Auditing I Week 9

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Auditing I Week 9
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Auditing I Week 9

• Auditors Contractual liability
• Liability to third parties under common law
• The effects of out of court settlements

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Litigation against auditors

• Auditors liability can be categorised under the
  following headings
• Liability under criminal law
• Liability under civil law
• Negligence under common law (TORT) to
• Clients under contract
• Third parties under the law of tort.

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Negligence

• Just by way of a note,
• The term negligence is an act or omission, which
  occurs because
• The person concerned has failed to exercise the
  degree of professional care and skill,
• Appropriate to the case, which is expected of
  auditors.

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Liability under Statute

• Civil Liability
• Under the Insolvency Act 1986 s.212
• Provides that an officer of the company and
  possibly auditors may be liable for financial
  damages in respect of the civil offences of
  misfeasance or breach of trust.
• Misfeasance being the improper performance of an
  act that is unlawful in itself)

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Criminal liability

• Again under
• s.206-211 Insolvency Act 1986 relates to
• Criminal offences involving officers in a winding
  up including auditors.

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Theft Act 1968

• States that a person commits an offence
• Who dishonestly, with the view to gain for
  himself or another or with intent to cause loss
  to another

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Theft Act 1968

• Destroys, defaces, conceals or falsifies any
  account or any record or document made or
  required for any accounting purposes.
• In furnishing information for any purpose
  produces or makes use of any account or any such
  record or document as aforesaid which to his/her
  knowledge is or may be misleading, false or
  deceptive in a material particular.
• An officer found guilty might be imprisoned for
  up to 7 years. Again, the term officer may
  include an auditor for the purposes of the Theft
  Act

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Financial Services Act 1986

• Under s.47 (1) Financial Services Act 1986 any
  person who
• Makes a statement, promise or forecast which he
  knows to be misleading false or deceptive or
  dishonestly conceals any material facts
• Recklessly makes (dishonestly or otherwise) a
  statement promise or forecast which is misleading
  or false or deceptive
• Is guilty of an offence, which is liable to
  imprisonment for a term not exceeding 7 years.

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Liability under Contract Law

• On acceptance of the audit engagement
• Enter into a contract imposing obligations upon
  them.
• The terms of the contract that both
• express
• implied.

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Express terms

• Stated explicitly within the contract
• Cannot override the Companies Act
• By restricting the auditors statutory duties
• Or imposing restrictions upon their rights to
  discharge their duties.

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Implied Terms

• Parties to a contract may have left unstated
• Because they consider them too obvious to
  express,
• But the law will impart into a contract.

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Implied Terms

• A duty to exercise reasonable care
• A duty to carry out the work required with
  reasonable expediency
• A right to reasonable remuneration.

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Implied Terms

• Implied terms can be very important when there is
  no or an inadequate engagement letter as in the
  case
• Fawkes-Underwood vs. Hamilton Hereward
  Phillips 1997

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The duty of care requirement

• Companies Acts does not state clearly the manner
  in which the auditors should discharge their duty
  of care
• This duty of care has therefore been left to case
  law to define
• Re Kinston Cotton Mill, 1896 Lopes LJ

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The duty of care requirement

• Re Thomas Gerrard Son Ltd 1967
• Trail judge commented on the fact that expert
  standards would be more exacting than those which
  prevailed in 1896.

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The duty of care requirement

• Obiter dicta by Lord Denning in
• Fomento (Sterling Area) Ltd vs. Selsdon Fountain
  Pen Co Ltd 1958
• they must come to it with an inquiring mind, not
  suspicious of dishonesty but suspecting that
  someone may have made a mistake somewhere and
  that a check must be made to ensure that there
  has been none.

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Liability for negligence under TORT

• Should a client wish to bring a civil claim
• Fasten on the auditors the financial
  responsibility for their loss
• Failure of the auditors to perform their duty
• Through their negligence in the manner of
  performing it

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Liability for negligence under TORT

• To bring a successful action the client has to
  prove
• Duty of care has to exist either under
• Common law
• Contract law
• Statute law
•  

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Liability for negligence under TORT

• Negligence
• In that where a duty of care existed the auditors
  were negligent in performance of that duty given
  the standards pertaining.

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Liability for negligence under TORT

• Damages
• The client has suffered some pecuniary loss
  directly because of the negligence of the
  auditors.

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Liability for negligence under TORT

• An early example of a client action is the case
• Wilde Others vs. Cape Dalgleish 1897
• Where the auditors failed to detect defalcations
  primarily from not examining the bank pass book
• Which was contrary to the generally accepted best
  practice at the time.

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Exclusion or restriction of their liability

• S.310 Companies Act 1985
• Unfair Contract Terms 1977

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Liability to third parties

• Deemed impartial expert
• Use of financial information by third parties
• May include either an audited report, or some
  other comment by the auditor

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Liability to third parties

• The staring point is
• Candler vs. Crane Christmas (1951)
• The defendants owed no duty of care to the
  plaintiff in preparing the accounts.
• Denning LJ thought the defendants might be liable
  because they knew the accounts were to be shown
  to the plaintiff,

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Liability to third parties

• The Hedley Byrne principle
• Hedley Byrne Co Ltd vs. Heller Partners 1963
• A duty of care exists where there is a special
  relationship
• Where the auditors knew or ought to have known
  that
• The audited accounts would be made available to
  and
• Would be relied upon by a particular person (or
  class of person)

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The Hedley Byrne principle

• For example
• MD of a company informs the auditors that
• He is going to show a friend of his the audited
  accounts
• And the members of his yacht club as they are
  thinking of buying shares in the company.

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The Hedley Byrne principle

• The essence of Hedley Byrne is that the third
  parties must have been known or identified in
  some way to the auditors.
• If the third party can show that they relied on
  the work of an auditor, which later turned out to
  be wrong
• Damages can be sought.

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Post Hedley Byrne

• Since 1963, there have been other cases,
• Which are important in considering the
  consequences of Hedley Byrne as discussed below
• Jeb Fasteners Ltd vs. Marks Bloom Co 1980

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Has the auditor a liability to a member of the
public

• Lloyd Cheyham vs. Littlejohn de Paula 1985
• Auditors defence was that they had fully
  considered the accounting policy
• Held that a thorough audit based on the APB
  standards
• Good defence against a negligence action

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Has the auditor a liability to a member of the
public

• Al Saudi Banque Others vs. Clark Pixley 1989
• It was held that there was insufficient proximity
  
• That no duty of care was owed
• The plaintiffs did not appoint the auditors.

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Where is a duty of care owed Caparo Industries
case

• This is the most important case in the area since
  the House of Lords handed down the decision.
• Caparo Industries plc vs. Dickman Others 1990
• Their lordships whilst keeping within the
  tripartite test for a duty of care that is

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Where is a duty of care owed Caparo Industries
case

• Foreseeability
• Proximity
• Whether it is fair, reasonable and just that a
  duty of care should exist.

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Where is a duty of care owed Caparo Industries
case

• Based their decision on the following
• plc auditors do not owe a duty of care to members
  of the public at large that relied upon the
  accounts in deciding to buy shares in the
  company.
• Even though the purchaser already owned shares in
  the company,
• They still stood in the same position as any
  other investor in the public arena.

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Where is a duty of care owed Caparo Industries
case

• The purpose of the audit was to fulfil the
  statutory requirements of the Companies Act 1985.
• There is nothing in the statutory duties of the
  auditors to suggest that they were intended to
  protect the interests on investors in the market.
  
• Hence, no special relationship could exist given
  the affairs of the company made it susceptible to
  a takeover bid

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Where is a duty of care owed Caparo Industries
case

• The essence of the case is the auditor does not
  exist to aid investment decisions
• Case brought a sigh of relief from the auditing
  profession
• Successful negligence litigation will be
  difficult
• Virtue of placing reliance on the audited annual
  accounts.

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Where is a duty of care owed Caparo Industries
case

• Advisors to clients seeking to purchase target
  companies will wish to obtain assurances on the
  truth and fairness from the targets auditors
• As recently shown in
• ADT vs. BDO Binder Hamlyn (BBH) 1995

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ADT vs. BDO Binder Hamlyn (BBH) 1995

• The details of this case clearly relate to the
  last point
• Of seeking assurances from the audit firm and
• Reliance being placed upon these assurances

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Conscious assumption of such a duty

• The court of appeal has in a recent case
• Electra Private Equity Partners vs. KPMG Peat
  Marwick 1999
• Accountants may be liable in terms of a breach of
  duty of care in negligence even when the initial
  facts do not establish that there was conscious
  assumption of such a duty
• This has refined the approach taken in ADT vs.
  Binder Hamlyn

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The Deep Pocket Syndrome

• Damages awarded to the plaintiffs have been even
  too high
• For the audit firms indemnity insurance premium
  to stand
• In particular the BCCI case with KPMG and the
  Binder Hamlyn noted above.

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The Deep Pocket Syndrome

• Commercial insurance policies will only indemnify
  up to a certain point
• Audit firms many find it difficult to obtain
  indemnity insurance at a reasonable cost.
• A recent article by Peter Wyman Past-President of
  the Institute of Chartered Accountants in England
  and Wales noted the possibility of
• Capping the liability of auditor