No more deep pockets: Why accountants are seeking to limit liability

The Big Six firms of accountants have had enough of unlimited liability. Several of the big firms seem likely to follow KPMG’s lead by placing their audit business in some form of limited liability vehicle. The article considers the advantages and disadvantages of taking this step.

The Big Six firms of accountants have had enough of unlimited liability. The recent £105 million award against BDO Binder Hamlyn and writs issued by the administrators of Barings have sent further shock waves through the profession. Several other big firms now seem likely to follow KPMG's lead by placing their audit business in some form of limited liability vehicle.

Joint and several liability

The core of the problem is the joint and several liability of partners under partnership law. Partners are liable for the debts and obligations of the partnership without limit (section 9, Partnership Act, 1890). Where a partnership is unable to pay its debts, a creditor is entitled to obtain payment from the private assets of the individual partners. Because the big firms have extensive financial resources, they are perceived to offer rich pickings to potential litigants.

And the court procedures for awarding damages do not help them. Even where there are a number of defendants in a case, the plaintiff can bring a claim and enforce a judgment against any one defendant (often the accountants) who must then seek contribution from co-defendants. The onus of establishing liability of other defendants and credit risk therefore shifts from the plaintiff to the defendant with the deepest pockets.

The Government has asked the Law Commission to consider the concept of joint and several liability but there are unlikely to be changes to existing law for the foreseeable future (if at all).


The House of Lords decision in Caparo offered some comfort to auditors (Caparo Industries plc v Dickman [1990] 2 WLR 358). The Lords held that a company's auditors are not generally liable to investors (including bidders) who deal in the company's shares in reliance on negligently audited accounts. This helped to head off a large number of claims against auditors from disaffected investors but accountants are still in the front line of potential defendants in a wide variety of cases.

But Caparo is unlikely to assist accountants outside a straightforward audit situation (see, for example, Morgan Crucible v Hill Samuel Bank Ltd and others (PLC, 1993, IV(4), 13)). The High Court has recently provided an unwelcome illustration of this. In a case brought against BDO Binder Hamlyn by ADT, the electronic security company, the court held that BDO was liable to ADT when an audit partner told ADT that he stood by the (negligently audited) accounts of a target company which ADT went on to purchase (see "The BDO Binder Hamlyn award" on this page").

Insurance and caps

Accountants have sought to limit exposure through insurance arrangements and contractual caps for non audit business. But neither approach has been successful in giving them absolute protection.

Large firms of accountants can now only obtain professional indemnity insurance for a small proportion of their overall potential exposure. For example, approximately £34 million of the £105 million award against BDO Binder Hamlyn is reported not to have been covered by insurance.

Like all accountants, the Big Six are required by the Institute of Chartered Accountants to carry adequate protection against potential claims. In order to comply, they have established a Bermuda based captive insurance vehicle to help meet claims in excess of their standard insurance arrangements. The amount of cover provided by the captive vehicle is a closely guarded secret but clearly the Big Six can envisage circumstances in which claims could not be met without recourse to partners' personal assets.

About this time last year, accountants started to introduce caps in engagement letters for non audit work. But merchant banks expressed concern that this could prejudice their own position in any litigation arising from transactions. The accountants have agreed to suspend caps pending the outcome of discussions between their own representatives and those of the merchant banks. (Accountants are unable to cap liability for audit work because of section 310 of the Companies Act 1985).

Limited liability

KPMG has been the first firm formally to limit liability. It has incorporated a new company to take on the audit work of listed and regulated companies - the high risk audits. The company has received formal authorisation from the Institute of Chartered Accountants and is due to replace the partnership as auditor of client companies at forthcoming AGMs.

Other firms (including Price Waterhouse and Ernst & Young) are working with the legislature of Jersey to frame a new law which would enable the firms to establish limited liability partnerships on the island. The main drawback of limited liability partnerships under English law is that the limited partners cannot participate in the management of the partnership without losing the right to limited liability. Further, at least one of the partners must be a general partner with unlimited liability. Draft Jersey legislation has not yet been produced but these are amongst the issues that are likely to be addressed.


Although limited liability appears to be superficially attractive, it falls well short of solving all the problems faced by accountants:

* Limited liability is only relevant in a "disaster scenario" when all other funds apart from the auditors' personal assets have been exhausted. Clients are likely to insist that audit companies are sufficiently capitalised to finance most claims against them and there will be no change to the Institute's protection requirements. A huge claim may not result in the bankruptcy of individual partners but will result in the liquidation of the audit vehicle.

* The attitudes of clients (and their shareholders) are yet to be tested. KPMG has doubtless sounded out major clients and not received adverse feedback but shareholders may well ask searching questions at forthcoming AGMs.

* There is a significant difference between the partnership philosophy and corporate approach. Even large partnerships are generally built on trust and mutual support. The desire to remain a partnership is understood to be the main motivation behind Price Waterhouse and Ernst & Young's Jersey move.

But limited liability (as a partnership or company) will not protect individual auditors from negligence claims in their personal capacity - so the loyalty of "partners" may well be put to the test in a disaster scenario irrespective of the choice of audit vehicle.CJM

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