7 common conditions.
by r. peter fontaine
whenever a professional liability lawsuit is lodged 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.
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current and former partners of cpa firms are wise to ask, “how am i covered in the event of a lawsuit is brought against me?” with the right indemnification and professional liability insurance coverage, both active and former partners should be able to sleep well at night.
insurance and indemnity
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, and 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 partners are protected against claims made by firm clients based on their acts or omission through an indemnification by the firm. 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 from the ancient legal principle that an employer is responsible for the acts or omissions of its employees.
it’s just good business
notwithstanding the statutory requirement for indemnification, many accounting firm partnership agreements have an indemnification provision – often coupled with a cooperation requirement – covering both active and former partners. the indemnification clause usually sets forth the prerequisites, parameters and limitations on the underlying statutory indemnification obligation. accounting firms should eagerly give their partners an indemnification, subject to certain conditions.
the reasons are very simple. first and foremost, it’s a good partner relations practice. partners are more likely to act in best interest of the firm and perform better knowing they are protected by the firm. 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 of any claim. finally, 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.
indemnify nuts and bolts
here are the common characteristics and conditions of the indemnification of its partners by accounting firms.
- 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.
- the partner who is 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. if the partner has been gone from the firm for a few years, the plaintiff/former client may not remember the name of the firm, or there may be “straddle claims” overlapping the period when the former partner was associated with the firm and thereafter.
- 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 respond to formal questions from the plaintiff(s), being available for depositions, helping develop defense theories and generally supporting the defense attorney(s). in complex litigation, the demands of assisting with the defense may be very 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 should cancel the firm’s indemnification obligation.
- in order to secure the indemnification, the partner must have acted properly, and within the scope of their employment and authority. the partner needs to have operated in good faith and for the benefit of the firm (rather than their own 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. accordingly, in addition to an indemnification provision, accounting firm partnership agreements should include clear guidelines for partners’ behavior.
- the partner cannot be indemnified twice for the same claim. for example, if a partner leaves the firm with some clients and is subsequently sued by a former client of the firm for work performed before and after they left their former firm, the partner cannot be indemnified by both the old and the new firm. in a word, the partner cannot “double dip.” whenever there is a “straddle claim,” the old and new firm – and their respective insurance carriers – need to collaborate on both the defense of the firms and the partner, as well as the apportionment of the expenses and any settlement.
- 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.
good as the coverage
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. close attention should be paid to the policy exclusions so that they are 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 the consent of the active partners and the former partners.