FRC issues draft guidance to auditor liability

by Penny Sukhraj

17 Dec 2007

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Draft guidance on auditor liability arrangements has been issued by the Financial Reporting Council today.

The guidance - written by a high-profile group of accounting and legal professionals led by former Commercial Court judge, Sir Anthony Coleman – clearly sets out what kind of agreements the Companies Act allows for, as well as points to be considered on the question of 'fair and reasonable' arrangements.

The 'fair and reasonable' test has particularly become contentious as the law allows for a court to override the terms of an arrangement in place, even if this was agreed to by a company's shareholders.

The group provided examples of contractual limits, which include:

• a limit based on the auditor’s proportionate share of the responsibility for any loss (under this approach, the company would agree that if there is someone other than the auditor who is also liable to the company for all or part of the same loss, the auditor's liability would be limited to the extent to which the auditor was responsible for that loss. The company would not be able to look to the auditor for any loss attributable to the acts of any other party);

• purely by reference to the 'fair and reasonable' test;

• a cap on liability, expressed either as a monetary amount or calculated on the basis of an agreed formula; or

• a combination of some or all of the above.

The group has also drawn attention to important factors - such as shareholder approval and the legal and professional obligations of auditors - that auditors and their clients must consider when considering whether a company should enter into a liability limitation agreement.

Examples of specific wording of agreements are also included, giving auditors and clients detailed guidance which they may use in their contracts, along with explanatory notes to help companies and auditors to write the contracts to their specific situations.

Further reading:

Read the guidance here

Investors lay down law on liability caps

FTSE 100 and auditors in liability stand-off

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