Auditor's liability towards third parties within the EU: A comparative study between the United Kingdom, the Netherlands, Germany and Belgium

• Author: Ingrid De Poorter
• Position: Doctor University of Gent (Belgium), Financial Law Institute Ingrid.
• Pages: 68-75

Auditor's liability towards third parties within the EU: A comparative study between the United Kingdom, the Netherlands, Germany and Belgium¹

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1. Introduction

Due to the increased market capitalization of companies during the last decade, the risk of auditing such companies has increased similarly. At the same time, access to insurance for auditors has fallen sharply, especially for firms auditing international and listed companies, thus leaving partners in audit firms with an unattractive prospect of entirely supporting the liability risks themselves. Numerous financial scandals such as Enron, Worldcom, and Parmalat (etc.) underlined these issues.

This paper will show that there are large discrepancies concerning auditor's liability towards third parties within the legal systems of the European Union. To be able to litigate an auditor some legal systems require specific conditions of a third party. Four legal systems are to be compared: the United Kingdom, the Netherlands, Germany and Belgium. These findings will have serious consequences on the debate about the limitation of auditors' liability because the number of claimants and therefore the amount of damage could vary enormously.

2. A European initiative to harmonize auditors' liability cap

In pursuance of article 31 of the Statutory Audit Directive 2006/43/EC (OJ L 157, 9.6.2006, 87-107), the European Commission ordered a report concerning this debate, more specific on the economic impact of current national liability rules carrying out statutory audits on European capital markets and on the insurance conditions for statutory auditors and audit firms, including an objective analysis on the limitations on financial liability. The extensive report of the London Economics on the economic impact of auditors' liability regimes of September 2006 indicated that the current amount of high value actual of potential claims arising from statutory audits may entail serious financial consequences for audits firms. Since the current level of commercial insurance is such that it would cover less than 5% of the larger claims some firms face nowadays in some EU Member States, the independence audit work could endangered. Within this debate, we may not forget the Enron-fraud already evolved in the elimination of one of the Big Audit Firms. Different solutions to resolve this extensive liability risk of auditors are to be debated.

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In January 2007 the Directorate General for Internal Market and Services issued a consultation document on this matter, to be precise on the auditors' liability and its impact on the European capital markets. It proposes a liability cap for European statutory audit. Four options are to be considered:

1. One single monetary cap for all EU member states

2. A cap depending on the company's size

3. A cap depending on audit fees charged to the company and proportionate liability.

4. Austria, Belgium, Germany, Greece and Slovenia already capped the liability of the auditors.

To harmonize the auditors' liability and the limitation of auditors' liability in particular, it is necessary to study the different legal systems within the European Union. In this paper, we highlight the major differences in some European legal systems on auditors' liability towards third parties. A Belgian auditor is liable towards each interested third party. In Germany, the Netherlands and the United Kingdom, an auditor has to encompass a special duty of care towards the third party to be liable. This means an evaluation will be made of the two European common law systems versus two European civil law systems, and with some reflections on the American system since the latter was an inspiration to some legal European systems. This element was not discussed in the London Economics Study (2006), but is a significant issue in the liability limitation debate since the number of claimants and damage could differ enormously.

3. The United Kingdom

3.1. Liability of an issuer of a statement:Hedley Byrne & Co v Heller & Partners-case

In the United Kingdom, the third party liability of an auditor is restricted. Numerous cases describe the necessary conditions in order for a third party to be able to rely on the auditors' statements.

The leading case concerning the liability of an issuer of a statement towards third parties, is the Hedley Byrne & Co v. Heller & Partners-case ([1963] 2 All ER 575). These third party liability principles were an inspiration for many auditor liability cases. In the Hedley Byrne & Co v. Heller & Partners-case, the House of Lords ruled that a third party who had relied to his detriment on a negligent statement could sue the issuer of the statement, despite the absence of privity of the contract. For the first time, the House of Lords recognised the possibility of liability for pure economic loss caused by a negligent statement was not dependent on any contractual relationship.

Persons uttering statements owe a duty of care to any third person with whom a 'special relationship' exists. A special relationship requires more than a fiduciary contractual relationship. It can arise because of a voluntary assumption of responsibility by the defendant. "All those relationships where it is plain that the party seeking information or advice was trusting the other to exercise such a degree of care as the circumstances required, where it was reasonable for him to do that, and where the other gave the information or advice when he knew or ought to have known that the inquirer was relying on him.".

3.2. Auditor's Liability:Caparo Industries v Dickman and others-case

The duty of care of an auditor to third parties was elucidated in the Caparo Industries v. Dickman and others-case ([1990] 1 All ER 568; AC 605). The Court specified the necessary relationship, as mentioned in the Hedley Byrne case, between the maker of a statement or giver of advice (adviser) and the recipient who acts in reliance on it (advisee) may typically be held to exist where:

1. "the advise is required for a purpose, whether particularly specified or generally described, which is made known either actually or inferentially, to the adviser at the time when the advise is given,

2. the adviser knows either actually or inferentially, that his advise will be communicated to the advisee, either specially or as a member of an ascertainable class, in order that it should be used by the advisee for that purpose,

3. it is known, either actually or inferentially, that the advice so communicated is likely to be acted on by the advisee for that purpose without independent inquiry and

4. it is so acted on by the advisee to his detriment.

5. That is not of course, to suggest that these conditions are either conclusive, but merely that the actual decision in the case does not warrant any broader propositions."

   Based on this judgment a three pronged test for a duty of care is applied:

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1. foreseeability of damage;

2. a relationship characterised by the law as one of proximity or neighbourhood (proximity) and

3. that the situation should be one in which the court considers it would be fair, just and reasonable that the law should impose a duty of care given scope on one party for the benefit of the other.

   Proximity was the focus of the Caparo Court's legal analysis, given that foreseeability is not difficult to establish in many situations. Proximity exists when

1. the professional knew that his or her work product would be communicated to a known third party or a known third party class;

2. the third party suffered damage as a result of relying on the professional's work product;

3. the work product was used for the purpose for which it was prepared.

   The professional's knowledge includes not only actual knowledge but such knowledge as would be attributed to a reasonable person situated as the defendant. The knowledge requirement must be met at the time the work product is prepared.

   The third requirement - that it should be fair, just and reasonable - was an additional restriction to the Hedley Byrne principles. Based on this three-pronged test, the Court rejected the claim of Caparo Industries against the auditor of a company, Fidelity plc. The facts were that the plaintiff acquired shares in Fidelity based on the accounts of Fidelity as audited by Dickmans, the...