Professional Negligence

 

Written by

Curtis Goodman

Darren Davies

Prepared for

UofL Management Law - 3010

November 22, 2007

Background Information

Professional liability and negligence should among the most significant matters concerning any professional today. Nearly all business transactions performed on a day-to-day basis will have some risk of professional liability. Be it the real estate agent offering advice to clients; accountants preparing financial statements; or the financial advisor’s market speculations – all professionals have a special relationship with the clients they serve. They offer services based on their specialized knowledge or skill – which are relied upon by the client as being the best solutions to their problems. Issues arise as a result of these services, where clients may be discontented over the quality of work performed – which may have resulted in economic hardship, or in some cases physical harm. As the business environment continues to globalize and increase in complexity, as does the need to understand the obligations and responsibilities of professionals. The fundamental areas of professional liability include: duty of care; standard of care; fiduciary duty; reasonable reliance; errors and omissions insurance; and how these fit within the legal framework of society.

Legal Context of Professional Liability

What Defines a Professional?

The contributions of professionals add great value to our society, but these individuals also have the ability to pose great detriment to society. So how do we define a professional? Legal definition classifies a person based on “such criteria as advanced and specialized training, and the continued use of intellect, discretion, and judgment, the majority of statutes merely present an open-ended list of job categories.”[1] In more general terms common professions include: accountants, architects and designers, bankers, lawyers, travel agents, and real-estate agents. By no means does this represent an exhaustive list of professions – but it does provide a clear context to distinguish the varying standards among professions. In some cases the standards may be formalized by professional organizations or they may be defined by legal precedent. Whether the professional is: under-trained; abusing their rights; being deceitful; or committing unfair practices – our society must have a channel to deal with these issues. There are three ways in which a professional can be held liable for their actions: under contract law; tort liability – negligence; fiduciary obligations and breach of trust.

Contract Law

Under contract law a professional is required to provide a reasonable level of performance. If sub-standard service were to result in economic losses, a professional may be liable under a breach of contract.[2] The level of service expected of a professional is usually set by professional organizations, usually in the form of acceptable conduct guidelines, fundamental principles, and standards. Although in the case of Kripps v. Touche Ross (1997) the courts narrowed the scope of the applicability of such standards.[3] Regardless, this aspect of contract law gives a basis to deal with economic losses arising from expectation shortcomings, making it “much better suited than tort law to deal with economic losses.”[4] In most cases contract liability is limited to the client in which the contract exists. Therefore third parties would have no claims as a result of sub-standard service. Professionals can use contractual agreements to their advantage, in-so-much as they can set limits, terms, and conditions. Under such contracts the professional has a foundation for a legal defense, which may defer potential litigation. These conditions of the contract will not protect the professional in their negligible actions under tort law however.

Tort Law – Negligence

Whenever wrongful conduct is involved the victim may be compensated for damages suffered. This is known as a tort and is defined as; a case where one person causes injury to another, harming his or her person, property, or reputation. If the actions of the professional were to fall below a minimum acceptable standard, then the right to sue for remedies arises. The two major focuses of torts are: intentional or deliberate acts; and unintentional or negligent acts. In the business world negligence is the most important area for tort liability. Negligence involves the unintentional careless conduct causing injury to another person or his property. Professional negligence under tort law must be distinguished between ordinary negligence. The major difference lies in the “reasonable reliance” the plaintiff has on the advice given. This is part of the four-part test to establish professional negligence: that a duty of care existed; that the professional breached that duty of care; causation exists; and that due to negligence calculable damages were incurred by the claimant.

Duty of Care

For professionals a primary question is to whom is a duty of cared owed to. In the past liability of professionals would only be owed to their clients based on the contracts they forged together and to their colleagues and clients based on fiduciary duty. When poor service is provided the liability would be held to the losses that the immediate party had suffered due to the breach in contract. In recent years courts have been willing to expand liability to include third parties.[5]

The courts establish if a duty of cared is owed with the reasonable foreseeability test. If it is concluded that it is reasonable foreseeable that the conduct in question would cause harm to the plaintiff, a duty of care exists. In the case of Donoghue versus v. Stevenson Lord Atkin, the presiding judge, made the following classic statement;

You must take reasonable care to avoid acts or omissions which you can reasonable foresee would be likely to injure your neighbor. Who, then in law is my neighbor? This seems to be – persons are so closely and directly affected by my act that I ought reasonably to have them in contemplation as being so affected when I am directing my minds to the acts or omissions which are called into question.[6]

 

If the reasonable foreseeable test is used exclusively to determine whether a duty of cared is owed or not. This test would allow for disgruntled investors to recuperate business losses by targeting professional accountants. Auditors would then be liable to all users of financial statements. This could cause serious problems as accountants would be very reluctant to audit financial statements due to their potential for liability.

The Ann’s case allowed courts to limit this indeterminate liability with a two-stage test to determine if a duty of care is owed.[7] The first stage is in determining that the two parties are in close enough proximity that the defendant would realize the potential for damages as a result of his actions. The second part looks deeper and provides exceptions to the reasonable foreseeability test. It asks if there is anyone reason that the duty should not be imposed, or whether it should be limited or damages reduced. This provides a certain amount of flex within the system, where judges are able to interpret the law based on the social context and allows for reduction in indeterminate liability. Jim Leitzel cautions the circular nature of this; “courts will protect the amount of reliance in which a reasonable person would engage, but a reasonable person would rely up to the extent the courts protect.”[8] Due to this the courts have devised a five part test in determining if a duty of care exists, if the majority of the conditions are met – then sufficient grounds for negligence exist.

1. The defendant had a direct or indirect financial interest in the transaction in respect of which the representation was made.

2. The defendant was a professional who possessed a special skill, judgment, or knowledge.

3. The advice was given in the normal operations of the defendants business.

4. The information or advice was given deliberately and not on a social occasion.

5. The information or advice was given in response to a specific inquiry or request.

This test also serves the court in determining if a reasonable level of reliance existed in the professional relationship. If the professional provides incorrect information, but has an understanding that the advice or information they offer will be used and relied upon in future actions, they can be held liable for those actions. However, the courts have made it clear that the person relying on the information must have certain levels of business acumen.[9] Meaning, the claimant must take the advice with a grain of salt –using their own business knowledge they should be able to evaluate the advice and it’s applicability to their case. If the defendant can demonstrate that the action or conduct of the plaintiff would have happened regardless of the defendants action then no liability exists. The second part in determining professional negligence is that a standard of care was violated.

Standard of Care

The standard of care expected from a professional is different from what is expected from a non professional. Professionals are implied to have certain skills and abilities and their conduct must live up to set standards. If the professional falls below this standard of care, then negligence can be established. The courts use a reasonable person test to determine this breach. The question is whether the defendant actions, in a given situation, breached a standard of care. If the defendant’s actions have fallen below what a reasonable person would do, then he will be negligent for the injury or loss.

The reasonable person test is then what would have been what would have a reasonable accountant or doctor would have done in a given situation. If an individual claims to be a Chartered Accountant (CA) then he better have the training and competencies to be a chartered accountant. This is especially true as the courts do not recognize inexperience as a negating factor in liability. It is expected that a new professional is more susceptible to making mistakes, however, these people have demonstrated their ability to be a member of this profession and as a result must live up to the standard and competencies of a reasonable person in their profession.

Causation and Damages

The final two elements in determining professional liability are causation and damage, and are not differentiated from ordinary negligence. The tort of negligence requires that calculable losses have occurred, either economically or physically. The courts must recognize these damages as being compensable, in so much as to return the plaintiff to their original state, prior to the negligible act. The conduct of the defendant must be proved to have caused the damages in question. The two tests for causation are the but for test and the remoteness test. “Plaintiffs must prove in court that but for the conduct in question no damages would have resulted.”[10] The remoteness test looks at the damages caused by the defendant’s actions. In recent years the courts have “become much stricter in the manner in which it will assess the loss to the claimant.”[11] According to Anu Massey the courts will award damages on the basis of two considerations:

First, to compensate the claimant for the loss of the opportunity to achieve a certain result had the negligence not occurred [general damages]… secondly, and losses that have been suffered of a monetary nature such as costs that have been incurred as a result of remedial action which had to be taken to put the position right [special damages].[12]

If a reasonable person, in similar circumstances, could not have anticipated the nature of the damages or injuries caused as a result of their conduct, then the courts will not impose a liability. Once the four conditions of negligence are met, and providing reasonable reliance existed, the courts can establish professional negligence exists. Another important area of professional liability is that of their fiduciary duty to put their client’s interests ahead of their own.

Fiduciary Duty

When a person comes to a professional seeking advice or services the professional has a fiduciary obligation to keep the act in the client’s best interest. This will include putting the clients interest before their own and avoiding situations where conflict of interest may arise. Business interests that may arise, as a result of the interactions with the client, should not be acted upon by the professional. This is true in circumstances which would pose no harm to the client, as a general rule the professional must remain independent of any business proceedings which may result. As well any information that becomes privy to the professional in the course of their services must not be used by the fiduciary to benefit their position. An implicit obligation to maintain confidentiality exists in all professional relationships. When a professional does not act in the best interest of the client it is a breach of trust and they may be held liable for any losses incurred. In the case of Hodgkinson v. Simms, a conflict of interest arose where the accountant promoted investment opportunities in which he was financially involved.[13] The courts found that in doing so the accountant breached his fiduciary duty and was therefore liable for the results. This exemplifies the court’s decision to extend fiduciary liability to include any situation where one person advises another and reliance is placed on that advice. Fiduciary liability is extremely important to professionals and poses as much risk as negligence if not taken seriously.

Liability Insurance

Liability insurance is now becoming a reality of doing business. Since professionals provide services which often their clients do not fully grasp, it is easy for errors in expectations to occur. According to the Duke Law Journal “professional liability insurance has become society’s chief agency for the distribution of the cost of malpractice by the medical profession.”[14] As such, professionals can take measures to protect themselves and their business from undue financial hardships associated with litigation. Professional liability insurance, also known as errors or omissions insurance usually protects from professional negligence or failure to perform duties. Essentially professional insurance can be broken down into two categories: primary coverage and extended coverage. “Primary layers are basic policies stating the risk and people covered, policy limits and period. Additional coverage or endorsements for special risks or events may be purchased at additional cost”[15] Most insurance policies will not cover fraud or breach of trust, which can become problematic in joint-ventures or partnership situations.[16]

Currently Canada lacks formalized definitions of what constitutes liability for many professions. This lack of standardization of professional responsibilities and requirements can lead to uncertainty in service expectations. What may be customary one day can be negligent grounds the next. During the 1990s James Thompson discussed an increasing trend in professional liability cases, citing the number of cases brought against accountants within a twenty year period was more than in the entire history of the profession.[17] As the number of liability claims increase, as do the premiums of insurance policies to protect from such litigation. This is especially true since the courts usually tend to treat the matter as expansive rather than limited. For this reason professionals need to be proactive in avoiding liability as an alternative to the costly insurance premiums.[18] This has become known as risk management, which is discussed in the following sections.

Implications

In our discussion of professional liability it is crucial to understand the effects in a greater context. Essentially this liability ensures confidence in the system, giving an appropriate course of remedial action when wrong-doing has occurred. The importance of this cannot be underestimated, as the effects of professional mal-practice can be devastating to the profession as well as society in general. The relationship society has with professionals is one based on trust and reliance which must be maintained especially as our dependence on these professionals increases. Whenever cases of professional liability come forth the faith people place in that professional slowly diminishes.

The stakeholders implicated through professional liability can be far-reaching. For example, audited financial statements are a cornerstone of many investments and when the courts decide that CAs have acted negligent there are many consequences. Resulting litigation and the financial burdens they impose may bring job loss for the business as they struggle to deal with these proceedings. For the professional who is held accountable the resulting damage to their credibility is irreversible. Accounting firms may also be less likely to accept new clients as a result of the potential liability. Alternatively investor confidence may be weakened, as they become hesitant to invest in business based solely on the audited financial statements. This is especially true if there is no legal entitlement to compensation based on their third-party status. The result of professional negligence is evident among the clients affected. Although courts try to provide adequate compensation, there is no clear way to calculate the potential losses incurred. The consequential hardships of professional negligence are far-reaching, and preventative efforts should be sought.

The next question that needs to be asked is what can professionals do to protect themselves? Liability insurance does help protect professionals from losses incurred from lawsuits, but a more a proactive response is needed. Risk management is part of preemptive steps a professional or firm will take to avoid litigation proceedings. Three strategies of risk management according to Thompson are: stressing quality control; submitting to regular peer review; and participating in continuing professional education courses.[19] Above all, professionals should always avoid promising more than can be delivered. In essence professionals must manage client expectations, ensuring open communication channels, and developing a contractual agreement.[20] In larger corporations it has become commonplace to employ an insurance and risk management consultant. This person can be an invaluable addition to the organization, as they actively correct internal weaknesses. These liaisons cannot guarantee employee competence on all levels. It is therefore important for organizations to hire qualified and well-trained individuals. Most professionals are members of a self-governing body, which impose strict standards and rules, and also enforce that members meet the requirements of the profession. These organizations act as a watch-dog, reprimanding individuals who fall below the standard. Professional bodies also defend against all unjustified lawsuits against their members, even in circumstance where it is cheaper to settle out of court. This will deter future unjustified lawsuits against members of that organization. Even when risk avoidance is used, negligent lawsuits may arise. It cannot be stressed enough that whenever entering into this type of relationship it is important to have written documentation of services to be provided, and clearly outline the obligations and responsibilities. These documents will be invaluable in mounting a defense for the professional, and may reduce the scope of liability.

Overall, professionals are important members of our society. It is important that professional organizations ensure their membership meets the necessary standards to evade the threat of liability. As we have outlined professional negligence and liability can be rooted in three main areas: contract law; tort law; and breach of fiduciary duty. Professionals can take preemptive steps to limit the threat of potential litigation. Risk management, on-going education and training, and peer-review are strategies to limit this liability. As the business world becomes more globalized and interconnected the issue of professional negligence and liability will continue to expand into the future.

 

Bibliography

Anns v. Merton, London Borough Council, 2 AII E.R. 492 H.L. (1977).

Busch, J. T. (2004). Risk Managment. Contract , 46 (8), 128.

Donoghue v. Stevenson, 562 H.L. (1932).

Feinman, J. M. (2000). Professional Liability to Third Parties. American Bar Association.

Haig v. Bamford, 466 S.C.R. 1 (1977).

Hodgkinson v. Simms, 3 S.C.R. 377 (British Columbia Court of Appeal 1994).

Kripps v. Touche Ross, 6 W.W.R. 421 (B.C.C.A.) [1997], 102 B.C.A.C. 238.

Leitzel, J. (1989). Reliance and Contract Breach. Law and Contemporary Problems , 52 (1), 87-105.

Massey, A. (2007). The Courts Approach to ASsessing Loss in Professional Negligence Cases. Credit Control , 28 (1), 8 - 11.

Professional Negligence. (Jan. 1973). University of Pennsylvania Law Review , 121, 627 - 690.

Thompson, James H. (1991). Professional Liability Insurance: Go Bare or Not? Journal of Accountancy , 172 (1), 111-118.

Yates, R. A. (2008). Business Law (8th Edition). Toronto, ON: Pearson Canada.