Limitation of Auditors' Liability - Take Care What You Sign.

It is when times get tough that problems which might have been easy to gloss over in better times start to make themselves visible. When serious problems that have remained undiscovered for a substantial period come to light, a company’s auditors may well find themselves facing a writ.

The sections of the Companies Act 2006 which allow auditors to limit their liability in relation to audit work, with the agreement of their audit client, are now in force and the Financial Reporting Council (FRC) has issued guidance on the use of such agreements.

Any agreement setting a limit on the liability of a company's auditors must be approved by the company's shareholders. An agreement cannot cover more than one financial period and will only be effective insofar as it is 'fair and reasonable'. In practice, whether or not the limit on liability is fair and reasonable will be determined by the courts, depending on the particular circumstances of each case.

The FRC guidance:

  • explains what is and what is not allowed under the 2006 Act;
  • sets out some of the factors that will be relevant when assessing the case for an agreement;
  • explains what matters should be covered in an agreement and provides specimen clauses for inclusion; and
  • explains the process to be followed for obtaining shareholder approval and provides specimen wording for inclusion in resolutions and the notice of the general meeting.

Many company directors can expect to receive a letter from their auditors, enclosing a liability limitation agreement, before their next financial year end.

This seemingly small change could have a significant impact and directors should give thorough consideration to the ramifications of signing any agreement limiting the liability of their auditors. Directors have the same responsibilities to a company's shareholders and creditors in this situation as they would when entering into any other agreement on the company's behalf. If your auditors propose a liability limitation agreement of any kind, we can advise you on your individual circumstances.

Partner Note
A PDF version of the guidance is available from http://www.frc.org.uk/images/uploaded/documents/FRC%20ALLA%20Guidance%20June%202008.pdf.

The FRC will review the impact and content of the guidance in two years' time to ensure that it incorporates developments in generally accepted practice and any other new developments.

Sections 532 to 538 of The Companies Act 2006 came into force in April 2008.

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