Question

Briefly describe the four stages of the auditor dispute process.

For what types of actions are auditors liable to a client under common law? Why would the client prefer to sue the auditor for a tort action rather than for a breach of contract?

Answer 1

Under common law, an auditor can be held liable to clients for

-Breach of contract,

-Negligence,

-Gross negligence/constructive fraud, and fraud.

A client would prefer to sue an auditor for a tort action because larger amounts for damages can be assessed than for a breach of contract.

The elements required for establishing an auditor's liability for negligence to clients are

(1) The duty to conform to a required standard of care,

(2) Failure to act in accordance with that duty,

(3) A causal connection between the auditor's negligence and the client's damage, and

(4) Actual loss or damage to the client.

The three standards that have evolved for defining the extent of the auditor's liability to third parties are

(1) Privity,

(2) Foreseen persons or classes, and

(3) Reasonably foreseeable third parties.

The traditional view held that auditors had no liability under common law to third parties who did not have a privity relationship with the auditor.

Privity here means that the obligations that exist under a contract are between the original parties to the contract, and failure to perform with due care results in a breach of that duty only to those parties. Many courts have reexamined the privity notion and substituted the concept of public responsibility. Under the foreseen persons or classes approach, Section 522 of the Restatement (Second) of the Law of Torts is applied to an accountant's third-party liability suit. The Restatement is a compendium of common law prepared by legal scholars and presents an alternative view to the traditional Ultramares rule.  

Finally, a small number of states have adopted a more expansive view of auditors' liability to third parties: the reasonably foreseeable third parties approach. The reasons cited for extending auditors' liability beyond privity include auditors' ability to spread the risk through the use of liability insurance.

Auditors' liability to third parties under common law is complex because court rulings are not always consistent across federal and state jurisdictions.