PROFESSIONAL LIABILITY
Is Privity All
That Necessary
in a Third-Party
Action?
Legal and Accounting
Malpractice Cases
By Ellen Bartman Jannette
and Erin L. Stafford
There are various
approaches to privity
taken in thirdparty professional
malpractice cases.
Larry Lawyer, a business transaction attorney you have
known for years, contacts you after being served with a
professional malpractice complaint filed by Beta Widget
Co. A few days later, ZZZ Insurance Company contacts
you to represent its insured, Amy Accountant, who is also being sued for professional malpractice in the same lawsuit
brought by Beta Widget. After reviewing
the complaint (and clearing any potential
conflicts), you meet with Larry and Amy
to obtain an understanding of their relationships with Beta Widget and to discuss the various facets of a professional
malpractice action including the elements
of duty, breach, causation, and damages.
Both Larry and Amy express shock and
confusion—as far as they know, they have
never been retained by Beta Widget or
performed professional services for the
company. How then, they ask you, can a
company for which they have never done
any work possibly bring a professional
malpractice claim against them?
After meeting with Larry and Amy, you
do some digging, and discover the following: both Larry and Amy provided services to Alpha Widget Co. Larry drafted a
letter on behalf of Alpha, affirming the
legality of its business model and practices. Amy provided accounting services
to Alpha, including compiling annual
reports. After Larry and Amy’s work for
Alpha was complete, a state investigation
revealed that Alpha was an illegal scam,
and was on the verge of bankruptcy. Alpha
was placed in a state receivership while
the state investigation proceeded. After
the investigation was complete, the state
receiver arranged to sell Alpha’s remaining assets to Beta Widget—including all
rights and legal causes of action Alpha
might possess. Beta Widget then sued
A partner in the Bloomfield Hills, Michigan, office of Plunkett Cooney PC, Ellen Bartman Jannette focuses
her practice in the areas of professional liability and insurance coverage. Ms. Jannette’s professional liability
practice includes the defense of lawyers, real estate agents and brokers, insurance agents and brokers,
accountants, and other professionals in various types of complex litigation. An associate in the Bloomfield
Hills, Michigan, office of Plunkett Cooney, Erin L. Stafford focuses her practice in the area of professional
liability with an emphasis on defending claims against attorneys and accountants.
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© 2014 DRI. All rights reserved.
Larry and Amy, alleging that they were
asleep at the switch as to Alpha’s scam,
and should have detected the fraud. Beta
Widget asserts that its purchase of Alpha’s
assets—including all potential causes of
action—permits it to sue Larry and Amy
for professional malpractice. When you
give this information to Larry and Amy,
they want to know—is Beta Widget correct? Can they, in fact, be held liable to
a third party for which they never performed professional services?
Historical Background of Privity in
Professional Malpractice Cases.
The answer to Larry and Amy’s questions lies in the steady erosion of the
requirement of privity in professional
malpractice cases. Originally, all states
followed the strict privity approach established in Winterbottom v. Wright, 152
Eng. Rep. 402 (Ex. 1842), and endorsed by
the United States Supreme Court in Savings Bank v. Ward, 100 U.S. 195 (1879).
In Ward, the Court ruled that strict privity was required in malpractice cases,
and stated that “[t]he obligation of the
attorney is to his client and not to a third
party” unless fraud or collusion was present. Id.at 200–03. Since the late 1950s,
however, this strict privity approach has
been gradually relaxed in nearly all states.
The vast majority of jurisdictions now
permit some non-­clients—who lack the
traditional strict privity—to sue for professional malpractice, at least under certain circumstances.
While nearly all states have abandoned
the strict privity approach exemplified by
Winterbottom and Ward, they have not all
adopted the same test to determine which
non-­client third parties will have standing
to sue professionals such as lawyers and accountants. Instead, states throughout the
country have adopted a variety of different
tests. To make matters even more complicated, the tests are not always identical for
all professionals even within the same state.
This article will attempt to walk through
the most common approaches currently
taken by the states. However, you should,
as always, ensure that you know the rule
followed in your jurisdiction. After summarizing the various approaches, this article
will highlight several common situations
in which disputes over privity have arisen.
And what of Larry Lawyer and Amy
Accountant? Can they be sued under the
various modern approaches to privity? We
will return to Larry and Amy’s question at
the end of this article, once we have gained
a more thorough understanding of the
rules governing their quandary.
Various Approaches to Privity Taken
in Professional Malpractice Cases
relying on the accountant’s work for purposes of providing the loan to the accountant’s client.
One State’s Approach to Third Party Privity
Issues as to Accountants and Lawyers
Since Ultamares was decided, New York
courts have addressed third party privity
arguments on a number of occasions, as to
Privity-of-Contract Approach
The most restrictive approach to privity taken by a small minority of states is
referred to as the privity or near privity
approach. This approach has been applied
to both legal and accounting malpractice cases.
The privity-of-contract approach was first
established in the New York case Ultamares
Corp v. Touche, 174 N.E. 441 (NY, 1931). In
Ultramares, Chief Judge Benjamin Cardozo
held that, before a third party to a professional services contract may sue for negligence, the third party must first establish
a contractual relationship with the professional or a relationship “so close as to approach that of privity” of contract. In this
approach, the third party plaintiff must be
in privity or near privity with the defendant
professional in order to recover for ordinary
negligence. The defendant professional must
know that a known third party intends to
rely on the professional’s work that is being performed for the professional’s client
for a particular purpose and there must be
some conduct by the professional that links
the professional’s work to the third party.
By way of example, privity and near
privity principles would be applicable in
the following scenario. An accountant is
retained by a client to audit financial statements required by a bank as a prerequisite for the client obtaining a loan from
the bank. The accountant is aware that
the bank will rely upon the financial statements for purposes of providing the loan
to the client. After the client goes belly-up,
the bank sues the accountant for failing to
communicate the inadequacies of the client’s internal controls and recordkeeping. Applying the near privity approach,
the bank would have standing to sue the
accountant even though there is no formal contract—that is, no formal privity—
between the bank and the accountant; the
accountant knows that the bank will be
The vast majorityof
jurisdictions now permit
some non-­clients—
who lack the traditional
strict privity—to sue for
professional malpractice,
at least under certain
circumstances.
both accountants and lawyers. Specifically,
the New York Supreme Court modified Ultamares in Credit Alliance Corp v. Arthur
Anderson & Co., 483 N.E.2d 110 (N.Y.,
1985) and limited an accountant’s liability
exposure to those with whom the accountant is in privity or in a relationship “sufficiently approaching privity.” The Credit
Alliance court formulated the following
three-part test for determining when a relationship of privity exists between the professional and a plaintiff third party:
• The professional was aware that his representation was to be used for a “particular purpose or purposes;”
• The professional “intended” for the
representation to be relied upon by a
“known party;” and,
• The professional engaged in conduct “linking” the professional to the
intended “known party,” which “linking” evinces the professional’s understanding of the known party’s reliance.
In Credit Alliance, the “linking” element
was lacking as there was no allegation that
the accountant had any direct communications or other direct dealings with the plainFor The Defense September 2014 71
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PROFESSIONAL LIABILITY
tiff third party. In comparison, however,
the same court held in European American Bank and Trust Co. v. Stauhs & Kaye,
483 N.E.2d 110 (1985)(which was decided
with Credit Alliance), that the elements of
the Credit Alliance test were met because
the accountant and the client’s lender directly communicated regarding the client’s
affairs over a period of time, including hav-
Instead, statesthroughout
the country have adopted
a variety of different tests.
ing meetings to discuss the client’s financial
condition, and because repeated in-person
representations were made by the accountant to the lender about the value of the client’s assets. In addition, the accountant was
allegedly aware that the lender was relying
on the accountant’s audit for purposes of
assessing the financial status of the client.
In contrast, in Security Pacific v. Peat
Marwick, 597 N.E.2d 1080 (N.Y., 1992),
the court held that there was insufficient
“linking” between the accountant and the
plaintiff third party where the only conduct between the two involved a single
telephone conversation initiated by the
plaintiff third party lender to the accountant, during which the lender announced
its intended reliance on the accountant’s
work and made inquiries regarding the
audit being performed by the accountant.
The court held that the contact between
the accountant and the plaintiff third party
was insufficient to establish liability and
determined that accepting the arguments
of the plaintiff third party would create an
extraordinary obligation on the accountant’s part by establishing liability based
on a single phone call. Similarly, in SIPC
v. BDO Seidman, 746 N.E.2d 1042 (N.Y.,
2001), the court held there was no “linking” conduct putting the accountant in
privity with the plaintiff third party since
the audits prepared by the accountant were
not for the specific benefit of, nor sent to,
the non-­client third party.
In legal malpractice cases, the strongest
challengers to the traditional strict privity
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requirement have been will beneficiaries or
personal representatives of estates. See Limits on the Privity and Assignment of Legal
Malpractice Claims, 59 U. Chi. L. Rev. 1533,
1539–40 (1992). Beneficiaries and personal
representatives make sympathetic third-­
party, non-­client plaintiffs because, by the
time any drafting error in estate planning
documents is discovered, the testator-­client
is usually deceased, depriving him or her of
the ability to bring the malpractice suit personally. Thus, a good test of a state’s adherence to the privity-­of-­contract approach is
to determine whether the state permits either will beneficiaries or personal representatives to bring legal malpractice claims for
drafting errors. The strong national trend
has been to abandon the strict privity requirement in such circumstances, and to
permit beneficiaries and personal representatives to sue for legal malpractice. See,
e.g., Stanley L. & Carolyn M. Watkins Trust
v. Lacosta, 92 P.3d 620, 626 (Mont. 2004).
For decades, New York was the most
notable holdout from the overall trend.
See Viscardi v. Lerner, 125 A.D.2d 662, 664
(N.Y. App. Div.
Dep’t., 1986). In 2010,
however, even that bastion of strict privity relaxed its approach. Estate of Schneider v. Finmann, 933 N.E.2d 718, 720–21
(N.Y. 2010). Notably, however, New York
chose to abandon its ban on malpractice
actions by the personal representative of
the estate without abandoning the privity-­
of-­contract approach. Id. Instead, New York
held that “privity, or a relationship sufficiently approaching privity, exists between
the personal representative of an estate and
the estate planning attorney [because] the
estate essentially stands in the shoes’ of a
decedent and, therefore, has the capacity
to maintain the malpractice claim on the
estate’s behalf.” Id. (citations and internal quotation marks omitted). Even while
relaxing its rule to permit the estate sufficient privity to sue, New York affirmed its
overall approach, emphasizing that “strict
privity remains a bar against beneficiaries’
and other third-­party individuals’ estate
planning malpractice claims absent fraud
or other circumstances.” Id. at 721. Thus, in
New York the current rule is that the estate
has privity-­of-­contract to sue for legal malpractice, but the beneficiaries do not.
In contrast to New York’s recent step
towards relaxing its absolute privity-­of-­
contract requirement, some states do
still maintain the traditional privity-­of-­
contract rule even in the estate planning
context. Robinson v. Benton, 842 So. 2d 631,
636 (Ala. 2002). In Robinson, the Alabama
Supreme Court confirmed its adherence to
the traditional strict privity rule, even in
the face of the overall national trend.
Restatement Approach
The approach adopted by a majority of the
states when determining whether a third
party has standing to bring a malpractice
claim against a professional is one which
follows the Restatement (Second) of Torts
(1977), Section 552. Under this approach,
the plaintiff third party must be in a class
of individuals or entities which normally
rely upon the professional’s work and the
professional knows, or reasonably should
know, of the reasonable reliance by this
class. This approach, like the privity-­of-­
contract approach, has been applied to both
legal and accounting malpractice cases.
The Restatement (Second) of Torts
(1977), Section 552, provides in pertinent part:
(1) One who, in the course of his business, profession or employment, or in
any other transaction in which he has a
pecuniary interest, supplies false information for the guidance of others in their
business transactions, is subject to liability for pecuniary loss caused to them
by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or
communicating the information.
The liability stated in Subsection (1) is limited to:
loss suffered (a) by the person or one of a
limited group of persons for whose benefit and guidance he intends to supply
the information or knows that the recipient intends to supply it; and (b) through
reliance upon it in a transaction that he
intends the information to influence or
knows that the recipient so intends or in
a substantially similar transaction.
Restatement (Second) of Torts, Section 552.
The policy behind Section 552 is
explained in the comments accompanying
the section, specifically:
[T]he duty of care to be observed in
supplying information for use in commercial transactions implies an under-
taking to observe a relative standard,
which may be defined only in terms of
the use to which the information will
be put, weighed against the magnitude
and probability of loss that might attend
that use if the information proves to be
incorrect. A user of commercial information cannot reasonably expect its
maker to have undertaken to satisfy this
obligation unless the terms of the obligation were known to him. Rather, one
who relies upon information in connection with a commercial transaction may
reasonably expect to hold the maker to
a duty of care only in circumstances in
which the maker was manifestly aware
of the use to which the information was
to be put and intended to supply it for
that purpose.
Id. comment a, at 128.
With regard to the requirement that the
plaintiff be a member of a “limited group
of persons for whose benefit and guidance”
the comments to the section provide:
[I]t is not required that the person who
is to become the plaintiff be identified
or known to the defendant as an individual when the information is supplied. It is enough that the maker of the
representation intends it to reach and
influence either a particular person or
persons, known to him, or a group or
class of persons, distinct from the much
larger class who might reasonably be
expected sooner or later to have access
to the information and foreseeably to
take some action in reliance upon it….
It is sufficient, in other words, insofar
as the plaintiff’s identity is concerned,
that the maker supplies the information for repetition to a certain group or
class of persons and that the plaintiff
proves to be one of them, even though
the maker never had heard of him by
name when the information was given.
It is not enough that the maker merely
knows of the ever-­present possibility of
repetition to anyone, and the possibility
of action in reliance upon it, on the part
of anyone to whom it may be repeated.
Id. comment h, at 132-133.
Cases Applying the Restatement Approach
to Claims Against Accountants
In Bily v. Arthur Young & Co., 834 P.2d 745
(Cal. 1992), the California Supreme Court
concluded that the Restatement approach
properly balances the indeterminate liability of the foreseeability test and the
restrictiveness of the near-­privity rule as it
“recognizes commercial realities by avoiding both unlimited and uncertain liability
for economic losses in cases of professional
mistake and exoneration of the auditor
in situations where it clearly intended to
undertake the responsibility of influencing
particular business transactions involving
third persons.” Id. at 769.
The Restatement approach was applied
to an accounting malpractice claim in
Hogue v. Hopper, 728 A.2d 611 (DC 1999),
where the court determined that accountants should be treated no differently from
attorneys and noted that “[a]n accountant may be held liable to stockholders of
a closely held corporation if the accountant knew (or, arguably, if he should have
known) that the stockholders would rely
on the accountants’ representation.” Id. at
615, fn. 4.
The extent to which the courts have
applied the Restatement approach can
be seen by comparing Haddon View
Investment, Co. v. Coopers & Lybrand,
436 N.E.2d 212 (Ohio 1982) and Federated Mgmt. Co. v. Coopers & Lybrand, 738
N.E.2d 842 (Ohio Ct. App. 2000). In Haddon View, limited partners in two business
enterprises asserted professional malpractice, breach of contract, concealment, and
fraud and deceit claims against Coopers
& Lybrand, the accounting firm that had
performed general accounting work for
the two business enterprises. After the
trial court dismissed the limited partners’ claims, an appeal was taken which
included the trial court’s dismissal of the
breach of contract and professional malpractice claims on the basis that the limited partners lacked standing to assert
such claims. Relying on the Restatement,
the Ohio Supreme Court held that “an
accountant may be held liable by a third
party for professional negligence when
that third party is a member of a limited
class whose reliance on the accountant’s
representation is specifically foreseen.”
Haddon View, 436 N.E.2d at 215. The court
went on to find that the limited partners
“constitute[d] a limited class of investors
whose reliance on the accountant’s certified audits for purposes of investment
strategy was specifically foreseen by [Coopers & Lybrand].” Id.
In comparison, in Federated Management., supra., the Court of Appeals of Ohio
declined to extend Haddon View to a group
of investment advisers and managers for
purchasers of notes issued by a corporation
for whom Coopers & Lybrand had audited
financial statements and rendered consult-
The most restrictive
approach to privity taken by
a small minority of states
is referred to as the privity
or near privity approach.
ing services. Federated Management. The
court determined no fiduciary relationship existed between the plaintiff third parties and Coopers & Lybrand as the plaintiff
third parties “were not a known group
possessed of vested rights and marked by
a definable limit. Indeed, they were more
akin to the extensive, faceless, and indeterminable investing public-­at-large.” Federated Mgmt., 738 N.E.2d at 856.
Cases Applying the Restatement
Approach to Claims Against Lawyers
For lawyers, the Restatement approach has
most commonly been applied to claims for
negligent misrepresentation, rather than to
legal malpractice claims per se. For example, in McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991 S.W.2d 787,
789 (Tex. 1999), the Texas Supreme Court
applied the Restatement approach to a claim
that the defendant-­attorneys had negligently
misrepresented a settlement agreement was
in compliance with federal banking law. The
court held that the Restatement test meant
that the negligent misrepresentation claim
could proceed, while notably also maintaining that “allowing a non[-­]client to bring a
negligent misrepresentation cause of action against an attorney does not undermine the general rule that persons who are
not in privity with an attorney cannot sue
the attorney for legal malpractice.” Id. at 791.
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PROFESSIONAL LIABILITY
Likewise, in Mehaffy, Rider, Windholz &
Wilson v. Central. Bank Denver, N.A., 892
P.2d 230, 236 (Colo. 1995), the Colorado
Supreme Court adopted the Restatement
approach for negligent misrepresentation
claims against lawyers, and held that “[p]
rivity is not a necessary element of a claim
for negligent misrepresentation.”
Thus, a good testof
a state’s adherence to
the privity-­of-­contract
approach is to determine
whether the state permits
either will beneficiaries or
personal representatives
to bring legal malpractice
claims for drafting errors.
Foreseeability Approach
A limited number of states follow the
foreseeability approach when addressing
whether a third party is in privity with the
defendant professional. Under the foreseeability approach, the professional is liable
to an individual or entity that the professional could reasonably foresee obtaining and relying upon the professional’s
work. Liability to non-­client third parties
can be widespread under the foreseeability approach, because the work performed
by the professional is highly dependent
upon the statements and information supplied by the client to the professional and
the client controls the dissemination of the
professional’s work upon the completion
of the work. As many courts have noted in
rejecting foreseeability as a test, if the foreseeability approach is applied, “a thoughtless slip or blunder, the failure to detect a
theft or forgery beneath the cover of deceptive entries, may expose accountants to a
liability in an indeterminate amount for
an indeterminate time to an indetermi-
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nate class.” Ultramares Corp v Touche, 255
N.Y. 170, 179 (1931). Nonetheless, certain
states—chiefly California, and primarily
in misrepresentation cases—have applied
a foreseeability analysis to privity professional malpractice cases.
By way of example, in Roberts v. Ball,
Hunt, Hart, Brown & Baerwitz, 57 Cal.
App. 3d 104, 111 (Ct. App. 1976), the California Court of Appeals applied the foreseeability approach to permit a negligent
misrepresentation suit against a defendant-­
attorney who had represented to the plaintiff that a certain company, BBC, was a
general partnership, which turned out to be
false. The court permitted the claim against
the lawyer to stand, arguing that “defendants undertook, on behalf of their clients,
to assist in securing loans from various
persons, including plaintiff, for the benefit
of BBC. The defendants’ opinion concerning the status of the partners was rendered
for the purpose of influencing plaintiff’s
conduct, and harm to him was clearly foreseeable.” Id.
Third-Party Beneficiary Approach
Certain states have adopted a third-­party
beneficiary approach, derived from contract law, to assessing privity. This approach
asks whether the party seeking to sue the
professional was an intended third-­party
beneficiary of the professional’s work by
asking if: (1) the recognition of the beneficiary’s right would be “appropriate to effectuate the intent of the parties,” and (2) the
performance would “satisfy the obligation
of the promisee to pay money to the beneficiary” or “the circumstances indicate that
the promisee intends to give the beneficiary
the benefit of the promised performance.”
Guy v. Liederbach, 459 A.2d 744, 751 (Pa.
1983) (citing Restatement (Second) of Contracts §302 (1979)).
In Chen v. Chen, 893 A.2d 87, 92 (Pa.
2006), the Pennsylvania Supreme Court
applied the third-­
p arty beneficiary
approach to decide whether a child could
sue an attorney for the allegedly negligent
drafting of a child support agreement. The
court held that the child was not a third-­
party beneficiary of her parents’ divorce
settlement, finding that the child was “not
an intended beneficiary under Section 302
[of the Restatement (Second) of Contracts]
and Guy because recognition of [her] right
to performance is not “‘appropriate to effectuate the intention of the parties.’” Id. at 96.
As a result, the child had no right to raise a
claim against the attorney who drafted the
child support agreement. Id.
Balancing of Factors Approach
The balancing of factors approach was
established in the California cases of
Biakanja v. Irving, 320 P.2d 16 (Cal. App.
1958), and Lucas v. Hamm, 364 P.2d 685
(Cal. App. 1961). The balancing approach
“involves the balancing of various factors, among which are the extent to which
the transaction was intended to affect the
plaintiff, the foreseeability of harm to him,
the degree of certainty that the plaintiff
suffered injury, the closeness of the connection between the defendant’s conduct
and the injury suffered, the moral blame
attached to the defendant’s conduct, and
the policy of preventing future harm.”
Stewart v. Sbarro, 362 A.2d 581, 588 (NJ
Super. App. Div. 1976).
In Stewart, 362 A.2d at 588, the New
Jersey court applied the balancing of factors approach to a case involving the sale
of all of the stock of a closely-­held corporation. The defendant-­attorney in Stewart,
who represented the plaintiffs, had taken
some documents at closing, promising the
buyers that he would return them with the
necessary signatures. Id. at 585. He then
failed to do so, and the buyers sued. Id. at
587. The court held that the balancing of
the factors at play in the case indicated that
the defendant-­attorney did owe a duty to
the buyers vis-à-vis the documents. Id. at
594. As a result, the suit could proceed. Id.
Statutory Approach for
Accounting Malpractice
The law of privity as to both lawyers and
accountants in most states is based in the
common law. However, select states have
enacted accountant liability statutes that
expressly limit the third parties who have
standing to sue accountants and under
what circumstances. Specifically, Arkansas
[ACA §16-114-302], Illinois [IL ST CH III
¶ 5535.1], Kansas [KSA 1-402], Louisiana
[LSA-RS 37:91], Michigan [MCL 600.2962],
New Jersey [NJSA 2A-53A-25], Utah [UCA
1953 §58-26a-602], and Wyoming [WS
1977 §33-3-201] have enacted such statutes. In accounting malpractice cases only,
certain states have passed statutes defining exactly which third parties can bring a
suit against an accountant. No such similar
statutes exist for legal malpractice, and a
lawyer’s liability to non-­client third parties
is entirely governed by the common law.
The rationale behind the statutes that
have been enacted is that an accountant
has the right to know the individuals and/
or entities for whom his work is intended
and who will rely upon his work. Once
that information is known to the accountant, the accountant should then be liable
to the person if the accountant’s work is
done negligently. If the client knows that
he intends to benefit or influence a third
party but fails to so advise the accountant,
the accountant should not be held liable to
the third party. Some states require that
the accountant be made aware of the third
party’s intended reliance at the time of the
engagement (Michigan, Arizona) while
other states do not (Illinois).
The language of the various state statutes are on par with each other and provide that an accountant shall not be liable
to persons not in privity, except for:
• Acts, omissions, decisions, or conduct
that constitutes fraud or intentional misrepresentations; or,
• Acts, omissions, decisions, or conduct if
the accountant is aware that a primary
intent of the client is for the professional
services to benefit or influence the third
party. Certain of the states with Accountant Liability statutes require a writing
between the accountant and his client
specifically identifying those persons
who are intending to rely on the accountant’s services.
Given the mandates of the explicit
Accountant Liability statutes, one would
assume that, absent a writing authored by
the accountant indicating the accountant’s
understanding and intention that his work
would benefit the third party, a third party
would be hard pressed to establish that it
has standing to sue an accountant for professional malpractice in states that have
enacted privity statutes. However, that has
not necessarily been the case. By way of
example, in Reynolds v. Bickel, 307 P.3d 570
(Utah, 2003), the owner of the client business successfully argued that he had standing to bring a professional negligence claim
against an accountant arising out of the
accountant’s work in attempting to minimize the owner’s tax liability from the sale
of the client’s assets and the assets of two
other entities. At issue in Reynolds was
whether the accountants had identified in
writing to their client that the professional
services being performed on behalf of the
client were intended to be relied upon by
the third party owner, as required by Utah
statute, UCA 1953 §58-26a-602. Reversing the trial court’s determination that the
accountant did not have standing, the Utah
Supreme Court first took into consideration
the facts of the case, which included the
fact that the owner (Reynolds) negotiated
the asset sale of three limited liability companies of which he was the sole shareholder
and that the companies were S corporations, which required Reynolds to report
the tax liability for the sale of the companies on his personal tax return. Although
the retention agreement with the accounting firm named one of the companies as the
“client,” Reynolds signed the agreement on
behalf of the company.
Determining that both the knowledge
requirement of subsection (2)(a) and the
writing requirement of subsection (2)(b)
of Utah’s accountant liability statute had to
be fulfilled before an accountant could be
liable to a third party, the Reynolds court
determined that “subsection (2)(b) does
not require an explicit statement in a single writing; it requires an ‘identifi[cation]
in writing’ that a third party is intended to
rely on the accountants’ services.” Reynolds, 307 P.3d at 574. Comparing Section
602 to the statute of frauds, the court determined that “for purposes of Section 602(2)
(b), one or more writings, not all of which
are authored by the party to be charged,
may be considered together as a memorandum if there is a nexus between them.”
Id., emphasis in original. The court then
accepted Reynolds’ presentation of 25
e-mails exchanged between the accountant and the company’s in-house counsel,
which focused on Reynolds’s potential tax
liability, as a writing that met the requirements of the statute.
One Illinois appellate court determined
that the fact that an accountant does not
write a letter identifying a third party as
an individual or entity that could rely on
the accountant’s work for the client does
not preclude finding that the accountant
is liable for the third party’s loss. In Chestnut Corp. v. Pestine, Brinati, Gamer, Ltd.,
667 N.E.2d 543 (Ill. App., 1996), the defendant accounting firm claimed that an
accountant could never be liable to a third
party unless the accountant gave written notice to the third party. Id., 281 Ill.
App. 3d at 723. After reviewing the Illinois accountant privity statute, specifi-
The approach adopted
by a majority of the states
when determining whether
a third party has standing
to bring a malpractice
claim against a professional
is one which follows the
Restatement (Second) of
Torts (1977), Section 552.
cally, subparagraph (2), the court stated
that “if the second clause in subparagraph
(2) of section 30.1 meant what defendants
claim it means—that there can never be
liability unless a letter is written—then
the first clause is trumped in all cases and
becomes meaningless surplusage.” Id., 281
Ill. App. 3d at 724. The court noted then
that a third party may state a cause of
action under the statute even though there
is no writing, specifically stating that “[w]
hen the accountant writes to no one, the
plaintiff must show the intent of the client
and knowledge of the accountant of that
intent.” Id. The court went on to find that
the plaintiff had shown that an issue of fact
existed regarding whether the accountant
knew its client intended plaintiff to rely on
the reports and financial statements prepared by the accountant, noting that the
third party and the accountant had visited the other’s respective offices and had
discussed a financial statement that the
accountant had given to the third party.
The court, therefore, held that a party not
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PROFESSIONAL LIABILITY
in privity with the accountant may bring
a cause of action against the accountant
for non-fraud claims if the party could
show intent through other evidence similar to awriting.
A highly restrictive approach to New Jersey’s accountant privity statute was taken
in Cast Art Industries, LLC v. KPMG LLP,
36 A.3d 1049 (New Jersey, 2012), when an
For lawyers,the
Restatement approach
has most commonly
been applied to claims for
negligent misrepresentation,
rather than to legal
malpractice claims per se.
acquiring company and its shareholders
brought a malpractice action against an
accounting firm that had prepared financial statements for the acquired company.
In Cast Art, the plaintiff asserted that had
KPMG not performed a negligent audit
of the acquired company, the accounting irregularities of the acquired company would have been revealed and Cast
Art would not have acquired the business. KPMG asserted that it could not be
held liable to Cast Art because it did not
know at the time that it agreed to perform the audits that its client and Cast Art
were contemplating a merger and that Cast
Art would be relying on KPMG’s auditing work. It further asserted that KPMG’s
mere knowledge that Cast Art needed the
audit reports to complete the merger transaction did not equate to an agreement by
KPMG that it owed an independent duty
to Cast Art.
In reaching its decision, the New Jersey Supreme Court focused on the phrase
“at the time of the engagement by the client,” in NJSA 2A:53A:-25 and determined
that the phrase was susceptible to two plausible interpretations. Initially, the court
rejected the lower appellate court’s conclu-
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sion that the phrase should be interpreted
consistently with the Code of the Professional Conduct of the American Institute
of Certified Public Accountants (AICPA),
under which an accountant’s “engagement” spanned the entire period of the
professional relationship with the client.
Cast Art, 36 A3d at 1058. The court then
reviewed the legislative history of the statute and determined that, in enacting the
statute, the New Jersey Legislature clearly
intended to restrict the potential scope of
an accountant’s liability to third parties for
the accountant’s negligent acts. Id. Guided
by the fact that the legislature inserted
the phrase “by the client” at the time it
amended the statute to require actual
knowledge on the part of the accountant,
as opposed to mere general awareness,
the court construed NJSA 2A:53A-25 so
as to interpret the phrase “at the time of
the engagement’” to mean “at the outset
of the engagement.” Id. Such construction,
the court determined, was “more consistent with the overall intent of the Legislature to narrow the circumstances under
which an accountant may be liable to a
third party than a construction that interprets the phrase to mean ‘any time during
the engagement’.” Id., 36 A3d at 1058-59.
The court further determined that the statute required “agreement, not mere awareness, on the part of the accountant to the
planned use of his work product.” Id., 36
A3d at 1060.
The Michigan legislature recently
amended its accountant liability statute
to make it more restrictive. The statute
requires a third party plaintiff to prove:
(1) the certified public accountant was
informed; (2) in writing; (3) by the client;
(4) at the time of the engagement; (5) that
the primary intent of the client was for the
professional public accounting services to
benefit or to influence the person bringing
the action for civil damages.
Further, subsection (c) of Michigan’s
statute imposes a reciprocal obligation
upon the certified public accountant. The
certified public accountant is required
to: (1) identify; (2) in writing to the client; (3) each person, generic group, or
class description that the certified public
accountant intends to have rely on the services. The certified public accountant may be
held liable “only” to each identified person,
generic group, or class description. Thus,
MCL 600.2962(c) establishes a two-­pronged
test requiring, on the one hand, that the
certified public accountant be informed
in writing by the client, at the time of the
engagement, of which parties the client
intends the accounting services to benefit
or influence and, on the other, that the certified public accountant identify in writing
to the client at the time of the engagement
those parties whom the accountant intends
to have rely on the services.
In comparison to Michigan’s statutes,
which burdens the third party with establishing the existence of writings by the
accountant and his client at the time of
the engagement indicating the third party
is to benefit from the accountant’s services, states such as Wyoming put the burden on the accountant to establish and
produce such a writing. The writing must
also include a statement “in a prominent
place that advises users of the document
that the liability of the accountant to third
parties who use the document may be limited pursuant to [statute].” WS 1977 §33-3201(d)(ii).
Application of Privity Analyses
to Common Factual Scenarios
Involving Suits by Plaintiff Third
Parties Against Professionals
Now that you can converse sufficiently
with Larry Lawyer and Amy Accountant
about the basic approaches to privity taken
by the states, a look at a few common scenarios in which non-­clients sue professionals is in order. While the courts in the
following cases do not always conduct a
formal privity analysis relying on one of
the approaches discussed above, the policy considerations underlying the privity
approaches do drive the courts’ handling
of these common situations.
Client Assigns Cause of Action to
Third Party Who Brings Cause of
Action Against Professional
Here, there is a difference between the
treatment of legal and accounting malpractice claims. The majority of states do
not permit the transfer of legal malpractice claims by assignment, following Goodley v. Wank & Wank, Inc, 62 Cal. App. 3d
389 (1976). In Goodley, the court held that
permitting the assignment of legal mal-
practice claims “could only debase the legal
profession,” because assignment “would
encourage unjustified lawsuits against
members of the legal profession, generate
an increase in legal malpractice litigation,
promote champerty and force attorneys to
defend themselves against strangers.” Id.
at 397–98. This outright ban on the assignment of legal malpractice claims has been
affirmed by the courts of many states. See,
e.g., Joos v. Drillock, 127 Mich App 99, 105
(1983). For example, the Michigan Court of
Appeals held that legal malpractice claims
can never be assigned, stating that:
the ever present threat of assignment
and the possibility that ultimately the
attorney may be confronted with the
necessity of defending himself against
the assignee of an irresponsible client
who, because of dissatisfaction with
legal services rendered and out of resentment and/or for monetary gain, has
discounted a purported claim for malpractice by assigning the same, would
most surely result in a selective process
for carefully choosing clients thereby
rendering a disservice to the public and
the profession.
Id. at 103–04. A few states, however, do
permit the assignment of legal malpractice claims. See, e.g., Hedlund Mfg. Co., Inc.
v. Weiser, Stapler & Spivak, 539 A.2d 357,
359 (Pa. 1988).
In contrast, states often permit the
assignment of accounting malpractice
claims, reasoning that the underlying policy concerns are different given the difference between the lawyer-­client and
accountant-­client relationships. See, e.g.,
Nat’l Union Fire Ins. Co. of Pittsburgh, Pa.
v. KPMG Peat Marwick, 742 So. 2d 328, 331
(Fla. Dist. Ct. App. 1999) approved, 765
So. 2d 36 (Fla. 2000) (“Therefore, because
accounting malpractice claims differ in a
number of crucial ways from legal malpractice claims, we have no difficulty in
concluding that the former should not be
prohibited from assignment and that the
insured’s claim in this case was an assignable claim.”); see also Riley v. Ameritech
Corp., Inc., 147 F. Supp. 2d 762, 770 (E.D.
Mich. 2001) (applying Michigan law prior
to the 2012 amendment of MCL 600.2962);
First Cmty. Bank & Trust v. Kelley, Hardesty, Smith & Co., Inc., 663 N.E.2d 218, 220
(Ind. Ct. App. 1996).
Client Enters into Asset Purchase
Agreement with a Third Party Who Brings
a Cause of Action Against a Professional
Some courts have found that the policy
considerations underlying the ban on the
assignment of legal malpractice claims are
not present when the claim is transferred
as part of a larger asset sale from one business to another. In St. Luke’s Magic Valley Regional Medical Center v. Luciani,
293 P.3d 661, 664 (Idaho 2013), the Idaho
Supreme Court held that the assignment of
a legal malpractice claim to a client’s successor in interest as part of a larger commercial transaction was valid. There, the
plaintiff brought a legal malpractice claim
against the defendant based on its status as
a successor-­in-­interest to the defendant’s
client. Id. at 663. The plaintiff had purchased all of the client’s assets as part of
its overall acquisition of the client’s business operations. Id. The Idaho Supreme
Court found that a distinction should be
drawn between “assignments to strangers, or former adversaries in litigation, as
opposed to successors.” Id. at 668. It reasoned that, without such a rule, “the mere
fortuity of [a] change in corporate ownership would mean that [an attorney] could
entirely escape liability for any alleged malpractice.” Id. Thus, to prevent “leaving clients without recourse,” the Idaho Supreme
Court held that the assignment of legal
malpractice claims would be permitted in
the context of a larger commercial transaction. Id. Similar conclusions have been
reached by the courts of several other jurisdictions as well. See Hedlund Mfg Co v.
Weiser, Stapler & Spivak, 359 A.2d 357, 359
(Pa. 1988); Thruston v. Cont’l Cas Co, 567
A.2d 922, 923 (Me. 1989); Cerberus Partners, LP v. Gadsby & Hannah, 728 A.2d
1057, 1059 (R.I. 1999); Richter v. Analex
Corp, 940 F. Supp. 353, 357 (D.D.C. 1996).
In contrast, in Earth Science Laboratories, Inc v. Adkins & Wondra, PC, the
Nebraska Supreme Court refused to permit the assignment of a legal malpractice
claim even as part of a larger commercial
transaction. 523 N.W.2d 254, 256 (Neb.
1994). Earth Science Laboratories relied
on the reasoning of the Kansas Supreme
Court in Bank IV of Wichita v. Arn, Mullins, Unruh, Kuhn & Wilson, 827 P.2d 758
(Kan. 1992), and found that “the same policy reasons which prevent assignment of
legal malpractice claims also prevent transfer of such claims by succession.” Id. Similarly, the court in General Sec. Ins. Co. v.
Jordan, Coyne & Savits, LLP, 357 F. Supp.
2d 951, 961 (E.D. Va. 2005) applied Virginia’s “bright-line rule against the assignment
of legal malpractice claims” and refused to
permit the transfer of a legal malpractice
claim by corporate succession.
Under the foreseeability
approach, the professional
is liable to an individual or
entity that the professional
could reasonably foresee
obtaining and relying upon
the professional’s work.
Third Party Acquires Cause of
Action Through Merger
Courts have drawn a distinction between
an asset sale and a merger when dealing
with privity issues. See, e.g., Greene’s Pressure Treating & Rental, Inc v. Fulbright
& Jaworski, LLP, 178 S.W.3d 40, 44 (Tex.
App. 2005) (citing In re Cap Rock Elec Corp,
Inc, 35 S.W.3d 222, 227 (Tex. App. 2000)).
In making this distinction, courts have
refused to defer blindly to the label applied
to a particular transaction by the parties.
See In re Cap Rock, 35 S.W.3d at 228-29.
Instead, courts have examined the “practical consequences” of the deal “rather than
the formalities of the particular transaction.” Tekni-Plex, Inc v. Meyner & Landis,
674 N.E.2d 663, 643 (N.Y. Ct. App. 1996).
In assessing whether the practical consequences of a deal point toward a merger
or an asset sale, courts have examined
several factors. First, they have looked
at whether a genuine attempt is made by
the successor company to “continue the
pre-­existing operation” of the prior company. Id. (citing FDIC v. Amundson, 682 F.
Supp. 981 (D. Minn. 1988)). Thus, in Tekni-­
Plex, where the acquiring company ran
the selling company’s business essentially
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PROFESSIONAL LIABILITY
unchanged, “with the same products, clients, suppliers and non-­managerial personnel,” the court found that the deal was
a merger. Id. On the other hand, where
the assets of the selling company are used
to run the acquiring company’s own pre-­
existing operation, rather than being continued as a separate business entity, courts
have founds that no merger takes place.
In accountingmalpractice
cases only, certain states
have passed statutes
defining exactly which third
parties can bring a suit
against an accountant.
Greene’s Pressure Treating, 178 S.W.3d at
44. Similarly, an acquisition that is part of
the complete liquidation of the selling company is not a merger. FDIC v. McAtee, 124
F.R.D. 662, 664 (D. Kan. 1988).
In addition to looking at whether corporate operations substantially continued
post-­acquisition, courts have also examined
several other aspects of a deal. They have assessed whether the transaction transferred
liabilities to the purchasing company along
with assets. See, e.g., Goodrich, 960 A.2d at
140; In re Cap Rock, 35 S.W.3d at 229. They
have scrutinized what percentage of an entity’s assets passed to the successor company.
See Greene’s Pressure Treating, 178 S.W.3d at
44. Finally, they have looked at whether the
owners of the selling company took on managerial or ownership roles in the acquiring
company. See In re Cap Rock, 35 S.W.3d at
229. Courts have balanced all of these factors in determining whether the “practical
consequences” of a certain arrangement indicate that a merger or a mere sale of assets
took place.
In Pell v. Weinstein, 759 F. Supp. 1107
(W.D. Pa. 1991), the court dealt with privity issues in a merger deal. There, the shareholders of the acquired corporation brought
suit against the acquiring corporation, its officers, directors and accountants. As to the
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accountants, the shareholder plaintiffs alleged claims of breach of a third party beneficiary contract and professional negligence.
Applying Pennsylvania law, the court found
no basis for a third party beneficiary claim
in spite of the plaintiffs’ argument that, as
potential investors, they were the contemplated users of the financial statements prepared by the accountants. Id., 759 F. Supp. at
1119. The court also rejected the plaintiffs’
professional negligence claim finding that in
order to maintain a professional negligence
action under Pennsylvania law, there must
be privity of contract between the parties.
Id. The court rejected plaintiffs’ argument
that the current business environment demanded the establishment of a new benchmark for accountant liability which would
require the abandonment of a requirement
of privity. Id., 759 F. Supp. at 1120.
Conclusion
So, now that you’re familiar with the various approaches taken to privity in legal
and accounting malpractice cases, what
answer can you provide Larry Lawyer
and Amy Accountant as to whether they
can be sued by Beta Widget Co.? Well, as
you can no doubt tell by now, that will
depend on the specific approach to privity taken by the state in which Larry and
Amy practice. A privity-­of-­contract state
with an accounting liability statute is
probably good news for Larry and Amy.
A foreseeability state is probably bad news
for them.
Is there anything Larry Lawyer and
Amy Accountant could have done to help
limit their exposure to any potential claim
by Beta Widget no matter which approach
their state of practice takes to privity?
Yes. Whether an attorney or an accountant, certain “good practice” approaches
should be taken upon undertaking representation of any client. Specifically, a professional should have an understanding
of the individuals who will and who may
rely upon the professional’s work and keep
those individuals’ actual or potential reliance in mind throughout the course of
the professional’s engagement. The professional should prepare an engagement
letter outlining the scope of his engagement and specifically identifying the client as well as any known third party that
the client has indicated will rely upon the
professional’s work. Finally, the engagement should be reviewed and discussed
with the client. The professional should
then have the client sign off on the engagement letter acknowledging the scope of
the engagement as well as those individuals or entities who will rely upon the professional services.