Audit Quality Forum Audit Purpose working paper

Current legal framework for the statutory audit Prepared for 15 December 2005 meeting of the Audit Purpose working group

Contents Background and Companies Act 1985 ..........................................................................2 Directors’ duties to prepare financial statements – Section 226................................2 Auditors’ primary responsibilities – overview ..........................................................3 Requirement for auditors’ report – Section 235 ........................................................3 Duties of auditors – Section 237 ................................................................................5 Company Law Reform Bill – future framework........................................................6 [N.B this paper was written in February 2006 and the section references refer to those in the original draft of the Company Law Reform Bill that was initially laid before Parliament]......................................................................................................6 Auditing Standards.........................................................................................................7 Ethical Standard 1 – Integrity, Objectivity and independence ......................................8 Auditors’ duties of care..................................................................................................8 Recent case law :Caparo v. Dickman [1990] 2 A.C. 605 ..........................................8 Complications ............................................................................................................9 Potential investors....................................................................................................10 Creditors and lenders ...............................................................................................12 Regulators and Trade Bodies ...................................................................................13 Claims by affiliates/associates of the audit client ....................................................14

The working paper was prepared for the Audit Purpose group to aid discussion of some of the issues around the purpose of an audit and to help the group to develop the paper, Audit Purpose. The working paper does not necessarily represent the views of the members of the Audit Purpose group or of the Audit Quality Forum, individually or collectively. No responsibility for any person acting or refraining to act as

No responsibility for any person acting or refraining to act as a result of any material in this paper can be accepted by the authors, the Audit Purpose working group, or the ICAEW’s Audit and Assurance Faculty.

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Audit Quality Forum Audit Purpose working paper

Background and Companies Act 1985 The legal requirement for preparing financial statements and an audit thereon is contained in the Companies Act 1985. The financial statements are the primary mechanism for shareholders to monitor the performance of directors. The audit therefore has an important stewardship role. According to Lord Oliver of Aylmerton (in the Caparo judgment): It is the auditors’ function to ensure, so 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 (by, for instance, declaring dividends out of capital) and, secondly, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company’s affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided. All limited companies must prepare a set of financial statements for each financial period. The financial statements must be audited unless the company is eligible for audit exemption and takes advantage of this by including a statement from the directors on the balance sheet of the financial statements acknowledging that the company is eligible and that it has taken advantage of this exemption. The relevant sections of the Companies Act are set out below.

Directors’ duties to prepare financial statements – Section 226 The Companies Act 1985 prescribes clear statutory responsibilities for directors in respect of the company accounts and administration of the company. The duty on the directors to prepare individual accounts is covered under Section 226 of the Companies Act. The relevant sections are: S226 (1) The directors of every company shall prepare accounts for the company for each of its financial years. S226A (2) The balance sheet must give a true and fair view of the state of affairs of the company as at the end of the financial year; and the profit and loss account must give a true and fair view of the profit or loss of the company for the financial year. The duty on directors to prepare group accounts is covered under Section 227. S227

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Audit Quality Forum Audit Purpose working paper (1) If at the end of a financial year a company is a parent company the directors, as well as preparing individual accounts for the year, shall prepare consolidated accounts for the group for the year. This section is subject to the exemptions provided by section 228 (parent companies included in accounts of larger EEA group), section 228A (parent companies included in non-EEA group accounts) and section 248 (small and medium-sized groups). Section 227A(1) says that Companies Act group accounts must comprise a consolidated balance sheet and profit and loss account dealing with the parent company and its subsidiary undertakings. Section 227A(B) covers IAS group accounts. If IAS group accounts are prepared the notes in the accounts must state that they have been prepared in accordance with IAS.

Auditors’ primary responsibilities – overview  To give an opinion to the members of the company as to the truth and fairness of the financial statements  To give an opinion as to whether the financial statements have been properly prepared in accordance with the Act They must consider:  Whether proper books and records have been kept;  Whether proper information has been supplied to them from any branches of the business they have not visited;  Whether the accounts agree to the underlying financial records and supporting information;  Whether the contents of the Directors’ report is consistent with the accounts;  Whether the information given in the operating and financial review of a quoted company for the financial year for which the annual accounts are prepared is consistent with the accounts; and whether any matters have come to their attention, in the performance of their functions as auditors of the company, which in their opinion are inconsistent with the information given in the operating and financial review;  If a directors remuneration report is prepared for the financial year for which the annual accounts are prepared the auditors shall report to the company’s members on the auditable part of the directors’ remuneration report, and state whether in their opinion that part of the directors’ remuneration report has been properly prepared in accordance with this Act; and  If the directors have taken advantage of exemption from preparing group accounts and in the auditors’ opinion, they were not entitled to, the auditors must state this in their report. Sections 235 and 237 lay down these requirements and responsibilities.

Requirement for auditors’ report – Section 235

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Audit Quality Forum Audit Purpose working paper Under Section 235 of the Companies Act 1985 the auditors report to the shareholders of the company. The auditors provide an independent report to the shareholders on the truth and fairness of the financial statements that are prepared by the board of directors. The UK audit plays a fundamental stewardship role and as the Caparo case has confirmed (a summary is provided later in this paper), UK auditors are directly accountable and hence owe a duty of care to the company’s existing shareholders as a body. S235 (1) states that a company’s auditors shall make a report to the company’s members on all annual accounts of the company of which copies are to be laid before the company in general meeting during their tenure of office. S235 (1A) explains what should be included in the auditors’ report. This includes:  An introduction identifying the annual accounts that are the subject of the audit and the financial reporting framework that has been applied in their preparation;  A description of the scope of the audit identifying the auditing standards in accordance with which the audit was conducted. S235 (1B) stipulates that the report must state whether in the auditors’ opinion the annual accounts have been properly prepared in accordance with the requirements of this Act (and, where applicable, Article 4 of the IAS Regulation). S235 (2) requires the report to state in particular whether the annual accounts give a true and fair view, in accordance with the relevant financial reporting framework – a) in the case of an individual balance sheet, of the state of affairs of the company as at the end of the financial year, b) in the case of an individual profit and loss account, of the profit or loss of the company for the financial year, c) in the case of group accounts, of the state of affairs as at the end of the financial year and of the profit or loss for the financial year, of the undertakings included in the consolidation as a whole, so far as concerns members of the company. S235 (2A) explains that the auditors’ report must be either unqualified or qualified and must include reference to any matters which the auditors wish to draw attention to without qualifying. S235 (3) requires the auditors to state in their report whether in their opinion the information given in the directors’ report for the financial year for which the annual accounts are prepared is consistent with those accounts. S235 (3A) deals with the requirements in the auditors’ report regarding the OFR: If the company is a quoted company, the auditors must state in their report – a) whether in their opinion the information given in the operating and financial review for the financial year for which the annual accounts are prepared is consistent with those accounts; and

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Audit Quality Forum Audit Purpose working paper b) whether any matters have come to their attention, in the performance of their functions as auditors of the company, which in their opinion are inconsistent with the information given in the operating and financial review. Likewise S235 (4) and (5) cover the directors’ remuneration report: (4) If a directors remuneration report is prepared for the financial year for which the annual accounts are prepared the auditors shall in their report a) report to the company’s members on the auditable part of the directors’ remuneration report, and b) state whether in their opinion that part of the directors’ remuneration report has been properly prepared in accordance with this Act. (5) For the purposes of this Part, “the auditable part” of a directors’ remuneration report is the part containing the information required by Part 3 of Schedule 7A.

Duties of auditors – Section 237 Section 237 sets out the duties of auditors. It deals with the auditor responsibility to form an opinion as to whether proper books and records have been kept. It is a silent opinion of soundness of accounting condition (the opinion is only reported if the opinion is negative). Its scope is not necessarily dependent on the size of numbers as reported. It is useful to directors as well as shareholders (and is especially useful to non-executive directors). S237 (1) requires a company’s auditors, when preparing their report, to carry out such investigations as will enable them to form an opinion as to a) whether proper accounting records have been kept by the company and proper returns adequate for their audit have been received from branches not visited by them, b) whether the company’s individual accounts are in agreement with the accounting records and returns, and c) (in the case of a quoted company) whether the auditable part of the company’s directors’ remuneration report is in agreement with the accounting records and returns. Under S237 (2), if the auditors are of opinion that proper returns adequate for their audit have not been received from branches not visited by them, of if the company’s individual accounts are not in agreement with the accounting records and returns, or for quoted companies, the auditable part of its directors’ remuneration report is not in agreement with the accounting records and returns, the auditors need to state that fact in their report. S237 (3) If the auditors fail to obtain all the information and explanations which, to the best of their knowledge and belief, are necessary for the purposes of their audit, they shall state that fact in their report.

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Audit Quality Forum Audit Purpose working paper S237 (4) states that if a) the requirements of Schedule 6 (disclosure of information: emoluments and other benefits of directors and others) are not complied with in the annual accounts, or b) where a directors’ remuneration report is required to be prepared, the requirements of Part 3 of Schedule 7A (directors’ remuneration report) are not complied with in that report, the auditors shall include in their report, so far as they are reasonably able to do so, a statement giving the requirement particulars. S237 (4A) deals with exemption from group accounts. If the directors of the company have taken advantage of the exemption conferred by Section 248 (exemption for small and medium-sized groups from the need to prepare group accounts) and in the auditors’ opinion they were not entitled to do so, the auditors must state that fact in their report.

Company Law Reform Bill – future framework [N.B this paper was written in December 2005 and the section references refer to those in the original draft of the Company Law Reform Bill that was initially laid before Parliament] The Company Law Reform Bill is about to receive its second reading in Parliament and once implemented, will replace the Companies Act 1985.

Directors’ duties to prepare financial statements Chapter 4, Part 15, Accounts and reports deals with the directors’ duties with regard to the annual accounts. Section 366 deals with the requirement for accounts to give a true and fair view. This is a new section and does not directly replace any section of the Companies Act 1985. S366 (1)

(2)

The directors of a company must not approve accounts for the purposes of this Chapter unless they are satisfied that they give a true and fair view of the assets, liabilities, financial position and profit or loss of the company. The auditor of a company in carrying out his functions under this Act in relation to the company’s annual accounts must have regard to the directors’ duty under subsection (1).

Section 367 deals with a duty to prepare individual accounts and replaces Section 226(1) of the Companies Act. Section 368 covers the applicable accounting framework, taking account of international accounting standards.

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Audit Quality Forum Audit Purpose working paper

Section 369 (2) is the equivalent of S226 A CA1985 dealing with the requirement for the accounts (i.e. balance sheet/profit and loss account) to give a true and fair view.

Auditors’ primary responsibilities – overview Auditors’ responsibilities are governed by Part 16 of the Bill and are very similar in nature to current requirements.

Requirements for auditors’ report Section 482 covers the requirement for an auditor’s report on the company’s annual accounts. S482 (1) of the Bill replaces S235 (1) CA1985, with a minor adjustment to reflect the changes regarding AGMs and private companies. S482 (2) is the same as S235 (1A). S482 (3) and (4) replace S235 (2) and S235 (2A) respectively. Sections 483 and 484 replace S235 (3) and (3A) respectively. Finally, S 485 deals with the auditors’ report on the auditable part of the directors’ remuneration report, thereby replacing S235 (4) and (5).

Duties of auditors Section 486 deals with the duties of auditors. S486 (1), (2), (3) and (4) replace S237 (1), (2), (3) and (4) CA 1985 respectively. S486 (5) states that: If the directors of the company have prepared accounts and reports in accordance with the small companies regime and in the auditor’s opinion they were not entitled so to do, the auditors shall state that fact in his report. However, S237 (5) CA1985 only deals with exemption from group accounts.

Auditing Standards ISA (UK and Ireland) 200, Objective and General Principles Governing an Audit of Financial Statements establishes standards and provides guidance on the objective and general principles governing an audit of financial statements. The Standard says that: The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. The phrases used to express the auditors’ opinion are ‘give a true and fair view’ or ‘presents fairly, in all material respects’, which are equivalent terms. The ‘applicable financial reporting framework’ comprises those requirements of accounting standards, law and regulations applicable to the entity that determine the form and content of its financial statements. Although the auditor’s opinion enhances the credibility of the financial statements, the user cannot assume that the audit opinion is an assurance as to the future viability

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Audit Quality Forum Audit Purpose working paper of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity. (paras 2, 2,1, 3)

Ethical Standard 1 – Integrity, Objectivity and independence The APB’s Ethical Standard 1 provides an explanation for the primary purpose of financial statements and the primary objective of the audit. The primary purpose of the financial statements of an entity is to provide its owners – the shareholders with information on the state of affairs of the entity and its performance and to assist them in assessing the stewardship exercised by the directors over the business that has been entrusted to them. (Para 1) The primary objective of an audit of the financial statements is for the auditors to provide independent assurance to the shareholders that the directors have prepared the financial statements properly. The auditors issue a report that includes their opinion as to whether or not the financial statements give a true and fair view in accordance with the relevant financial reporting framework. Thus the auditors assist the shareholders to exercise their proprietary powers as shareholders in the Annual General Meeting. (Para 3)

Auditors’ duties of care To establish liability, a claimant needs to show that the auditor assumed legal responsibility to the claimant to guard against the loss for which damages are claimed. Where the claimant is a company whose accounts were audited (or the shareholders as a body) it is not difficult to establish a duty of care. The scope of auditors’ common law duties to the company and its shareholders was set out in the case Caparo Industries PLC V Dickman and others.

Recent case law :Caparo v. Dickman [1990] 2 A.C. 605 Caparo had begun purchasing shares in Fidelity a few days before the annual accounts had been published to shareholders and alleged that in reliance on those accounts they made further purchases of shares so as to take over the company, and that the auditors owed both shareholders and potential investors a duty of care in respect of the certification of the accounts and should have known that Fidelity’s profits were not as high as projected and its share price had fallen significantly, that it was susceptible to a take-over bid and that reliance on the accuracy of the accounts would be placed by any potential bidder. The House of Lords said that, for a duty of care to arise, the claimant must prove that: (i) (ii)

it was reasonably foreseeable that damage of the kind allegedly sustained would be suffered if the defendant failed to take reasonable care there was sufficient proximity between the parties and

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Audit Quality Forum Audit Purpose working paper (iii)

it would be just, fair and reasonable to impose a duty of care on the defendant.

Since the purpose of the statutory requirement for an audit of public companies under the Companies Act 1985 was the making of a report to enable shareholders to exercise their class rights in general meeting and did not extend to the provision of information to assist shareholders in the making of decisions as to future investment in the company, and since, additionally, there was no reason in policy or principle why auditors should be deemed to have a special relationship with non-shareholders contemplating investment in the company in reliance on the published accounts, even when the affairs of the company were known to be such as to render it susceptible to an attempted take-over, the auditors had not owed any duty of care to the plaintiffs in respect of their purchase The House of Lords also laid down criteria for determining whether or not there is sufficient proximity between an auditor and a non-client party, such as to give rise to a duty of care on the part of the auditor to protect that party from a particular loss. The conclusion was that there will only be sufficient proximity where: (A) (B) (C)

the work produced was required for a purpose made known to the auditor; and the auditor knew or should have known that its work product would be communicated to the non-client party for that purpose; and the auditor knew or should have known that its work would be likely to be acted upon by the non-client party for that purpose, without independent enquiry.

After Caparo, it was generally considered that, in auditing a company’s accounts, auditors owed a duty of care only to the company’s existing shareholders as a body and, even then, only in relation to their ability, derived from their existing shareholdings to exercise rights of stewardship over the company.

Complications However, problems arise where the party which alleges that it has suffered a loss as a result of what the auditor did is a non-client, such as an investor, creditor or regulator. The auditor may have received no fees from such a person and no contract might exist between them but it might still be held that the auditor owed the non-client party a duty to take reasonable care in doing its work. There have been a number of cases since Caparo which have involved the application of these principles. Some of the more relevant cases are highlighted below and have been split into categories. Source for the following cases: Audit Liability – claims by third parties. This is an Audit and Assurance publication prepared in conjunction with Simmons and Simmons.

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Audit Quality Forum Audit Purpose working paper

Potential investors ADT v Binder Hamlyn - [1996] B.C.C. 808 ADT proposed to acquire the balance of the shares which it did not already own in Britannia Securities Group Plc (“BSG”). Binder Hamlyn were the joint auditors of BSG. At a meeting held before ADT finally committed itself to the deal, the audit partner at Binder Hamlyn orally confirmed to a director of ADT that he stood by BSG’s 1989 audited accounts. ADT subsequently purchased the remaining BSG shares. The company fell into difficulties and ADT lost the value of its shareholding. ADT then made a claim against Binder Hamlyn. ADT argued that, by effectively restating at the meeting that the 1989 audited accounts showed a true and fair view of the state of affairs of BSG, Binder Hamlyn had assumed a legal responsibility to ADT to protect it from paying too much for the company on the basis of incorrect information contained in the accounts. Following the principles established in Caparo, ADT could not succeed in a claim against Binder Hamlyn on the basis of the audited accounts alone, because those accounts had been prepared with only BSG in mind. However, the crucial difference between this situation and Caparo was the oral statement which the Binder Hamlyn partner made at the meeting with ADT. In particular, the Court found that: (A) (B) (C)

(D)

Binder Hamlyn had been fully aware of the very nature of the transaction ADT proposed to enter into; Binder Hamlyn knew that ADT would rely on the statement made at the meeting; given that the meeting was seen as the “final hurdle”, and that it was never open to ADT to have an independent accountants’ investigation into the affairs of BSG, it was obvious that further detailed investigation into BSG’s accounts after the meeting would not take place; and Binder Hamlyn took it upon themselves to give information or advice directly to ADT.

In the light of these findings, the Court decided that Binder Hamlyn should be taken to have assumed a duty of care to protect ADT from over-paying because of errors in the accounts. However, ADT still had to show that the statement made at the meeting was negligent and had caused ADT to suffer a loss. The Court concluded that the statement was negligent and that it had played a real and substantial part in ADT’s decision to commit to its investment in BSG. Accordingly, the Court ordered Binder Hamlyn to pay ADT compensation, reflecting the difference between the price which it had paid for the shares and their true value. Binder Hamlyn appealed, but the case settled before the hearing of the appeal, at a figure (it is understood) in excess of the firm’s available insurance cover. Barker v Grant Thornton This case looked at a key element of the Caparo decision regarding proximity and the proviso ‘without independent enquiry’. The target company’s auditors were held not to have assumed a legal responsibility to the investor. Part of the judge’s reasoning was that it would have been reasonably practicable for the investor to have obtained 10

Audit Quality Forum Audit Purpose working paper professional advice (for example, by instructing investigating accountants) from alternative sources, but he chose not to spend the money. The court was also influenced by the fact that GT had expressly disclaimed responsibility to the investor. Peach Publishing Limited v Slater & Co The court will also look at the purpose of any statement made by the auditors. In this case the auditors of ASA (a company being purchased by Peach) gave oral assurance at a pre-completion meeting to Mrs Land the owner of Peach concerning the accuracy of ASA’s management accounts. The accounts substantially overstated ASA’s profitability. Mrs Land claimed she had relied on that oral assurance in deciding to go ahead with the purchase. However, the Court of Appeal concluded that, although the assurance had been directed at Mrs Land, its purpose was not to reassure her that the accounts were ‘right’ but rather to indicate to the auditors’ client, ASA, that it could give a warranty to Peach in relation to those accounts. Another factor which the Court of Appeal considered to be relevant was that both parties had their own legal and accountancy advisers. Yorkshire Enterprise Ltd v Robson Rhodes The fact that other advisers are not retained is not, always conclusive. In this case, the judge decided that Robson Rhodes knew that venture capitalists would rely on statements made in the audited accounts for the purpose of deciding whether or not to make the investment and the court found that a duty of care was owed. Robson Rhodes were in a particularly good position to assess the profit of the business and the judge concluded that they did not expect the venture capitalists to carry out any real further investigation of the figures which they had audited. Robson Rhodes had not sought to disclaim liability. Electra Private Equity Partners v KPMG The Court declined to strike out claims against the auditor even though the claimant investor had the benefit of independent advice. A similar conclusion was reached in Man Nutzfahrzeuge Aktiengesellschaft and Others v Ernst & Young & Others. These were both important decisions as they demonstrate that, depending on the facts of any particular case, it is possible for auditors to be taken to have assumed legal responsibility to an identified third party, not on the basis of anything the auditors said or did beyond auditing the accounts, but merely on the basis of what the auditors were told when they carried out their audit. Precis (521) PLC v William M Mercer Limited This case involved actuaries but also involved the application of the Caparo principles and so is of interest to auditors. The actuaries, Mercer provided a copy of an actuarial valuation to Precis, a would-be purchaser six months after the valuation had been

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Audit Quality Forum Audit Purpose working paper prepared. The valuation showed a pension fund deficit but this had been underestimated. This error only came to light after Precis had duly purchased shares in the company. Mercer was successful in arguing that there was no duty of care but only after a long fight. This case emphasised the need for auditors to be cautious when asked to provide copies of their reports to third parties. In the absence of a statement making it clear that no responsibility was being assumed, the third party could later seek to make out a claim based solely on the auditor agreeing to provide a copy of its work to that third party.

Creditors and lenders The same principles apply to those who lend to (rather than invest in) companies on the basis of audited accounts. Royal Bank of Scotland v Bannerman Johnstone Maclay The Scottish Court of Session decided that, in preparing the audited accounts of a company called APC Limited, Bannermans may have owed Royal Bank of Scotland, one of APC’s creditor banks a duty of care. The issue arose because facility letters required APC to provide audited financial statements to its principal lender, RBS, within six months of its year-end. Bannermans prepared audited accounts for the periods to 30 November 1995 and 31 March 1997. APC sent those accounts to RBS, which then made certain overdraft facilities and term loans available to APC. APC went into receivership and RBS lost its money. RBS then sought to recover its losses from Bannermans, saying that their preparation of the audited accounts had been negligent and in breach of a duty of care owed to RBS. Bannermans applied to strike the claim out on the basis that, even if RBS’s factual allegations were true, they did not owe RBS a duty of care. The application was dismissed by the Court and again on appeal. The key point was this: to establish the existence of a duty of care, did RBS have to show that Bannermans intended that RBS would rely on the audited accounts for the purpose for which RBS actually relied on them, or was it enough that Bannermans ought to have known that RBS would rely on them for that purpose? The Court said that it was sufficient for RBS to show that Bannermans should have been aware that the accounts would be provided to RBS for the purpose for which RBS actually relied on them, even though this was different from the statutory purpose for which the accounts had been prepared. It was, said the Court, particularly significant that: Bannermans had prepared APC’s business plan, which provided the foundation of RBS’s lending to APC; unlike the situation in Caparo, the audited accounts were not put into general circulation but were (as Bannermans knew) provided specifically to RBS; and due to the terms of the facility letters relating to APC’s overdraft, Bannermans knew that the audited accounts would be passed to RBS and would be

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Audit Quality Forum Audit Purpose working paper relied upon by RBS for the purpose of making decisions about the level of its lending to the companies. Accordingly, the Court refused to strike the claim out and it was allowed to proceed to trial. The trial judge noted that the absence of a disclaimer in the audited accounts was one of the factors which enabled the inference to be drawn that the auditors had assumed a legal responsibility to RBS for the content of the audit report. It is worth noting that, in holding that intention on the part of the auditors was not determinative of liability, the Court in Bannermans effectively resisted an attempt to introduce a requirement which had not been present in Caparo itself. Bannermans appealed. However, the Inner House of the Scottish Court of Session (equivalent to the Court of Appeal in England and Wales) dismissed the appeal. The Court said that to establish the relevant duty of care, it may be sufficient in some circumstances that the provider of the information or advice knew that it would be passed to the third party recipient for a specific purpose and that the recipient was likely to rely on it for that purpose. Whilst intention, if present, may support the existence of proximity between the auditors and the third party, intention was not essential "in every case." What really mattered was not the intention of the auditor, but its actual or presumed knowledge that the information or advice was likely to be relied on by the third party. On the relevance of Bannermans’ failure to disclaim responsibility, the Court of Session agreed with the judge at first instance and confirmed that a failure to disclaim against a third party could, in appropriate circumstances, be a factor pointing to an assumption of responsibility on the part of the auditor. One point of interest was the Court of Session's comment about the scope of section 310 of the Companies Act 1985. Bannermans had argued that the Court should not take the absence of a disclaimer in the audit report as an indication that they had assumed a responsibility to the bank because, in any event, such a disclaimer would have been void under section 310. However, the Court rejected this argument and stated that section 310 was not relevant because that provision only applied to claims made against auditors by the company. In other words, there was nothing in section 310 to prevent an auditor from disclaiming liability to third parties.

Regulators and Trade Bodies The English Court of Appeal reached similar conclusions in Andrew & Others v Kounnis Freeman. This case involved the submission by the auditors of audited accounts to the CAA. The Court of Appeal held that, although the audited accounts had been prepared for a statutory purpose, it was clearly arguable that reasonable accountants in Kounnis Freeman’s position would know that: a) the company’s financial position was a matter of importance to the CAA in considering whether to renew the ATOL licence; b) the CAA would take the audited accounts as having been prepared with due skill and care

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Audit Quality Forum Audit Purpose working paper c) the CAA would be likely to rely on the accounts in taking its decision. It was therefore arguable that Kounnis Freeman had assumed a duty of care towards the CAA. Other relevant cases include Independents’ Advantage Insurance Company v Personal Rrepresentatives of Michael Cook (deceased) regarding bonding requirements under ABTA/IATA rules and the Law Society v KPMG Peat Marwick case regarding solicitors’ accounts rules work.

Claims by affiliates/associates of the audit client Other recent cases have considered the circumstances in which auditors may owe a duty of care to entities affiliated or associated with the audit client. Clear examples of this arose in the BCCI litigation (Bank of Credit and Commerce International (Overseas) Ltd (in liquidation) and Others v Price Waterhouse and Others) and Barings plc (in administration) and Others v Coopers & Lybrand and Others. Auditors of a company in a group therefore need to exercise caution in their dealings with auditors of other group companies.

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