Nicholas Heaton

We can finally see clearly for the first time what the regime for auditors’ liability will be in future and it is one the profession should welcome.

Since the government published the company law reform bill last year it has been clear that auditors would be permitted to limit their liability, but there had been confusion over what limits would be allowed. Now that an agreement seems to have been reached on this, further substantial change looks unlikely during the bill’s remaining stages.

The regime approved by the House of Lords gives auditors the broadest possible scope to agree limits on their liability by reference to any mechanism they choose – including capping liability to a specific sum, capping by reference to multiples of the audit fee and proportionate liability.

As the reform of auditors’ liability has progressed there has been a great deal of confusion over whether auditors would be able agree caps on liability or only proportionate liability. The government confused everyone by originally saying that it would allow auditors to agree proportionate liability, but when the bill was published it allowed liability caps and, on one view, would not have allowed proportionate liability.

The government’s changes to the bill clarifying that auditors will be allowed to agree proportionate liability is certainly good news.

Another change agreed has the potential to erode the progress made to date. This is the inclusion in the bill of a power for the government to make regulations specifying what can and cannot be included in agreements limiting liability. This opens up the spectre of the debate over auditors’ liability continuing. But, the government says it wants to have this power in case the way in which auditors use their hard won freedom to limit liability distorts competition in the audit market.

Mid-tier firms are apparently concerned they could be disadvantaged if the Big Four set caps at very high levels. Although the government does not think that competition will be distorted, the issue has come to prominence again with the publication in April of the FRC’s study on competition in the UK audit market and last week’s publication of a discussion document.

There appears to be no immediate intention to make any regulations, but auditors should take note that the power to regulate the content of agreements limiting liability could be used for any purpose and is not limited to dealing with competition issues. Regulations could, at least in theory, be used in future to restrict the freedom given by the bill to auditors and clients to set limits on liability by whatever mechanism they think best.

Many auditors would have settled for being able to agree proportionate liability but the bill gives them much more flexibility. That said any celebrations will be muted by continuing concern over the criminal offence introduced of knowingly or recklessly giving a misleading, false or deceptive report.

Auditors believe that this offence could criminalise honest but careless auditing. The government has so far refused to make any concessions on this issue and this will now become the focus of auditors’ efforts.

Nicholas Heaton is a professional indemnity partner at law firm Lovell