Until today, there wasn’t any law in North Carolina on the proper choice of law analysis to decide what state’s law to apply in an accounting malpractice case. That changed with the North Carolina Business Court’s decision today in Harco Nat’l Ins. Co. v. Grant Thornton LLP, 2009 NCBC 11 (N.C. Super. Ct. April 20, 2009)
Harco sued Grant Thornton, alleging that it relied on the accounting firm’s audit of Capital Bonding Corporation, a Pennsylvania company, in deciding to participate in a bonding program. Capital failed and Harco paid millions of dollars in claims for bonds issued by Capital.
The claim touched at least three states: Illinois, where both Harco and Grant Thornton are headquartered; Pennsylvania, where Capital was based and where Grant Thornton did its auditing of Capital; and North Carolina, where Harco directed its operations with regard to the bonding program, Harco’s key officers were located, and where Harco paid its first and some of its most significant losses on the bonding program.
The three states have very different approaches to the duty of care owed by an auditor to a third party claiming reliance on an audit opinion. Grant Thornton moved for summary judgment relying on Illinois law, which requires near privity, a standard very favorable to accountants when they are sued by third parties claiming to have relied upon an audit. In fact, Judge Tennille said that Grant Thornton would have been entitled to summary judgment under Illinois law.
Harco argued for the application of North Carolina law, which is less favorable to accountants. North Carolina follows the test of the Restatement (Second) of Torts §552, which is not as stringent a standard as privity but which requires more than reasonable forseeability.
Judge Tennille, however, ruled that Pennsylvania law should apply, under what he referred to as the "Audit State Test." He held that "[t]he law of the state where an audit is performed, delivered, and disseminated (the ‘Audit State’) should control the scope of liability to third parties not in privity with an accountant." Op. ¶30.
The justifications for this choice of law standard, according to Judge Tennille, are that "the Audit State has the most significant public policy interest in the liability of auditors performing audits within the state for local companies," and that it "provides clarity, certainty, and consistency for the auditing profession and those relying on the auditor’s work." This will promote "clear risk analysis" for both the auditor and those relying on the auditor’s work. Op. ¶¶31-32.
The clarity will be only short-lived, because Pennsylvania has not clearly staked out a position on the issue of the liability of auditors to third parties.
The painting at the top is of Luca Pacioli, the "Father of Accounting." According to the website of the American Institute of Incorporated Public Accountants, Pacioli said "do not go to bed at night until the debits equal the credits."
Harco Amended Brief In Support Of Choice Of Law Determination
(Grant Thornton’s Brief was filed under seal).