Broadbent Plastics, Plc and Auditor Cap Agreements - Assignment Example

MEMO Jenny Garnham, Training Partner. Ref: Broadbent Plastics, plc and auditor cap agreements. In reference to the matters you have brought to my attention, I would like to reiterate that the relevant issue you have asked me to address is whether any legal issues arise in connection with Broadbent Plastics plc entering into an agreement with the auditors for capping their liabilities. This would be beneficial to the Company because it would secure then a 20% reduction in the fees payable to the auditors. In this context, I would like to clarify that there is statutory provision available for such an agreement to be legally executed and it may be possible for such an agreement to be negotiated without adverse legal implications. Therefore, since Mr. Broadbent seeks to withhold information about this agreement from the But I would like to point out that such an agreement must mandatorily be disclosed and information about it cannot be withheld from the Company, as explained further below. The Companies Act of 2006 allows auditors to limit their liability on the basis set out in their agreement with their clients. The Act allows scope for the formation of liability limitation agreements that limits “the amount of liability owed to a Company by its auditor in respect of any negligence, default, breach of duty or trust or breach of trust, occurring in the course of the audit of the accounts.”1 This could be on the basis of proportionate liability or any other basis such as a reasonable fixed cap. It allows auditors to negotiate a “contractual proportionate limit of liability” in order to limit their damages payable to the client2. On this basis, it is possible to conclude that should Broadbent Plastics plc seek to negotiate a mutually beneficial agreement between themselves, by capping auditor fees in exchange for a 20% reduction on auditor fees, this is quote permissible and there are no legal restrictions contravening the negotiation of such an agreement. But there is a strong area of concern which arises where the question of concealing such an agreement is concerned. The proposal by Mr. Broadbent and the auditors to withhold the information about the negotiated agreement and the proposed cap on the liability of the auditors from other Company members, may be contravened under the Companies Act of 2006. This Act clarifies that a limited liability auditor agreement could be declared invalid and void unless it is “authorized by the members of the Company.”3 As a result, Mr. Broadbent and the auditors would be guilty of a statutory violation and can be held legally liable if they enter into a negotiated agreement without informing the Company, because for all legal intents and purposes, such an agreement would be null and void. Further, the Company Act also states that in the case of a liability limitation agreement between a private Company and its auditor, there are certain conditions to be fulfilled before it can be authorized. One of these is the need to pass a resolution, either authorizing the agreement before entering into it or approving the agreement after it has been formulated4. Since all Company members need to be aware of accompanying terms before a resolution can be passed, this further supports the argument that it may not be possible to keep any agreement on capping auditor liability a secret from the Company shareholders. Mr. Broadbent can choose when the Company and all its members are to be informed about the agreement, i.e, it could be either before the agreement is concluded or after the agreement is concluded when it could seek to get a resolution passed by the Company members approving the agreement. But concealing the contents altogether would not be an available option for Mr. Broadbent to exercise because of the legal ramifications. It may also be noted that revealing details of any agreement limiting auditor liability is also mandated under the Companies Act by the specific requirement for public disclosure, laid out under Section 538. The Company is required to disclose details of the agreement as the Secretary of State might require. Such disclosures are to be made “in a note to the Company’s annual accounts”5 or “in the director’s report.”6 This requirement for public disclosure also means that if Mr. Broadbent and the auditors choose not to disclose any caps on liability, they could be legally liable. They will be unable to withhold details of such an agreement because the statute as laid out above requires them to disclose these details either in the Annual Report or the Director’s Report, both of which would be available to other members of the Company. The question of whether or not the option to limit liability is used and what exactly its terms are to be, will depend upon shareholders of the Company, especially the institutional ones. A limitation agreement cannot be kept a secret from the shareholders, it will require their assent and they will have the option to veto it if they choose to do so7 at the time that a resolution is passed to approve the agreement. Another issue that must be mentioned here is that the capped amount would have to be carefully estimated. In order to avoid violating statutory provisions, the amount of capping that is permissible is subject to the requirement that it is “fair and reasonable in the circumstances.”8 This would also have to take into account the professional standards generally expected of auditors, which cannot be compromised. Therefore, the capped amount cannot slip below the level that would be considered fair and reasonable. On this basis, it would appear that in order to avoid any potential legal action or legal disputes, it would be advisable for Mr. Broadbent to make a full disclosure about the proposed agreement with the auditors to cap their liability. Irrespective of how difficult it is likely to be to gain their approval, the agreement cannot come into existence without the approval of these Company members. Secondly, the amount of capping of the liability cannot be such that it is too low to satisfy the standards of what is considered fair and reasonable taking into account the professional standards expected from auditors. Mr. Broadbent could however also consider entering into an agreement where auditor liability is limited on a proportionate basis, i.e, damages would be payable on par with the extent to which the auditors have deviated from the professional standards expected of them. This option may be more acceptable to other Company members as opposed to a fixed capped amount. References: * Chapter 6, Section 534 of the Companies Act of 2006, http://www.opsi.gov.uk/ACTS/acts2006/pdf/ukpga_20060046_en.pdf; * Doherty, Christian, 2007. “Auditor Liability”, ACAA, 5 November, 2007. http://www.accaglobal.com/members/publications/accounting_business/archive/2007/october/3030624; * Zubli, Talia, 2007. “Solving the problem of unlimited auditors liability”, http://www.the-financedirector.com/features/feature941/; Read More