The CPA Journal

ADR: Risk Containment Tool

By John F. Raspante, CPA

There is a saying that illustrates the limitations of litigation: “With time, the case gets worse for both sides.” This is especially true of cases requiring large amounts of discovery, investigation, evidence preparation, and testimony. The financial and emotional costs of a trial, and the uncertainty of the outcome, all tend to grow with time.

The prospect of protracted legal maneuvering and negative publicity causes the vast majority (about 96%) of liability claims to be settled before going to trial. Mediation, arbitration, and other out-of-court settlement procedures, known as Alternative Dispute Resolution (ADR), facilitate such settlements by providing speedy, cost-efficient, and private alternatives to time-consuming, costly, and public trials.

The two most common forms of ADR, which differ by the degree of control the disputing parties have over the outcome, are—

mediation, which provides for a neutral third party to help the parties resolve their differences voluntarily; and

binding arbitration, which provides for one or more impartial persons to assess both sides of a dispute and to make a final and binding decision.

ADR is one of the more significant and powerful risk containment tools available to CPAs. We make this statement with caveats, however:

CPAs should not use binding arbitration language in engagement letters or contracts, with the exception of fee disputes.

In many states, such as New York, ADR is more effective when used as part of an engagement letter or contract signed by the client. Clients are often less inclined to agree to ADR after a dispute has arisen, especially a fee dispute.

ADR must be used appropriately in order to minimize the CPA’s exposure to unnecessary losses. Used incorrectly, ADR can impose irreparable damage to a liability defense. CPAs should consult with their insurer, risk advisor, or legal counsel regarding individual situations.

Mediation

Mediation language should be included in engagement letters for all disputes, regardless of the engagement. Mediation provides a setting where the involved parties can present their arguments and information, helping the parties better understand each other’s positions and expediting the settlement process.

For example, one scenario in which mediation can be effective is when a third-party creditor sues a CPA for an allegedly substandard audit or review. The dispute arises when a client defaults on a loan or declares bankruptcy, and a creditor then sues the CPA in an attempt to recoup the loss.

Mediation provides the opportunity to demonstrate that a trial jury might be inclined to believe the CPA’s side of the story. CPAs generally enjoy a favorable public image compared to bank executives or other kinds of creditors. If the point can be made that the bank or creditor did not closely follow all of its own policies when approving credit, the CPA could then argue that the creditor knowingly took an imprudent risk in order to collect the loan fees (fees that may be much larger than those collected by the CPA from the same client). In other words, mediation can enable the creditor to see the case the way a jury might see it: that the creditor should bear the blame for its own losses.

A mediation session also provides an opportunity for the parties to see how complex and difficult their case will become. The more documents and expert witnesses a jury will need to consider, the more difficult it becomes for either side to predict an outcome. The certainty of a facilitated settlement becomes an increasingly attractive option.

Mediation can also lead to creative solutions, such as a settlement wherein the CPA would provide additional services, instead of money, to the client. In short, mediation allows both sides to talk and work their problems out with each other.

Binding Arbitration

In the case of fee disputes, binding arbitration is recommended as a second step after mediation, regardless of the type of services rendered. CPAs should avoid, at all costs, suing a client for fees. The fees in dispute are usually relatively small, but experience indicates a high propensity for malpractice countersuits far in excess of the fees. There is less risk of a malpractice countersuit when binding arbitration has been agreed to in the engagement letter. Again, the letter should clarify that only fee disputes will be submitted for resolution through arbitration.

Binding arbitration transfers the decision making to impartial adjudicators. Most non-fee disputes, either because of the complexity or financial impact of the issues, might be better addressed through litigation. Because arbitration is faster and less expensive than litigation, adjudicators generally do not have the benefit of full discovery or possess the skills or competence to assess and understand the technical issues in dispute. The arbitration process can be appealed in court on account of conflict of interest or fraud, but the burden of proof makes doing so prohibitive. Therefore, all unresolved disputes, except for fee disputes, should be left open to litigation as a last result.

Using Mediation and Arbitration

The following are practices will optimize the use of mediation and arbitration:

Establish an understanding with the client for how disputes will be handled. Addressing this topic before a dispute encourages an honest and open dialogue. An ideal place for this type of predispute agreement is the engagement letter.

Discuss the the rights and obligations under the predispute agreement with an insurer, risk advisor, or legal counsel. Many firms use language stipulating the use of ADR without truly understanding the impact on their practice. Attorneys that do not understand the nuances of professional accounting services may provide guidance that actually increases risk.

Don’t give up the ability to litigate significant disputes and the attending rights of discovery, testimony, and cross-examination. Using binding arbitration for all disputes exposes the CPA to considerable additional risk.

Effective ADR establishes a collaborative framework for dispute resolution, without relinquishing the right to litigate significant, high-risk disputes. If the parties agree to this framework, conflicts can be mediated before they become adversarial. If they cannot be mediated, they are at least given an efficient and private forum.

Further guidance and sample engagement letter language can be seen at www.adr.org. The American Arbitration Association can be contacted at (800) 778-7879. Sample engagement letter language can also be found in the CPA’s Guide to Effective Engagement Letters (Harcourt Professional Publishing, (800) 831-7799). Questions can also be directed to CAMICO’s advisory services hotline at (800) 652-1772.

John F. Raspante, CPA, is manager of CAMICO’s New York office. He has worked as a staff accountant for AIG and Lehman Brothers, and as the sole proprietor of a public accounting practice.

Editor:
Philip Zimmerman, CPA
Mediator and Arbitrator

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The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

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