Auditors in Australia are subject to a wide range of laws, from contract law to common law and statute (Harlow 1995p.54). Their conduct is also regulated by various professional bodies, including the Institute of Chartered Accountants in Australia (ICAA) and CPA Australia. The government plays its part in regulating auditors through its agencies like Australian Securities and Investment Commission (ASIC) and the Australian Competition and Consumer Commission (ACCC). The common law tort of negligence imposes a duty of care on auditors. Holding auditors liable requires one to prove that a breach of duty occurred, and that the breach caused damage within the context of the case (Harlow 1995).
According to Hodgson et al (2007), the standard of care requires auditors to apply a certain level of skill and care in the professional services they offer. This duty came into place following Pacific Acceptance Corporation Ltd v Forsyth. For a plaintiff to make a successful negligence claim there must be proof that the auditor acted carelessly and failed to meet the required standard of care. If an auditor (defendant) is found liable for negligence, the law of restitution entitles the plaintiff to damages payments to recover losses. For cases involving third parties, like directors of a company, the plaintiff’s damages entitlement will be reduced (Mitchell et al 2010).
In the case of Esanda Finance Corp Ltd v Peat Marwick Hungerfords, auditors’ scope of liability was effectively narrowed when the High Court denied a claim by third parties against the auditors for negligent misstatement (Lunney and Oliphant 2003p.117). The plaintiff finance company had suffered a loss after using audited reports prepared by the defendant. The reports were used to approve loans to the defendant’s client company. The court found in favour of the defendant and held that the auditor’s intention was not for the financier to use the audited accounts. Therefore, even though the auditors knew that the reports did not represent the company’s accurate financial position, the reports they prepared were not meant for the purposes of the financial company.
In Brown & Hatton v National Australia Bank, the judge stated that “directors should bear their proper share of responsibility with respect to losses suffered by their company” (Pacini et al 2002p.430). The reasoning is that it is unfair for directors to escape liability completely, more so when auditors are to bear the full burden of compensating the aggrieved parties. This defence of contributory negligence is aimed at spreading blame fairly to the parties responsible, especially in cases where a third party’s commercial misjudgement resulted in financial losses. Auditors have the option of this form of defence under common law, and a good case example is AWA Ltd v Daniels T/A Deloitte Haskins & Sells &Ors. Here, the Supreme Court of New South Wales ruled that the plaintiff company was proportionately liable together with the auditors since it had failed to meet the professional standards necessary for its own protection.
Siliciano (1997p.340) pointed out that Australian courts tend to use the test of proximity to determine auditors’ liability when it comes to third parties. This was initially used by Barwick CJ in the case of Mutual Life and Citizens’ Assurance Co Ltd v Evatt to determine if a duty of care existed. The court held that a proximate relationship existed in situations where an auditor knows or should have known that the plaintiff had intentions of using the report for a particular purpose.San Sebastian Pty v The Minister provided opportunity for additional tests of reliance. It held that a duty of care is owed by auditors to third parties in cases where “a statement was made to the plaintiff, or a class of persons which included the plaintiff, with the intention of inducing them to act in reliance thereon” (Harlow 1995). The case R Lowe LippmanFigdor andFranck v AGC (Advances) Ltdsupports this view, and the auditors got a favourable ruling from the courts in limiting the scope of liability.
Donoghue v Stevenson AC 562
This case is considered the cornerstone of the tort of negligence and formed the basis of the common law duty of care. The ruling in this case widened the scope of a duty of care to cover anyone at risk of being reasonably affected by the acts or omissions of another party. The ‘neighbour principle’ articulated by Lord Atkin put some responsibility on a party to consider how others, even when not linked directly, are likely to be affected by the party’s acts or omissions (Hodgson et al 2007). For many decades, it was the guiding principle in the determination of a duty of care but many situations have come up in the courts that required significant alternatives and exceptions.
Current law differs in principle with the provisions of Donoghue v Stevenson in several ways. For example, the principle of proximity is now considered alongside the neighbor principle when it comes to determination of a duty of care. The House of Lords reaffirmed this ruling in the case of Sutradhar v Natural Environmental Research Council (2006). Judges find themselves having to depart from a strict application of the neighbor principle due to moral and practical considerations (Lunney and Oliphant 2003p.149).
I agree with the current law on cases of negligence of auditors for several reasons. First, there is a need to protect professionals whose line of work makes them susceptible to negligence claims. Auditors would find it difficult to practice their profession if they were left liable to all manner of suits from parties aggrieved by their clients. This also reduces the incidences of opportunism, or companies just looking to sue any to help them recover from financial losses they have suffered. Secondly, the defense of contributory negligence ensures that directors of collapsed companies bear their share of responsibility related to losses suffered by their company. This also reduces the penalty to be suffered by the auditors in terms of damages compensation to the plaintiff as the amount will be shared proportionately as determined by the courts. The issue of duty of care cannot be determined by the neighbor principle in all cases, but also requires the consideration of other relevant factors. These include the relationship between the parties, and how just the decision would be under the circumstances. It is good that judges are given the powers to make determinations based on their assessments of each particular case (Mitchell et al 2010).
Harlow, C. (1995). Understanding tort law. London, Fontana Press.
Hodgson, J., Lewthwaite, J., & Lewthwaite, J. (2007). Tort law textbook. Oxford [England], Oxford University Press.
Lunney, M., & Oliphant, K. (2003). Tort law: text and materials. Oxford, Oxford University Press.
Mitchell, C., & Mitchell, P. (2010). Landmark cases in the law of tort. Oxford, Hart Pub.
Pacini, C., Hillison, W., Alagiah, R., & Gunz, S. (2002). Commonwealth Convergence Toward a Narrower Scope of Auditor Liability to Third Parties for Negligent Misstatements. Abacus. 38, 425-464.
Siliciano, J. A. (1997). Trends in independent auditor liability: The emergence of a sane consensus? Journal of Accounting and Public Policy. 16, 339-353.