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Accountant Liable to Third Party Principle Upheld
Published in the December 2007 issue of Litigation Notes - View Article
The British Columbia Supreme Court decision in Kumar v. Picco released in late November serves as a warning for accountants about agreeing to meet with third party readers of a client’s financial statements. Picco, a chartered accountant, was found liable to Kumar, a prospective purchaser of the client company, for negligent misrepresentation on the basis of meetings arranged by the client.
The case involved Picco’s engagement to review the client’s annual financial statements without audit. The financial statements indicated that the client, an auto dealership, paid approximately $25,000 to the provincial taxing authorities for the prior year. That amount was far less than one might expect to have been paid based on the volume of car sales during the period. In fact, the client owed about $750,000 in unpaid provincial sales tax for the current and prior years. The financial statements did not disclose the shortfall. Picco maintained that the misstatement was not the result of negligence because, on a review engagement, the accountant is only required to be satisfied that the statements are plausible, rather than having to verify figures reported for specific liabilities. The court rejected that defence, concluding that Picco should have done a quick mental calculation to determine whether $25,000 was a reasonable amount for annual tax remittances. Had he done so, he would quickly have recognized that the correct amount was nearly ten times higher.
The question then became whether Picco could be liable to Kumar for his negligence. Under the common law an accountant generally does not owe a duty of care to readers of the client’s financial statements, particularly in respect of losses resulting from an investment made on the strength of the statements. However, such a duty can arise in some circumstances, including situations where the accountant had direct involvement with the third party reader.
When Kumar began discussions with the client about a purchase, the client said that he was not good with numbers and that questions about finances should be put to Picco as the company’s accountant. Picco later attended several meetings regarding the sale together with Kumar and answered questions arising from his review of the financial statements and Picco’s review report. Kumar then decided to purchase the dealership and paid a $250,000 deposit. However, rather than paying the deposit funds to his lawyer to hold in escrow pending closing, he paid the money directly to the client company. The client company and its principal both went bankrupt before the purchase was concluded. Kumar then sued Picco to recover the $250,000.
The judge rejected Kumar’s evidence that Picco told him that the deposit would be adequately secured. If he had done so, that statement would itself have been a negligent misrepresentation. The judge did find that Picco knew that Kumar intended to pay the deposit directly to the client and thought it inadvisable to do so. However, Picco was quite rightly found not to be responsible for advising Kumar regarding whether and how to conclude the purchase transaction. Kumar had his own lawyer and accountant involved advising him about the transaction.
The judge then considered whether Picco owed Kumar a duty of care as a result of attending meetings and answering questions about the statements. The answer was yes. By having agreed to meet Kumar and provide information without in any way attempting to limit Kumar’s use of the statements Picco was found liable for the loss of the deposit funds associated with the negligent misrepresentation in his review report on the financial statements.
The judge went on to find that Kumar was contributorily negligent for his own loss by not having acted on the advice of counsel to place the deposit funds under his care. Kumar had acknowledged at trial that his failure to do so was foolish. The judgement allocated 75% of the fault for the loss to Kumar for failing to protect his own interests. Picco was ordered to pay Kumar $62,500 in damages – one quarter of the deposit amount.
Kumar v. Picco, [2007] B.C.J. No. 2463 (S.C.)