You look over a company's audited financial statements, figure that it looks sound, and decide to do business with it -- extend it credit or write an insurance policy covering its liability. But in fact the auditing was sloppy, not catching significant weak spots in the operation. The company falters. Can you sue the auditor?
Courts have been debating that question for decades. Last month two decisions, handed down within a week of each other, make clear that the answer is still "it depends."
What it depends on, more than anything else, is where all this happens. It is state law that defines the situations in which a plaintiff can collect damages. State legislatures seldom pass laws stating exactly when an accountant can be sued, but state and federal judges read their tea leaves and decide what the lawmakers would be most likely to do.
Some states, following a 1931 decision by the top court in New York, say that the accountant is paid by the client and owes no duty to anyone else. The only time anyone else hurt by the negligence can sue is if the client made it clear that the report was going to be shown to a company in hopes of, say, getting it to open a line of credit. On Aug. 19, the U.S. Court of Appeals in Chicago, in Toro Co. v. Krouse, Kern, decided that was the route to be followed in Indiana.
Other jurisdictions have taken a middle ground, holding the accountants liable when they knew that the client was going to show the statement to a particular category of third parties -- such as potential suppliers -- even if they did not know exactly which other companies were likely to rely on the document. But auditors are still protected from suits by any other businesses that used the audit.
In 1983, however, state courts in New Jersey and Wisconsin went further. Auditors owe a duty of doing a competent job to all those whom they might "reasonably foresee" would rely on the financial statements, these courts say.
That doesn't mean that if the accountants fouled up anyone at all may sue, but it does mean that vendors, inventors and lenders -- those businesses that typically look at financial statements to make big decisions -- should be able to count on the auditor doing the job right.
On Aug. 26, the Mississippi Supreme Court agreed. There's no sense in letting some third parties sue and not letting all predictable players have the same right, the justices said in Touche Ross v. Commercial Union.
In other cases, courts ruled that: Occupational health officials can close the barn door before the horse is stolen. The U.S. Court of Appeals in Washington backed Labor Department demands that textile companies begin medical surveillance of workers involved in cotton processing, even though the levels of cotton dust they are subjected to are not now deemed to be injurious. Officials have the authority to require "backstop" monitoring to spot those sensitive to hazardous substances before they suffer damage, the judges said.
National Cottonseed Products Association v. Brock, Aug. 7 Businesses may have a legal duty to warn customers not to go home. Traditionally, a company has an obligation to advise customers only of dangers on its own property. But in a precedent-shattering ruling, the Wyoming Supreme Court told the owners of a movie theater that they were liable for losses suffered by a family that ran into flash floods on the way home from a show. A child died.
Managers of the theater knew that the National Weather Service had been broadcasting thunderstorm alerts, but the family watching the film had not heard them. In such cases, business owners must make sure that customers know of the danger, the justices ruled.
Mostert v. CBL & Associates, Aug. 14 The boss has to be in charge. The U.S. Tax Court nixed an imaginative set-up that a personnel leasing company designed to get around the tax law requirement that an employer's fringe benefit package be offered to all workers on an equitable basis. The leasing company hired executives who had an ownership stake in their own firms, gave them lush benefit packages, and then leased them back to their previous firm to work.
The Tax Court decided that the executives were not really employes of the personnel leasing company, since it exercised little control over their work, so the value of the benefits would have to be counted as income. That erases the primary reason for the arrangement.
Professional & Executive Leasing v. Commissioner, Aug. 3 Gullibility may pay. It is a standard of bankruptcy law that a debtor cannot use the system to slip out a debt that he got in the first place by lying to the lender. But the misrepresentation has to be about something that the lender really relied on. In recent years some federal appellate courts have taken that further, saying that the reliance has to be reasonable. In the latest ruling on the issue, however, the U.S. Court of Appeals in St. Louis refused to go along with the trend, and said that there's no requirement in the code that the lender's faith has to have been reasonable.
Thul v. Ophauq, Aug. 26Moskowitz covers legal affairs for McGraw-Hill World News.