- By R. Peter Fontaine, Managing Partner, NewGate Law, www.newgate.law
Whenever a professional liability lawsuit is brought against an accounting firm, chances are one or more of the firm’s partners will be named. They are front and center in the client relationship, and the client looks to the partner to make sure everything is right. Partners of CPA firms, including departing or retiring partners, are wise to ask, “How am I covered in the event of a lawsuit against me?”
Most accounting firms carry professional liability insurance. The CPA firm’s policy covers the actions of its partners and employees, subject to the limits, deductibles and exclusions of the policy. However, the policy is between the firm and the insurance carrier; partners and employees usually do not have a direct coverage relationship with the insurance company.
This is particularly true with respect to former partners. The firm indemnifies the partners against claims made by firm clients regarding partner acts or omissions. Under most state laws, employers are required to indemnify their employees for claims lodged against them when acting within the scope of their employment. This statutory indemnification arises under an ancient legal principle that makes an employer responsible for the acts or omissions of its employees.
Why Indemnification Benefits the Accounting Firm
The statutory requirement for indemnification notwithstanding, many accounting firm partnership agreements have an indemnification provision — often coupled with a cooperation requirement — that covers both active and former partners. The indemnification clause usually sets forth the prerequisites, parameters and limitations on the underlying statutory general indemnification obligation.
Accounting firms should eagerly give current and former partners an indemnification, subject to certain conditions and time limits. The reasons are very simple. First and foremost, it’s a good partner relations practice. Partners are more likely to act in the best interests of the firm — and possibly sleep better at night — knowing the firm protects them. Additionally, so long as the firm is covering the partners’ defense costs and liabilities, the partners are much more likely to cooperate and assist in the defense. The firm can use the lawyers of their choosing to represent the partner, advance a common defense strategy and control what happens, including a settlement.
Indemnification Conditions and Terms
Here are the common characteristics and conditions that accounting firms include in the indemnification of partners.
- The indemnification usually includes a duty to defend. If a partner gets drawn into a lawsuit, the firm is required to either assume the legal defense of the partner or pay the defense costs on behalf of the partner. This is in addition to coverage of any of the partner’s liability for damages that might result.
- A partner named in a lawsuit needs to give the firm prompt notice. In most cases, the firm will get sued along with the partner, but not in all situations. Sometimes, if the partner left the firm a few years ago, the plaintiff/former client may not remember the name of the firm.
- Partners typically need to assist and cooperate with the firm in the defense of any legal claim. This includes providing factual information to the defense team, helping to respond to formal questions from the plaintiff(s) (known as “interrogatories,”), being available for depositions, helping to develop defense theories and generally supporting the defense attorney(s). In complex litigation, the demands of assisting with the defense may be significant. A former partner may or may not get compensation for helping, but should at least have any out-of-pocket expenses covered.
- While fairly unusual, partners who are defendants in a lawsuit may voluntarily (and surreptitiously) cooperate with the other side in an attempt to get themselves dismissed from the case. This effort should cancel the firm’s indemnification obligation.
- In order to secure the indemnification, the partner must have acted properly, and within the scope of employment and authority. The partner needs to have operated in good faith and for the benefit of the firm (rather than for personal benefit). The partner cannot have committed any gross negligence, intentional misconduct, fraud, or knowingly any criminal act. Whether a partner has acted appropriately is occasionally an area of considerable ambiguity. In addition to an indemnification provision, accounting firm partnership agreements should include clear guidelines for partner performance.
- The partner cannot be indemnified twice for the same claim. For example, say that a partner leaves a firm with some clients. One of those clients sues the partner for work performed before and after leaving the former firm. That partner cannot be indemnified by two firms. In other words, the partner cannot “double dip.” Whenever there is a “crossover claim,” the old and new firms — and their respective insurance carriers — need to collaborate on both the defense of the firms and the partner, as well as the apportionment of expenses.
- If the partner does not comply with the foregoing requirements, the firm’s obligation to defend and indemnify the partner may go away. In addition, the partner may be required to repay any amounts the firm advanced for the partner’s defense or settlement.
An indemnification is only as good as the party that gives it. Accordingly, both active and former partners should insist that the firm carry professional liability insurance with deductible/retention amounts, policy limits and exclusions that are consistent with other firms of similar size and risk profile. Pay close attention to the policy exclusions, keeping them in line with the indemnification. The indemnification in the partnership agreement should not exceed what the policy covers.
Finally, active partners should make sure that when they become former partners that insurance coverage cannot be modified without at least a notification to the former partners.
With the right indemnification and professional liability insurance coverage, both active and former partners should be able to sleep well at night.
R. Peter Fontaine is Managing Partner of NewGate Law, which provides risk management services to members of CPA Mutual as well as legal services exclusively to the accounting profession. NewGate advises clients on mergers and acquisitions, partnership agreements, regulatory compliance professional practice matters, and risk management. In addition, NewGate assists clients with third-party subpoenas problem engagement and pre-litigation circumstances. www.newgate.law.
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