The Italian Supreme Court issued a judgment on 17 April 2015 that addresses the important question of whether an accountant can seek indemnification from a client’s directors and statutory auditors.

Factual background

In this case, two companies instructed KPMG to perform  an audit. KMPG’s mandate agreement expressly obligated it to audit cash and reconcile bank balances. The companies alleged that KPMG breached its duty by failing to report some shareholders’ missing payments, which were  relevant to a capital increase approved by shareholders. The companies sought compensation for damages in an amount at least equal to the missing payments.

KPMG sought dismissal of all the plaintiffs’ claims or, alternatively, indemnification by former directors and statutory auditors (joined as third parties in the proceedings) in the event of an unfavorable decision. In the course of the proceedings, KPMG also filed an action in recourse against the former directors and statutory auditors.

Court’s decision

The lower courts upheld the plaintiffs’ claims and dismissed KPMG’s indemnification claim and action in recourse. This decision was affirmed by the Supreme Court of Cassation, which reasoned:

  1. Concerning the breach of accounting principles: it is not necessary to prove the breach of accounting principles if the omitted conduct is in breach of a specific obligation mandated by an agreement between auditors and audited companies. KPMG was expressly engaged to audit cash and reconcile bank balances. Its failure to report the missing payments was considered a breach of its obligations under the agreement. The court stated that, in such context, KPMG’s conduct amounts to per se negligent conduct.
  2. Concerning causation: Auditors have the burden to prove a lack of causation between the (omitted) activity and the damage. The Supreme Court clarified that the judge has authority to examine the evidence to determine whether the alleged damages would have been avoided if the auditor had conducted the omitted work. According to the Supreme Court, the lower courts correctly concluded that causation existed. In addition, KPMG did not provide evidence to the contrary, as required under the Italian rules governing the burden of proof.

Based on previous precedents (e.g. the 1993 case Banca Popolare di Milano v. KPMG, Court of Milan) an accounting firm that has been proved to be negligent in carrying out an audit may not be held liable absent evidence that the damages sought were a direct consequence of the negligent conduct. This new Supreme Court decision clarifies that the judge may verify causation on his own motion and the auditors have the duty to prove the that no causation exists if the breached obligations are clearly within the scope of the mandate agreement).

  1. Concerning indemnification claim and action in recourse: the action in recourse was dismissed on procedural grounds as untimely filed. With reference to the indemnification claim, the court stated that an accounting firm is obligated to scrutinize the actions of the directors and statutory auditors — not just conduct a “mere formal inspection.” The court further noted that “if the audit activity had been carried out diligently, this would have revealed the fraud or, in general, the misconduct of the statutory auditors and directors.” As a result, although the claimed damaged were caused by the negligence of both the accounting firm and the internal bodies, the accounting firm cannot avoid liability for its own actions by seeking indemnification from the directors and statutory auditors.