Illinois pulls accountants out of the line of fire from third-party lawsuits

In a victory likely to ripple across the country, accountants in Illinois have secured protection against liability claims for certain types of negligence. On Aug. 6, Gov. James Thompson signed into law a measure that significantly limits the filing of lawsuits by certain users of financial statements or audits prepared by accountants.

Before the law was passed, Illinois accountants were exposed to liability claims for negligence by an unlimited number of third parties with whom the accountants had no contractual relationship.

If, for example, an accountant and a manufacturing company constitute the principal parties in a financial reporting transaction, then a bank (from which the manufacturer might seek a loan) could be defined as the third party. Before passage of the new law, the bank, relying on the financial statement to make a loan, could sue the accountant if the business later failed.

The new law requires that unless such third-party users of a financial statement are explicitly identified and recorded at the time the audit is prepared, they cannot later sue the accountant for negligence.

The new law leaves unaffected the ability of an accountant's direct client (here, the manufacturer) to sue the accountant.

The Illinois amendment comes at a time of widespread concern about the equity of laws governing injuries to persons or property. Congress and more than 40 states are now involved in tort reform initiatives.

Accountants see themselves as particularly vulnerable, because once a business has failed they become prime targets for attempts to recover resulting losses. According to industry figures, eight of the largest accounting firms have paid nearly $180 million in settlements since 1980, most of which were audit related.

``As a practical matter, this bill will make a lot of difference in court,'' noted Lawrence Wojcik, a Chicago lawyer and accountant.

Mr. Wojcik, who has extensive experience defending accountants accused of malpractice, cautioned that the new law was not an absolute bar against suits and that there was still some room for judicial interpretation. Furthermore, accountants would still be subject to federal securities laws.

The Illinois law appears to be the first time the so-called privity rule has been incorporated into a state statute. Privity is the face-to-face relationship that exists among parties to a transaction, and it has been recognized for many years by judges as a kind of contract. A seller and a buyer have privity; so do an accountant and his client.

Where privity does not exist, lawsuits for negligence were historically unsuccessful. But since about 1960 the concept of privity as a legal basis for fending off third-party lawsuits has been eroding, lawyers note. Increasingly, judges have put aside this relatively narrow contractual foundation in granting awards, choosing instead to interpret liability more broadly. The Illinois amendment reverses this trend by fixing privity in state statute.

Promoting the privity rule as a means of limiting accountants' exposure to liability for negligence is one of five planks in the ongoing legislative efforts for tort reform undertaken by the American Institute of Certified Public Accountants.

The institute has drafted a ``model'' bill, similar in objective to the Illinois one, and sent it to its satellite CPA organizations in the various states. It is generally believed that legislative initiatives for accounts, similar to the one in Illinois, will be undertaken in other states.

While accountants generally applaud what they have accomplished in Illinois, others are less approving. Illinois state Rep. John Countryman (R) opposed passage of the bill, on the basis that insulating accountants from liability works to compromise their professional competence.

Mr. Countryman says that many Illinois governmental departments (insurance and agriculture, in particular) rely on financial audits for licensing and regulatory activities. Liability protection lessens the standards for accuracy, he says, and deprives third parties of a legal basis for relying on a financial report.

He also believes that true tort reform should not provide select immunity to special-interest groups on a profession-by-profession basis, but should do it comprehensively across the board.

``What bothers me,'' says Michael Polelle, a law professor at John Marshall Law School in Chicago, ``is that every special-interest group is coming out of the woodwork to get protection. . . . If it's true legislative reform, it should apply to all defendants.''

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