Contracts must be bullet-proof
One sure way to limit liability, writes Paul Redfern.
One sure way to limit liability, writes Paul Redfern.
One of the main threats facing accountants in practice today is the ‘nuclear bomb’ claim, which exceeds the professional indemnity cover available and threatens ruin to the firm and individual partners. The threat is as real in the case of a small or medium-sized practice, as it is for one of the Big Five.
Claims come from unexpected sources and often arise out of the ‘deep pocket syndrome’, where the accountant is the only party available to sue with any funds. Every major insolvency appears to be accompanied by a claim against the auditors, and disaster can strike any firm if a claim tops its level of insurance cover.
A firm’s contract with the client provides the accountant with an opportunity to limit liability before work begins by using exclusion clauses. Provided the clause is worded sufficiently clearly and is not made ineffective by statute, it can protect against liability for both breach of contract and breach of tortious duty of care. Liability can only be limited by a clause if it forms part of the contract. Any attempt to insert an exclusion clause at a later date unilaterally will be ineffective.
Notifying clients is not sufficient; the clause must be agreed with them.
Ideally a client should give informed consent to any limitation of liability. The engagement letter setting out the limitations should be signed by the client, those clauses limiting liability should be highlighted and reference should be made to the client having read and understood these clauses and had them explained and agreed.
Many accountants say that their clients will not accept such limitations of liability and threaten to take their business elsewhere.
But more accountants are standing firm on this issue; patient exploration of the reasons for the limitation will often succeed.
The client would expect to limit its exposure by contract after all, so provided the limitation is set at a reasonable level there is no valid argument. One mistake, frequently made in the past by accountants and other professionals, is to try to include exclusion clauses in a report submitted to the client. These are of no use as far as restricting liability to the client is concerned; agreement must be reached in the contract with the client before carrying out the assignment.
While it is not possible to cap liability in respect of statutory audits under Section 310 of the Companies Act 1985, it is becoming increasingly common to limit liability in monetary terms for other types of work. One interesting example is the agreement reached between the Big Five accountants and the British/French Capital Association.
This limits liability in due diligence engagements for private equity transactions in bands, according to the value of the transaction.
Any exclusion clause must pass the test of the Unfair Contract Terms Act 1997. Broadly speaking, provided the clause is reasonable in the light of the relative bargaining power of the parties, it will be enforceable.
Any clause excluding liability must be tightly constructed, as any ambiguity will go against the accountant. Clauses limiting liability are much more likely to be successful.
In the House of Lords case of Henderson v Merrett (1995), Lord Goff indicated that he saw no reason why parties, by agreement, cannot exclude or restrict their duties both in contract and in tort.
The factors that the courts are likely to take into account when assessing reasonableness are as follows:
Whether the client knew, or ought to have known, of the term and that it was clearly brought to the client’s attention before entering into the contract.
The nature and bargaining powers of the parties. The more sophisticated and larger the client, the more likely it is that the term will be held to be reasonable.
The resources of the accountant and the availability to him of insurance cover. The greater the resources, the higher any limit on the extent of liability should be.
The nature of the transaction and the size of the likely, or potential, loss. The limit should relate to the transaction and potential loss.
The availability of similar services from another provider without a similar exclusion or limitation.
If there are providers in the marketplace who will provide a similar service without limitation, the client may not be able to argue that he was forced to accept the terms.
The size of the fee – the higher the fee, the higher the limit should be.
Did the client receive any inducements to agree to the terms? If an inducement was included, it is easier to argue that the term was reasonable.
In the modern business world, where potential liabilities can be vast, it is important that accountants educate their clients to expect reasonable limitations to the liabilities that they face.
Provided the accountant purchases professional indemnity cover commensurate with the type of work being carried out then, in my view, the reasonable client should agree to limit claims to a similar figure.
If a client refuses to accept such restrictions, an accountant must seriously ask what the client’s motive is for doing so and whether he wants to act for that client.
Paul Redfern is a litigation partner at law firm Wansbroughs Willey Hargrave. He regularly defends negligence claims against accountants
FIVE THINGS THAT MUST BE INCLUDED
A (non-exhaustive) checklist of items which should appear in a letter of engagement.
Is an agreement to restrict liability included?
Is a statement of the agreed limit of the firm’s total liability to the client included in the letter?
Has the client agreed not to pursue claims against any individual partners and/or staff (including any consultants, agents etc used by the firm)?
Does the agreement include, in the total agreed limit of liability to the client, any liability for interest or claims in respect of contract or tort or otherwise arising in connection with the engagement?
Does the letter include an acknowledgement that the limit does not apply to any acts, omissions or representations which are criminal, dishonest or fraudulent on behalf of the firm, its partners or employees?