The Companies Act 2006 has for the past year loomed large over UK business. The 2006 Act brings in a wide range of changes to corporate law, altering, for example, the rules relating to director's duties, the constitution of companies generally and audit of companies.  To spare business the indigestion of trying to swallow all these changes at one sitting, the 2006 Act comes into force in stages.  Some are already in force and all will be in force by 1 October 2008.   The provisions relating to auditors, found in Part 16 of the act will have effect from 1 October 2007.  For the most part, Part 16 restates the existing law though there are a couple of significant changes.
The most significant change in this area is the introduction of the ability of auditors to limit their liability by way of agreement with the company that they are auditing.  The Act states that such a limit requires to be "fair and reasonable."  These so-called Liability Limitation Agreements ("LLA") can only apply to a single year's audit. By dint of the fact that they are between the auditor and the client company, the limitation of liability is restricted to that company's audit.   Further, the shareholders of the company in question must approve the terms of the agreement.  Shareholders in private companies can waive the need for approval but given that such a waiver can only be granted in respect of a single year's LLA, the administrative advantages of this route may not be particularly great.
Where dispute arises as to whether a limit on liability is "fair and reasonable" the court must not take into account anything which occurs after the loss or damage in question was incurred, nor any matters which may have an impact on the possibility of recovering compensation from the others liable in respect of the loss or damage.  This limitation is designed to afford some protection to auditors, who can often find themselves to be the only one of the liable parties in a position to provide any compensation that may be awarded to the company. 

If the court does determine that the liability limit was not fair and reasonable, it will, from 1 October 2007, have the power to set aside the limit in the LLA, substitute a limit of its own devising, and leave the duly altered LLA operative. 

The second major development is the introduction of a new criminal offence: that of knowingly or recklessly including a "materially misleading, false or deceptive matter" in an audit report or for failing to include any of the required statements in the report (for example, where the company's accounts to not accord with the accounting records and returns, a statement to that effect).  If an auditor is found guilty of such an offence, they can be fined.  If he or she is tried by jury, and found to be guilty, the court can impose an unlimited fine.

A number of other changes to the law stem from the Government's desire for greater transparency in the auditing of companies.  These include a new power for the Secretary of State to require the disclosure of the terms of appointment of auditors; a right for shareholders of quoted companies to raise questions about the work of auditors.   It remains to be seen whether these innovations will help to restore public confidence in the auditors of companies.

George Boyle is a partner specialising in corporate finance with UK commercial law firm Shepherd and  Wedderburn
0141 566 8515

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