Auditor's liability to third parties

It’s understood that the House of Lords has declined to hear a further appeal
in the Freightliner/Ernst & Young litigation, in which the Court of Appeal
gave its decision in September 2007. This leaves open issues about the liability
of auditors to third parties.

Freightliner was held liable for false statements about ERF’s accounts made
by Steven Ellis of ERF to MAN when MAN was acquiring ERF from Freightliner.
Freightliner brought a third party claim against ERF’s auditors E&Y.

The Court of Appeal said E&Y could owe Freightliner a duty of care in
respect of the accounts warranties in the SPA, but no warranty claim had been
available.

It was therefore decided that E&Y did not owe a duty of care to
Freightliner because E&Y didn’t foresee Freightliner would make any
representations as to the accuracy of ERF’s accounts, which went beyond those
contained in the SPA.

And even if that had been foreseeable, mere foresight was not enough:
‘Something more’ was required.

Previous third party audit liability cases have differed on the question over
whether, in addition to showing the defendant knew of the transaction which the
claimant had in contemplation, that the information would be communicated to him
and that the claimant would rely on it in deciding whether or not to pursue the
transaction. It had to be shown that the defendant intended such reliance.

In a number of cases, intention had been rejected as a requirement (most
recently in Bannerman case of 2005). Lord Oliver in the Caparo case of 1990
viewed knowledge as the key.

The Court of Appeal has now said, however, ‘something more’ than knowledge is
required, but without saying what that is. It appears from the Freightliner
decision that there must be some indication, capable of objective
identification, from the auditor to the recipient that the auditor’s statement
can be relied upon by the recipient for its particular purpose.

Auditors seeking to limit their third party liability ought to be careful not
to give any such indication to any third party.

In practice disclaimers of responsibility to third parties have been widely
used by auditors since the Bannerman case and will no doubt continue to be used
in the light of the Freightliner case.

Hardeep Nahal is a partner at law firm Herbert
Smith