Question 2 Legal Liability (25)

In November 2021, Cox Manufacturing applied to renew its line of credit with the International Bank & Trust (IBT). IBT informed Cox they must provide a set of audited financial statements for the year ending December 31, 2021 to support the loan application. Cox engaged Tyler & Tuffly, CPAs to audit their financial statements, and informed Tyler & Tuffly that the purpose of the audit was to support their applications for bank loans. Tyler & Tuffly completed the audit in February 2022 and issued a clean (unqualified) opinion on Coxs financial statements. After completion of the audit Cox provided copies of the financial statements and auditors report to IBT, and to several local banks where they had also applied for loans. Coxs line of credit of $2 million was renewed by IBT in March 2022. Cox also obtained a $1 million loan from the Mason Bank and Trust (MBT) based on the audited financial statements in March 2022. MBT is a local bank that Tyler & Tuffly are not familiar with.

In July 2022, Cox defaulted on its interest payments to both IBT and the MBT and filed for bankruptcy. Neither IBT nor MBT are expected to recover their loans to Cox. After an investigation, it was determined that Coxs 2021 financial statements had been fraudulently misstated by top management to conceal the companys weak financial condition. Tyler & Tuffly failed to perform certain required auditing procedures during their examination of Coxs financial statements, and as a result of the omission of these procedures they did not detect the fraud.

Required: Respond to each of the following independent questions. (12.5 each)

1. Assume that the International Bank and Trust (IBT) commences litigation against Tyler & Tuffly to recover their losses. Explain (a) what the legal status of IBT would likely be in this case; and (b) what the likely outcome of the case will be. Clearly explain your reasoning.

2. Assume that Mason Bank and Trust (MBT) also commences litigation against Tyler & Tuffly to recover their losses. Explain (a) what the legal status of MBT would likely be in this case; and (b) what the likely outcome of the case will be. Clearly explain your reasoning.