Don’t let a bankrupt client bankrupt you

When people lose money, CPAs get sued. A simple statement, and a reality in the world of professional liability claims. Another reality? When people lose a lot of money, as is generally the case in bankruptcy, CPAs get sued for a lot of money. In fact, client bankruptcy is a large claim red flag, especially if the CPA was the bankrupt entity’s auditor.

Consider these experiences of CPA firms in the AICPA Professional Liability Insurance Program:

• A CPA firm audited the financial statements of a furniture manufacturer for several years. During the years audited by the firm, a bank made loans and issued other credit facilities to the client, requiring the client to provide audited financial statements as part of its underwriting and annual renewal process. The client later defaulted, the bank filed a complaint against the client, a receiver was appointed, and the client was liquidated. While the bank obtained a judgment against the client for over $10 million owed, it was unable to collect and brought suit against the CPA firm. In the complaint, the bank asserted that the audited financial statements contained a number of irregularities, including unsubstantiated and undisclosed related-party transactions, and the bank claimed it relied upon the inaccurate financial statements when extending credit. The bank demanded that the CPA firm pay the full amount of the judgment obtained against the defunct client.
• An insurer provided surety bonds for a commercial plumbing company that specialized in large-scale commercial property developments. The plumbing company was unable to complete a large, bonded project, and the insurer had to step in to pay to complete the bonded projects and make payments totaling nearly $20 million to the plumbing company’s unpaid subcontractors, workers, and suppliers. The plumbing company eventually filed for bankruptcy, and the insurer filed suit against the CPA firm that audited the plumbing company, asserting it relied on the audited financial statements when issuing the surety bond and stating that the firm failed to perform appropriate audit procedures, including independent verification of contracts, and failed to disclose the less-than-prosperous financial condition of the plumbing company.

To limit losses stemming from business failures, clients’ lenders, shareholders, and bankruptcy trustees may seek to pursue claims against CPA firms. But aren’t these parties also responsible for performing their own credit evaluation, you say? Of course they are — but that does not stop these parties from bringing claims against a CPA firm. In a typical bankruptcy, the damages are so substantial that even if the firm is found partially liable, a small percentage of the substantial damages amount is still a large claim.

The dark clouds of bankruptcy and large claims may be on the horizon. According to federal court data, Chapter 7 and 11 bankruptcy filings have been on an upward trajectory in recent years. Notably, in the 12 months ended June 30, 2025, business Chapter 7 and 11 filings increased over 6% compared to the prior 12 months and a whopping 48% relative to the year ended June 30, 2023. This may be a foreboding sign for CPAs, as professional liability claims may be asserted years after services are rendered.

RISK MANAGEMENT RECOMMENDATIONS

Proactively identify clients in financial difficulty

Client acceptance and continuance is a CPA’s first opportunity to show a potentially problematic client the door or not allow a risky prospect entry to the firm in the first place. Clients in financial difficulty or those that operate in a financially at-risk industry pose other challenges beyond professional liability risk. The client may experience higher turnover, making it difficult to gather audit evidence. The CPA firm may be unable to collect fees timely or to charge more for the additional work that inevitably arises with a higher-risk client.

Consider quality management and team composition

Maintain effective quality management, especially with respect to supervision and review. Assign senior, experienced team members to perform the going concern evaluation and other high-risk audit areas. Consider assigning a quality reviewer to help support the team. Include thorough workpaper documentation that supports the ultimate conclusion reached.

Be alert to changing economic conditions that can affect the client, the client’s industry, or its major customers or suppliers, including subsequent events arising after the balance sheet date but prior to the issuance of a report.

Do not give into pressure to modify the report or delay issuance

Many clients fear that a going concern disclosure and related modification to the CPA’s report will be the kiss of death for their company. They may pressure the CPA to either exclude the disclosure or delay issuance of the financial statements until management can rectify the matter. Nevertheless, if the company subsequently fails, the CPA may be sued under a developing legal theory called deepening insolvency. Under this theory, it is argued that the life of a troubled company was artificially prolonged through additional financing, resulting in increased losses to the company’s creditors and shareholders. A plaintiff attorney may assert that the company’s true financial condition was misrepresented and that, if the CPA had addressed the going concern matter sooner, additional financing may not have been extended, and losses could have been minimized.

While it may be difficult to issue this disclosure, the CPA is not doing the client, or the firm, any favors by failing to directly address a going concern matter. If a client refuses to include a going concern disclosure in the notes or pressures the CPA to delay its issuance, consider terminating the client.

Avoid communication with third parties

Avoid communication with third parties regarding a client’s financial condition. Participating in discussions with third parties may permit the third party to bring a claim against the CPA. To successfully file a negligence claim against a CPA, a third party must prove that a privity relationship exists. While the requirements necessary to establish privity vary by jurisdiction, one factor is behavior, such as a conversation with a client lender, that links the CPA to the third party and demonstrates the CPA understood that the third party would rely on the CPA’s words and work product (see the July 2021 Professional Liability Spotlight article, “An Evaluation Framework for Responding to Requests“).

FEE COLLECTION

CPA firms that provide services to clients that may eventually file for bankruptcy may worry about their fees getting clawed back in bankruptcy as a preferential payment. This is a legitimate concern best addressed by legal counsel. A transaction that is a contemporaneous exchange in the ordinary course of business may not be considered preferential. To help minimize the risk of nonpayment, include billing and payment terms in the engagement letter and strictly adhere to them. Require payment in advance and/or consider a regular payment schedule to help support an ordinary-course-of-business nature. Cease services if the client becomes delinquent.

21.9%

The percentage of companies that received a going concern opinion in fiscal year 2023 — the second-highest going concern rate since fiscal year 2016.

Source: Going Concerns: a 20-Year Review, published by Ideagen Audit Analytics using data from SEC filings.

Sarah Beckett Ference, CPA, is a risk control director at CNA. For more information about this article, contact specialtyriskcontrol@cna.com.

Continental Casualty Company, one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com.

This article provides information, rather than advice or opinion. It is accurate to the best of the author’s knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations.

Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice.