Over many years, Jake and Jo Bob built up a barbeque ribs business, Hambones, Inc., which caters picnics and parties and sells ribs and corn at county fairs. They have several creditors, including Sauce Supply and First State Bank.
Two years ago, in reliance on an audit of the company's books prepared by Hambones, Inc.'s accounting firm, Able & Henderson, First State Bank made a loan to Hambones, Inc. It now appears that the audit failed to disclose financial improprieties in Hambones, Inc.'s maintenance of its books: Certain liabilities were being carried off the books, causing Hambones, Inc.'s bottom line to appear more favorable than it really was. The decision to carry the liabilities off the books was made by Jake and Jo Bob, but there is now an argument as to whether a more careful audit would have uncovered the liabilities. Jake told the accounting firm that the audit was being done at the bank's request in order for the loan to be approved, and that it was really important that the company receive a clean bill of health from the audit. Able & Henderson didn't want to lose Hambones, Inc. as a client.
Sauce Supply also knew that Hambones, Inc. had been audited and heard from Jake and Jo Bob that the auditors were very satisfied with Hambones, Inc.’s financial position. Jake gave Sauce Supply's president, Sandy Saucy, a copy of the audit report. Able and Henderson had no knowledge of these statements, or that Sauce Supply had received a copy of the audit report.
What standard of care applies to Able and Henderson's accounting work for Hambones, Inc.? Does Able and Henderson face any negligence liability to First State Bank or Sauce Supply in a state that has adopted the Ultramares rule? In a state that has adopted the Restatement rule? In a state that has adopted the Reasonably Foreseeable User rule?
In general, the standard of care for accountants in conducting audits and preparing financial statements is that they must exercise a reasonable degree of skill, care, and diligence. However, the specific liability will depend on the jurisdiction and the rule adopted by the court.
1. Ultramares Rule: Under the Ultramares rule, which is followed in some states, an accountant can only be held liable for negligence to parties with whom they have a direct contractual relationship or who are specifically identified as intended beneficiaries. If the state in question follows this rule, Able & Henderson would not face negligence liability to either First State Bank or Sauce Supply, as they did not have a direct contractual relationship or specific knowledge of their reliance on the audit report.
2. Restatement Rule: Under the Restatement rule, which is followed in some states, an accountant can be held liable for negligence to any foreseeable user of the financial information. If the state in question follows this rule, Able & Henderson may face negligence liability to both First State Bank and Sauce Supply, as they could be considered foreseeable users of the audit report.
3. Reasonably Foreseeable User Rule: In some states, the Reasonably Foreseeable User rule applies. Under this rule, an accountant can be held liable for negligence to any user of the financial information that the accountant knows or should know will rely on it. If the state in question follows this rule, Able & Henderson may face negligence liability to both First State Bank and Sauce Supply, as Jake informed the accounting firm about the importance of a clean audit report for the loan approval, and Sauce Supply received a copy of the audit report.
Please note that the specific liability in this case will depend on the actual laws and court decisions in the relevant jurisdiction. It would be best to consult with a legal professional familiar with the laws of the specific state in order to determine the exact liability Able & Henderson may face.
To determine the standard of care that applies to Able and Henderson's accounting work for Hambones, Inc., and the potential negligence liability they may face in each scenario, we need to understand the three different rules that are commonly adopted in relation to third-party liability for negligence in professional services, such as accounting.
1. Ultramares Rule:
The Ultramares rule, named after the landmark case Ultramares Corporation v. Touche, established a narrow standard of care for accountants. According to this rule, accountants can only be held liable for negligence to third parties with whom they are in "privity of contract" or "known users" of their financial statements. Under this rule, it is unlikely that Able and Henderson would face negligence liability to either First State Bank or Sauce Supply, as there is no evidence of a direct contractual relationship or knowledge of Sauce Supply's reliance on the audit report.
2. Restatement Rule:
The Restatement (Second) of Torts expanded on the Ultramares rule and introduced the concept of "foreseeable users" to determine negligence liability. According to this rule, accountants can be held liable for negligent misrepresentation to any third party who is a "foreseeable user" of the financial statements and who relies on them in making business decisions. Under this rule, Able and Henderson may face negligence liability if it can be established that First State Bank or Sauce Supply were "foreseeable users" of the audit report and relied on its accuracy.
3. Reasonably Foreseeable User Rule:
The Reasonably Foreseeable User rule is an even broader approach to third-party liability. It holds that accountants can be liable for negligence to any third party who reasonably relies on their financial statements, regardless of whether they have a direct contractual relationship or are explicitly identified as intended users. Under this rule, Able and Henderson may face negligence liability if it can be shown that First State Bank or Sauce Supply reasonably relied on the audit report in their business dealings with Hambones, Inc.
To determine the specific standard of care and potential negligence liability for Able and Henderson in a particular state, it is important to consult the relevant state laws and any applicable case precedents that have adopted one of these rules. An attorney with expertise in professional negligence and state-specific laws would be best equipped to provide a definitive answer based on the specific jurisdiction.