…the Financial Reporting Council (FRC) has published its long-awaited guidance on auditor liability limitation agreements (LLAs)?

Under sections 532 to 538 of the Companies Act 2006, which came into force on 6 April 2008, companies are for the first time permitted to enter into contractual arrangements with their auditors to limit the latter’s liability, provided that shareholder approval is obtained. The auditors’ liability may only be limited to an amount which is “fair and reasonable” in all the circumstances.

The new FRC guidance aims to provide practical assistance to companies and their directors on how to apply these new provisions. In particular, it aims to:

  • Explain what is and is not allowed under the new Act
  • Set out some of the factors that will be relevant when assessing the case for a LLA
  • Explain what matters should be covered in a LLA and provide specimen clauses for inclusion
  • Explain the process for obtaining shareholder approval and provide specimen wording for resolutions and notices of general meeting.

The guidance does not attempt to determine whether particular arrangements will be considered “fair and reasonable”, as every arrangement will need to be assessed in the context of the particular circumstances.

The FRC has said it will review the impact of the guidance in the second half of 2010.

The Institutional Shareholders Committee (which includes the ABI and NAPF) has published a statement on what institutional investors are likely to expect from companies seeking shareholder approval for LLAs. The starting point is that investors are generally willing to support “agreements providing for proportional liability or those providing for liability to be at the level that is fair and reasonable”. However, they will not support agreements which include a fixed cap element, and are unlikely to support agreements after the audit work for the year has been completed. The ISC will expect companies to use the specimen principal terms for LLAs contained in the FRC guidance.

PIRC, however, has already said in its shareholder voting guidelines that it is not in favour of LLAs.

The FRC Guidance, together with the covering press release, is available on its website at www.frc.org.uk/press/pub1644.html. The ISC statement is available from the Institutional Shareholders Committee website at www.institutionalshareholderscommittee.org.uk/library.html