It goes without saying that, when a business operation hires a CPA to provide professional services, the accountant owes a duty of care to the client and can be held liable to the client if the services are negligently rendered.
But does the CPA owe a duty of care to others who are not the CPA’s clients? For example, if you extend business credit to a firm based upon financial information supplied by professional accountants to that firm, can you sue the CPA if the financial information turns out to be incorrect and you sustain damages?
Well, the answer is “a definite maybe.”
For many years, it was a “definite no,” based on the idea that the only duty the CPA owed was to its client.
Wisconsin’s 1983 Timm Decision
One of America’s best known accountant liability cases was decided by the Supreme Court of Wisconsin in 1983. The case, Citizens State Bank v. Timm, Schmidt & Co., 113 Wis. 2d 376, 335 N.W.2d 361 (1983), involved a relationship between a manufacturer and a CPA firm hired to perform its annual audit. Relying upon the financial statements prepared by the CPA auditors, a bank loaned the manufacturer some $300,000. Subsequently, the CPA firm discovered a number of errors. When they were corrected, more than $400,000 in negative adjustments had to be made. When the bank was notified of the adjustments, it recalled the loan. The manufacturer filed bankruptcy and, after liquidating the collateral, the bank was still short $150,000. It sued the CPA firm for its loss.
The Supreme Court concluded that accountant liability cases ought to be decided under the ordinary principles of Wisconsin negligence law. Under those principles, anyone responsible for a legal wrong can be fully liable for all foreseeable consequences of his or her act except as those consequences are limited by public policy factors.
Bank’s Use of the Statements Was Foreseeable
The Court stressed that it was foreseeable that third party businesses, such as the bank, would rely upon the financial information prepared by the CPA firm. That the CPA firm did not know the manufacturer intended to apply for the specific loan with the bank was not important. The CPA firm knew that its audit gave a measure of believability to the manufacturer’s operation. The Court added that, unless the CPA could be held liable, his or her negligence would go undeterred.
Recovery Against a CPA or Other Professional is Not Assured
The Court carved out six instances in which there could be no recovery against the CPA or other professional. No liability would be found if:
- The injury was too remote from the negligence,
- The injury was wholly out of proportion to the fault of the CPA or other professional,
- In retrospect, it appeared too extraordinary that the negligence should have brought about the harm,
- Allowing recovery would place too unreasonable a burden on the CPA or other professional,
- Allowing recovery would likely open the way for fraudulent claims, and
- Allowing recovery would enter a field that had no sensible or just stopping point.
Not All CPA-Prepared Financial Reports are Audits
Businesses should note that not all reports are audits. There are two other, more limited, types of engagements:
- “Review engagements” are conducted to provide limited assurance that there are no material modifications that should be made to the financial statements of the client. They provide much less assurance than an audited financial statement.
- Compilation engagements merely assist management in presenting financial information in the form of financial statements without undertaking to provide any assurance that material modifications should not be made.
Just because one of your customers provides you with some sort of CPA-prepared statement, understand that it may not be an audited report and it, therefore, may supply less than reliable information. For review engagements and compilation engagements, the duty owed by the CPA firm to the public is much, much less than for audited materials.
Milwaukee Business and Commercial Litigation Attorneys
Has your business detrimentally relied upon financial information provided by a CPA firm? If so, contact the Milwaukee business litigation firm of Kerkman Wagner & Dunn We have over 50 years of combined legal experience representing business owners in Wisconsin. Our firm has big firm talent and provides small firm attention. Call us at 414–278–7000 or complete our online contact form today.