lines, Inc. [455 F.Supp. 351 (N.D. Ill. 1978)].

But judicial decisions are only one way that doctrines become extant law. A second method is through the legislative process. Other than for investors of publicly held companies for whom the concept of privity is defined by federal statutes, the enacting of laws to establish definitions of privity falls to the individual states. To date, only two states have enacted such laws, while privity laws have been proposed in three other jurisdictions. This article will review those state laws that describe who is in privity and who, therefore, has the capacity to sue the independent accountant in that state.

Arkansas

Arkansas passed its privity law in 1987. Section 16-114-302. "Liability of Accountants" provides:

No person, partnership, or corporation licensed or authorized to practice under the Public Accountancy Act of 1975 . . . or any of its employees, partners, members, officers, or shareholders shall be liable to persons not in privity of contract with the person, partnership, or corporation for civil damages resulting from acts, omissions, decisions, or other conduct in connection with professional services performed by such person, partnership, or corporation, except fro: (1) acts, omissions, decisions, or conduct that constitutes fraud or intentional misrepresentations; or (2) other acts, omissions, decisions, or conduct if the person, partnership, or corporation was aware that a primary intent of the client was for the professional services to benefit on influence the particular person bringing the action. For the purposes of this subdivision, if the person, partnership, or corporation: (A) identifies in writing to the client those persons who are intended to rely on the services, and (B) sends a copy of the writing or similar statement to those persons identified in writing or statement, then the person, partnership, or corporation or any of its employees, partners, members, officers, or shareholders may be held liable only to the persons intended to so rely, in addition to those persons in privity of contract with such person, partnership, or corporation.

Kansas

Kansas approved its privity law in 1988. Section 1.402 of the Kansas Statutes Annotated states:

Liability for professional negligence; restrictions. No person, proprietorship, partnership, professional corporation or association authorized to practice as a certified public accountant . . . shall be liable to any person or entity for civil damages resulting from acts, omissions, decisions or any other conduct amounting to negligence in the rendition of professional accounting services unless: (a) the plaintiff directly engaged such person . . . to perform the professional accounting services, or (b)(1) the defendant knew at the time of the engagement or the defendant and the client mutually agreed after the time of the engagement that the professional accounting services would be made available to the plaintiff who was identified in writing to the defendant; and (2) the defendant knew that the plaintiff intended to rely upon the professional accounting services rendered the client in connection with specified transactions described in writing.

Texas

Texas has proposed an amendment to its Civil Practices and Remedies Code. Below are the main points of the proposed Chapter 5.

An accountant owes professional duties and has liability for acts of omissions committed in connection with compiling, reviewing, certifying, auditing, or otherwise reporting of analyzing a financial statement or other information only to: (1) the injured person who contracted directly with the accountant to perform those services; or (2) those persons: (A) to whom the accountant was aware at the time the services were performed that the financial statement or other information would be made available for use in connection with a specified transaction and the injured person was specifically identified to the accountant; (B) with whom the accountant communicated directly concerning the financial statement or other information; and (C) as to whom the accountant was aware that they intended to rely on the financial statement or other information in connection with a specified transaction and communicated that awareness by words or conduct.

Chapter 5 also provides for terminology that can be placed on the bottom of each page of a financial report that denotes which parties can rely on the statements.

Massachusetts

Senate Bill 901 currently being debated by the Massachusetts legislature states the following:

Section 2. Chapter 112 as appearing in the Massachusetts General Laws 1986 edition is amended by adding after Section 87E a new section as follows: Section 87E 1\2 (1) A person may not bring negligence action against an accountant in any court in the Commonwealth unless: (a) the plaintiff engaged the defendant accountant to perform accounting services; or (b)(1) The defendant accountant knew at the time of the engagement of the accounting services: (i) that the client intended to use the accounting services for a specified transaction with the plaintiff, and (ii) that the plaintiff intended to rely upon the defendant's accounting services to the client, and (2) the accountant communicated with the plaintiff and expressed by words or conduct an understanding of the plaintiff's reliance on the services.

Wyoming

In 1988, the legislature in the State of Wyoming passed Senate File No. 0052 which provided:

No accountant is liable to any person other than a client for civil damages resulting from acts, errors, omissions, decisions or other conduct in connection with the provision of professional accounting services unless: (i) the acts, omissions, decisions or conduct constitute fraud or intentional misrepresentations; (ii) the accountant knew within 30 days after entering into a contract with a client that the professional accounting services rendered the client would be made available to another person who was identified in writing to the accountant or to a class of persons who were specifically identified and defined in writing to the accountant; or (iii) the accountant and client mutually agreed in writing after the contract commences to making the professional accounting services rendered the client available to another person or class of persons

The above legislation was vetoed by the governor--a trial attorney. The state society hopes to reintroduce the legislation when the political climate is more favorable.

Summary

The seeds have been sown. Through Judicial decisions and the legislative process the breadth of accountants' legal ability has been reduced to realistic dimensions in a few jurisdictions. Other states have such legislation on the docket, while others are in the process of attempting to have such legislation introduced (e.g. Mississippi where proposed legislation was not reported out of committee).

Though the laws cited above are worded differently, they are remarkably the same. Some of the laws have a stricter definition of privity than provided for by the Credit Alliance case. Each of the extant laws requires that third parties, those not contracting for the services, be identified to the accountant in writing, while the Credit Alliance case doctrine is closer to the provisions of the proposed Massachusetts law.

But the extant legislation is just a drop in the bucket (see Exhibit 1). There is much work to be done. Where a law does not exist, the state legislature should be lobbied by the state society and every other professional group that is organized within the state. Where does your state stand?

Edward A. Becker is a professor and director of the master of accounting program at Nova University's Friedt School of Business and Entrepreneurship in Fort Lauderdale, Florida.
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Author:Becker, Edward A.
Publication:The National Public Accountant
Date:Mar 1, 1990
Words:1622
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