Director and Auditor liability
John Davies highlights the key points of a consultation paper on the liability of directors and auditors.
In December 2003 the DTI published a consultation paper on the issue of the liability for negligence of company directors and auditors.
These matters had been addressed previously by the DTI-sponsored company law review exercise between 1998 and 2001 and, subsequently, by the DTI's White Paper on company law reform in 2002, but no attention was given to it in the Companies Bill presented to Parliament in December 2003.
The decision to consult further on the issue followed concern expressed in the Higgs Report over the exposure of directors to liability and highly publicised calls from Ernst & Young and other large firms for auditors to be allowed to cap their liability.
With regard to auditor liability, the consultation paper is restricted in its scope. In rejecting, for the moment at least, any radical reforms to the principle of joint and several liability, the DTI points to the conclusions reached by the studies carried out by the Law Commission and the DTI itself in the late 1990s - namely that it would be inappropriate to consider the introduction of full proportionate liability for auditors in isolation from a comprehensive reform of the law on negligence.
Instead, the consultation paper offers for discussion two possible ways forward:
- allowing auditors to limit their liability with the client company by contract, with or without the addition of benchmark rules set by statutory regulations, which would, for example, fix caps as a multiple of the audit fee or a multiple of the auditor's turnover
- considering detailed reforms to the law on contributory fault and negligence so as to bring about a fairer allocation of responsibility where damages are awarded.
The first of the above options would be, on the face of it, the simplest solution: the members of a company, as the addressees of the audit report, vote to approve a limitation of the extent of the auditor's financial responsibility to them in respect of negligent work. But at what stage do they approve the limitation? How is any limitation to be determined - should the upper limit on liability be a multiple of the audit fee, the company's turnover, or the audit firm's annual income?
Whichever basis was agreed, it would be likely to be arbitrary and without obvious direct relevance to the loss which may be suffered by the company's shareholders. This is without considering whether it is, in any case, desirable for professional advisers to limit their liability to a client in advance.
The second option may be better able to help achieve the objective of ensuring a fairer allocation of responsibility for shareholder loss in the audit scenario. That the auditor is liable on a joint and several basis for shareholder loss is, arguably, inconsistent with the nature of the audit and its restricted scope. The position of the auditor vis-à-vis the shareholders is also distorted by the fact that a plaintiff will always look to sue not the party which is most at fault but the party which is most likely to be able to pay. This has obvious implications for the cost of insurance.
Other Areas of Interest
The consultation paper also invites comment on a number of specific questions. These include:
- should 'potential' investors in a company have any right to claim damages against directors and auditors?
- is concern about liability affecting the willingness of individuals to become non-executive directors and partners?
- should the auditor's duty of care be extended or set down in law?
- are liability-related issues having an effect on the audit market generally?
The deadline for responding to this consultation paper was 12 March, by which date ACCA will have submitted its comments.
John Davies - Head of Business Law, ACCA