UK: Are Umbrellas Stormproof? International Networks Face Tests From US Courts

Last Updated: 19 February 2009
Article by James Roberts and Andrew Forsyth

Two US court decisions within the last 12 months have demonstrated the perils for international networks when member practices are sued in the US. These decisions coincide with a period in which closer links are being forged within some of the largest networks.

Background

Traditionally, most large accountancy networks have operated as relatively loose associations of national firms, with membership regulated by a non-trading "umbrella" entity which does not own any interest in the member firms. In order to protect and enhance the international brand, the umbrella entity is typically given power to lay down professional standards to be followed throughout the network, and may undertake activities such as quality review, training, arranging staff transfers and client data sharing.

Since June 2006, two of the Big 4 networks have each announced their own plans for much closer legal relationships between some or all of the European member firms within each network. In each case, rather than creating an international legal partnership to take the place of the national firms, the new arrangements involve the establishment of a new LLP as a non-trading holding entity for the national firms which are to be trading subsidiaries.

These new structures exhibit two features that merit comment here:

  • Although under common ownership for the first time, the national firms will continue to trade separately from each other.
  • The geographical range of these new arrangements is regional rather than worldwide.

The majority of accountancy networks have not followed this example, although some have indicated that there will be closer relationships between firms at a regional level. Clearly, developments such as these are driven by commercial factors, but issues concerning legal risk are an important part of the background to these changes.

A legal risk that is particularly associated with network structures is that a member firm may become exposed to allegations that it is vicariously liable for the acts and omissions of other member firms. Although claimants have very rarely seen fit to chance their arm before a judge in an English court on such matters, the decisions of courts in the United States have provided some of the strongest indications of the legal risks involved in closer worldwide integration of firms within accountancy networks.While that much is predictable, the outcome of US litigation in this field is proving to be less so. Over the last decade, US claimants have often failed in their attempts to construct a case against a "deep pocket" member firm such as the US firm, where that case is entirely founded either upon that firm's actual relationship (through the network) with the principal defendant firm, or on the representations made about that relationship.

Claimants have had more success in persuading US courts of the viability of their cases against umbrella organisations. They typically advance their case on one or more of the following theories of liability (which have also featured in the claims attempting to fix member firms with liability for the faults of other members):

  • the "alter ego" theory, in which it is argued that the international umbrella entity is so dominated by a member firm that it primarily transacted the member firm's business rather than its own affairs;
  • the "agency" theory, in which it is argued that the member firm is acting on behalf of the international entity and is under its control;
  • the "partnership" theory, in which it is argued that there is a single business carried out by the member firm and the international entity together. Alternatively, it may be argued that the international entity is in effect bound by a representation made by the member firm that they are in partnership, which the claimant had relied on when engaging the services in question.

Umbrella entities have been relatively successful in dismissing alter ego and partnership claims. However, in the last 12 months US courts have made two decisions which have highlighted the dangers presented by agency allegations. In both cases, the substantive allegations of agency are now to undergo trial by jury.

The Banco Espirito Santo case

In spring last year, in Banco Espirito Santo International Ltd v BDO International BV, the Florida Court of Appeal (Third District) overturned a judgment in favour of BDO International which had been made following a successful motion at the trial of claims in tort and contract against it and its US member firm. The trial judge had found that the plaintiffs had failed to present sufficient evidence to succeed in their agency claim. However, the appellate court decided that, when seen in the light most favourable to the plaintiffs (the relevant test for the application being made), the evidence was capable of establishing the three requirements of an agency relationship so as to support a verdict in favour of the plaintiffs:

  1. acknowledgment by the principal that the agent will act on its behalf;
  2. acceptance by the agent of the undertaking; and
  3. control by the principal over the actions of the agent.

The necessary evidence was chiefly located by the Florida Court of Appeal in the following:

  • The objects of business set out in the Articles of Association of BDO International, which included the control and management of partnerships in the international association;
  • The testimony of BDO International's secretary that it "co-ordinated and monitored" the member firms;
  • The Member Firm Agreement ("MFA") signed by the US firm. This stipulated that BDO International owned the intellectual property in the technical manuals containing the auditing standards and procedures which the US firm was required to follow and the software it had to use, under the terms of the MFA, in all of its audits (therefore, including the audit that was the subject of the claim). The court also considered that the terms of the MFA "imposed operating directives and restrictions that extend far beyond those utilized in mere licensing agreements" (for example, requiring firms to assist in product development) and bore similarities to operations manuals distributed to mere franchisees; and
  • BDO International annual reports referred to the quality control exercised over member firms.

The Parmalat decision

On 27 January 2009, a New York court refused a motion for summary judgment made by Deloitte Touche Tohmatsu ("DTT"), its US member firm ("Deloitte US") and the individual who was CEO of both entities, in defence of the class action by investors in Re Parmalat Securities Litigation which alleges violations of US securities legislation. The Parmalat plaintiffs allege that DTT is liable for the acts of its supposed agent Deloitte Italy in auditing Parmalat, and that DTT is the alter ego of Deloitte US and that the CEO is liable under the securities laws as a "control person". A strike-out motion (directed at the adequacy of the pleaded case) in respect of the allegation of agency was dismissed by the same court in June 2005.

The summary judgment motion argued that DTT was merely a secondary actor and, as such, not liable for Exchange Act violations in light of the Supreme Court decision in Stoneridge Investment Partners LC v Scientific-Atlanta Inc1. The court rejected the contention that Stoneridge provides a defence for parties sued under US securities legislation for the acts of their agents. The court also held that summary judgment could not be ordered here because agency was capable of being established by various pieces of evidence including:

  • the objects set out in DTT's Articles;
  • DTT's role in setting audit methodologies and stipulating software to be used;
  • the provision made in member agreements for DTT to review compliance with quality standards;
  • DTT's control over the acceptance of engagements including referrals from other members;
  • the use of DTT legal staff by member firms; and
  • the authority conferred on DTT's CEO role, by a practice manual, to arbitrate disputes between member firms, and the role played by DTT in arbitrating such a dispute over the content of an audit opinion in respect of a Parmalat entity. In the court's view, this suggested that DTT had the power to impose its will on a firm's professional judgment

The court repeated its strike-out decision concerning s20(a) of the Securities Exchange Act that DTT could be held liable for parties under its control, irrespective of whether it exercised specific control over them in respect of the particular engagement.

Deloitte US and the CEO were also unable to persuade the court to dismiss the Parmalat claim for lack of evidence. The court found that there was sufficient potential evidence of Deloitte US control over DTT, on the basis that its executives (including the CEO) occupy key positions at DTT, it contributes a significant portion of funding for DTT, and that there was evidence of influence over DTT's decision making.

What lies ahead for International networks

There is nothing exceptional about many of the arrangements that were regarded in these two cases as constituting sufficient evidence to allow the "agency" claim to proceed to trial by jury. Networks will rightly object that, if the umbrella entities were to be shorn of all such functions, their ability to promote and safeguard the network brand in the interest of all members would be severely limited. Nevertheless, Parmalat suggests that claimants will be given added encouragement if an umbrella entity, rather than an external party, acts as arbiter between member firms, or gives the appearance of influencing the course or outcome of a member firm's engagement.

Of course, the umbrella entities faced a much higher evidential threshold on the motions which resulted in these two judgments than they would at trial. There they will be able to present evidence of member firms' autonomy and raise other matters which sit uneasily with the agency theory (such as the retention of profit by member firms). The ultimate evaluation of these factors will, however, now lie with the jury in those cases.

The real prize for US claimants is the deep pocket of any member firm that might be attacked through the umbrella entity. It is to be expected that networks will have long sought to protect their members from the risk of being required to indemnify umbrella entities against potential vicarious liabilities. While member firms have recognised the risk of claims alleging their direct control over other firms, the claim against the US firm in Parmalat demonstrates that member firms might also face claims in US litigation involving (in effect) allegations of indirect control exercised through their alleged control of umbrella entities. The liability of the member firm in question is then wholly dependent on the issue of the umbrella entity's own vicarious liability. Pending the final outcome of the claims in Banco Espirito Santo and Parmalat, a member firm that is particularly influential within a network organisation should be aware of the danger arising from any activity that might be capable of being presented as consistent with an allegation of control over the umbrella entity (for example through the actions of partners or executives who sit on the board of that entity). Firms may also wish to consider whether their insurance policies provide appropriate protection against claims based on their indirect control of other firms through umbrella entities.

The Banco Espirito Santo and Parmalat cases serve as a reminder that international networks, and leading member firms, continue to face vicarious liability risk in the US. For so long as that remains the case, the current fashion for international integration may be unlikely to lead to true global partnerships or common ownership across the members of each of the large accounting networks. Networks will undoubtedly monitor future developments in order to gauge whether the effect of recent integrations has been to increase the opportunities for claimants to select the US as a forum for litigation, and to balance this against any commercial advantage to be gained from establishing closer legal relationships between member firms in a highly globalised business environment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.