Statute of Limitations
Triggered by Deficiency Notice
T he California Court of Appeals, Second Appellate District, ruled that for purposes of maintaining an accountants malpractice action, the applicable statute of limitations begins when the Internal Revenue Service issues a tax deficiency notice. Richard Talley retained the firm of Henriksen, Bobrowske & Andrews to prepare his income tax returns for the 1986 to 1989 tax years. In 1989, the IRS began auditing Talleys 1987 tax return. Later, the IRS also audited his 1988 tax return.
On January 28, 1992, the IRS sent a notice of deficiency to Talleys home regarding his 1987 tax return. On February 19, 1992, the IRS sent a similar notice of deficiency for the 1988 tax return. On August 10, 1993, Talley filed an accounting malpractice action against the firm. However, this action was dismissed because it was not properly served on the defendant. On June 15, 1994, Talley refiled the action alleging the same malpractice against the firm. The firm filed a motion for summary judgment, stating that Talleys second action was barred by the two-year statute-of-limitations period governing accountants malpractice actions. The trial court granted this motion, and Talley appealed this case.
In upholding the trial courts judgment, the appellate court noted that a cause of action accrues as soon as the injured party discovers, or should have discovered, the loss or damage suffered. The client must also suffer actual injury from the negligence before the cause of action can be established. In a tax deficiency case, actual injury occurs when the IRS provides its notice of tax deficiency, penalties and interest. In this case, actual appreciable injury occurred on January 28, 1992, and February 19, 1992. The court rejected Talleys argument that the statute of limitations should be tolled (that is, the clock should stop running) because the accounting firm continued to represent him after February 1992.
The case is part of a continuing trend in tax cases to require plaintiffs to file their actions within two years of the date of first notice of a tax deficiency from the IRS. Also, the court did not adopt the "continuous representation rule" for these types of cases. Even if an accountant continues to work for a client, in the absence of any fraud or negligent misrepresentations, the statute continues to run. This is contrary to positions taken in legal and medical malpractice cases in which courts have allowed the tolling of the statute of limitations if the defendant continues to represent the plaintiff after the alleged malpractice date. ( Richard W. Talley v. Henriksen, Bobrowske & Andrews , 96 Daily Journal D.A.R., 12451)
Third Parties Can Rely on Auditor's Work
A Florida appellate court ruled that a clients notice to an accounting firm that said the client needed audited financial statements for multiple parties entitled those parties to rely on the accountants work and later to bring suit against the accounting firm. Lake Technologies retained Ernst & Young to audit the company. While the firm was working on the audit, the companys president advised the firm that these statements were urgently needed to obtain bonding, increase a line of credit, obtain favorable credit from suppliers and submit bids on projects in other states.
In alleged reliance on the financial statements, a surety bonding company issued payment and performance bonds to the client. After the surety company was required to pay the bonds, it sued the firm for negligence in preparing the financial statements. The surety company alleged the firm had failed to disclose the clients substantial debt to the IRS. The firm responded by filing a summary judgment motion, stating the surety company was not a client of the firm and therefore the firm owed it no duty. The trial court granted the firms motion for summary judgment.
On appeal, the court reversed and remanded the trial courts ruling. The court noted that under Florida law, the firm owed a duty to a limited group of parties for whose benefit the accountant knew the client intended to supply information from the audit. Since the firm had been notified that the surety bonding company was an intended user of the financial statements, it owed a duty to this party. The firm argued that because the client had provided a virtual laundry list of potential users, there was in fact a limitless number of foreseeable users. The court found this argument unpersuasive. As long as the firm was notified of the potential users of its financial statements, the size of the potential group was not relevant. Specific notice of the bonding companys reliance on the financial statements was sufficient.
This case pushes the outer envelope of parties that may reasonably rely on the auditors work product. By defining "limited class" broadly, it invites audit clients to identify a broad group of parties that may rely on the audited financial statements. It also encourages third parties such as bonding companies and banks to communicate to potential clients that they wish to be identified to the auditor as parties that may rely on the auditors work product. ( Amwest Surety Ins. Co. v. Ernst & Young, no. 95-2499, Fla. App., 8/2/96)
Editors note: Thanks to Diana Courteau of Courteau & Anschultz for the Talley case.
Edited by WAYNE BALIGA, CPA, JD, CPCU, CFE,
president of Aon Technical Insurance Services.