FRC issues draft guidance to auditor liability

Draft guidance on auditor liability arrangements has been issued by the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’

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

• 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:

the guidance here

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