Claims against auditors or accountants can arise when an assurance engagement has been performed. Assurance engagements result in the auditor or accountant issuing a report on the statements and include audits and reviews of financial statements. An audit provides the highest level of assurance.

 

An auditor or accountant can be found negligent if the standards of the profession, as outlined by CPA Canada, have not been upheld in conducting the engagement. The standards provide guidance on the appropriate accounting treatment for transactions as well as direction on process and work that should be performed in an assurance engagement. Other standards may also apply, such as the usual practice at the time of the engagement.

 

An error in a financial statement is not sufficient to prove negligence. If in conducting an audit or a review the auditor complied with the standards of the profession at the time, there will likely not be a finding of negligence. This leaves the question of how a financial statement can be materially incorrect if all the standards of the profession have been upheld? In most cases when a financial statement is materially incorrect the audit or review broke down somewhere through the engagement process.

 

When is there an allegation of auditor or accountant negligence?

 

The vast majority of claims against auditors and accountants are initiated because an individual or an entity relied on a financial statement and as a result made a decision to lend, buy, sell or contract with the audited company and lost money. Claims against auditors for negligence rarely happen unless there was reliance and a loss.

 

Who can sue an accountant?

 

It’s difficult for a company to succeed in suing their external accountant or auditor.

 

Four elements of negligence must be established to sue an auditor:

  1. There is a legal duty of care to the plaintiff
  2. There is a breach in that duty
  3. Damages resulted
  4. There is a connection between the breach of duty and the resulting damage

 

An accountant has a duty of care to known third parties and reasonably foreseeable third parties who would rely on their representation and that reliance would be reasonable. The notion of reasonable reliance, however, is limited. Based on the Hercules Management Ltd v Ernst and Young [1997] decision, auditors have a duty of care to the corporation that hires them, but no liability to shareholders or creditors. This limitation protects auditors from unlimited liability, however if the auditor should have foreseen that a limited class of investors would reasonably rely on the auditor’s representation, there is a duty of care.

 

In the recent case of Deloitte LLP v. Livent Inc. (Receiver of), the company being audited, Livent, successfully sued their auditor and accordingly there may be new activity by companies seeking to sue their auditors.

 

Livent staged live theater shows in the 1990’s, filed for insolvency protection in November 1998, and went into receivership in 1999 after new owners identified issues with Livent’s accounting.  Livent’s founders were subsequently convicted of fraud and sentenced to jail terms in 2009. The insolvency caused numerous creditors and shareholders to lose millions. Because of the Hercules Management Ltd. ruling, Livent bondholders did not sue Deloitte directly. Instead, the legal action was launched by Livent’s receiver and financed by the bondholders who will receive much of the award.

 

How long after the fact can an accountant be sued?

 

An auditor is liable for two years from the date the plaintiff knew or should have known that there was an issue.