Don’t Get Spooked: 4 Ways to Avoid An Accounting Lawsuit
As a tax practitioner, you are required to master complex tax issues in order to prepare tax returns and give advice to your clients. This responsibility can be scarier than any haunted house. With this come risk of making a mistake that generates a malpractice lawsuit. But before you go hide under the covers, read about the risks and what you can do to avoid them.
Why worry about getting sued?
First, if your client runs into financial trouble, their lawyers might look to sue everyone involved. For example, if fraud is committed, the lawyers will likely say that the client should look into suing their accountant. Even if you didn’t commit the fraud, they may blame you for not catching it.
Secondly, your client’s lawyers know that you have Errors and Omissions Insurance (also known as Malpractice Insurance or Professional Liability Insurance), and this is seen as a potential payout source. Because business insurance pays for the damages you owe clients when you lose a lawsuit, a client's lawyers may attempt to sue you, knowing your insurance can pay out.
Finally, third parties are another complication in legal matters. According to Insureon, 30 percent of accounting lawsuits are filed by third parties. If a client goes bankrupt, their lenders, shareholders and business partners could file a lawsuit against you in an attempt to recover their losses.
No one is perfect, so at some point in your career you will probably make a mistake. However, here are some things you can do to avoid the kind of mistakes that will cost you big time.
1. Research and investigate clients. Not only should you do this for any new clients, but for existing clients. An ounce of prevention is worth a pound of cure. Be sure to check into any litigation by or against your client. The insights your research will provide can help you consider your professional risks and whether or not this particular client would pose a threat to your stability.
2. Know your client’s business. This can take a bit of effort, but it is worth it in the long run. If you understand the daily business being conducted by your client you are more likely to catch mistakes or possible fraud attempts. If you do happen to be sued by the client, you will be asked how much you knew about the happenings of the business and why you didn’t know more. Additionally, this will set yourself up for success because you will be able to offer the client quality advice, consulting or additional services. This will help keep them satisfied and less likely to take legal action against you anytime in the future.
3. Use an attorney approved engagement letter to set scope and limitations. Be sure to update a client’s engagement letter regularly. According to accountingtoday.com, engagement letters often are obtained when a client relationship begins, but thereafter firms may not be diligent in obtaining engagement letters for each new service performed or when services are performed again. Failure to obtain an engagement letter for new services may result in a plaintiff arguing that the accountant took a more expansive role, with additional duties, beyond what they understood they were undertaking.
An engagement letter should include:
- The reason for engagement and services to be provided
- The limitations on the scope of engagement and services
- The specific obligations of accountant and client
- A statement that the services provided and any opinion or work product is for the benefit of, and is to be used only by, the client and/or third parties specified by name
- Arbitration or other dispute-resolution clauses and a jury waiver
- Limitation-of-liability and indemnification provisions (there are differences in state and federal law regarding the enforceability of these types of provisions)
4. Don’t ignore questions. If your client or other staff accountants voices any questions or concerns about anything in their engagement do not brush them off. Take the time to investigate the legitimacy of these. Even more important, be sure to document how the issue was resolved, whether there was a reasonable answer or action had to be taken. If you do not complete detailed documentation, it will be hard to recall how issues were handled years later when a lawsuit has been filed and details are questioned.
One of the major risks of being a CPA is being the subject of a lawsuit. You may not be perfect 100 percent of the time, but following these tips can help you to avoid being stuck in courtroom drama. If you want to know more about legal standards related to malpractice and learn from “horror stories” involving tax practitioners whose lack of technical understanding (and/or lack of common sense) led them into disastrous situations, sign up for our Tax Practitioner Horror Stories Webinar today!