Statute of Limitations

STATUTE OF LIMITATIONS; CONFUSION AND OPPORTUNITY

Copyright . James J. Rigos. All Rights Reserved.

Table of Contents

1. REQUIREMENT THAT SUIT BE BROUGHT TIMELY
2. REPORTING ENGAGEMENT RULES
3. TAX ENGAGEMENT COMPLEXITY
4. CONTRACT MAY OVERRIDE STATE DEFAULT RULE
5. COLLECTION ACTION POSSIBLE WITHOUT MALPRACTICE COUNTERCLAIM
6. USE TIME LIMITING LANGUAGE IN ENGAGEMENT LETTERS
7. APPLICATION TO LAW PRACTICE

1. REQUIREMENT THAT SUIT BE BROUGHT TIMELY

A lawsuit against an accountant must be filed before the procedural statute of limitations time period has elapsed or the claim is time-barred. State law determines this period if the parties do not agree to the contrary in their contract. Most state default statutes of limitations specify that an action for professional negligence must be commenced within two or three years. While this determines the time period that the plaintiff has to bring suit, the trigger date refers to when the time period starts running. As the below analysis indicates, this second question is more complicated - particularly in the tax area.

2. REPORTING ENGAGEMENTS RULES

  A. Act or Omission Date

For a reporting engagement, the statute is usually triggered as of the date the CPA committed the negligent act or omission. This general rule is based upon the notion that this is when the client suffered damages and the right to bring a lawsuit.

  B. Discovery date

The date of discovery will apply for client claims that are "inherently undiscoverable," such as embezzlements. Another application is where there was continuous professional representation such that the client may have been hampered in learning of the claim. See Brown v. Accounting Firm, 856 S.W.2d 742 (Tex. App. 1993).

3. TAX ENGAGEMENTS COMPLEXITY

The time period within which the client must file suit is more complicated in the tax area than in reporting engagements. There are three default rules and the CPA should check with local counsel to determine which applies in your state.

  A. Work Product Date

Ackerman v. Accounting Firm, 644 N.E.2d 1009 (N.Y. 1994) held that the client's statute of limitations to sue the CPA is triggered when the taxpayer received the tax return. This was a case involving limited partners who were trying to sue six years after the CPA firm had completed the work. This repose rule was held to apply even though the appeals process and tax court adjudication may take over three years. The AICPA wrote a fine amicus brief in this case urging the policy that there must be some determinable time limit to our liability period. See also Owyhee County v. Accounting Firm, 593 P.2d 995 (Idaho 1979) in which Idaho adopted this common-sense approach.

  B. Final Assessment Date

Other states have held that the statute commences only upon the receipt of the final audit assessment, since that was the date the legal obligation to pay arose. See International v. Accounting Firm, 38 Cal. Rptr.2d 150 (Cal. 1995) for an example where the claim was asserted considerably beyond the three years. This California line of reasoning leaves unclear when a CPA can be certain that a malpractice claim is time barred. Such a rule allows a liberal judge to extend the period to some "final date". Does this mean the conclusion of the tax audit, or might it include the Appeals Division review, the adjudication in tax court, the Circuit Court of Appeals, or even review by the Supreme Court?

  C. Discovery Date

Many states have a date of discovery rule requiring an analysis of the government audit process. Under the "discovery" rule, the statute is triggered when the taxpayer knew to a reasonable degree of certainty that damages would result from the tax error by the accountant. Discovery of the fact that damages were to be suffered because of the CPA's tax error or omission triggers the statute of limitations period.

  D. Case Example

A good example of the discovery rule is the Washington state case of Cotton v. Accounting Firm, King County Superior Court 94-2-18663-9. This was a tax malpractice case seeking the additional tax and consequential damages from an alleged mistake in classifying an income item on a Washington State sales tax return. The taxpayer hired a new accountant to represent him in the audit. In the first meeting, the tax auditor stated that an assessment would be made because some of the revenue was subject to a higher rate of tax. The misclassification resulted in a $20,000 tax assessment against the taxpayer. The taxpayer claimed this forced him to sell his business at a large loss. He sued the accountant for both the tax and alleged consequential damages of the business bankruptcy.

After taking the depositions of the client and his new accountant, the defendant filed two summary judgment motions on the basis that the consequential damages were too speculative. The second motion was successful, and most of the dollar claim was dismissed. The issue remaining was the applicable statute of limitations for the tax, penalties, and attorney fees. On cross-motions for summary judgment, King County Superior Court Robert Judge Lasnik rejected both the "work-product" and "final assessment" rules. His holding was that the date of "discovery" applied and that this question was for the trier of fact; this case could therefore not be dismissed on a summary judgment motion.

The accountant's subsequent motion to bifurcate the trial and try the statute of limitation issue first was granted. At trial, both the state auditor and the taxpayer's new accountant testified. The decision held that the taxpayer's representative knew to a reasonable certainty that an assessment would be made after the second meeting with the auditor. The fact that the taxpayer testified that he personally did not know was not controlling because his agent knew. While the final assessment was within the three years of filing the suit, the discovery was not. The suit was thus not brought timely and the issues of liability and damages were moot.

4. CONTRACT MAY OVERRIDE STATE DEFAULT RULE

There are always inherent uncertainties in applying the above standards. A judge may not understand the process and juries easily become confused. "Discovery" (and thus the trigger date) is a factual question. The trigger date becomes less important if the period of exposure is shorter. Regardless of the state default period provision, it normally applies only if the parties do not specify a different term in the contract.

  A. Reduce Window of Risk

Many fewer claims would certainly be asserted if the client was limited to a one-year period of time. This feature would thus be quite attractive, regardless of whichever rule triggered the running of the statute. Why not specify in the agreement that the Statute of Limitations for error or omission claim is limited to one-year? If this works, it would substantially reduce the period in which a claim may be brought against the CPA.

  B. UCC Authority

UCC 2-725(1) allows the parties to stipulate to a shorter period of exposure in the agreement. The UCC does limit the period to no less than one year. The one-year period is thus attractive and appropriate because this duration is also specified as the time period of liability exposure under the 1933 SEC Act.

  C. Accounting Services

For personal service engagements, such as a CPA's reporting and consulting services, the same principles apply. IBM v. Catamore, 548 F.2d 1065 (1st Cir. 1976) upheld a contractual provision agreeing to a one-year period of limitations for claims arising from a MAS engagement involving installation of a computer system and hardware. The opinion states "when a supplier and its customer, neither of whom is helpless in the marketplace, agree on terms limiting the period of liability for future services to one year, those terms must be respected." Id at 1075.

See also Hays v. Mobil Oil, 930 F.2d 96 (1st Cir. 1991) and Kardios v. Perkins, 645 F. Supp. 506 (D. Md. 1986). Both of these opinions referred with approval to the IBM precedent particularly as it applies between sophisticated parties. This loss reduction technique seems most useful if applied to a CPA's business clients who are knowledgeable in commercial matters. The application to consumers may be less certain. It would seem that the only down-side risk to contract inclusion is that a judge could hold unenforceable the limitation, thereby restoring the default rule.

5. COLLECTION ACTIONS POSSIBLE WITHOUT MALPRACTICE COUNTERCLAIM

CPAs should specify in their client engagement letter that there is a one-year period to bring a claim for error or omission. Not only may this reduce the exposure period, but it would also make it possible to sue a client in a collection action after one-year without any possibility of a counter-claim. This is important because 13% of serious malpractice claims are asserted as counter-claims in fee suits. See Adler v. Exclusive, 466 N.Y.S.2d 337 (N.Y. App. Div. 1982) and Bedolla v. Logan, 125 Cal Rptr. 59 (Ca. App. 3 Dist. 1975) both of which held the client's counterclaims for negligence were time barred in a fee lawsuit.

This time restriction obviously would be helpful against a client. But, in some states, it may also be useful against third parties as well. Many enlightened states have a privity rule fashioned after the New York Ultramares doctrine requiring strict privity. A third party suing in such a state may attempt to avoid the privity rule application by alleging third party beneficiary status. See Seaboard Surety v. Accounting Firm, 823 F.2d 434 (11th Cir. 1987) which held a third party beneficiary receives no greater rights than the client; the one-year period would thus be binding.

6. USE TIME LIMITING LANGUAGE IN ENGAGEMENT LETTERS

CPAs should use the below standard provision from the RIGOS Risk Prevention manual in their client contracts. You will notice that both the period of time for the client to bring a claim against the CPA and the period for the CPA to sue on a collection action (normally six years) have been reduced. This is intended to indicate to the court that the parties bargained for this term and agreed to jointly shorten their respective periods. The clause which the engagement letter should contain is:

No claim arising from services covered under this agreement may be brought more than one year after the cause of action has accrued except a claim for non-payment may be brought within three years of the final bill.

7. APPLICATION TO LAW PRACTICE

While the above opportunity seems useful for CPAs, there is some question whether it would be available to a Attorney-CPA. Dual practitioners must comply with the ethical constraints of both professions, The Model ABA Rules of Professional Conduct section 1.8(h) states "A lawyer...shall not make an agreement prospectively limiting the lawyer's liability to a client for malpractice unless permitted under law and the client is independently represented in making the agreement..."

It is not clear if this would include a provision that merely jointly shortens the time claims could be brought or if the limitation restriction applies only to dollars. The latter would include a contractual clause limiting the damages from malpractice to the fee collected. If applicable, it would appear that the client would also have to have the actual consultation of an independent lawyer; a mere recitation might be insufficient. While this puts some hurdles in the path for an Attorney-CPA, there may still be some situations where the time adjusted risk-fee ratio is of such a magnitude that the engagement is attractive only if the statute of limitations periods are shortened.

 

Copyright . James J. Rigos.

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