On 20 July 2009, the GC100 published an updated version (www.practicallaw.com/4-386-7911) of its issues note on auditor liability limitation agreements under sections 534 to 538 of the Companies Act 2006. Since 6 April 2008, companies have been able to enter into liability limitation agreements with their auditors to limit an auditor's liability to the company for negligence, default or breach of duty or trust in relation to the audit of accounts, provided they seek prior shareholder approval (see further, Practice note, Liability limitation agreements: Companies Act 2006 (www.practicallaw.com/0-202-4476)). It is thought that very few public companies have yet sought shareholder approval to enter into such an agreement.
Additional issues highlighted in the updated note from the previous version of the note published in January 2009 (see Legal update, GC100: issues note on auditor liability limitation agreements (www.practicallaw.com/8-384-7577)) include the following:
The GC100 believes that it is still important for its member companies to be aware of the issues regarding auditor liability limitation agreements even though the UK auditing firms are not proposing to their UK listed clients that they consider a liability limitation agreement this year (due to the SEC's apparent refusal to allow SEC registrants (including foreign private issuers) to enter into an auditor liability limitation agreement).
Guidance on what is meant by the term "proportionate liability" in the context of such liability limitation agreements (as identified by the FRC guidance; see Legal update, Auditor liability: FRC publishes guidance on use of auditor liability limitation agreements (www.practicallaw.com/3-382-2923)). If proportionate liability is agreed:
the auditor would no longer be liable for the entire loss but only the share for which the auditor is judged responsible. The company would be left to recover the balance of the loss from the other parties responsible;
this does not provide any form of certainty in advance (either to the company or the auditor) as to what the auditor's liability will be if a claim arises. In each case, it will only be when the claim arises that it is possible to determine the significance and extent of other parties' responsibilities; and
in most cases, due to the uncertainty over how the liability will apply at the time of the claim, there is likely to be a consequential impact on any settlement negotiations.
The FRC's specimen clause identifies a wide class of potentially relevant third parties when considering an auditor's liability, including the company itself, its directors and employees, the company's advisers, other professionals and those dealing with the company. It may also include anyone who perpetrated a fraud on the company and government and regulatory bodies who are in breach of duty. The GC100 highlights that, although this wide approach is consistent with the principle of proportionate liability, it may mean that the auditor's liability is reduced significantly if there are others who are principally responsible for the loss.
The GC100 recommends that the board should be satisfied, before it agrees to recommend an auditor liability limitation agreement to shareholders, that it understands the impact of the proportionality principle on the company's ability to recover damages from a negligent auditor or to negotiate an acceptable settlement with the auditor's insurers.