On 30 June 2008, following the introduction by the Companies Act 2006 of a new regime permitting a company to enter into agreements to limit the liability of their auditors in certain respects, the Financial Reporting Council (FRC) published guidance on the use of such agreements.

The FRC guidance has been developed by a working group established for this purpose and included representatives of companies, investors and the accountancy profession. The FRC guidance aims to provide practical assistance to companies and their directors on the new regime.

The new regime specifically allows (but does not require) a company to enter into an agreement to limit the liability owed to a company by its auditors in respect of any negligence, default, breach of duty or breach of trust occurring the course of auditing a company's accounts subject to compliance with certain terms set out in the relevant provisions of the Companies Act 2006 and provided that shareholder approval is obtained. Previously, auditors were prohibited from entering into agreements that would have the effect of reducing or excluding their liability in relation to statutory audit work carried out for a company.

The FRC's guidance paper covers:

  • what the law allows;
  • certain issues that directors should have regard to in considering an auditor liability limitation agreement;
  • the principal terms that should be covered in any such agreement; and
  • the process for obtaining shareholder approval.

The FRC guidance paper contains specimen terms for use in auditor liability limitation agreements. The impact and content of the FRC guidance will be reviewed by the FRC in the second half of 2010 to ensure that it incorporates relevant developments.

Contemporaneously with the publication of the FRC guidance paper, the Institutional Shareholders' Committee (ISC) issued a statement on auditor liability limitation agreements. This statement emphasised that:

  • institutional investors are generally willing to support agreements providing for proportional liability or providing for liability to be capped at a level that is fair and reasonable but do not consider agreements with a fixed cap (however such cap is calculated) to be appropriate;
  • institutional investors will welcome the opportunity to discuss proposed agreements with companies early in the process in order to understand the reasons for entering into such an agreement and its terms; and
  • institutional investors will be unlikely to support such agreements after the audit work for the relevant year has been completed.

To view the FRC guidance, please click here (46 page pdf) To view the ISC statement, please click here (2 page pdf)

To view the ISC statement, please click here (2 page pdf)