law 101 for cpas

SMART. BOLD. CREATIVE.

CPA’S IN PRIVATE INDUSTRY

LIABILITY OFCPA’s IN PRIVATE INDUSTRY

• Two distinct situations in which a CPA, acting as a controller or C.F.O., may find himself facing personal liability:

• The liability of the CPA individually to third persons with whom he deals on behalf of his employer; and

• Liability to the employer.

LIABILITY TO THIRD PERSONS

• What of the C.F.O. who prepares false financial statements on behalf of the company to present to the bank or a supplier?

• Isn’t there a degree of reliance on the CPA Brand?

• London Drugs Ltd. v. Kuehne & Nagel International Ltd. (1992), 73 B.C.L.R. (2d) 1 (S.C.C.):

• “There is no general rule in Canada to the effect that an employee acting in the course of his or her employment in performing the ‘very essence’ of his or her employer’s contractual obligations with a customer, does not owe a duty of care, whether one labels it ‘independent’ or otherwise, to the employer’s customer.

• “It is now well established that the question of whether a duty of care arises will depend on the circumstances of each particular case, not on predetermined categories and blanket rules as to who is, and who is not, under a duty to exercise reasonable care….”

• The way is open for banks and suppliers to pursue the C.F.O. of insolvent companies where the C.F.O. negligently misrepresents the affairs of the company to banks.

• PROBLEM: There is no professional liability insurance available for a CPA employee or a contractor with one client

LIABILITY TO THE EMPLOYER

• D.H. Overmyer Co. v. Wallace Transfer Ltd. (1976), 65 D.L.R. (3d) 717 (B.C.C.A.) held that the manager had breached his duty of care to his employer to exercise his managerial duties with reasonable care and skill.

LIABILITY TO THE EMPLOYER

• Dominion Manufacturers Ltd. v. O’Gorman (1989), 24 C.C.E.L. 218, an Ontario Court held a CGA liable to his employer for late filing penalties to CRA

• Pelione v. Marmot Concrete Services Ltd., (1996), Alberta Court held a senior employee liable for damages when he failed to properly supervise company employees

REALISTIC EXPOSURE

• Most likely only face liability in a counterclaim should you sue for wrongful dismissal

• Because you haven’t got any insurance…

• You’re more likely to get to know the members of the Professional Conduct Enquiry Committee

PROFESSIONAL CONDUCT RULES

• It is essential to remember that a profession does not cease to be a profession because a proportion of its members enter private employment.

• These members continue to belong to the profession and to be subject to the Rules of Professional Conduct – Forward to the Rules of Professional Conduct

PROFESSIONAL CONDUCT RULES

• Members not in public practice are bound by the same Rules of Professional Conduct, unless the Rule is only applicable to public practice

• “Professional Services” is not just public practice – it is where anyone relies on the CPA in expectation that as a CPA, there will be due care, integrity and objectivity

OVERRIDING RULES

• 201 – Act at all times in a manner which will maintain the reputation of the profession and its ability to serve the public interest

• 202 - “A member, student or licensed firm shall perform professional services with integrity and due care

RULE 205

• A member cannot associate with any statement, oral or written, which the member knows, or should know, is false or misleading

• A breach of this rule is almost universally regarded as also a breach of Rules 201 and 202

RULE 206

• 206.2 -All financial statements prepared by a CPA should be presented fairly in accordance with generally accepted standards of practice of the profession.

• 206.3 -Carry out Audit Committee or Directors responsibilities with the care and diligence of a competent CPA

RULE 208 - CONFIDENTIALITY

• Two aspects of this Rule:

• Inappropriate Disclosure to Third Persons

• Inappropriate Use by the Member

WHEN IN DOUBT?

• Institute Practice Advisors

• Other senior members

• Lawyers

Defensive Assurance Practice

THE FACTS of a RECENT CASE

• Small CA firm does Review Engagement of extremely profitable Co. for many years

• As both revenue and actual (vs. reported) profit margins increased, the trusted comptroller steals $3 million + over last six previous years

• Comptroller won’t reveal where money went – gets five years in prison

• Two distinct claims brought against CA partners in the lawsuit that followed:

• By the Client

• By the shareholder who sold his interest in the company after $3 million had been stolen in reliance upon the Review Engagement Reports and attached financial statements

PROBLEMS

• What do you think the first impression/ reaction is going to be of the Court on these facts

• Remember: The Defense goes second, after only the harmful evidence is introduced by the Plaintiffs

• Result: The Defendant CPA’s may be left to the cross examination skills of their counsel and the willingness of the Court not to “prejudge” the case

• Working papers recorded that each year

• The CA had challenged the owner managers on the ratios and why the company wasn’t more profitable

• Each year the managers provided an explanation

PROBLEMS

• Responsible CA died unexpectedly just as litigation commenced

• CA Firm was not a Limited Liability Partnership

• Insufficient insurance to cover the claim

• Executor put on notice not to distribute CA’s estate to spouse

THE ISSUE - METAPHORICALLY

• Why would you want to go into a firefight…..

• With the only bullet in your ammunition clip being, “ But I met the standard of care”…

• When you can have so much more…

• And much of it’s free on the ICABC website

TOPICS FOR TODAY

• Lawsuits – what are the two primary bases and how long have they got?

• Observations about common causes leading to litigation

• Proper use of the tools in your ICABC tool chest

THE EXPOSURE of TODAY’S CPA

• Client sues in both contract and in tort

• Implied term of contract - “adherence to professional standards” (no negligence)

• Negligence: The failure to adhere to the standard of care expected of a reasonable and prudent CPA in the provision of services to one to whom you owe a duty of care.

EXPOSURE TO THIRD PARTIES

• Potentially to whoever could foreseeably be given your financial statements and rely upon them

• Lenders

•New Investors or Purchasers

• Bonding companies, suppliers

• All under the tort of “negligent misrepresentation”

NEGLIGENT MISREPRESENTATION

• 1974 to 1998: Haig v. Bamford, SCC

• It must be reasonably foreseeable to the CPA that this class of persons could rely upon the Assurance Report.

• The representations in the Report or attached financial statements must be untrue, inaccurate or misleading.

• The truth would have been discovered had the CPA not acted negligently in the conduct of the engagement.

• It must have been reasonable for the reader to have relied on the Report as a basis for his decision.

• Damages must have resulted from the reliance

• 1998, SCC added a sixth requisite in Hercules Managements Ltd. v. Ernst & Young

• The Report must have been prepared for the purpose that the reader would rely upon it in the way that he did

• Applied in International Culinary v. Grant Thornton, LLP, BCSC 2010

HOW LONG ARE YOU EXPOSED

• For a loss discovered today

• 6 years if the cause of action ought reasonably to have been discovered before June, 2013

• 2 years if after May 31, 2013

• 15 years ultimate from date of error or wrong doing

HOW LONG ARE YOU EXPOSED

• The 2 years doesn’t start until the Claimant knows or ought reasonably to know:

• Injury, loss or damage has occurred;

• It was caused by an act or omission;

• The act or omission is by the defendant; and

• Having regard to the nature of the injury, loss or damage, a court proceeding would be an appropriate means to seek a remedy

TOO COMMON to IGNORE

• Three conditions which seem common to all too many lawsuits and complaints of professional misconduct

• True for not just CA’s, but lawyers, engineers and other professionals

No. 3 – THE DIFFICULT CLIENT

• The difficult client is not only more likely to sue you, particularly in a fee dispute, but affects your whole work attitude

• Stress and unhappiness caused by one or two clients can affect your entire performance on other matters

• Life is too short: Work to upgrade your client profile to those clients that are both responsible and responsive

No. 2 – DISMISSING YOUR INSTINCTS

• “I just wish I had listened to my gut and not ____________.”

• Your subconscious is the sum total of all the experience and knowledge you bring to bear

• Problem: It’s incoherent while still trying to identify what’s wrong

• Seek a second opinion before overruling your gut

No. 1 –

• If your client can’t afford to pay enough for you to do it right

• Do it wrong for what he can afford

• He’ll thank you now

• The lawyer your insurance company appoints to defend you will thank you later

FOSTER CLIENT AWARENESS

• Does your client really understand its responsibilities vs. limitations of a review or audit

• Be blunt: The lack of timeliness and responsiveness will cost your client more:• I may have to do the same work

twice;

• It tells me that I have to be more skeptical of what you finally do provide me

DEFALCATIONS

• Go beyond the Handbook

• If not electronic, returned cheques do not go to the “trusted” controller or CFO

• Sr. Mgmt. other than the Accounting dept. should review the cheques for irregularities

WHAT’S IN YOUR TOOLBOX

• Engagement Letters

• Working Papers

• Disclaimers of Liability

LIMITATION CLAUSES THAT WORK

• Hunter Engineering Co. v. Syncrude Canada Ltd. – 1993, SCC

• “Sophisticated parties can limit liability and contract out of limitation periods in circumstances that are not unconscionable, unfair, unreasonable or otherwise void for public policy”

OBJECTIVE

• Limit your liability to your client in contract

• If liability is to be limited to third parties, concentrate upon restricting:

• The purposes for which the Report is issued; and

• The reasonableness of any reliance by anyone other than the Client

ENGAGEMENT LETTER PROTECTION

• A dollar limit to the amount of your liability – not just fees!

• No individual personal liability

• Several liability limited to your proportionate fault

• A time limit ,E.g. 3 or 4 years from delivery of the Assurance Report;

CLIENT RESISTS AMOUNT?

• Remind client that the financial statements are those of the client

• A review for plausibility or testing for audit doesn’t change client’s responsibility

• “What are you not telling me when I say I am willing to risk $50/ 100 K and you say that’s not enough?”

ENGAGMENT LETTERS

• How to render the engagement letter useless:

• Send it out but don’t get it signed

•Have it signed after the work is done and the client has no real choice

•Don’t draw the limitation of liability language to the client’s attention

• Limit liability to just your fees

LIMITATION CLAUSES THAT WORK

• Freedom to contract, to say no, and find another CA firm to provide the services

• Not contrary to public policy or law

• And if the client actually negotiates a revision to the terms before you start the work …..

• That’s what they call an “iron clad contract”

LIMITING THE USE OF THE REPORT

• Set out in engagement letter

•Who will be entitled to rely upon the report and for what purposes

• Report will carry a “Restriction on Use”

• Confirm who and for what use in Working Papers, both planning and discussion

E.g. PURPOSE WORDING

“We will include with our report a section entitled “Restriction on Use” which identifies the limited purpose for which our report is issued, and disclaiming any liability to any third person who chooses to rely upon our report without our written permission. We reserve the right to refuse to provide that permission.

RESTRICTION ON USE

Below the signature on the Report Page:

These financial statements were reviewed and this Review Engagement Report issued solely for the use of [name of client]. We make no representations of any kind to any other person in respect of these financial statements and accept no responsibility for their use by any other person in the absence of our written consent.”

Questions or Comments?

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