The pending split between McGladrey & Pullen and tax prep giant H&R Block is getting ugly.

Just days after M&P's blockbuster announcement in late July that it was terminating its administrative services agreement with Block, the tax prep giant's affiliate, RSM McGladrey, filed suit against the Bloomington, Minn.-based audit and attest firm, claiming that M&P had no intention of abiding by clauses in the contract that prohibit M&P from encouraging RSM employees to resign and M&P from taking on new loans or debt.

McGladrey & Pullen's audit practice is an independent, partner-owned firm, but under a 1999 pact with Block, related professional services have been offered through RSM, which operates in an alternative practice structure with McGladrey. M&P focused on audit and attest services, while RSM provided other types of accounting and tax services.

"We are disappointed that H&R Block has chosen to pursue litigation," McGladrey & Pullen managing partner Dave Scudder told Accounting Today. "We are committed to respecting our legal obligations and are confident we are doing so. Thus we are confident this lawsuit has no merit. Under the terms of our shared services agreement, we have every right to terminate that arrangement. We have chosen to do so because it is the best business decision for McGladrey & Pullen LLP in order to serve our clients in the increasingly complex business and regulatory environment."

Under the contract, M&P was supposed to have the right to end the deal at any time, with a workout period to smooth the transition for clients. "We've always had the ability to walk away," Scudder reiterated. "We've always been an independent firm, and there's no reason we wouldn't retain those rights going forward."

Block and RSM did not immediately respond to requests for comment.

Meanwhile, one day following the announcement, Block CEO Russ Smyth issued a strongly worded statement warning of risks to M&P. "We believe the path proposed by certain of M&P's leaders is fraught with significant business and financial risk and is not in the best interest of M&P partners, employees or clients," he said. "Whether the full M&P partnership is willing to assume these immense risks remains to be seen."

Scudder explained the decision to end the agreement as a response to current conditions in the market. "Times are very different from 1999, when we entered into this arrangement to outsource some of the administrative services to them," he said. He described the decision as a "combination of economic conditions and the overall cost benefits of that agreement, combined with what we think is the opportunity and what's going on in the marketplace right now."

Block noted that under the agreement, M&P had received a significant line of credit from RSM to finance its receivables and working capital, as well as office space, and said that M&P has also received substantial capital investments from Block affiliates to assist in acquisitions of professional services firms, to develop software and other technology for attest and other practices, and to support the overall development of the business.

During the notice period, the existing agreements remain in effect.

"It will be interesting to watch it unravel," said Allan Koltin, CEO of consultancy PDI Global. "At the end of it, the fifth largest accounting firm in the U.S. will be somewhat smaller but potentially very different. The tricky part will be figuring out which entity the partners and associates that were in both entities will now be part of. They have a lot of people who were active in both. They will have to divide up any common marketing, human resources, technology and financial issues between the firms. Will RSM McGladrey still refer audit work to McGladrey & Pullen, and will McGladrey & Pullen still refer tax and consulting work to RSM McGladrey?"

(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.

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