The Professional Liability Crisis and the Need for Professional Limited Liability Companies: Washington's Model Approach

• Publication year: 1995
• Citation: Vol. 18 No. 03

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 18, No. 3SPRING 1995

COMMENTS

The Professional Liability Crisis and the Need for Professional Limited Liability Companies: Washington's Model Approach

Bryan Smith(fn*)

Litigation and its threat have begun to metastasize to virtually every sector of the economy. Retailers sue manufacturers, franchisees sue franchisers, commercial tenants sue office and mall developers, and everyone sues accountants.(fn1)

People never used to sue lawyers, just doctors .... But (now) they are suing lawyers.(fn2)

Ambulance chasers used to be confined to automobile accidents[.] Now . . . business accidents are a lot more valuable.(fn3)

I. Introduction

There is currently a crisis in this country,(fn4) involving the liability of professionals-lawyers and accountants in particular(fn5)-to clients, investors, and regulators. Professionals are being subjected to lawsuits at an alarming rate,(fn6) a large proportion of which have sprung out of the savings and loan debacle.(fn7) Although some of the litigation is justified, many of the suits are warrantless wastes of precious judicial resources.(fn8)

The accounting profession has been hit the hardest by the outbreak in lawsuits,(fn9) but lawyers are quickly becoming targets as well.(fn10) The litigation trend has already had several detrimental effects upon the accounting profession,(fn11) including exorbitant increases in insurance costs, cutbacks by firms in high risk areas, and failures of national accounting firms.(fn12) These same consequences will fall upon the attorneys in this country if something is not done to change the current system.

Several remedies are available to solve this problem, including reform of the joint and several liability standard(fn13) and reinstatement of the privity requirement regarding audited financial statements.(fn14) However, this Comment focuses upon the need for a change in the status quo of unlimited liability of professionals through use of the partnership entity,(fn15) which mandates that each partner's interest in the partnership and her personal assets be available to creditors.(fn16)

A new entity, the limited liability company (LLC), provides an answer to the unlimited liability problem of professionals. First introduced in Wyoming in 1977,(fn17) LLC legislation has been codified in forty-eight states (including the District of Columbia),(fn18) and is being considered by each remaining state in one form or another.(fn19) Washington passed its LLC statute in April, 1994, and it became effective on October 1, 1994.(fn20)

Of the states that have enacted LLC statutes, thirty-nine have specifically provided for professionals within the legislation, including Washington. At this time, three states prohibit professionals from becoming LLCs (including California and Oregon),(fn21) thirty-six allow them to do so,(fn22) and the remainder of the states omit any mention of use by professionals.(fn23)

This Comment argues that every state should allow professionals to take advantage of LLC statutes, as Washington has done. Such action will provide protection for accountants and lawyers from the wave of litigation that has surfaced in recent times and to restore an element of confidence to these professions. This Comment further asserts that allowing professionals to use LLC statutes is not only consistent with the duties peculiar to the accounting and legal professions, but also a necessary step when viewed in light of the policies of fairness, efficiency, and public protection.

Initially, Part II of this Comment describes the litigation crisis in this country and the sources of and reasons for the crisis. Part III discusses the current and potential future effects of the crisis if it is not addressed by lawmakers. Part IV introduces the LLC as a remedy for the effects of excessive litigation, describes the Washington LLC Act as it applies to professionals, shows how various statutes have addressed the issue of LLC use by professionals, and demonstrates how the LLC fits within the ethical codes of the legal and accounting profession. Part V of this Comment then illustrates how the LLC will help to remedy the litigation crisis, while Part VI shows why the LLC is a proper entity for professionals, and asserts that the Washington LLC act provides an ideal compromise between the interests of professionals and consumers. Finally, Part VII concludes that the LLC can provide professionals with much needed relief from the perils of excessive litigation, but that in order to do so, every state must follow Washington's lead and pass or amend legislation to permit professionals to utilize LLCs.

II. The Crisis

Lawsuits against professionals are at an all-time high.(fn24) This Part describes the various aspects of this crisis. Section A describes how it has hit the accounting profession; section B does the same with regard to attorneys; section C illustrates the sources of the crisis, while section D explains why professionals have come under such intense legal scrutiny over the last three years.

A. Accountants

The accounting profession has been hit the hardest by the explosion in litigation,(fn25) and the crisis has been termed "the premier threat to the profession."(fn26) As one commentator recently noted, "[t]he problems with the accounting profession . . . can be summed up in one word: liability."(fn27) In addition, a prominent figure in the profession has stated that, "[the profession's] liability burden is more than five times that of the manufacturers seeking product liability relief."(fn28) Some of the most prominent cases against accountants include:

- a $400 million settlement between Ernst and Young and federal thrift regulators;(fn29)

- a $338 million judgment recently levied against Price Water-house by an Arizona jury;(fn30)

- a $200 million verdict against Coopers and Lybrand by a jury in Texas;(fn31)

- an agreement by Arthur Andersen to pay $22 million to settle private lawsuits regarding its part in the Lincoln Savings and Loan Failure;(fn32) and

- the recent $312 million settlement reached between federal regulators and Deloitte and Touche in an action in which the government sought $1.4 billion in damages from the firm.(fn33)

In relation to revenue, litigation costs for accounting firms have risen from 7.7% in 1990,(fn34) to 9.0% in 1991,(fn35) to a high of 14.3% in 1992(fn36) Furthermore, the number of suits filed against accountants has increased each year over the past ten years.(fn37) A recent survey reports that between 1987 and 1991, ninety-six percent of accounting firms with over fifty members experienced an increase in their liability exposure.(fn38) The industry as a whole now faces over thirty billion dollars in pending lawsuits.(fn39)

The most disturbing factor is that, although the largest firms are most often mentioned with regard to the crisis,(fn40) smaller firms are feeling the pains of litigation as well. A recent survey showed that firms outside the six largest experienced a two-thirds increase in litigation between 1987 and 1991, and have seen a 300 percent increase in liability premiums since 1985.(fn41)

B. Attorneys

Although accountants clearly lead the liability race,(fn42) attorneys are not far behind.(fn43) Enormous verdicts against attorneys have become commonplace in recent years,(fn44) and a large number of suits arising from the savings and loan crisis have been filed against attorneys.(fn45) Two of the more well known cases have involved the lawyers working with the failed Lincoln Savings and Loan: the Kaye Scholer settlement of $41 million in the face of a freeze on its assets by the Office of Thrift Supervision,(fn46) and the $24 million that Cleveland megafirm Jones Day Reavis and Pogue paid out to settle its portion of the damage resulting from the now infamous thrift's failure.(fn47)

Indeed, law firms are beginning to experience the effects of the litigation. As one expert noted, "[t]hey're laying people off, and now they're faced with significant cash outlays, and I think you may see more partnerships dissolve just because they're not going to be able to pay the bills."(fn48) The statistics support this statement: 100 of the largest law firms in this country eliminated between five and ten percent of their partnership positions between 1990 and 1992,(fn49) and an estimated 256 lawsuits arising from the savings and loan scandal remained to be filed against attorneys at the end of 1992.(fn50) One partner of a New York firm summed up the current state of the profession: "You have to be out of your mind to be a partner in a law firm today."(fn51)

C. Sources of the Crisis

1. Savings and Loan Failures

a. Introduction

Much has been made of the banking scandal of the '80s and the bailout and cleanup of the '90s,(fn52) and for good reason. Approximately 550 thrift institutions have failed(fn53) as a result of the overly aggressive (and frequently fraudulent) practices employed by those institutions, and the estimates of the cost to the taxpayer to clean up the mess continue to grow,(fn54) running between $200 and $500 billion.(fn55) Because of these failures, and because few officers and directors of the failed thrifts have any assets remaining,(fn56) the federal government has become preoccupied with identifying a "meaningful class of deep...