Part 16 CA 06: ss532-538
When in force
6 April 2008
Summary of Changes
- A company is still not permitted to indemnify its auditor from liability (s532). Such indemnities are void except where expressly permitted.
- As now a company may indemnify its auditor against costs of successfully defending a claim but can no longer purchase insurance for its auditor.
- For the first time auditors are permitted to agree to limit their liability to a company by contract. This is a liability limitation agreement (LLA). An LLA may cover negligence, default, breach of duty or breach of trust on the part of the auditor to the company occurring in the course of the audit of accounts.
- An LLA:
- must be authorised by company members,
- must specify and be limited to one financial year’s audit, and
- must limit liability to not less than a "fair and reasonable" amount (having regard to the auditor’s responsibilities, the nature and purpose of the auditor’s contractual obligations to the company and the professional standards expected of him).
- In a dispute as to whether an agreed limit is "fair and reasonable", the court must not consider circumstances arising after the loss or damage is incurred or the possibility of recovering from others. If the court considers a limit is not "fair and reasonable", it can substitute its own limit and the agreement remains valid.
- LLAs are approved by ordinary resolution (unless the articles specify a higher threshold) by public and private companies either before or after they enter into it, although private companies can resolve to waive the need for approval (s536). If entered into before approval of shareholders, an LLA should be made conditional upon approval being obtained.
- A company’s members may by ordinary resolution withdraw authorisation for an LLA either before the LLA is entered into, or before the start of the financial year to which the LLA relates (s536).
- The Secretary of State has the power to make regulations requiring or prohibiting LLAs containing specified provisions and requiring companies to disclose LLAs.
- The Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) Regulations 2008 require a company to disclose the principal terms of an LLA and the date of the approval resolution (or resolution waiving the need for approval in the case of a private company) in a note to the company’s accounts.
Implications for practice
- Private companies should consider whether they will waive the need for shareholder approval of LLAs (s536).
- Negotiating the terms of an LLA is likely to form part of a company’s annual audit engagement. Listed companies and their auditors may wish to accelerate audit engagement negotiations to earlier in the financial year, so that terms are agreed when shareholder approval is sought at the AGM.
- Firms will need to consider the form the LLAs may take. CA 06 states that the limit need not be a sum of money or a formula.
- The Financial Reporting Council (FRC) has published a consultation and draft guidance on the use of LLAs. The consultation closed on 14 March 2008 and the FRC states that it intends to publish final guidance in May 2008.
- For listed companies, the Association of British Insurers (ABI) has warned that it will "red top" any company that:
> agrees a fixed financial cap for their auditor’s liability rather than a proportional cap based on the extent of the auditor’s role and responsibility, and
> does not provide assurances as to the appropriateness of an LLA.
The ABI also recommends that LLAs should be made available for shareholder inspection.
- The National Association of Pension Funds has stated that investors should consider voting against resolutions which propose any form of liability limitation other than proportional liability, unless there are compelling reasons why that is not appropriate and why another form of liability limitation is "fair and reasonable".
Peter Brien (partner)
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