Auditor Liability Limitation Agreements

Under Sections 532 to 538 of the Companies Act 2006 auditors are able to negotiate with companies whose accounts they are auditing to limit liability by contract to an amount that is “fair and reasonable in all the circumstances”. A separate agreement will be required for each year’s audit, and each one must be approved by the company’s shareholders. 

In July 2007 the Financial Reporting Council established an independent working group to produce guidance to directors on the use of agreements to limit the liability of auditors of companies. This was done at the request of the accountancy profession and after consultation with other interested parties. The working group was chaired by Sir Anthony Colman, previously a Judge of the Commercial Court, and included representatives of companies, investors and the accountancy profession.

The full membership and terms of reference of the working group can be found here.

Between December 2007 and March 2008 the working group consulted on draft guidance. The consultation document, a summary of the responses and copies of individual responses can be found here.

The final guidance was published in June 2008 and can be downloaded here:

 Guidance on Auditor Liability Limitation Agreements (July 2008) (498kb)

Printed copies can be obtained free of charge from FRC publications, tel: 020 8247 1264 or email: customer.services@cch.co.uk

The intention of the guidance is to:

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

The impact and content of the guidance will be reviewed by the FRC in the second half of 2010 to ensure that it incorporates developments in generally accepted practice and any other new developments.

Other sources of information and guidance

As well as the FRC guidance, there are other sources of information and guidance to which directors, auditors and shareholders may find it helpful to refer when considering whether to propose or approve an auditor liability limitation agreement. Links to the most important sources can be found below; others will be added as they become available.

Legislation

• Companies Act 2006

Sections 532 to 538 of the Companies Act 2008 address auditor liability limitation agreements, and are summarised in Section 2 and Appendix A of the FRC Guidance.

• Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) Regulations 2008

The Regulations require that a company which has entered into a liability limitation agreement must disclose the principal terms of the agreement in a note to the company’s annual accounts for the financial year to which the agreement relates, unless the agreement was entered into too late for it to be reasonably practicable for the disclosure to be made in those accounts in which case it must be disclosed in the next annual accounts. They also specify the information to be disclosed.

• European Commission Recommendation

In June 2008 the European Commission issued a Recommendation concerning the limitation of the civil liability of statutory auditors and audit firms. The Recommendation states that EU Member States should take national measures to enable auditors to limit their liability and suggests the types of such agreement that should be permissible, which include those contemplated by the Companies Act 2006. The Recommendation also states that agreements should be conditional on receiving shareholder approval and that a description should be included in any financial statements published by the company concerned, as required by the Companies Act 2006 and the accompanying regulations.

Guidance

• Institutional Shareholders’ Committee Statement

 The Institutional Shareholders’ Committee (ISC) is a forum which allows the UK’s institutional shareholding community to exchange views and, on occasion, co-ordinate their activities in support of the interests of UK investors. Its constituent members are the Association of British Insurers (ABI), the Association of Investment Companies (AIC), the Investment Management Association (IMA) and the National Association of Pension Funds (NAPF).

The ISC has issued a statement setting out what institutional investors are likely to expect from companies proposing to enter into an auditor liability limitation agreement. It will be of interest to institutional investors and directors of public and private companies in which they invest.

The National Association of Pension Funds has separately issued guidance to its members:

• NAPF Policy And Voting Guidelines