Privity Test

To be clear, privity, and thus a duty of care, does not ordinarily exist between an accountant and a third party. New Jersey’s privity statute defines a set of factual circumstances that must occur in order for an accountant to be liable to a third party, in the absence of privity. For liability to attach for negligent accounting services, the third party must be specifically known to the accountant in connection with a specific transaction, the accountant must know that the third party intended to rely on the accountant’s services for that specific transaction, and the account must have directly expressed to the third party this understanding. For the protection of all parties, in almost every case, it is best that such expression be made in writing. Where time is of the essence, an oral communication may be followed immediately by a written communication. In the case of third party banks, there must be a written acknowledgment from the accountant. [See sample letters]

In the case of a client that desires a third party bank to be provided with financial statements prepared by an accountant, the law requires that the accountant must acknowledge the bank's intended reliance on the professional accounting service, as well as the client's knowledge of that reliance, in a written communication. It is generally recommended that the accountant send the written communication to the accountant's client with a copy to the bank.

An accountant may not want a third party to rely on any work done for a client. This may be because the accountant believes the third party does not have a valid business reason for obtaining or relying on the accountant’s work, or the accountant wishes to send a "red flag" to the third party about the accountant's client, or due to some other reason (e.g., existence of significant uncertainties). Although the accountant's silence may be sufficient to evidence a lack of understanding concerning reliance by the third party, a response to the client may be more appropriate under certain circumstances. Legal counsel should be consulted to limit any potential liability.

When CPAs provide reliance letters for compilation reports to a third party the CPA may be representing that the compilation report provides greater assurance than what is intended, since a compilation report is limited to presenting information that is the representation of management. To the extent that a third party seeks to rely upon any unusual services performed by the CPAs, the CPA should be similarly cautious. NJCPA has developed a response form for compilations, which qualifies the acknowledgment and contains language regarding the limited nature of a compilation report.


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