memorandum of advice`(Legal Liability of Accountants & Auditors Under Australian Law)

With increasing scope of accountants and auditors negligence for misstatement has given rise to concept of duties of care on them. Being negligent means failure to take reasonable care while performing services. A person is expected to take reasonable care in regard to other people, where it is reasonably foreseeable that other people could be harmed by their actions and omissions. The law of negligence has developed through common law. The cases of Donoghue v Stevenson,1 and Grant v Australian Knitting Mills2, clearly established the tort of negligence.

If we see history of this profession it becomes apparent for users of financial statements to question capability of accountants and auditors in reporting as we can see in the following table that how many times auditors are held liable for being negligent and have to pay damages to the plaintiff.

3

As we can see that the reputation of these professionals has befallen in recent years because of repeated collapse of high profile corporations. Under Trade Practices Act 1974 both accountant and auditors are held liable for providing misleading and deceptive information and are enforced by law to pay damages to the plaintiff.

Accountants who provide professional services are characterized as being engaged in trade and commerce and section 52 of Trade Practices Act 1974 is posited on them on this basis. For number of reasons it has been held that the provision of accounting services falls within that definition and accountants have been held liable successfully under this s 52.4 There are provisions such as financial feasibility studies, investment advice and other similar types of information prepared by the accountant is work done in trade and commerce so as to attract the sanction of the Trade Practices Act. The general points concerning application of the requirements of the Trade Practices Act in relation to other professionals also equally apply to accountants. Under TPA 1974 s52 has been applied in several cases in relation to work of accountants.5

The calculation of damages for an accountant’s failure to take reasonable care & skill will be the same for breach of contract or negligence due to the existence of concurrent liabilities.6 The remedy most commonly sought by clients or third party misled by the advice of an accountant is damages claimed under s82 or compensation under s87 of the Trade Practices Act 1974. Similarly, in common law claimant will only be able to recover the economic loss, which is suffered by claimant as a consequence of misleading conduct.

Auditors are of great importance to users who use financial statements, as they require an unbiased & independent opinion on the information quality and by doing so auditors add value to financial reporting. As we can see that auditors are play active role in evaluating financial statements so, at times when corporate collapse or financial loss occurs, then either client or third party can sue them and demand damages under Trade Practices Act 1974. Section 52 (1) of the TPA 1974 states ‘A corporation shall not, in trade and commerce, engage in conduct that is misleading or deceptive or is likely to mislead or deceive’. If we view from auditing perspective, this particular section would most likely be used in nexus to audit reports given that they might be inappropriately worded or incorrect so, as to mislead or deceive.

As auditors are among the skilled professionals and they offer expert opinions so, basis of requirement for reasonable or adequate is stricter. It is not necessary to any intention to mislead or deceive information under s52 of TPA 1974. The only thing to consider is whether the conduct was misleading or deceptive or is likely to mislead or deceive.8 Furthermore claims for auditors not only originate from claims made by the clients but also other user like shareholders or investors. Therefore, s52 also imposes a duty to correct prior statements so, auditors should take care to correct previous statements as soon as they can if they find mistake within financial statements in the future.

Analysis of liability of Accountants & Auditors under common law & Trade Practices Act: -

For long period judges and commentators use to consider law of negligence as a separate series of duties of care that applied in different way in different situations. More notably, regardless of ‘neighbourhood principle’ liability was not placed for loss suffered as a consequence to negligent misstatement. However it doesn’t mean that neighbourhood principle had no impact but influence of this principle was not concrete but abstract. Rather than Lord Atkin’s principle being applied directly by passing time it led to increased generalism in the law, which almost slowly moved away from the idea of individual duties of cared. As in case of Ultramares Corporation v Touche, plaintiff didn’t get any damages as it was held that accountants are not liable to any third person. In Esanda Finance Corp Ltd v Peat Marwick Hungerford, high court held that auditors did not owe a duty of care to the plaintiff. Very soon it was realized that this generalist approach suffered from vital flaws and it seemed to be impossible to impose liability under this approach.

It was in 1932 that after the judgement passed by Lord Atkin in Donoghue v Stevenson, the court established the ‘neighbour principle’ as a way of explaining a person’s duty of care. It is one of the most important cases decided in the world of common law. It has established the basic principles in relation to liability in cases of negligence. After this landmark decision law of negligence has grown to cover a range of areas where people must take reasonable care so that their acts or omissions do not harm others. Lord Morris concluded that:

         

Lord Denning in case of Candler v Crane, Christmas & Co, concluded by upholding the duty of care of accountants not only to their clients but also to all those who to their knowledge will rely upon their accounts in the transaction for which those accounts were prepared.

In case of Pacific Acceptance Corporations Ltd v Forsyth, changes in expectations in respect of the auditor’s responsibility, with the standards of reasonable care rose.  

The court in case of Hedley Byrne & Co Ltd v Heller & Partners Ltd, held that a negligent though honest misrepresentation may give rise to an action in which plaintiff can ask for damages for economic loss caused regardless of any contractual or fiduciary relationship between the parties.  This case is considered as foundation case for negligent misstatement and under this case House of Lords determined that in certain circumstances a defendant may owe a duty of care to third parties for economic loss incurred as a result of negligent misstatement. In the case it was held that defendant bankers would have been liable for negligence for giving misleading information in relation to credit worthiness, on which plaintiff acted on, and as result he would have suffered heavy losses. This principle was further extended by the high court in Shaddock v Parramatta CC, where the high court held council liable for the damages suffered. Person suffering damage because of negligent advice or information is liable to recover damages from the person who gives advice or information – it is one of the principles established from these cases. Thus, Hedley Byrne is up-and-coming as one of the most important case in English Law in relation to the field of duty of care for economic loss.

Recently decision of the High Court of Australia in Travel Compensation Fund v Tambree(t/as R Tambree & Assocs), High Court has confirmed the extended liability of accountants and auditors for negligent misstatement where the both of them were aware that their financial statements will be forwarded to third party and that party will be relying upon these statements seriously for business purpose. Professionals extended liability to all the people other than client and also there owing of duty of care to them as result of judgement in cases discussed earlier, is one of the leading development in legal system of Australia by High Court. Also as with increased numbers of cases decided where auditors/accountants are held liable and had to pay damages to the plaintiff, it is required that they carry professional indemnity insurance in order to pay claims when failing to exercise their duties in reasonable manner as expected by users and society.

 

If plaintiff suffers pure economic loss then something more than forseeability needs to be established before the defendant will come under duty of care to avoid that harm. This was one of the unanimous decisions of the High Court in Perre v Apand Pty Ltd. One of the major advantages of bringing proceedings under TPA is that it clearly provides remedy for recovery of pure economic loss without any obstructions or hurdles. It was confirmed in case of Wardley Australia Ltd v Western Australia, the reference to ‘loss or damage’ in s82 includes pure economic and financial loss.

As per Hornsby Building Information Centre Pty Ltd v Sydney Building Information Centre Pty Ltd. Under s 52 plaintiffs has to only prove that the defendant’s conduct was misleading or deceptive and as it is considered to be one of the most strict section of TPA.

Corporations being more vary of liabilities under Trade Practices Act than under common law:-

Under identification doctrine, the conduct of individual is taken to that of corporation. The fact that the conduct of that officer also forms the basis of corporate liability does not provide shield against personal liability.

It is relevant to say that it is better alternative for claimants or plaintiff to use s 52 to establish liability on defendant as this section does not require any relationship of proximity nor does it require that the defendant’s conduct amount to negligence. Both accountants/auditors are held liable under s 52 of TPA on many occasions. Also damage for pure economic loss under s 82 has no doubts and damages against third party will not be impeded by the uncertain requirements attached to such claims in tort.

Companies vary more of TPA than under common law because Australian Trade Legislation is extended the area under which professionals are held liable and also under s 52 it has been shown that it provides attractive alternative to the unsatisfactory & restrictive rules of common law. Under s 52 defendants will not be relieved of liability even if the misleading or deceptive conduct was a consequence of reasonable and honest mistake. Hence, defendant cannot use defences available at common law like lack of proximity, honest & reasonable mistake, due diligence & mistaken belief. Facts like plaintiff could have discovered the misrepresentation does not prevent liability. Liabilities under s 52 of TPA are more open-ended and strict, Plaintiff just has to show that defendant’s conduct was misleading or deceptive or is likely to mislead or deceive.

Conclusion

From the discussion so far we can see that on many occasions’ accountants/auditors are held to be liable not only to their clients but also to investors and, creditors and shareholders. The rulings have become stricter for these professionals as Australian financial history has suffered collapses of big corporations and professionals like these are also held to be responsible for that. Proceedings under TPA does not require various factors of forseeability & proximity as in case under tort of negligence.

In order to avoid litigation under law professionals like accountants & auditors are required to:

Bibliography

1. Beazer, Margaret and Gray, Josie, Access & Justice, (7th ed, 2005)
2. Bernstein, Robby, Economic Loss, (1993)

---