Out of all proportion: why the liability cap doesn't fit

Most clients, including merchant bankers, would be content to see accountants incorporate themselves. To put it crudely, backing an opinion with the assets of the entire firm seems an entirely appropriate sanction.

But the accountancy profession does not appear to feel that this is a sufficient resolution of the liability problem.

Accountants have, therefore, been seeking liability caps. Most corporate clients seem to have accepted the concept of a liability cap for due diligence work and the like. Yet this problem can be resolved by incorporation and is therefore not on its own an adequate excuse for capping one’s liability.

My view is that liability caps are a blunt instrument and may not be the best way of dealing with the problem.

Venture capitalists, with whom accountants have been discussing liability caps, are concerned that investors will take action against fund managers if the latter waive rights of recourse against their investigating accountants.

This effectively transfers the liability to the venture capitalist.

But corporate financiers as sponsors of prospectuses have not found a way whereby the reporting accountant can cap its liability to the merchant bank sponsoring the issue without leaving the latter unreasonably exposed.

There are powerful grounds for examining whether proportionality can provide a useful alternative to caps, on the basis that it is an effective means of allocating the costs of mistakes in a way seen as fair both by the plaintiff and defendants. If so, I believe caps will become unnecessary.

I wonder whether the law on joint and several liability could be made more restrictive in defining the circumstances in which it should apply.

Where two people together cause injury to a third by the same action jointly undertaken, it seems right they should be jointly and severally liable.

But there are a number of situations which fall significantly short of such joint action. For example, where an investigating accountant fails to detect a cover-up of a fraudulent director. No loss would have been caused by the accountant’s failure if that director had not also misbehaved.

Is it right that the accountant should bear the whole of the loss because the guilty director is a man of straw?

Another example is the prospectus where, often, different aspects are made the responsibility of different advisers. It may be the tasks are quite separate and that it is wrong that one adviser should be responsible for the mistakes of another. It may help if the law is changed so that one wrong-doer can only be made responsible for the acts of another if the two really did act together.

The Law Society’s special committee which responded to the DTI’s consultation paper on joint and several liability suggested that a proportionality regime should be constituted by statute, to be available as an option which parties to a particular commercial contract or network of contracts could adopt on an ad hoc basis if they so wished. The aim was that joint and several liability should only be able to be abandoned by a deliberate choice by those affected, but if they chose to do so then there was an acknowledged framework for creating proportional liability between them.

The Law Society did not specifically discuss whether the system could be used in circumstances when it was not possible for potential plaintiffs to sign a document adhering to it – prospectuses being an obvious example.

I cannot see why the regime should not be available in such circumstances, although legislation would need to specify the activities where proportionality should be permitted – and it should only be so permitted when effective notice can be given.

It is hard to find a downside to this idea. Adopting it would mean the plaintiff was left with the risk of insolvency of any one defendant, but in any commercial contract, one party is at risk to the insolvency of the other. It seems fairer in such cases that the risk should be borne by the plaintiff who selected the adviser who became insolvent, rather than by one of his fellow advisers who took no such part in his selection, and may not even have been aware of his identity until too late.

Clearly, proportionality – or a narrowing of the scope of joint and several liability – will not relieve individual partners in a professional firm from the risk of bankruptcy or shareholders in a merchant bank from the risk of losing their investment. But either would help prevent the deep pocket adviser being made to pay for damages more fairly attributable to others, and this in turn would help to avoid the need for liability caps, with their inherent inefficiencies and adverse effects on third parties.

Antony Beevor is a director of Hambros and chairman of the corporate finance committee of the London Investment Bankers Association.