article
Protecting your interests
14 October 2009
Over recent months there has been a steady increase in the number
of claims people are bringing against their professional advisers.
The fact is that a recession usually brings with it an upturn in
litigation. In good times, people simply don’t micro manage their
finances; when times are bad people look to see where the next
pound is coming from.
This recession has seen a huge number of companies struggling
and many collapses or sell offs that 18 months ago none of us would
have foreseen. The Madoff scandal in particular raised alarm
bells.
When the Big Four accountancy firms start getting alarmed about
the situation you know things are getting serious. The bringing
down of a large accountancy firm is not unknown; the Enron scandal
brought about the downfall of Arthur Andersen and of course in this
country we saw Ernst and Young being sued by Equitable Life with
newspapers reporting that the costs involved in that litigation
totalled £30m. Most of the Big Four are facing major pieces of
litigation worldwide. At a hearing before the US Treasury’s
Advisory Committee of the Auditing Profession in 2008 the six
largest accountancy firms advised that they had 27 outstanding
litigation proceedings with over $1bn damages being claimed in each
case. In seven of those cases the damages were pleaded at an excess
of $10bn.
The threat of a major lawsuit is so serious that the Big Four
auditing firms lobbied the government for a change in the law so
that an upper cap of damages would apply in the event of legal
action being brought successfully against them.
The government did not accede to their demands indicating that
they believed that current legislation protects accountancy firms
adequately. Therefore what protection is available and what can
small and medium sized firms do to prevent big ticket litigation
which has the potential to wipe a firm out?
The common law situation is that an accountant would be held
liable for all losses which arise from any negligent act or breach
of contract. With proper risk management, the potential for a claim
can be reduced. Some steps are relatively simple but it is amazing
how many times claims result from the most basic requirements being
ignored.
First and foremost it is important to scope out the work that
will be carried out for the client. Firms need to avoid the risk of
clients suggesting that they acted as some sort of general advisor.
Two recent cases looked at this subject. In the case of Football
League Limited v Edge Ellison a firm of solicitors was sued in
relation to an agreement governing the televising of league
football. The broadcasters went into liquidation and the Football
League suggested that the solicitors should have extracted
guarantees from the parent companies and that if they had they
would not have suffered any financial loss. The court took the view
that the solicitors were not employed to take a general overview of
commercial considerations.
Likewise in the case of J P Morgan Bank v Springwell the court
took the view that in view of the trading relationship and the
contractual terms, the bank was not employed on the basis of an
advisory capacity and held that the bank only contracted on the
basis of a trading and banking relationship.
In looking at such cases the court will always look at the facts
and documents which exist. Therefore it is important for firms to
protect themselves in writing. The scope of the work should be
clearly set out at the start of the retainer and also the extent to
which advice ought to be relied upon. Any changes to the retainer
should be similarly recorded. All advice or suggestions should be
recorded in writing. If advice is given over the telephone then
this should be confirmed by letter or email.
As of 6th April 2008 it also became possible for auditors to
limit their liability in terms of a negligence claim, breach of
duty or breach of trust pursuant to Part 16 of the Companies Act
2006. This can be done via a liability limitation agreement
(“LLA”). There are various hoops to jump through to put an
agreement in place namely:
The agreement must be authorised by company members. Agreements
are authorised by ordinary resolution, unless varied by the
articles or if a private company has waived the need pursuant to
section 536. A LLA can be made conditional upon obtaining
approval.
It must specify to which year of accounts it relates and can
only run for one financial year.
The limitation to liability must be “fair and reasonable”. This
looks at the situation at the time that the agreement is entered
into and will take into consideration the nature of the auditor’s
responsibilities and the contractual obligations.
Under the Companies (Disclosure of Auditor Remuneration and
Liability Limitation Agreements) Regulations 2008 the date and
principal terms of the agreement need to be inserted as a note in
the company’s accounts.
Further guidance together with some draft specimen clauses can
be found on the Financial Reporting Council’s website
(www.frc.org.uk). The content will be reviewed in the second half
of 2010.
Accountancy firms dealing with SMEs should consider putting a
LLA in place. Again there are practical issues to consider
including:
The level of the cap on liability. Rather than a fixed financial
limit it is best to have a proportional cap based on what work is
being carried out.
Diarising when the audit is due to take place and conducting
negotiations with the client well in advance of the audit to ensure
that the terms of the LLA are agreed in time for the audit.
In some ways LLAs are easier to enter into for small and medium
sized practices with no international focus since they are frowned
upon by the US’s SEC. There is a suspicion within the SEC that they
may compromise an auditor’s independence. This may explain why The
Times has recently reported that no blue chip company has elected
to limit their auditor’s liability and also why the big four
auditing practices are now seeking protection.
With 2010 being an election year and it looking likely that
there will be a change of government, it remains to be seen whether
there will be a change of policy. It is suggested that all firms
should be given the same level of protection and a key point to
bear in mind is the effect on the economy (and not just that of the
UK) if one of the big four were to fold.
This article was first published in
Accountancy
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