International Networks Face Tests From U.S. Courts – First of Series

(In this first of a series, we will discuss the background of how some global networks of professionals operate. In this series, we will specifically review the global network of an accountant firm.)

 

Two U.S. court decisions within the last 18 months have demonstrated the perils for international networks when member practices are sued in the U.S.. These decisions coincide with a period in which closer links are being forged within some of the largest networks.

 

Background

Traditionally, most large accountancy networks have operated as relatively loose associations of national firms, with membership regulated by a non-trading "umbrella" entity which does not own any interest in the member firms. In order to protect and enhance the international brand, the umbrella entity is typically given power to lay down professional standards to be followed throughout the network, and may undertake activities such as quality review, training, arranging staff transfers and client data sharing.

Since June 2006, two of the Big 4 networks have each announced their own plans for much closer legal relationships between some or all of the European member firms within each network. In each case, rather than creating an international legal partnership to take the place of the national firms, the new arrangements involve the establishment of a new LLP as a non-trading holding entity for the national firms which are to be trading subsidiaries.

These new structures exhibit two features that merit comment here:

1. Although under common ownership for the first time, the national firms will continue to trade separately from each other.
   
2. The geographical range of these new arrangements is regional rather than worldwide.
   

The majority of accountancy networks have not followed this example, although some have indicated that there will be closer relationships between firms at a regional level. Clearly, developments such as these are driven by commercial factors, but issues concerning legal risk are an important part of the background to these changes.

A risk that is particularly associated with network structures is that a member firm may become exposed to allegations that it is vicariously liable for the acts and omissions of other member firms. Although claimants have very rarely seen fit to chance their arm before a judge in an English court on such matters, the decisions of courts in the United States have provided some of the strongest indications of the legal risks involved in closer worldwide integration of firms within accountancy networks. While that much is predictable, the outcome of U.S. litigation in this field is proving to be less so. Over the last decade, U.S. claimants have often failed in their attempts to construct a case against a "deep pocket" member firm such as the U.S. firm, where that case is entirely founded either upon that firm's actual relationship (through the network) with the principal defendant firm, or on the representations made about that relationship.

Claimants have had more success in persuading U.S. courts of the viability of their cases against umbrella organizations. They typically advance their case on one or more of the following theories of liability (which have also featured in the claims attempting to fix member firms with liability for the faults of other members):

• the "alter ego" theory, in which it is argued that the international umbrella entity is so dominated by a member firm that it primarily transacted the member firm's business rather than its own affairs;
  
• the "agency" theory, in which it is argued that the member firm is acting on behalf of the international entity and is under its control;
  
• the "partnership" theory, in which it is argued that there is a single business carried out by the member firm and the international entity together. Alternatively, it may be argued that the international entity is in effect bound by a representation made by the member firm that they are in partnership, which the claimant had relied on when engaging the services in question.
  

Umbrella entities have been relatively successful in dismissing alter ego and partnership claims. However, in the last 12 months U.S. courts have made two decisions which have highlighted the dangers presented by agency allegations. In both cases, the substantive allegations of agency are now to undergo trial by jury.

In the next installment of the series, we will discuss two (2) major cases that have impacted the global accountants' network.