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credit crunch raises the stakes on auditor liability cap 01/07/2008 The woes brought about by the credit crunch could increase the profile of new rules allowing auditors to limit their liabilities if they are found to be negligent.
But West Midland directors have been urged to be cautious about agreements with auditors to limit their liability. The warning has come from David Allison, a senior corporate law partner at Birmingham and London law firm Martineau.
One consequence of an economic downturn is often more litigation, as more companies fail and as directors look around for an opportunity to pin the blame for failure on someone.
Until recently, there was a real temptation for aggrieved parties to sue the auditors as they generally were seen to have deep pockets backed by professional liability insurance.
New Companies Act legislation, which came into force earlier this year, permitted auditors to cap their liabilities where shareholders agree.
Taking its cue from this, at the end of last month, the Financial Reporting Council issued guidance and the Institutional Shareholders' Committee ('ISC'), a key group of institutional shareholders, declared that directors will have to justify to their shareholders any agreements they enter into to cap auditors' liabilities.
Mr Allison explained: "The ISC has effectively declared itself against cash limits on liability but in favour of terms that are proportionate and which provide for a liability on the part of auditors that is 'fair and reasonable'.
"This means that a court will decide and it can substitute a higher amount if the original limit is deemed to be too low.
"Though the main focus will be on the 'Big Four' accounting firms and their large multi national clients, the rules will apply to unlisted companies too.
"Auditors will be asking clients to limit their liabilities and clients will have to decide how to respond in the context that directors have a responsibility to the company and to the shareholders.
"Naturally, auditors could decide not to undertake the audit of a company which declines to agree to capping.
"I suspect that the Big Four will come up with a broadly similar formula but other firms will vary in their approach and there will be some interesting negotiations. Competition could encourage audit firms to take a reasonable view."
The new rules permitting liability capping follow a protracted debate, against a backdrop of concern that a major claim could destroy the audit operations of one of the Big Four and perhaps the firm itself.
Such a failure could have had a catastrophic effect on the corporate scene and leave UK plc with even less competition in the audit market.
"The old regime of auditors carrying the can was unfair because the fault was often elsewhere, whether at the door of the directors or of managers or others who caused the problem in the first place," said Mr Allison.
"I do believe that it's fair to limit liabilities to those that result from the auditors' actions or omissions but I also think that directors need to be careful when they are negotiating terms with their auditors.
"What's more the directors sometimes rely excessively on auditors for advice and comfort. The directors really have primary responsibility and they should remember that."
For further information please contact David Allison on
david.allison@martineau-uk.com
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