It is when times get tough that problems which might have been easy to gloss over in better times start to make themselves visible. When serious problems that have remained undiscovered for a substantial period come to light, a company’s auditors may well find themselves facing a writ.
The sections of the Companies Act 2006 which allow auditors to limit their liability in relation to audit work, with the agreement of their audit client, are now in force and the Financial Reporting Council (FRC) has issued guidance on the use of such agreements.
Any agreement setting a limit on the liability of a company’s auditors must be approved by the company’s shareholders. An agreement cannot cover more than one financial period and will only be effective insofar as it is ‘fair and reasonable’. In practice, whether or not the limit on liability is fair and reasonable will be determined by the courts, depending on the particular circumstances of each case.
The FRC guidance:
explains what is and what is not allowed under the 2006 Act;
sets out some of the factors that will be relevant when assessing the case for an agreement;
explains what matters should be covered in an agreement and provides specimen clauses for inclusion in agreements; and
explains the process to be followed for obtaining shareholder approval and provides specimen wording for inclusion in resolutions and the notice of the general meeting.
Many company directors can expect to receive a letter from their auditors, enclosing a liability limitation agreement, before their next financial year end.
Says <<CONTACT DETAILS>>, “This seemingly small change could have a dramatic impact and directors should give thorough consideration to the ramifications of signing any agreement limiting the liability of their auditors. Directors have the same responsibilities to a company’s shareholders in this situation as they would when entering into any other agreement on the company’s behalf.”
Given the directors’ responsibility for the management of the company and preparing the financial statements, it is difficult to imagine a situation in which the auditors would be found solely liable for losses to a company. The potential impact of this change in the law is magnified for companies that regard their auditors as an essential part of their system for reducing the risk of fraud.
If your auditors propose a liability limitation agreement of any kind, contact us for advice on your individual circumstances.
Sections 532 to 538 of The Companies Act 2006 came into force on 6 April 2008.