War Story: The Perils of Overlooking a Hidden Stakeholder

By:
RON KLEIN, J.D., CFE
Published Date:
Sep 8, 2015

Outland Property Co., the owner and manager of large tracts of land in the Rocky Mountains, leased a mountain slope on a percentage-lease basis to Sugar Pine Ski Resort. Sugar Pine, in turn, built chair lifts and a ski lodge, providing skiers with rental equipment, lessons and meals.

The lease agreement specified that a percentage of receipts from the lift tickets, rentals, lessons and food sales would go to Outland. Any further modifications to the agreement would have to be negotiated by Outland and Sugar Pine.

Over a 20-year period, Sugar Pine grew steadily into a major ski area. The company added condominiums to the property, as well as restaurants, retail shops and spas. The ski lifts and slopes were enhanced and expanded to the point where Sugar Pine was able to host major ski championships, from which it received fees from corporate sponsors. Income paid from Sugar Pine to Outland under the terms of the lease grew from about $75,000 per year to $500,000 per year.

Sugar Pine became a successful corporate entity, and the owners of Outland became elderly retirees who relied entirely on their managers for the direction of Outland. The managers, lawyers and CPAs of Outland and Sugar Pine negotiated a new lease agreement that excluded fees that Sugar Pine customers who rented condos paid to cover the costs of water and other utilities, as well as certain other fees, including sponsorship fees that corporations paid Sugar Pine for ski championships.

Another decade went by, and income paid by Sugar Pine to Outland under the terms of the lease grew to about $800,000 per year. The CPAs for Outland’s retired owners, however, astutely perceived the change in dynamics between their elderly clients and the corporate management teams running Outland and Sugar Pine. Those CPAs working for both management teams had also become a little too “cozy” with their clients.

The retirees’ CPAs closely examined the lease agreement and found definitions in it that could be construed to be self-contradictory, especially where the word “receipts” was used. The retirees then filed a lawsuit, claiming that certain receipts excluded by the agreement should have been included.

During the trial, the jury was sympathetic toward the retirees and generally interpreted the terms of the lease agreement in their favor, finding that fees specifically excluded from the agreement should have been included, namely the ski championship sponsor fees and the utility fees for condo rentals.

As a result, the fees payable by Sugar Pine to Outland were increased by about $400,000 per year over the 10-year period, totaling about $4 million. Sugar Pine then sued its CPA for failing to correctly determine the amounts payable under the lease agreement. 

Loss prevention tips
The absentee owners were represented by a management team that did not adequately include them in the lease negotiations. The resulting agreement appeared to neglect the best interests of the elderly retirees, who turned to their own CPAs and attorneys to rectify a perceived wrong. In cases like this, the CPA should—

  • determine, on an annual basis, who the stakeholders are in an engagement and make certain that they are receiving copies of the audit or other work, especially if the stakeholders are third-party beneficiaries of the work;
  • insist in writing that all parties in a transaction, including hidden stakeholders, use legal counsel to represent their own unique positions. One size attorney does not fit all parties;
  • consider having all parties involved afforded all of the same protections under the agreement. The CPA should avoid being exposed to broader liability from third parties or other stakeholders than his client is exposed to in the underlying agreement;
  • have an attorney review the language in the agreement, vis-à-vis the actual business operations, and give an opinion to the firm about how the document should be interpreted;
  • use the engagement letter to clearly define responsibilities, possibly excluding specific areas.

Ron Klein, J.D., CFE, is risk management counsel for Camico (www.camico.com). He has been with the company since its inception in 1986 and managed the claims department for 20 years. In his current role, he applies his extensive knowledge of CPA professional liability issues to help Camico policyholders practice sound risk management.

For information on the Camico program, call Camico directly at 800-652-1772, or contact: (Upstate) Reggie DeJean, Lawley Service, Inc., 716-849-8618, and (Downstate) Dan Hudson, Chesapeake Professional Liability Brokers, Inc., 410-757-1932. 

 

 

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