Auditors: Just how accountable are they?

In October 2013 we wrote about the courts’ continued unwillingness or perhaps inability to break down the legal barriers that protect auditors from negligence claims. However, a recent case suggests that the tide may be changing and that it is only a matter of time until the accountability of auditors is subject to a close review by our highest court:


"The scope of an auditor’s duty and its relationship to the illegality defence may one day need to be revisited by this court…"

Judgment was handed down by the Supreme Court on 22 April 2015. Unusually, the case was heard by 7 Supreme Court Justices (5 is the norm), and in their speeches the Justices devoted considerable time to analysing a decision made by their predecessor as the UK’s highest court, the House of Lords, in 2009. In the earlier case, the House of Lords determined that where a "one man company" had engaged in serious fraud, the company’s auditors could rely upon that illegality as trumping any failure on their part to detect the fraud. The result was that he creditors of the company were left without a defendant with the wherewithal to meet their claim.

Whilst the recent Supreme Court decision is of general importance in relation to the limitations the court placed on the future application of the so-called illegality defence, as can be seen from the opening quotation to this article, it also raises some other interesting questions in the context of the liability of auditors.

Dealing firstly with the limitations to the illegality defence that the court has now recognised, here are some quotations from the speeches of the Justices:

"…the time has come in my view for us to hold that the decision in [the earlier House of Lords case] should, as Lord Denning graphically put it in relation to another case in In re King [1963] CH 459, 483, be ‘put on one side and marked ‘not to be looked at again’"

"…it is not in the interests of the future clarity of the law for [the earlier House of Lords case] to be treated as authoritative or of assistance save as already indicated."

"[The earlier House of Lords case] stands as authority for the point which it decided, namely that on the facts of that case no claim lay against the auditors, but nothing more"

It can therefore be seen that the applicability of the illegality defence in claims against auditors would seem now to be very limited. However, the recent case considered by the Supreme Court did not involve a claim against an auditor – it concerned a claim by a company in liquidation alleging that its directors and certain third parties had conspired to cause it to participate in a fraudulent VAT scheme. Because the company was itself the vehicle for the fraud, one of the defences it was met with was illegality, i.e. that it could not pursue the claim because it had itself been party to the fraud.

Of course the Supreme Court did not have much truck with this defence, but their references to a seeming desire to review the position in connection with claims against auditors is perhaps the more interesting development. The Justices were not in a position to review the law relating to auditors in the case before them because it was not a case involving auditors.

There is the intriguing possibility that a future review might not be limited only to the illegality defence, but could include a wider review of the extent of auditors’ duty of care. It is conceivable that the Justices could consider whether it is appropriate for auditors’ duty of care to continue to lie only to the companies they audit and their shareholders and to any persons to whom they have specifically assumed responsibility. Nevertheless on the basis of this admittedly limited encouragement, it would still take a very brave (and wealthy) creditor of an insolvent company to pursue a claim against the negligent auditor all the way to the Supreme Court …