United States: CPAs Dealing With The High-Stake Responsibilities Of Handling A Client's Financial Affairs Would Do Well To Live By The Motto, "Serve & Protect."

When a CPA performs work for a client, a contractual relationship exists, which, naturally, creates potential legal exposure for the CPA. The possibility of legal action doesn't end with the client, however.

Non-client third parties (and potential third-party users) also may seek legal recovery from CPAs, based on allegedly negligent work. Thankfully, though, a law exists to limit the potentially broad legal exposure of CPAs to third parties.

In 1986, the Illinois CPA Society was instrumental in obtaining the passage of The Illinois Privity Law (225 ILCS 450/30.1). Here, we provide you with a brief explanation of the law and a list of considerations for practitioners seeking to maximize their protection:

The principle behind the Privity Law is simple: An accountant has a right to know for whom his or her work is intended and, once the accountant understands the client's intention, the accountant should be liable only to the client and that person if the work is done negligently.

In essence, the Illinois Privity Law provides that no licensed or authorized CPA will be liable for civil damages resulting from his or her professional services unless: (1) that conduct constitutes fraud or intentional misrepresentations; or (2) the CPA was aware that one of the client's primary intents was for the professional services to benefit or influence the person who is bringing the lawsuit.

Special attention should be paid to the concept of "intent." It is the client's intent to benefit or influence the third party, and the CPA's awareness of that intent creates the potential for civil liability to the third party. The intent of any third party is, in itself, irrelevant.

The Privity Law also states that, if the CPA identifies in writing all those persons who will benefit from his or her services—in the form of a "privity letter," for example—and provides a copy of that document to each of the individuals, then only the client and the individuals listed may seek legal recovery from the CPA.

Banks, financial institutions or any other creditor to the client typically seek privity letters. The cautious CPA will consider the following points when confronted with the decision of whether and how to issue the letter.

1. The Privity Law is specific to Illinois, and therefore typically will not affect suits based on federal law or the law of other states.
2. The CPA should always respond to a formal, written request to establish a third-party relationship, even if only to deny acknowledgment of the third party's reliance or to state certain limitations.
3. The CPA firm should consider having a written policy to offer guidance in determining whether privity letters should be utilized in a particular engagement.
4. Consideration should be given to the timing of the request for the privity letter, and to whether the procedures performed address any increased engagement risks with respect to issuance of the letter. Along the same lines, consideration should be given to whether the financial statements are "stale," or whether material events have occurred since the financial statements were issued.
5. It is generally preferred that the privity letter be addressed to the client only, with a copy furnished to the third party.
6. The privity letter should always include a clear statement of the need for the third party to exercise his or her own due diligence.
7. The privity letter should be restricted to a single engagement; that is to say, the letter should not provide a blanket acknowledgment of the client's intent for the third party to benefit from reports that may be issued in connection with future engagements.

Needless to say, these provisions cannot anticipate every possible situation, and certainly are not a substitute for sound judgment and objective consideration of all applicable legal issues. As a safeguard, practicing CPAs would be wise to consult with their attorney regarding the application of the Privity Law in the context of other pertinent laws.

Reprinted courtesy of Insight, the magazine of the Illinois CPA Society.

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.