Auditor Negligence Claims – A Practical Guide

As specialist professional negligence solicitors, we act for clients nationwide in auditor negligence claims, as well as in claims against other traditional and emerging professionals.

In this practical guide, we seek to answer the initial questions that corporate representatives and stakeholders are likely to have about the possibility of pursuing a claim for damages for professional negligence against an auditor, after sustaining a substantial financial loss or liability.

It should be noted from the outset that, even in comparison to many other types of professional negligence claims, which in general are often more complicated than many of the more routine forms of litigation, audit negligence claims can be relatively complicated and involved. That is a reflection partly of the underlying subject matter, which is extensively regulated, but also the array of legal issues that they frequently give rise to.

In turn, this means that, while pursuing successful claims can be of real commercial benefit, they often require a significant commitment, both in terms of management time and funding. It also means that inexperienced litigation solicitors intending to ‘dabble’ in this area should think twice, as should any individual or board of directors minded to instruct them.

What is the recognised function of an auditor?

The statutory functions of an auditor are set out within Part 16 (Chapter 3) of the Companies Act 2006. However, they were summarised more succinctly by Lord Oliver in the seminal auditor negligence case of Caparo Industries v Dickman (1990) as follows:

‘It is an auditors’ function to ensure, as far as possible, that the financial information as to the company’s affairs prepared by the directors accurately reflects the company’s position in order, first, to protect the company itself from the consequences of undetected errors or, possibly, wrongdoing…and, secondly, to provide the shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company’s affairs and to exercise their collective power to reward or control or remove those to whom that conduct has been confided.’

Distilled yet further, it may be stated that the role of the auditor is to safeguard the company and its members, by investigating and opining on the adequacy of the annual accounts produced by the directors.

However, while each of these accounts assists in defining the traditional role of the audit, none of them prohibit the auditor (or his firm) from undertaking ancillary or related functions, either in his capacity as auditor or as an accountant. Therefore, when assessing whether there may be grounds upon which to pursue an auditor negligence claim, it is often worth considering what other services, if any, the auditor (or his firm) performed.

Who can pursue an auditor negligence claim?

Whether or not a party can pursue a claim for auditor negligence will depend in large part on whether or not a legal duty of care was owed to it by the auditor.

Meeting this essential requirement is often relatively straightforward for the company being audited, which will have entered into a contractual relationship with the auditor. This in turn will give rise to an implied duty on the part of the auditor to exercise reasonable skill and care (pursuant to section 13 of the Supply of Goods and Services Act 1982), in addition to any similar express duty. Nevertheless, issues can still arise here in relation to the scope of that contractual duty, as well as any coextensive duty owed in tort or in equity.

The courts have also acknowledged that a duty of care is owed in the law of tort by auditors to the shareholders of a company, albeit as a group or collective. In Caparo, Lord Bridge observed that:

‘…The shareholders of a company have a collective interest in the company’s proper management and insofar as a negligent failure of the auditor to report accurately on the state of the company’s finances deprives the shareholders of the opportunity to exercise their powers…the shareholders ought to be entitled to a remedy.’

However, whether an actionable duty of care is owed by an auditor to an individual shareholder or to a third party has been, and continues to be, a more hotly debated issue in auditor negligence claims. That is because the courts have both recognised and guarded against the potential injustice of exposing auditors to the risk of liability to an indeterminate class of potential claimants, whose reliance may not be foreseeable and whose potential losses could be various and very substantial.

The result is a developing, and perhaps less certain, area of law where inter-changeable legal tests are applied to the individual circumstances of the case, to assess both the existence and scope of the duty of care potentially owed to third parties.

Nevertheless, and having regard to the foregoing policy concerns, it may be generally stated that a duty of care to a third party is less likely to be upheld where that duty is likely to create an indeterminate liability, than where the potential liability would be restricted to a smaller class and where the auditor is aware of the particular purpose for which his opinion is to be relied upon.

Some examples of cases where the courts have found that either an actual or an arguable duty of care was owed by an auditor to a third party are:

·       ADT Ltd v BDO Binder Hamlyn (1995)

In ADT the Claimant was the intended purchaser of a holding company (‘BSG’), which controlled a group of companies that installed the second largest number of security alarms in the UK. The Defendants were the auditors of BSG.

Before completing the acquisition, the Claimant insisted on a meeting with the Defendants at which an audit partner provided assurances that BSG’s accounts provided a true and fair view of the state of affairs at BSG and that there was nothing else that the Claimant should be told.

In the event, however, the accounts did not provide a true and fair view and, if the audit had been properly planned and performed, either a qualified or a delayed opinion should have been given.

Sitting in the High Court, Mr Justice May held that the Defendants did owe a duty of care to the third party Claimant. He observed that the audit partner was fully aware of the intended transaction and had given advice directly to the Claimant, which he knew the Claimant would rely upon without further enquiry.

·       Siddell & Another v Smith Cooper & Partners (A Firm) (1998)

In Siddell the Claimants had purchased an off-the-shelf company (‘Paxwood Ltd’) as a vehicle to buy shares in two other companies. The Defendants had been appointed as the accountants and auditors of Paxwood Ltd and to provide accountancy and financial advisory services to the Claimants personally.

Several years later the financial director of Paxwood Ltd left, at which time various financial irregularities were discovered. This resulted in the appointment of administrative receivers and the enforcement of personal guarantees given by the Claimants.

The Claimants subsequently commenced an auditor negligence claim, alleging that the Defendants had failed to take sufficient care when auditing the accounts of Paxwood Ltd. The Defendants then applied successfully to strike out the claim on the grounds that they owed no duty of care to the Claimants.

However, on appeal by the Claimants the Court of Appeal restored the claim. This was on the basis that (i) the Defendants had acted as accountants as well as auditors and it was arguable that in this capacity they had owed a duty of care to the Claimants; (2) it could not be said that the existence of a contract to advise the Claimants in respect of their personal financial affairs necessarily precluded the existence of a wider duty of care to the Claimants in other respects; and (3) in providing direct advice to the Claimants it was arguable that the Defendants had assumed a responsibility towards them.

·       RBS v Bannerman Johnstone MacLay (2005)

RBS was a claim that came before the Scottish courts. The Claimant was the banker and a shareholder of a plant hire company (‘APC Ltd’) and its subsidiary. The Defendant was the appointed auditor, who had also supplied an employee to act as financial controller of APC Ltd.

In 1998 both companies become insolvent and the substantial loans and investments the Claimant had made were lost in their entirety. The Claimant subsequently commenced an auditor negligence claim, alleging that it was owed a duty of care by the Defendants.

At first instance, and in response to the Defendants’ application to strike out the claim, the court held that there was a case to answer as the Defendants had known when auditing APC Ltd’s accounts that the results of the audit would be communicated to the Claimant, and that the Claimant would use that information in deciding whether to provide, or continue to provide, finance to it. The court further held that it was arguable, in view of the relationship between the two companies, that the Defendants’ duty of care also extended to both the Claimant’s loans to the subsidiary and its purchase of equity in APC Ltd.

Although the Defendants lodged an appeal, this was rejected. The appeal court concluded that it was clearly arguable that the Defendants had owed a duty of care to the Claimant in respect of the finance provided to both companies. Amongst other matters, the court noted that the Defendants had been directly involved in obtaining set-up finance and that the survival of both companies had depended on the Claimant’s continued support, which in turn depended on satisfactory management accounts verified in due course by the Defendants as auditors.

For what losses can an auditor be held liable?

Whether a particular head of loss is recoverable will be governed by the circumstances of the case and the application of certain legal principles and policy. In this latter respect, issues of legal causation and scope of duty have been a frequent feature in auditor negligence claims, where their application (and, on occasions, their mis-application) by the courts has served to restrict some of the losses for which auditors might otherwise have been found liable.

However, some of the heads of loss for which damages have been awarded by the courts are:

  • Defalcations/thefts by an employee or director which could have been prevented
  • Bonuses paid to directors that would not have been approved
  • The difference between the price an investor paid for shares and their true market value
  • Irrecoverable loans made to subsidiary companies
  • Expenditure on management fees that would not have been incurred
  • Dividends paid to shareholders out of capital that would not have been declared
  • Profits diverted from subsidiary companies which would otherwise be available as dividends
  • Costs of undertaking a fresh audit

How prevalent are auditor negligence claims?

Both in the 1990s and at the turn of the 21st century there were a string of high profile and legally significant auditor negligence claims. While these types of claims then subsided during the following decade, they are once again becoming more prevalent. This is apparent not only from the high-profile claims that have recently gone to trial, but also from the raft of negative headlines that have appeared in the financial press, examples of which include:

Where economic conditions deteriorate this trend may become even more pronounced. Not only do tougher trading conditions have a tendency to expose previously latent anomalies, but they can also lead to a change of office holders which, in turn, can provide fresh scrutiny of a company’s affairs.

Are there any time limits for pursuing auditor negligence claims?

Time limits apply to auditor negligence claims as they do for claims against other professionals. These time limits can be found in the Limitation Act 1980. In short, they require legal proceedings to be commenced within:

  • 6 years of the date upon which damage or financial loss occurs – section 2
  • 6 years of the date upon which the mistake occurred – section 5
  • 3 years of the earliest date upon which the claimant has both the knowledge required for bringing a claim and the right to bring a claim – section 14A
  • 15 years of the date on which the mistake occurred, even if the time limit prescribed by section 14A has not expired – section 14B

Therefore, where there are grounds for pursuing an auditor negligence claim, a claimant will generally have 6 years from the date of wrongdoing or loss, but may have 3 years from the date of discovery, if later, in which to bring any claim, subject to a long stop of 15 years.

However, while these time limits may appear straightforward in summary form, applying them in practice can be much more challenging. Unfortunately, there are a multitude of cases in which they have been misapplied, not only by lay clients acting as litigants in person but also by solicitors and other lawyers who have themselves fallen into error.

Although limitation is a complicated area of law with a large body of case law relating to it, further information about it can be found in our introductory guide: Time limits for professional negligence claims – FAQ

When considering limitation periods for auditor negligence claims, it should also be noted that an auditor’s appointment is an annual one, as is apparent from the provisions of section 495 of Companies Act 2006. Accordingly, any appointment for a following year is to be regarded as a consecutive appointment, rather than a continuing one.

What funding options are available for an auditor negligence claim?

Before embarking on any professional negligence claim it is imperative to consider how it will be funded. Fortunately, there are a number of ways to fund litigation. Each has its own advantages and disadvantages and can be more or less suitable, depending on individual circumstances. Further information about these different funding options can be found in our related guide: Fund a claim

How is an auditor negligence claim commenced?

Most auditor negligence claims are commenced by correspondence and by following the procedures set out in the Pre-Action Protocol for Professional Negligence.

The aim of the Protocol is to make the process of resolving professional negligence claims more open and more efficient and, by doing so, to reduce the number of professional negligence claims that require judicial intervention. Happily, and since the introduction of the Protocol in July 2001, the vast majority of professional negligence claims are now resolved at the Protocol stage and without the need to institute and pursue costly and time-consuming court proceedings.

However, it should be noted that as helpful as the Protocol is, it provides only a generic framework for resolving professional negligence claims. It does not identify or assess what facts, issues or evidence is relevant and irrelevant in any particular case, nor does it contain legal advice.

Should the auditor be reported to a regulator?

Under section 1212 of the Companies Act 2006, a person may only act as a statutory auditor if he is a member of a recognised supervisory body (RSB) and is eligible for appointment under the rules of that body.

There are currently only four RSBs. These are:

  1. Association of Chartered Certified Accountants (ACCA)
  2. Institute of Chartered Accountants in England and Wales (ICAEW)
  3. Institute of Chartered Accountants of Scotland (ICAS)
  4. Chartered Accountants Ireland (CAI)

It is possible to identify which RSB regulates a particular auditor by searching the Register of Statutory Auditors.

Each RSB has its own complaints and disciplinary policies, which are published online. In most cases, these policies require any complaint to be made to the auditor or his firm in the first instance, which should maintain their own complaints handling policy.

If the complaint relates to a serious breach of an RSB’s code of conduct, it may well take disciplinary action against an auditor. However, such action is unlikely to result in the payment of any financial compensation to the complainant. Therefore, where a significant financial loss or liability has arisen, a complaint of this nature would be better made in conjunction with, rather than as a substitute for, a civil claim for auditor negligence.

Whether any conduct by the auditor should be reported to an RSB should be decided on a case-by-case basis. Any disciplinary action taken might be in the public interest but may not have a direct bearing on the outcome of any auditor negligence claim.

Where can I obtain further legal advice?

If you are considering embarking on a claim for auditor negligence and require legal assistance, we would be happy to discuss the matter with you.

To arrange an initial consultation with us, free of charge or commitment, please contact us on 0800 195 4983 or by email at

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