Third-party beneficiary claimPostaudit loss and S-1 review.

A New York court ruled that a CPA firm does not owe a duty to a surety company that, when it extended surety bonding to a construction company, allegedly relied on financial statements the firm had audited. The surety company brought suit against the accounting firm after the construction company defaulted on jobs the surety company had bonded. The plaintiff alleged that, as surety for the construction company, it was a third-party beneficiary of the contract between the accounting firm and its audit client, the construction company. The plaintiff claimed that the sole purpose of the audited financial statements was to secure the bonding. Thus, the plaintiff argued, it was entitled to sue the accounting firm for breach of contract, which included an alleged failure to conduct its audits in accordance with GAAS.

The firm argued that the construction company had many reasons to obtain an audit, such as satisfying the requirements of its bank loan. The defendant also said it had audited the company for many years before it had a relationship with the plaintiff. If the plaintiff indeed was a third-party beneficiary, the defendant said, it would have the right to demand disclosures of client information. This would place the CPA firm in the position of having to disclose client confidences to a third party — a possible breach of ethical standards.

The court ruled that neither the CPA firm nor the construction company had intended to grant the surety company third-party beneficiary status. The court observed that the firms engagement letter made no mention of the surety company, and the construction company did not specify that the company was to provide the surety company with audited financial statements. The court granted the firms motion for summary judgment.

In this situation, prudent use of an engagement letter bolstered the case. Accounting firms should note in their engagement letters that the engagement is being undertaken solely for the clients benefit. Also, the letter should say that the firm will not disclose client information to a third party without permission. Firms should deliver financial statement reports directly to the client, not to the clients surety company or bank. Firms can thus make it clear that the parties did not intend for a third party to benefit from the engagement. ( Firemans Fund Insurance Co. v. Glass , 1997 WL 289858, S.D. N.Y., May 30, 1997.)