Question: What constitutes a terrible day at your accounting firm?
Answer: A court process server delivers a legal complaint against the firm alleging accounting malpractice, which caused a client to lose big bucks!
Does this situation happen to great firms that have never been sued and pride themselves on exceptional work for good, long-term clients? Of course it does – every single day. It’s a sickening feeling in the gut, a violation of trust, a question of integrity. And you thought this client was a friend!
No matter what the service – tax, consulting, attest or non-attest – if a client loses money, they want to recover. And, unfortunately, you are a likely target. After all, you (allegedly) knew about the client’s problem — or should have known — and you could have prevented the loss. You also happen to carry liability insurance, and you have deep pockets. The client’s allegation may or may not have merit, but the complaint is a definite call to action.
What can you do in this situation? After reading the complaint, you must move quickly. Time is of the essence. Let’s explore the next steps.
First and foremost, you must notify your insurance carrier. After all, the reason you have paid premiums for many years is to insulate yourself from a catastrophic loss from a legal claim.
Secondly, for the time being, forget your working papers on the engagement. Thinking about those comes later.
Your insurance contract requires you to put the carrier on notice when you first suspect there may be a claim, even if a complaint has not been filed. Once it has, you must allow the insurance company to employ defense counsel to answer the complaint. Remember: This is a legal matter, and you are not a lawyer.
“Wait,” you’re probably saying. “Allow the insurance company to employ defense counsel?” You read that correctly. Unless the carrier lets you choose from a list, it is their choice of attorney who will provide your defense.
The insurance company pays for the defense within the terms of the policy, and the attorney they hire represents you and the carrier. However, the lawyer’s first loyalty is to the carrier.
In my experience, it pays off to hire your own attorney to oversee the litigation. You want the case resolved as early as possible for many reasons, namely to reduce the embarrassment, time and cost of being in litigation.
Litigation is painfully expensive, and not just in monetary cost. The cost of defending a malpractice claim can easily exceed $100,000 in defense attorney fees.
There is also the cost of lost time to consider. Your time at your billing rates and your focus on running the business are lost.
In a case I worked where CPAs were sued, they spent all their time reviewing, gathering documents and attending depositions and hearings. The firm’s cost of lost production at their standard billing rates was over $500,000.
You must remember that litigation can be a lengthy process. Courts set dates for legal filings, hearings on motions, depositions, trials and how the discovery process proceeds. These dates often get moved for unforeseen reasons, such as illness, vacation time or other conflicts. The process is long, complicated and one the defendant CPA cannot control.
Insurance companies are experts – especially at defending accounting malpractice claims. Your case is not their first. They work on accounting malpractice defense every day and know the process.
One fact is certain, however: The longer the case proceeds through the legal system (normally in terms of years), the greater the chance of arriving at a lower settlement — regardless of whether the claim has merit. Most accounting malpractice cases are settled before the trial.
Remember: The attorney hired by the carrier works for the carrier to defend you. But the carrier decides; they hire the lawyer, they pay them, they decide when to make offers of settlement and they decide when to settle and for how much.
It is true that you must pay for your own attorney with no reimbursement. But, your lawyer works for you. They are loyal to you. They can provide leverage for you. They know the law and the process, can monitor all the court filings, attend the hearings and recommend to you and the carrier’s attorney how to best proceed.
I am not an attorney. I am a CPA hired as an expert by lawyers in accounting malpractice cases. And I have watched this legal process play out in over three dozen cases.
Consider this: If a case costs $500,000 in lost billing alone, how much less does it cost to close a malpractice case quickly with the help of outside counsel? As a CPA, you can make this calculation.
Ralph Q. Summerford, CPA, CFF, ABV, CFE, CIRA, CDBV, is the president of Forensic Strategic Solutions and has a broad range of forensic expertise, testifying as an expert witness in federal and state courts on matters involving complicated financial transactions, including fraud, economic damages, business valuation, bankruptcy and accountants...