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What is a Legal Audit Letter?

As your San Diego and California business grows, you are going to eventually need audited financial statements prepared by a certified public accountant (“CPA”). If you have sought out conventional investor financing, having such certified financial statements is often a prerequisite to obtaining the financing. Your talented and experienced business lawyer has a role to play in preparing financial statements in responding to what is called the Legal Audit Letter. You might be asking: What is a legal audit letter? Here is what you need to know.

San Diego Business Law: What is a Legal Audit Letter?

When a certified public accountant prepares a financial statement for your San Diego business, among the financial information that must be included are legal costs and expenses charged by the company’s lawyers, costs with respect to ongoing litigation, and potential costs and expenses with respect to threatened litigation. For our purposes, “litigation” should be read broadly to include any sort of litigation-like proceeding including any arbitrations and/or any governmental, administrative, or regulatory proceedings.

In gathering such information on legal and litigation costs, the auditor will send out what is known as a legal audit letter asking various standard questions and requesting a response directly from your business lawyer. In proper practice, the letter is sent to you, the San Diego business, and then you forward it to your attorney. Your attorney then responds to your CPA.

San Diego Business Law: Do I Have to Agree to a Legal Audit Letter Being Sent?

Legal audit letters may sound like a “big deal” and the letters themselves are often full of legalese and seem intimidating to nonlawyers. But, in truth, audit letters are standard and routine. Moreover, as noted, information about legal and litigation costs are necessary to prepare a financial statement. The best general and standard practice for CPAs is to obtain that information independently from the company’s attorneys. Thus, while you can object to your CPA sending a legal audit letter, or you can refuse to allow your lawyer to respond; this is just routine and objecting to the letter will negatively impact your audit and your financial statements.

San Diego Business Law: What Information is Sought?

Legal audit letters have become standardized to some extent and the questions are more or less the same (although, a CPA might add extra or more detailed questions if the circumstances warrant the extra questions). In general, the legal audit letter is about two pages long and, depending on the number of lawsuits that might be pending and/or threatened, the response might be three or four pages (longer if there are a lot of lawsuits).

Information is sought for three broad categories:

(i) Outstanding legal fees that are currently due and how much,

(ii) The expected future costs for any and all pending litigation and

(iii) What are the expected future costs for threatened litigation.

For CPAs, the distinction between categories (ii) and (iii) are important. In addition, often your lawyer will be asked to give his/her legal opinion about the likelihood of “adverse outcomes.”

As an example, your trusted business lawyer may respond via letter by saying: “… all Firm legal invoices have been paid” through such and such date, here are the current cases and brief descriptions and explaining that two are covered by insurance (zero costs) and three others cost about $5,000 a month in legal billing and “the Firm is unaware of any material threatened litigation, governmental actions, etc.” As for opinions, your lawyer might say something like: “there is insufficient information to provide an opinion” or “based on limitations set forth herein, without being a guarantee, our opinion is that an adverse result is unlikely,” etc.

San Diego Business Law: Your Confidentiality and Privilege are Protected

Note, as seen above, the best practice is to have your CPA send the legal audit letter first to you and then you send the letter to your lawyer. This gives your lawyer permission to respond. Under ethical obligations and various laws, your lawyer cannot disclose confidential information or otherwise violate the attorney-client privilege without your consent. But, assuming your consent is given, in addition to providing the needed information to your CPA, your trusted lawyer will

Establish limitations on how your CPA can use the information provided — only for the audit, for example
Limit who may rely on the information — only your CPA
Disclose no confidential information beyond what is essential for the audit
Communicate with you, the client, during the process
Confirm that the responding letter is not a waiver of confidentiality or privilege
Appropriately narrow and limit any legal opinions

San Diego Business Law: Contact San Diego Corporate Law

If you would like more information about legal audit letters, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides a full panoply of legal services for San Diego and California businesses. Mr. Leonard has been named a “Rising Star” three years running by SuperLawyers.com and “Best of the Bar” by the San Diego Business Journal. Mr. Leonard can be reached at (858) 483-9200 or via email.