Professional liability issues in succession planning

September 4, 2019

Professional Liability “Success”ion Planning

Congratulations! You’ve decided it’s time to retire. While you may be ready to walk out the door and hang up that 10-key for good, your professional liability risk will not be able to retire when you do. Due to the nature of services provided by CPA firms, claims often arise several years after the service was delivered.

Walking away from the CPA firm that you’ve put your heart, soul and life is difficult enough. Nobody wants their swan song to be a professional liability claim. There are many ways a CPA may choose to terminate their practice.  Managing professional liability risk subsequent to retirement varies depending upon the chosen path. Follow these tips to help you sail into the sunset!

Sale to another CPA Firm

Providing Client Information to a Potential Purchaser

According the AICPA Code of Professional Conduct (the “Code”) ET §1.700.050, allowing a prospective buyer to review a CPA’s working papers may threaten the member’s compliance with the “Confidential Client Information Rule.” Fortunately, this threat may be reduced to an acceptable level by taking appropriate precautions to ensure the prospective buyer does not disclose any information it obtained during the review. To do this, the Code suggests the execution of a confidentiality agreement between the CPA and the prospective purchaser.

If tax information is being disclosed, additional obligations may apply. The CPA should review its obligations under Internal Revenue Code (IRC) §301.7216-2(n). This provision permits the prospective purchaser to review a client list created by the practitioner if:

  • The review is conducted pursuant to a written agreement that requires confidentiality of the tax return information disclosed; and
  • The written agreement expressly prohibits the prospective buyer from further disclosure or use of the tax return information for any purpose other than that related to the purchase of the business.

According to IRC §301.7216-2(n), the client list provided to a prospective buyer may include the following taxpayer information:

  • Name;
  • Mailing address;
  • E-mail address;
  • Phone number;
  • Taxpayer entity classification; and
  • Income tax return form number(s).

Notably, CPAs who provide services to health care providers and have access to patient billing records or other protected health information as defined under the Health Insurance Portability and Accountability Act may have additional notice obligations. Other international, federal and state consumer privacy laws should be considered as well. Because of the numerous privacy rules and regulations that may apply to a CPA’s firm and its clients, consultation with an attorney is recommended.

Client Notification

Properly transitioning clients is important to both the purchaser and the seller. Sellers want to ensure their long-time clients receive proper service, and purchasers want to retain as many of the seller’s clients as possible. This becomes even more important if the selling price is contingent upon subsequent client billings.

            Clear communication of changes to clients is important for a smooth transition and required under paragraph three of ET §1.400.205. As a starting point, AICPA Private Companies Practice Section members can utilize the resource, Client Letter from Mergee Firm, located within Chapter 5, “Merging Your Firm,” of Succession Planning Guide & Tools.

For some clients, a letter or an email may suffice, while others may require a phone call. Key clients may require a personal introduction to the successor CPA to review the services provided and any client or engagement nuances.

Providing Client Information to a Successor CPA Firm

Post-acquisition, the successor CPA firm may request a copy of the predecessor CPA’s records. Paragraphs .01 and .02 of ET §1.400.205 require that the seller submit a request to each client requesting consent to transfer the client’s confidential information contained within the CPA’s records. This request may include a provision that the client’s consent is presumed after 90 days if the predecessor CPA does not hear otherwise. The predecessor CPA is not permitted to provide working papers to the successor CPA until an affirmative consent is received from the client or 90 days elapses. For efficiency, consider incorporating this consent request with the aforementioned client letter communicating the firm’s transition or closure.

            Note that the presumed consent permitted by ET §1.400.205 may not apply if tax information is being transferred to the successor CPA. For tax clients, the predecessor CPA should review its obligations under IRC §301.7216-2(m) and (n) and obtain the required consent prior to transferring any tax information to the successor.

Upon receipt of the client’s consent or after the passage of 90 days (for non-tax clients), the predecessor CPA should provide copies, not originals, of its workpapers or other support to the successor.

Retention of Client Records

In the event of a malpractice claim or a professional or regulatory inquiry, the retiring CPA should maintain the original working papers. Having access to them will be critical to effectively responding to such claims or inquiries. Consequently, workpapers should continue to be maintained by the retiring CPA consistent with the firm’s record retention policy. The retention period depends on a number of factors including the statutes of limitation applicable to the CPA’s practice, the type of service rendered and any regulatory or contractual requirements. Because multiple statutes of limitation exist and vary by state, CPAs should always consult with their attorney before establishing retention periods.

Professional Liability Insurance Coverage

Professional liability risk associated with prior services may linger for several years after the service is delivered. As such, maintenance of professional liability coverage for work previously performed is important. Whenever a significant change in your practice occurs, consult with your insurance agent or broker who can advise CPAs of choices available to help protect their liability into retirement.

Assumption of Prior Acts

If your practice is acquired, the acquiring firm may agree to insure your firm for “prior acts,” services performed prior to the acquisition date. This option is not always available or may have limitations, and the successor firm may not wish to assume liability for services it did not render.

Extended Claim Reporting Period (ECRP) Coverage

If the acquiring firm does not agree to cover your firm’s “prior acts” or if a retiring CPA discontinues its practice without a sale or transfer to a successor CPA, the retiring CPA should consider purchasing Extended Claim Reporting Period coverage, where available, commonly referred to as “tail” coverage.

Generally, tail coverage provides an extended period of time after the end of the policy period during which coverage may be provided for an otherwise covered claim that is first made and reported during the tail and that arises out of a wrongful act that occurred during the Policy period. There are typically several time frames offered for ECRP coverage (one, three, five years, or unlimited, for example) available. Be sure to purchase tail coverage that extends, at a minimum, to the length of the applicable statutes of limitation. As discussed above, consultation with an attorney is recommended when determining the period that is right for your firm.

In the case of a “retirement tail,” it is important to recognize that the tail may terminate upon certain conditions, including resuming private practice.

Sale Contract

Regardless of the level of formality of the transfer to a successor CPA, memorialize the transaction in a sales contract prepared by the firm’s attorney prior to execution by the parties. The following items should be addressed in the contract:

  • Insurance for the selling firm,
  • Records management, including responsibility for copying records,
  • Client transitions,
  • Work-in-progress,
  • Opt-out clauses, providing either the purchaser or seller an option to change its mind,
  • Staffing including employment agreements, and
  • Responsibilities and roles of merge partners.

Practice Discontinuation

If a retiring CPA elects to discontinue the firm rather than sell to another firm, the advice provided above, for the most part, applies.

  • Paragraph .03 of ET §1.400.205 requires notification to clients of the discontinuation of the practice and the orderly transfer of records. A client may request records for their new CPA firm. Consult ET §1.400.200 for guidance on responding to records requests.
  • Be sure to retain workpapers to help respond to a subsequent professional liability claim or regulatory action consistent with the firm’s record retention policy.
  • Don’t forget about professional liability insurance. If you are discontinuing your firm, purchasing tail coverage may be the best option. Consultation with the firm’s insurance agent or broker is recommended.

Retirement from Continuing Firm

An owner in a multi-owner firm may retire. To help manage professional liability risk related to the departure of a firm owner, consider the following:

  • Advise clients of the owner’s departure to ensure clients understand the owner no longer represents or speaks for the firm.
  • Unless a firm’s ownership agreement says otherwise, workpapers and other records related to services delivered by the departing owner are typically the firm’s property, not the departing owner. As such, the departing owner is generally not entitled to these records and removal of them from the firm may be considered a discreditable act in accordance with the Code.
  • Professional liability risk related to services delivered by the departing owner remains with the continuing firm. Even if the firm’s ownership agreement permits the firm’s records to be transferred to a departing owner, the continuing firm should provide copies only and retain originals in accordance with the firm’s record retention policy to defend any subsequent claim or regulatory action.
  • If the departing owner establishes a new firm, taking firm clients with him or her, advise the departing partner to obtain professional liability insurance coverage for their new firm.

In Conclusion

You’ve worked your entire life to build your practice. Ensure you end your career with a standing ovation by addressing the professional liability risks proactively.

This information is produced and presented by CNA, which is solely responsible for its content.

The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the date of the article. Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional. In addition, CNA does not endorse any coverages, systems, processes or protocols addressed herein unless they are produced or created by CNA. CNA recommends consultation with competent legal counsel and/or other professional advisors before applying this material in any particular factual situations.

Any references to non-CNA Web sites are provided solely for convenience, and CNA disclaims any responsibility with respect to such Web sites.

To the extent this article contains any examples, please note that they are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental. In addition, any examples are not intended to establish any standards of care, to serve as legal advice appropriate for any particular factual situations, or to provide an acknowledgement that any given factual situation is covered under any CNA insurance policy.

Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured. All CNA products and services may not be available in all states and may be subject to change without notice.

Continental Casualty Company, one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program.

“CNA" is a registered trademark of CNA Financial Corporation. Certain CNA Financial Corporation subsidiaries use the "CNA" trademark in connection with insurance underwriting and claims activities. Copyright © 2019 CNA. All rights reserved.