More is still to be sail? however in light of the AICPA Board of Directors' decision to recommend to Council that the AICPA Code of Ethics be changed to permit CPAs to practice in regular corporate form Even with a change at the AICPA level, CPAs are still governed by the laws of the states in which they are licensed to practice.

Under all state statutes a shareholder in a PC who commits a wrongful professional act or engages in professional misconduct remains personally liable for his or her own conduct. A PC shareholder's personal liability for the wrongful acts or misconduct of other shareholders or employees is not so universal. It has previously been stated:

"Responsibility for ordinary business debts and responsibility of innocent shareholders for their fellow shareholders' professional liabilities are the two aspects of the liability question that have caused confusion in the courts. This confusion is heightened by: 1) poorly worded statutes that do not address both aspects of the liability question; and 2) courts which, on public policy grounds, have broadened the scope of statutorily mandated liability." 1

STATE STATUTES

For example, statutes in Alabama, New Mexico, and North Dakota limit the liability of a shareholder in a PC in the same manner as the liability of a shareholder in a business corporation. On the other hand, statutes in Arizona, Oregon, and Wisconsin make the liability of a PC shareholder similar to that of a partner in a partnership, at least with respect to the performance of professional services. However, in most states the statutory liability of PC shareholders seems to lie between these two extremes. Statutes in 12 states provide limited liability for ordinary business debts and some degree of limited liability for professional malpractice. These states would hold a shareholder personally liable only for his or her own wrongful acts or omissions. Another 16 states and the District of Columbia provide limited liability for ordinary business debts and limited liability for innocent shareholders.

It appears that all states' PC statutes intend to retain personal liability of a professional-shareholder for any wrongful acts or omissions committed by the professional while rendering professional services. What is not clear is how much further the statutes intend to extend personal liability of the shareholder in a PC for ordinary business debts of the entity or for misconduct, wrongful acts, or malpractice of other employees who are not under direct supervision of the shareholder sought to be held personally liable. 2

THE CASE LAW

The authors examined one Federal Court of Appeals decision and 10 State Appellate Court decisions involving the personal liability of shareholders in PCs. The state decisions were rendered from 1974 to 1988. The federal decision dates back to 1969, shortly after many states began to allow professionals to incorporate so as to obtain the federal income tax advantages that were then available only to corporations).

In O'Neill v. United States, 3 the plaintiff was a professional who had incorporated his medical practice under Ohio law. The IRS refused to recognize the corporate status of the taxpayer's professional association for federal tax purposes. The professional paid the additional taxes assessed by the IRS and sued for refund in the U.S. District Court in Ohio. One issue in the case was whether a shareholder in an Ohio

Professional Association, in his capacity as a shareholder, enjoyed limited liability. Both the trial court and the Court of Appeals for the Sixth Circuit answered that question in the affirmative, which in turn led both courts to conclude that an Ohio Professional Association possessed more corporate than non-corporate attributes. Hence, the Ohio Professional Association was recognized as a corporation for federal income tax purposes and the taxpayer won his refund.

THE LOGIC OF O'NEILL

O'Neill is relevant to the issues addressed herein because it sets forth a well reasoned argument for upholding limited liability of professionals in PCs. 4 That argument is that the states, in passing statutes allowing professionals to incorporate, did so with the intent that the incorporated professional practices would henceforth be entitled to favorable federal income tax treatment. However, to qualify as a corporation for income tax purposes, federal tax laws and treasury regulations required the PCs formed under state law to have more corporate attributes than non-corporate attributes. Limited liability of shareholders is one of six factors that were examined under the attributes test. Therefore, the court reasoned, since the stated intention or purpose of the state legislation was to obtain favorable federal tax treatment for professionals who incorporated under state law, state legislature must have also intended that the incorporated professionals-shareholders enjoy, the same limited liability as shareholders in other business corporations incorporated in the state.

Although subsequent federal tax laws largely eliminated tax differences between sole proprietorships, partnerships, and incorporated professional practices, the O'Neill rationale is still relevant in statutory interpretation. Indeed, that same reasoning was used by state courts in Indiana and New York in 1477 and 1984 decisions that upheld the limited liability of shareholders in PCs.

No Vicarious Liability in Indiana

Birt v. St Mary Mercy Hospital of Gary, Inc., 5 involved a medical malpractice claim whereby the plaintiff attempted to impose personal liability on shareholders in a medical PC. The Indiana Court of Appeals held that no vicarious personal liability could be imposed upon non- negligent shareholders, directors, officers, or employees of a professional entity incorporated under the indiana Medical Professional Corporation Act. Reasons for the decision stated by the Court of Appeals included the tax argument enunciated in O'Neill and the statutory and common law rules in Indiana limiting shareholder liability for corporate debts. The indiana court further held that a corporate stockholder, director, agent, or employee was not liable for torts of the corporation merely because of said person's office or stockholdings.

Finding no reason not to apply indiana's General Corporation Act to PCs, the court stated that some additional connection with the tort, such as negligent conduct or inadequate supervision by the defendant, would be required to impose vicarious liability on the shareholder- professionals. This court also examined and rejected the public policy argument that vicarious liability is necessary to protect expectations that the entire PC will be engaged on the plaintiffs behalf rather than solely those professionals with whom the plaintiff may deal.

New York PC Protects Against Non-Professional Liability

A second case that relies upon the tax arguments voiced in O'Neill was We're Associates Co. L Coben, Strachner & Bloom, P.C, 6 decided in 1984. This New York case involved a suit for unpaid rents under a lease. Here plaintiffs sought to impose personal liability upon the shareholder-professionals on the grounds that the limited liability of shareholders rule did not apply to shareholders in PCs. The New York court soundly rejected plaintiff s argument and clearly stated that the same limited liability afforded to shareholders of any other form of corporation was intended to be available to members of any PC in the State of New York, regardless of the profession involved.

Two, wears later in 1986, the New York Court of Appeals, in Hill v. St. Clare's Hospital, 7 restated the rule announced in We're Associates, that absent some additional connection to the corporate debt or tort, there could be no vicarious liability for shareholders in any PC. However, the court also stated that a physician who owned a medical clinic as a sole proprietor could be held vicariously liable for medical malpractice of another physician employed by the clinic even though the owner/physician neither participates in nor controls the diagnosis made or treatment prescribed. This holding, however, was based upon a fraud wherein the owner-physician had the attending physician use his name in order to preserve the value of his practice while he was unable to work. These cases emphasize the obvious advantages of utilizing PCs to conduct professional practices in the State of New York.

INNOCENT PROFESSIONAL BEWARE

A contrary result occurred when Ohio state courts were faced with the issue that had been raised in federal court in O'Neill, namely the limited liability, or the lack thereof, of shareholders in Ohio PCs. In 1969 the federal courts had held in O'Neill, based upon their interpretation of Ohio law, that shareholder-professionals in PCs incorporated under the Ohio Professional Association Laws were entitled to limited liability in their capacity as shareholders. In Reiner v. Kelly, 1983, 8 the Ohio Court of Appeals held to the contrary. In Reiner, one shareholder in a PC committed fraudulent acts unbeknownst to the other shareholder. The plaintiff sued both shareholders individually and the PA. The Ohio Court of Appeals rejected the innocent shareholder's objections that he should not be held vicariously liable merely because of the ownership of shares in the same PC as the fraudulent professional. The Court stated that the veil of a PC offered no such protection and proceeded to affirm the personal liability of the innocent professional based on the language of the ohio statute which makes each shareholder a guarantor of the financial responsibility of the PA.

No Vicarious Liability for Fraud

Further complicating the matter are several other cases from other jurisdictions that also reach conflicting results. In 1974, the North Carolina courts confronted a fact situation not unlike the one considered by the Ohio courts in Reiner. In the North Carolina case, Zimmerman v. Hogg & Allen, Professional Association, 9 one member of a legal professional association was accused of wrongfully misapplying client funds delivered to him for investment. The plaintiff sued the professional association itself, the guilty professional and all other shareholders in the professional association. One issue posed was the extent of limited liability afforded to shareholder- professionals in PCs under North Carolina law. The court held that "under North Carolina law, professional corporations are liable to the same extent as if they were a partnership." However, the plaintiff still lost his case against the professional association and the non-culpable shareholders because the court ruled that committing fraud in the investment of client funds was outside the scope of the association's professional practice. Hence, only the individual professional who misapplied the client funds was liable to the disgruntled client and the other member of the PC, as well as the PC, had no responsibility.

Radiologists Were Not Protected

In a subsequent case in 1985, involving a different profession, the North Carolina Court of Appeals, following the rule announced in Zimmerman, again held that professionals in North Carolina professional associations did not enjoy the same limited liability as shareholders in ordinary business corporations. The case, Nelson Patrick 10 involved the vicarious liability of non-negligent shareholders in a radiological professional association for alleged malpractice of an associate. The North Carolina Court of Appeals decision consistently referred to all of the defendants as partners," apparently ignoring their status as shareholders. Citing Zimmerman as precedent, the court stated that all the "partners" in the professional association could be held personally liable for alleged malpractice of any other radiologist, that occurred in the association's professional practice.

Other Conflicting Results

Two earlier cases, one from Kentucky and one from Illinois, involving professional malpractice by members of PCs also reached conflicting results. In the Kentucky case, Boyd v. Badenhausen, 11 the Kentucky Supreme Court held that the veil of a professional service corporation does not protect its members from personal responsibility for negligence of corporate employees. In the State of Illinois, however, in Fure v. Sherman Hospital, 12 the Illinois Court of Appeals held that shareholders, officers, directors, agents, and employees of PCs formed under Illinois' Professional Service Corporation Acts were insulated from liability for negligent acts of other employees, including the professional malpractice of other shareholders, provided the shareholder in question rendered no service to the plaintiff and did not supervise or control the party committing the alleged negligent act.

Two additional cases, both decided during the 1980s, involving the vicarious liability of shareholders in legal PCs, also reached conflicting results. In 1983, in First Bank & Trust Co. v. Zagoria, 13 the Georgia Supreme Court held that non-culpable shareholder- professionals in a PC were not insulated from personal liability for professional misconduct of a fellow professional in the same PC. Stating that it "is inappropriate for the professional to be able to play hide- and-seek in the shadows and folds of the corporate veil. . . it appears that the rationale of Zagoria was based on the court's perception of public policy and the responsibilities of professionalism. However, the Zagoria court also stated that shareholders in Georgia PCs would have the same insulation from liability as shareholders of other corporations with respect to obligations of a purely business and non-professional nature. It should be noted, however, that the decision of the Georgia court was largely based on the notion that the courts, and not the legislature, were empowered to establish standards for the legal profession and, therefore, any attempt to immunize attorneys from liability, by the legislature was of no effect.

Utah Strikes a Middle Ground

The court of appeals of the State of Utah, in Stewart v. Coffman 14 reached a conclusion contrary to the North Carolina court. In Stewart, the Utah court held that shareholders in a corporation organized under the Utah Professional Corporation Act are not vicariously liable for the acts or omissions committed by other shareholders in the performance of professional services unless the shareholder in question participated in the alleged acts or omissions. The Utah court's decision was based largely on statutory interpretation. The court cited a specific provision of the Utah Professional Corporation Act which emphasized a legislative intent that Utah PCs, as nearly as possible, were to be treated the same as other corporations.

The Utah court also rejected the plaintiffs argument that the disciplinary rules of the defendant's profession were intended to extend vicarious personal liability to shareholder-professionals incorporated under the Utah Professional Corporation Act. In doing so, the court noted that the Utah act did not alter in any manner the relationship between the professional actually rendering the services and the person receiving the professional services, including personal liability for negligence in rendering those services.

BUT WHAT ABOUT ACCOUNTANTS?

The research for this article did not uncover any reported cases involving personal liability of shareholders in accounting PCs. Nevertheless, there are numerous reported cases involving the personal liability of other professionals, i.e., attorneys, architects, dentists, and medical doctors. It would appear that these cases are relevant to accountants in that the public policy arguments stated seem equally applicable to the accounting profession.

CONCLUSION

Accountants who incorporate to secure the benefits of limited liability may not in fact limit their liability to the extent they plan or desire. Because the laws vary from state to state, it would be to their benefit to examine closely the PC act of their state and the limited liability case law in their jurisdiction, prior to incorporating.

While it appears that most states' PC statutes intend to retain personal liability for the accountant-shareholder for any wrongful acts or omissions committed by the accountant while rendering professional services; in many states it is not clear how much further the statutes intend to extend personal liability of the accountant-shareholder for ordinary business debts of the entity or for misconduct, wrongful acts, or malpractice of other employees who are not under direct supervision of the accountant-shareholder.

1. Comment, "Shareholder Liability in Professional Legal Corporations: A Survey of the States," 47 University of Pittsburgh Law Review 817-818 (1986) (by Karen M. Maycheck).

2. It should be noted that approximately one-half of all state statutes retain vicarious liability for P.C. shareholders in one or more circumstances. See August 1990 The CPA Journal, pages 22-27.

3. 410 F.2d 888 (6th Cir. 1969).

4. The states are divided in denominating professional organizations as "professional corporations" or "PCs" and "professional associations" or "PAs." it is the latter group that tends to raise questions as to whether limited liability was intended.

5. 175 Ind. App. 32; 370 N.E. 2d 379 (ct. app. 3rd D, 1977).

6. 65 N.Y. 2d 148 (1985).

7. 67 N.Y. 2d 72 (1986).

8. 8 Ohio App. 3d 390; 457 N.E. 2d 946 (Ct. App. 10th Dist. 1983).

9. 286 N.C. 24 (1974).

10. 73 N.C. App. 1; 326 S.E. 2d 45 (1985).

11. 556 S.W. 2d 896 (Ky. 1977).

12. 55 III. App. 3d 572; 371 N.E. 2d 143 (1st Dist. 1977).

13, 250 Ga. 844 (1983).

14. 748 P. 2d 579 (Utah 1988).

Gamewell Gantt, JD, CPA, is Associate Professor at Idaho State University and is a member of the Idaho State Bar and a CPA in both Idaho and Texas. Mr. Gantt is a member of the State of Idaho's Endowment Investment Board

Lela D. Pumphrey, PhD, CPA, is Associate Professor and Acting Associate Dean at Idaho State university. She is a member of the AICPA and the Idaho Society of CPAs and coordinates the standards Enforcement Programs of the Idaho State Board of Accountancy. Dr Pumphrey currently chairs the Financial Management Standards Committee of the Association of Government Accountants.