The Financial Reporting Council has issued some guidance for auditors who wish to enter into liability limitation agreements with their audit clients.

Under sections 532 to 538 of the Companies Act 2006, which came into effect on 6 April 2008, companies are allowed to limit the liability of their auditors by contract provided that shareholder approval is obtained. These arrangement are effective only to the extent that they are ‘fair and reasonable’ in the particular circumstances.

In general terms the auditor can limit their liability in three ways: to a proportionate share of any loss, by a fair and reasonable test or by a cap on the liability. Each of these methods are explained in detail.

The guidance also covers matters such as:

• What does the law allow?
• What should be covered in any agreement?
• What processes must be followed to implement the agreement?
• When can shareholder approval of the agreement be given?
• How long does the agreement last?
• Can approval of the agreement be withdrawn?

The guidance has a section relating specifically to private companies, explaining the different matters that should be considered where the private company has shareholders that are not closely involved in the running of the company, in particular relating to obtaining shareholder approval of the agreement.

Probably the most useful section of the guidance are the appendices, as these contain specimen terms and conditions that can be incorporated into any agreement, and also specimen resolutions that the company will need to pass in various situations.

The full guidance can be obtained from the FRC’s website, or by following this link: http://www.frc.org.uk/publications/pubs.cfm  

Philip Bown 
July 2008