explain the liabalities of a company auditor

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explain the liabalities of a company auditor..

Auditor's liability

On 3 November 2005 the government issued the Company Law
Reform Bill. This contains important amendments to the law
on limitation of liability by auditors and introduces a new
criminal offence in relation to audit reports. This part
of the Bill responds to the audit profession's call for the
ability to limit their liability to prevent the
next "Andersen". It derives from a consultation process
that has been ongoing for several years and builds on part
of a White Paper issued in March 2005 and draft clauses
published in July 2005.

The key points in relation to auditors are as follows:

• The Bill allows auditors to limit their liability.
 Auditors will for the first time be free to agree limits
on their liability to companies in respect of statutory
audits. Any limit on liability must be agreed with the
company. It must also be approved by shareholders each
year.
 An agreement limiting the liability of an auditor will
not be effective to limit liability to less than what is
fair and reasonable in all circumstances having regard to
the auditors' responsibilities, professional standards and
contractual obligations.
 The Bill expressly provides that the effect of failing
this "fair and reasonable" test will not be that the clause
is invalid. Instead the limit set will be what is
considered fair and reasonable. This gives auditors a
significant advantage as they will not run the risk of
having no protection if the original agreement went too far
in limiting liability. Generally if a clause limiting
liability is considered unreasonable it will fail
altogether and the court will not rewrite the parties'
agreements to make it effective. This is a change from the
earlier draft clauses.
 The draft Bill gives auditors the freedom to set limits
on their liability by reference to a fixed amount (a cap)
or by whatever other criteria they think appropriate. This
gives auditors much more freedom than was suggested by the
White Paper, which had said that the legislation would only
permit auditors to agree proportionate liability with
companies. Introducing proportionate liability would have
allowed auditors to limit the amount for which they are
liable to a level that the court determines to be just and
equitable in the light of the relative responsibility of
the auditor and any other defendants. Although it would
still be open to auditors to agree proportionate liability
with the company, the Bill does not restrict them to this
and allows monetary caps.

• A new criminal offence
 The bill introduces a new criminal offence for auditors
of knowingly or recklessly causing an auditor's report on
company accounts to include any matter that is misleading,
false or deceptive in a material particular. This will
apply to individuals only, not firms. In a change from
earlier draft clauses, the penalty for the offence has
been reduced to a fine. As a result, the risk of auditors
being imprisoned for this offence has been removed.
 Auditors will remain concerned that the offence can be
committed through "reckless" behaviour. The concept of
recklessness potentially causes difficulty when applied in
the context of an audit, which always involves an element
of risk. If the same definition of recklessness is applied
by the courts to this offence as to others, this will be a
worryingly low threshold and could amount to a judgment on
whether the auditor acted "reasonably". The concern is
that an honest mistake could attract a criminal penalty.

• Shareholders (100 together or holding 5% of the voting
rights) have been given the right to require the company to
publish on its website statements on any matter relating to
the audit or the circumstances of an auditor leaving
office. The company must pass these to the auditor but
there is no obligation on the auditor to answer any
questions put.

• A company audit must be signed (where the auditor is a
firm) by a person authorised to sign on its behalf and the
senior statutory auditor (pursuant to the relevant
standards). It is provided that the senior statutory
auditor will not be subject to any additional civil
liability as a result of doing so.

• The position with regard to audit resignation statements
is amended. Previously (under s. 394 of the Companies Act
1985) the court could only prevent the statement from being
sent to the members if the auditor was seeking needless
publicity for defamatory material. Now it can do so in
wider circumstances were the auditor is abusing the rights
given to it. Summary The clauses allowing auditors to
limit their liability are a very helpful development for
the audit profession. They have also received the bonus of
being allowed to cap their liability and not just agree
proportionate liability. Moreover, by providing that
agreements limiting liability below a fair and reasonable
level do not fail, but are effective to limit liability to
a fair and reasonable level, auditors are put in a better
position than all other professionals in relation to
liability caps (and in a better position than accountants
for their non-audit work). Auditors will be disappointed
that their intense lobbying over the wide scope of the new
criminal offence has not changed the definition of the
offence but will be relieved to see the potential penalty
reduced from imprisonment to a fine.

For further information or comment please contact:

John Trotter, Partner and head of Lovells professional
negligence team 0207 296 2606/john.trotter@lovells.com

Nicholas Heaton, Partner, Lovells professional negligence
team0202 296 5919/nicholas.heaton@lovells.com

Kate Horsfield, PR Manager, Lovells020 7296
2675/kate.horsfield@lovells.com

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