The new UK Companies Act 2006 will allow auditors to conclude liability limitation agreements with their clients.

The new Companies Act 2006 reforms and restates company law in the UK. It will be fully operational by 1 October 2008. Until then, there will be a phased introduction of the provisions of the new legislation. Parts of the Act are already in force. Chapter 6, which will take effect from 6 April 2008, contains important new provisions about auditors’ liability that will enable auditors to enter into liability limitation agreements (LLAs) with their clients.

An LLA is an agreement that purports to limit an auditor’s liability to a company in respect of any negligence, default, breach of duty or breach of trust by the auditor vis-a-vis the company, and which occurs during the audit of the accounts. Broadly speaking, arrangements protecting auditors from liability are regarded as void under section 532 of the Act. However, the legislation expressly exempts LLAs providing they comply with section 535 and are authorised by members of the company (see section 532(2)).

Scope of LLAs

So what are the requirements of section 535? First, the LLA can only cover acts or omissions relating to the audit that occur during a single financial year. It must also specify the financial year to which it applies. Second, and in order to prevent adverse effects on competition, the Secretary of State can issue regulations about what should (or should not) be contained in the LLA.

Subject to these parameters, an LLA can be in any form and the limit on the amount of the auditor’s liability does not have to be a specific sum of money or calculable only according to a formula contained in the agreement. It will therefore be possible to limit auditors’ liability in line with their relative responsibility for the damage actually suffered by the company.

Section 536 sets out the authorisation procedures. Basically, an LLA is regarded as authorised by members of the company providing it has in fact been formally authorised under section 536 and that authorisation has not been subsequently withdrawn. Separate authorisation procedures exist for private and public companies. The common factor is that a resolution must be passed (either before or after the LLA has been concluded) approving the terms of the agreement.

Disclosure

Finally, an LLA must be disclosed by the company in a form specified by the Secretary of State. It seems likely the disclosure will either have to be via a note attached to the company’s annual accounts or it will have to be expressly set out in the directors’ report.

Sting in the tail

So far, so good, but there is a potential sting in the tail. Section 537 provides that an LLA cannot limit the auditor’s liability to less than the amount that is fair and reasonable in all the circumstances of the case. In this context, particular attention will be paid to the auditor’s statutory responsibilities, the nature and purpose of the auditor’s contractual obligations to the company and the professional standards expected of him or her. In determining what is fair and reasonable, no account is to be taken of anything that has happened after the loss and damage in question has happened, or which could affect the possibility of recovering compensation from others who may be liable for the same loss or damage.

Future

It will be interesting to see how the UK courts interpret LLAs in the future. Depending on how this new instrument develops, it may ultimately be appropriate to introduce LLAs into Hong Kong’s company law.