Whilst there is a contractual relationship between an auditor and his client, the company as a legal entity, on which the client company can sue, the contentious legal area arises in respect of other people who may rely on reports made or advice given in a non-contractual capacity. Indeed, in many situations, the potential plaintiff may be unknown to the accountant. Although it is apparent that the law of negligence allows individuals in non-contractual relationships to sue for damages sustained as a result of the negligent behaviour of another party, the success of any such action in relation to company auditors appears to depend upon the purpose for which reports are made or accounts prepared and on establishing a duty of care between the auditor and the person making the claim in negligence. The applicable law may be derived from a number of important cases.
In JEB Fasteners v Marks, Bloom and Co (1983), the defendants, a firm of accountants, negligently overstated the value of stock in preparing audited accounts for their client. At the time of preparation, the accountants were aware that their client was in financial difficulties and actively seeking financial assistance. After seeing the accounts, the plaintiffs decided to take over the company. They then discovered the true financial position and sued the accountants for negligent misstatement. It was held that a duty of care was owed by the accountants as it was foreseeable that someone contemplating a takeover might rely on the accuracy of the accounts, but that they were not liable as their negligence had not caused the loss to the plaintiffs. The evidence revealed that, when they took over the company, they were not interested in the value of the stock but in acquiring the expertise of the directors, so, although they relied on the accounts, the accounts were not the cause of the loss as they would have taken over the company in any respect.
The case of Caparo Industries plc v Dickman (1990) served to limit the potential liability of auditors in auditing company accounts.
Accounts were audited in accordance with the Companies Act 1985. The respondents, who already owned shares in the company, after seeing the accounts, decided to purchase more shares and take over the company. They then incurred a loss, which they blamed on the inaccurate and negligently audited accounts. It was held that when the accounts were prepared, a duty of care was owed collectively to members of the company, that is, the shareholders, but only so far as to allow them to exercise proper control over the company; enabling the shareholders collectively to question the past management of the company, vote for or against the appointment of directors and take other decisions affecting the company. This duty did not extend to members as individuals, even when they used the accounts as the basis for purchasing more shares in the company, and it certainly did not extend to potential outside purchasers of shares. The onus was clearly on the appellants in these circumstances to make their own independent enquiries, as it was unreasonable to rely on the auditors.
However, in Morgan Crucible Co plc v Hill Samuel Bank Ltd (1991), it was held that, where express representations are made about the accounts and the financial state of the company by directors or financial advisers of that company, with the intention that the person interested in the takeover will rely on them, then a duty of care is owed, and the auditor will be responsible for consequential losses. This was also the situation in ADT v BDO Binder Hamlyn (1995) where a partner in the defendant accountancy firm told the plaintiff company that he stood by the audited accounts of BSG, the company that the ADT were in the process of taking over.
This was taken as an assumption of responsibility and as the accounts had been prepared negligently, Binder Hamlyn were held liable to repay the amount that ADT had overpaid for BSG, a total of £65 million.
Following Caparo Industries plc v Dickman (1990), it can be stated that a company’s auditors certainly do owe a duty of care to shareholders collectively as a body to allow them to exercise proper control over the management of the company.
As regards members individually, then again following Caparo, normally the auditors do not owe them a duty of care, even when they use the information supplied to purchase more shares in the company.
Consequently it can be seen that auditors owe no duty of care to non-members unless they actually assume responsibility for the accuracy of information they supply (Morgan Crucible Co plc v Hill Samuel Bank Ltd (1991) and ADT v BDO Binder Hamlyn (1995)). |
