Audit liability: will one size fit all?

The many different approaches to auditors’ liability among the EU’s 27 member
states make harmonisation a thorny subject.

In the UK an auditor’s liability is based on a duty owed to the audited
company and its shareholders as a body (although not to individual
shareholders). But when the relevant provisions of the Companies Act 2006 come
into force, for the first time in more than 75 years auditors will be allowed to
agree limits on their liability to the companies they audit.

Any agreements seeking to limit auditor liability will have to comply with
certain requirements, but, subject to these safeguards, the Act gives auditors
and companies a great deal of freedom.

For example, any method may be used to determine the precise limit on an
auditor’s liability – although any limit will be null and void in cases of fraud
or dishonesty by the auditor.

The approaches most likely to be adopted are to fix a limit by reference to a
specified amount or formula (for example, a multiple of fees), or to agree
proportionate liability. If proportionate liability is agreed, the auditor will
only be liable to the extent that it is responsible for the damage suffered,
taking into account the fault of others.

Heterogeneous europe

The position in the other 26 EU states varies considerably. In some countries
auditors’ liability is based in contract and some in tort (a non-contractual
civil claim) and in others, like the UK, in both.

In some countries a duty is normally owed only to the company being audited,
and not to third parties. In some, it is also owed to shareholders acting on
their own behalf (for example, in buying or selling shares). In others, the duty
is wider still and is owed to third parties such as banks. The law on when that
duty is breached also varies.

In France, for example, an auditor’s duty is based in tort and is owed not
only to the company but also to third parties such as creditors, banks and
purchasers. French auditors cannot limit their liability.

The position in Germany, on the other hand, is quite different. The duty is
owed in both contract and tort and the duty is owed to third parties only in
narrowly defined exceptional cases. There is a statutory limit on a German
auditor’s liability of ¤1m – or ¤4m for a quoted company. However, these caps do
not apply for deliberate breaches of duty.

Four other EU states (Austria, Belgium, Greece and Slovenia) currently have a
statutory limit on an auditor’s liability and a number of others allow a
contractual limit on liability.

The European statutory audit directive, which came into force last year,
required the European Commission to prepare a report on the impact of current
national liability rules for statutory audits. Commissioners have since produced
a report and initiated a consultation. The report also considers the impact of
allowing auditors to limit their liability.

Perhaps the most surprising thing about the European Commission report is
that it considers four options for limiting auditors’ liability and does not
focus on whether, as a matter of principle, there should be a limit on liability
at all. While it may be reading too much into it at this stage, it looks like
the introduction of some sort of limitation is assumed.

Interventionist approach

Nor is there any mention of one of the key conclusions of a report by
consultancy London Economics – namely, that the EU’s member states may require a
degree of latitude to adopt an approach that fits their specific circumstances
best. This suggests a more interventionist approach may be adopted by the EU
than was initially contemplated.

There are still widely different approaches to auditor liability, and in
particular whether it can be limited, across the EU. There does, however, appear
to be an increasing momentum behind the introduction of limits on auditors’
liability. As EU internal market commissioner Charlie McCreevy said in November
2005: ‘Now that some EU countries already have limitations or are moving in that
direction, we think the time is ripe for EU-wide action.’

While it is still early in the process, an EU law capping an auditor’s
liability is now a real possibility. It is not yet clear what form this will
take, but it seems unlikely to be a limitation of liability agreed between an
auditor and the company it audits, of the kind just adopted in the UK, as this
is not one of the proposals put out for consultation.

THE EU COMMISSION REPORT

The European Commission has recently published a report that seeks views on
four different possible approaches to limiting auditor liability in the EU. The
four options are:

? One single monetary cap on liability set at EU level
? A cap on liability depending on a company’s size
? A cap on liability depending on the audit fees charged to the company
? Proportionate liability.

Absent from this list is the option that the UK has recently adopted –
namely, allowing companies and auditors to agree limitations of liability by
contract.

This is not surprising when you consider that any EU-wide regime has to work
in jurisdictions, such as France, where a duty of care is routinely owed to
someone other than the company being audited (in other words, a party with which
there is no contract).The ability to limit liability by contract would not,
therefore, give the desired protection, and the UK’s soon-to-be-implemented
contractual solution might not be viable on a Europe-wide basis.

The European Commission is currently seeking views on the four options. The
consultation closes on 15March 2007.

Nicholas Heaton is a partner in Lovells’ professional
indemnity group