Cap in hand: for the first time in the UK, accounting firms are legally entitled to ask an audit client for a liability-limitation agreement, Nick Gibbon urges businesses to think carefully before accepting such a deal.
| Author | Gibbon, Nick |
British companies of all sizes may soon find their auditors knocking on the door--if they haven't already done so--seeking an agreement to limit their liability. Why is this and what is the appropriate response?
Accountancy firms and other advisers have been seeking liability limitations in their engagement letters for years, of course--companies that have instructed accountants on M&As or securities issues, for example, will be familiar with this. But on April 6 this year the Companies Act 2006 finally allowed UK accountancy firms to limit their liability for core audit work. This concession marked the culmination of years of lobbying by auditors. The UK's complex system of joint and several liability means that they face the unhappy prospect of being sued for 100 per cent of shareholder losses even where they are only partially "to blame". Accountancy firms in company insolvency situations are in the worst position because theirs are often the only deep pockets available to those who have suffered.
The reason that their lobbying campaign has succeeded lies in the diminished number of top-tier auditors since the demise of Arthur Andersen after the Enron scandal in 2002. The UK government is concerned, as are other administrations including the European Commission, that if one of the four remaining big players--Deloitte, Ernst & Young, KPMG and PwC--were to disappear, it would seriously limit competition in the market for audit and other accountancy services.
It's hard to object to the concept that auditors shouldn't be held liable for losses for which they aren't to blame. Indeed, the situation before the Companies Act 2006 was unfair on them. In effect, the new legislation permits a company to enter an agreement with its auditors to limit their liability for any negligence, default or breach of duty occurring in the course of an audit of accounts, as long as two main conditions are satisfied. The first is that the agreement covers only a specified financial year. This means that liability-limitation agreements (LLAs) are likely to be entered into on an annual basis. The second is that each LLA must be authorised by the company's shareholders and not only its board. The precise requirements differ slightly between public and private companies, but in essence a majority of shareholders will need to approve at least the main terms of an LLA.
But an LLA will not be effective if the limitation it contains is such that the company would recover...
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