Falling hurts. So does litigation.

In an old “Looney Tunes” bit, a school-age Elmer Fudd walks off a precipice but does not fall. He hadn’t learned gravity yet. A young Bugs Bunny gives him the book Gravity for Beginners, and you can guess what happens next.
 
Real life is not as forgiving as animation. What happens when you can’t tell or don’t realize that the gap in your path is actually a cliff? This month’s column, the first in a two-part series, provides a primer on ordinary negligence and litigation to shed light on terrain you may not realize is riddled with professional liability cliffs. Recognizing the links between risk management and litigation can help CPAs understand why and how risk management advice speaks to behaviors frequently present in professional liability claims against CPAs.
 

What is ‘negligence’?

In layman’s terms, professional negligence can be thought of as mistakes you make serving clients when you aren’t trying to make a mistake. In litigation, as discussed below, things are not so simplistic.
 

Negligence and lawsuits

Lawsuits alleging negligence must show four elements: duty of care, breach, causation, and damages. Each succeeding element builds upon or is connected to the one preceding it. A duty of care may be present, but if there is no breach, the inquiry stops. Similarly, you cannot have a breach if no duty exists.
 

Duty of care

Duty of care is the qualitative standard of conduct to which one must adhere in a given situation, given the nature of the relationship between two parties. There are two important questions: Do you owe the duty, and, if so, do you meet the standard of care?
 
Owing a duty of care requires that a legally recognized relationship exists between you and another party. The relationship may be contractual (e.g., a signed engagement letter) or based on common law where courts have previously determined one exists. A relationship may also be found to exist when the parties behave as if one exists despite having taken no formal steps to establish one (e.g., providing services with no engagement letter).
 
Meeting the standard of care requires that your conduct toward the other party falls within acceptable bounds. To explain, let’s imagine 100 random auditors are asked, “What is considered ‘material’ for a particular audit?” The 100 responses will not be identical, but there will likely be sufficient commonality in the responses that if you created a single, summary definition based on those 100 responses, a large majority of those auditors would say, “Yes, that sounds about right.”
 
This collective understanding roughly equates to the bounds of acceptable conduct — the “standard of care.” When a CPA owes an ordinary duty of care, the inquiry in civil negligence cases will be whether their actions (errors) or inactions (omissions) were reasonable under the circumstances. Therefore, litigation asserted against CPAs often involves objectively comparing the CPA’s conduct to what the average, reasonable CPA would do in a similar situation. Meeting the standard of care is fact-specific and affected by numerous factors, including industry standards and professional standards and, often, what courts have said regarding permissible professional conduct — not always by CPAs — in certain situations.
 

Breach

Breach occurs when a duty is owed, and you either perform an act the proverbial “100” would find inappropriate or neglect to perform an act they would agree is necessary. Although violation of professional or ethical standards is not a de facto breach of duty, it is frequently indicative of one. Absent rare or extenuating circumstances, ethics or professional standards transgressions are likely to be viewed as outside the bounds of acceptable conduct.
 

Causation

Causation is the linkage between the inappropriate act or omission and some pecuniary loss experienced by the person to whom the duty was owed. In other words, would the loss have occurred but for the inappropriate conduct?
 

Damages

Damages are the measurable loss of money or value that is a foreseeable outcome of the error or omission. In general, the loss cannot be speculative or remote. However, a lack of quantification may not prevent a lawsuit from being filed or damages being awarded.
 
To summarize, for professional liability purposes, allegations of negligence require showing that someone to whom a duty of care was owed experienced some identifiable loss as a result of a CPA’s act or omission that did not conform to an expectation of reasonable behavior. A claimant must prove all four parts factually. A CPA may have an affirmative defense — a legally recognized excuse — addressing any, some, or all of the four parts. Now, what happens in litigation?
 

Bring in the attorney$!

Over the course of months or even years — court hearings are scheduled months in advance and frequently rescheduled — most litigation follows a general pattern.
 

Complaint and response 

The plaintiff/aggrieved files a complaint, alleging facts the plaintiff/aggrieved believes constitutes negligence. The defendant then files a response, asserting on legal and/or factual grounds that one of the four negligence elements is missing; a valid legal defense to any of the four elements applies; and/or the lawsuit should not be brought/heard. Assuming neither the complaint nor response results in immediate resolution, the parties may begin settlement negotiations, conduct discovery, or both.
 

Discovery

The parties trade requests for information — documents and (sometimes unpleasant) interviews with relevant individuals — to evaluate the accuracy of the complaint’s allegations. In litigation involving accounting services, experts on both sides are frequently brought in to evaluate the CPA’s work and opine on whether a similarly situated CPA would have addressed matters differently.
 

Pre-trial and mediation 

Once information learned in discovery has been shared between the parties, the court may say, “Go try to figure this out without me.” The parties then work with a third-party mediator to discuss the relative strengths and weaknesses of each side’s arguments and whether they can mutually agree on resolution. If the parties cannot agree, the court sets a timeline for a trial.
 

Trial

The dispute is heard through a rules-based presentation of oral evidence, physical evidence, and arguments to ascertain whether the plaintiff has met the legal standard required to show negligence. The finder of fact — jury or judge, depending on type of trial — decides, based on evidence, what it accepts as “fact.” In a jury trial, legal precedents are provided to jury members via jury instructions drafted and agreed upon by the parties’ attorneys, which guide the jury’s deliberations. The combination of laws and facts is then used to reach a verdict.
 
CPAs should understand that in trials involving negligence allegations against accountants, juries are often composed of people who are neither attorneys versed in professional liability nor CPAs familiar with audit, tax, or other areas that constitute the practice of public accounting. Yet these same individuals are tasked with listening to complex and frequently conflicting testimony, weighing the evidence, applying the law and/or professional standards, and ultimately deciding whether the CPA is or is not liable. As a result, jury deliberations in professional liability cases inherently have a degree of unpredictability in outcome that cannot be underestimated.
 

Post-trial and appeal

Once a verdict is rendered, the parties may either accept or challenge the verdict. A challenge, or appeal, may be brought on numerous grounds, but is often based upon what can be generically described as “legal error” — incorrect application of law in the proceedings. If a timely appeal is not filed, a judgment is entered via court order, which is binding on the parties.
 

‘But I’m right!’ ‘we the jury disagree.’

A word of caution. Nowhere does litigation conclusively determine “fact,” “right,” or “wrong.” As a CPA, you also need to understand, bearing in mind the reasonableness standard, that in litigation your deeply held conviction of rightness or correctness is largely irrelevant and may actually be counterproductive. Also, arguing “good client service” may have little if any bearing on whether you met your duty. The key question is: How compelling is your story based upon the evidence?
 
With this background, hopefully you start to see the cliffs around you, and have an appreciation for why the most common risk management advice to CPAs is to document — i.e., write down essential conversations/acts that are subject to debate or are not self-evident. Doing this prior to a dispute, rather than relying on experience to poorly predict when litigation will come knocking, can be of great benefit to a CPA.
 
The second part of this series, which will be published in July, examines how risk management advice dovetails with hard lessons learned from professional liability litigation.