Legal briefs

By Mélanie Raymond

Two recent court cases brought against accountants in Quebec illustrate how legal obligations apply in the real world.

The legal obligations accountants have toward their clients are diverse. Two recent Quebec court decisions are good examples of how these different responsibilities apply. One decision highlights the nature of the auditor's obligation to his or her clients when it comes to advising them on business decisions; the other deals with the necessity of accountants knowing, in some situations, how tax laws work in provinces outside their own.

Obligation to advise
In the case of Migneault v. Morissette, the court decision illustrates the sub- stance of auditors" obligation to advise their clients. The case was dismissed on appeal in September 2000. The clients were suing their accountant, claiming they had been poorly advised about the purchase of a restaurant. The clients also claimed that the accountant was in a position of conflict of interest.

The clients, Estelle Migneault and Arlette Lévesque, wanted to buy a restaurant in Mont Joli, Que. They had already approached the owner and obtained a selling price of $150,000. With this information in hand, they contacted accountant Claude Morissette and asked him to determine whether the asking price was acceptable.

After studying the file, including the in-house financial statements, Morissette met with Migneault and Lévesque and advised them not to buy the restaurant, mainly because of an announcement that a large chain of restaurants would be opening in Mont Joli. But the clients had other plans for the restaurant, including a catering service, and they were not worried about restaurant chains. The accountant then suggested they offer no more than $115,000.

Negotiations between Migneault, Lévesque and the res-taurant owner continued without the accountant, and they settled on a price of $135,000. Unfortunately, it was not long before the restaurant closed.

The judge, Gaetan Pelletier, considered that the accountant had acted only as a consultant to the buyers and not as a mandatary in the sale transaction. The fact that the accountant had prepared forecast statements to help the buyers obtain financing from financial institutions did not change his status. Thus, the accountant did not breach his duty to provide advice to his clients because, first of all, he advised them not to buy the restaurant and, when he came to the realization that Migneault and Lévesque did not agree, he suggested they reduce their offer. Furthermore, he did not take part in the negotiations.

Morissette could have been held liable because of the forecast financial statements, since the clients" expert witness claimed he had been overly optimistic. However, Justice Pelletier concentrated instead on the end-user of the forecast statements and noted that not only were the statements intended solely for the financial institution, but also that the clients did not seem to have relied on them when deciding to buy. The restaurant's closing was due to incalculable factors, including the fact that one of the buyers became ill and that more restaurant chains than expected sprung up after the clients purchased the restaurant.

As for an additional allegation -- conflict of interest -- the court did not accept the buyers" claim that the accountant had favoured the seller. Although Morissette was the partner of the seller's accountant -- not an ideal situation -- the judge noted since Morissette had advised them not to buy the restaurant, there was no conflict of interest or damages stemming from this fact.

Accordingly, the judge did not uphold the expert witness's claim that a perceived conflict of interest was sufficient. Upon reading the decision, however, it is impossible to clearly establish whether the judge rejected the element of a perceived conflict of interest as a criteria for assessing the situation, or if he considered that there was simply no perceived conflict of interest in this case. Nevertheless, he did point out that the situation would have been completely different had the accountant's partner played any role in determining the selling price or in the negotiations.

Knowledge of legislation
Even though they practise in a specific province, CAs are not automatically exempt from liability in another province because they are unaware of its tax legislation. Such was the March 2001 ruling by Quebec judge Yves Alain in Louton v. Malenfant.

It all started when New Brunswick's Department of Finance sent the client, Louton ltée, a new notice of assessment. Louton is a home-building company operating in Quebec and New Brunswick and was being assessed for unpaid taxes for materials purchased in Quebec but used to construct housing units in New Brunswick. Louton had failed to comply with the voluntary reporting requirements provided for under New Brunswick's income tax act, mistakenly believing the seller, not the buyer of materials, was supposed to collect the tax.

Louton took action against its then accountant, Malenfant, and his partner, accusing them of breaching three different duties: installing an adequate accounting system, keeping the books and auditing the financial statements.

With respect to the first breach, the accountant and his partner were mandated to implement a system to determine and control the costs of the company's home-building contracts.

According to Justice Alain, when a client wants to obtain a cost-control system and the professional is aware that work will be carried out in both Quebec and New Brunswick, it is important to know if the seller of the goods has to collect the tax or if the buyer has to voluntarily declare it to the tax office.

Even if he or she was not directly asked to do so by the client, it is the accountant's responsibility to research this information.

Regarding the bookkeeping duties, the breach in the mandate to implement an accounting system was made worse by the fact that in 1993 employees at Louton had contacted a member of the accountant's staff to find out whether the buyer or the seller was responsible for the New Brunswick taxes.

They were allegedly told Louton had no responsibility toward the government. The accountant was, therefore, allegedly at fault for transmitting false information as part of his mandate to keep the books on a monthly basis, which also involved the calculation of source deductions and the preparation of tax reports for the two governments.

Louton also claimed there had been an error in the audit of the financial statements and the preparation of financial statements in the form of a review engagement. Although Justice Alain had little to say on the subject, it is interesting to note his conclusion that accountants were not liable on this point.

Despite these breaches, the accountant was liable for only half the amount claimed -- the other half being the responsibility of the client since the evidence showed some invoices had been poorly coded and it was impossible to tell whether they originated in New Brunswick or whether the goods purchased were for New Brunswick or Quebec.

Consequently, the judge said, even if the accounting system had been adequate, errors could have occurred as a result of the improper codification, which would have triggered an assessment from the New Brunswick Department of Finance.

Concerning damages, an interesting argument was raised. Louton had argued that if it had known from the start it had to pay certain taxes, it would have passed on the cost to the buyers of its buildings by increasing the estimated cost of the contract by the amount of taxes payable. The company went so far as to claim a gross margin of 25% applied to the cost of the contract, plus taxes.

However, Justice Alain did not uphold this argument. In the judge's opinion, the client's evidence did not show it would have been in a position to increase the selling price of the buildings to recover the unpaid taxes. In other words, there was no proof the market would have supported a higher price.

The judge focused instead on the fact that there was a legal obligation to pay the provincial tax, and he did not award damages on this point. Only the penalties, interest and expenses paid to produce the notice of objection could be claimed. This did not include the expert fees to prepare for the trial and hearing.

Consequently, of a claim of more than $65,109, the accountant and his partner were ordered to pay a total of $12,135.50 in damages, to which were added the interest on the damages from the date of the formal demand.

Mélanie Raymond, BCL, is an MA (comm.) student and lawyer with Nicholl Paskell-Mede in Montreal

T echnical Editor: Mindy Paskell-Mede, BCL, LLB, is a partner in Nicholl Paskell-Mede