An Accountant’s Liability or a Client’s Loans, What?

November 2, 2017

By Mark F. Himsworth, Esq.

Does an accountant who prepares financial statements for a client’s use in obtaining a loan have exposure to the lender when the client subsequently becomes incapable of repaying the loan? Even when the accountant has no direct relationship with the lender? This question was very recently addressed by the Pennsylvania Superior Court in Fulton Bank v. Sandquist, and the answer is – definitely maybe.

In Fulton Bank, the bank issued a commitment for a commercial line of credit in the amount of $4.2 Million, another loan in the amount of $1.8 Million, and another commercial loan in the amount of $1.25 Million, after it reviewed a borrower’s financial statements. Eventually, the borrower ceased operations and was without sufficient assets to repay the loans. The bank later learned of certain systematic fraudulent practices of the borrower with respect to its accounts receivable reporting, whereby the borrower “refreshed” accounts receivable that had aged to or beyond 90 days from the original date of the invoice. The bank claimed that the accountants were aware of this practice, although there was no allegation that this practice was initiated by the accounting firm, or that there was any collusion with accountants. Instead, the bank alleged that the accountants did not take sufficient steps to determine whether the age of receivables remained less than one year old. This practice, they contended, violated generally accepted accounting principles (GAAP). Consequently, the bank sued the accounting firm.

Notably, the trial court found for the accountants. In the trial court’s view, the accountants were not engaged for the specific purpose of preparing financial statements to be used in obtaining credit from the bank, or any other potential lending institution. In the trial court’s opinion, in the absence of any allegations to the contrary, the financial statements provided to the bank were prepared in the regular course of the ongoing business relationship between the borrower and the accountants; that the statements were prepared for the borrower and no one else; and that the relationship between the borrower and the accountants predated any contact with the bank by many years. While the information was ultimately transmitted to the bank for review, the trial court found there was no allegation that the accountants prepared the financial documentation with actual notice that it would be used by the bank (or some other lending institution as opposed to internal use by the borrower). Thus, the trial court dismissed the suit against the accountants.

On appeal, however, the Superior Court reversed. According to the Superior Court, contrary to the trial court’s view, the bank did allege facts sufficient to state a claim for “negligent misrepresentation.” The bank alleged that the accountants were in the business of supplying professional accounting information for the borrower; that they supplied information regarding the financial condition of the borrower specifically for a meeting with the bank; that an accountant was present at that meeting where those financial statements were discussed; and that the bank specifically relied upon this information and extended multiple loans to the borrower. Relying upon Bilt-Rite, an analogous case whereby liability was imposed upon architects and design professionals whose erroneous information was relied upon by a contractor, the Superior Court pointed out that there can be liability where it is “foreseeable” that the accounting information would be used and relied upon by third persons, even if there were no direct contractual relationship with them.

The bottom line: adhere to GAAP, err on the side of caution, know your audience, know your foreseeable audience, and in any engagement, to the extent possible, limit who can rely upon what’s been prepared.

Questions Every Business Must Ask

Q. Has your business recently reviewed its legal structure to determine whether it is set up in the most advantageous manner for legal and tax purposes, considering recent developments and changes in the law?

Q. Do the owners of your business have a current, updated buy-sell agreement which controls how ownership interests in the business are to be transferred in the event of an owner’s death, disability or termination of employment?

Q. Have the owners of your business developed a succession plan to define how ownership and authority will transition upon the death or retirement of the present owners?

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