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Clause 551 provides a reasonableness test against which to judge an agreement. Clause 552 provides that
the Secretary of State could introduce regulations that require disclosure of an agreement in the annual accounts or the directors report. Will the Minister tell the House whether the Government intend to introduce such disclosure regulations and, if so, when she expects them to come into force?
Mr. Austin Mitchell: Does not any limitation of liabilitywhether introduced by agreement, a cap or some other meansstrengthen the big four against the smaller accountancy businesses that the hon. Lady and I want to protect and encourage?
Justine Greening: That is an interesting point. Companies can engage whichever audit firms they choose. If a company felt that its accountant was pressing for a limited liability agreement that was excessively limited, that could result in the audit business being made more competitive. There are clearly only so many firms that are in a position to audit multinational companies, but I do not think that this agreement will change that. If anything, it could open the door to some medium-sized companies, to allow them to compete in relation to the agreement that they put in place.
It would be helpful if the Minister could provide the background to Government amendment No. 648. When I read the existing clause, I felt that it was adequate as it stood. The Government are proposing a change to ordinary resolutions, and it would be helpful if she could clarify the background to this proposal.
We are trying to enforce liability, particularly against the big firms. The auditor has responsibilities and it is not reasonable that liability should be limited in any way. We are saying that there is a principle here that applies in no other fieldthat is, when a product, which is what an audit is, fails or is not fit for use, there should be no redress against the producer of that product. If that applied in relation to baked beans or Coca-Cola, consumer protection legislation would be reduced to farce.
Why should the big fourthe species that we are told is in danger of extinctionhave protection from their own failures, which is effectively limitation of liability? This has a long history, and I have been surprised by some of the concessions made by my Government. I was involved in a Companies Bill in the 1980s, under a Conservative Government. The audit firms came to us to say that they were threatened because they had deep pockets, poor creaturesthe more money they have, the more threatened they feel.
Those companies were exposed to law suits against them, most of which came from other members of the big four. The audit arms were being pursued by the insolvency arms, so it was fairly incestuous, as my hon. Friend the Member for Newcastle upon Tyne, Central pointed out. They came quaking in fear and said, We want our liability limited. How did they want it limiting? They said, We should be able to set up as limited companies, rather than as partnerships.
So the Bill was changed as a result of representations from the chartered institute and the big audit firms. They were given the right to set up as limited companies, but they did not use it, because they had moved on to another stageupping their demands. They produced a demand for limited liability partnerships, but the Conservative Government wisely refused to grant it.
Those firms then bought legislation in Jersey and promised the Jersey legislature, which is not a paragon of virtue, that they would provide the legislation, which they did. It cost more than a million quid and was written by the big accountancy firms here. The legislation passed through the States of Jersey, but the promised flock of dark-suited immigrants who would come to Jersey to set up accountancy businesses to benefit from limited liability partnership did not arrive. Nobody came.
Those firms then turned to our Government, who, having told us that there was no time to introduce the independent regulation of accountancy and audit as in the United States, which is the only way forward, decided that there was time to limit liability of partnerships. That came in, over our protests.
The only concession that we gained came about because the Minister was desperate to go to Norway that particular night. If we had continued to talk here, his journey would have been threatened, so he gave us the concession that the proposal would not come into force immediately and that there would be consideration of the exact effects. We achieved a minor victory, but here we are again.
The argument is specious. We are, effectively, providing limitation of liability, but the amendments would stop either any such agreement or any form of cap. Those big, secretive firms have never produced evidence that there is a huge threat against them or that huge damages would be awarded against them. Only two cases from the 1960s to the 1980s were cited earlier, as I recall, and in the 1990s the big four auditing firms were spending just 2.6 per cent. of their income to meet liability costs. What I have to spend on insurancehouse, car and personalamounts to far more than 2.6 per cent.
Stephen Hesford: I am following with care my hon. Friends argument. In dealing with the big four, however, is it not clear that there is a lack of ability to prosecute a case against them? Whether liability is limited is not therefore the issue; the issue is whether we can get to them in the first place. Therefore the point that he makes is not really the one that he should be making.
Mr. Mitchell: That is correct, and the reluctance of even big City law firms to embark on a case against the big four has been pointed out. They do, however, embark on cases against each other. When there is a question of making the auditor liable, the case is usually brought by the insolvency arm of another of the big four. They are fairly adept at taking action against each other, which is what they fear. They want limitation of liability to protect them from each other.
All the precedents indicate that such limitation is dangerous. In 1986, the Law Commission said that a cap on auditor liability or proportional liability were against the public interest. The Office of Fair Trading also rejected the idea. Section 137 of the Companies Act 1989, which I mentioned earlier, allowed firms to buy insurance to cover their liability should they wish, but no major company has taken advantage of that. When such companies tell us that they would not get insurance, I wonder what kind of business they are running. One can buy insurance against Martians landing on the roof of ones house. How come the big four are so shady that they cannot get insurance? The crisis of huge cases pending against the big four, threatening to end the existence of any one of them, is entirely spurious.
It is clear that Enron, WorldCom, Xerox, Tyco, Adelphia and all the other scandals resulted directly from the limitation of liability in the United States. Joseph Stiglitz, who was an adviser to President Clinton, has said that the US liability laws directly paved the way for auditor negligence and the mega-scandals. If we limit liability, we get scandals. If liability is limited, what will keep auditors up to the mark? What will improve their performance and make sure that they are providing good audits? It seems a crazy principle to adopt.
The president of the Institute of Chartered Accountants of Scotland, which examined failuresour chartered institute does not seem inclined to take on the big four, largely because it is permeated and dominated by them, and they provide the personnel and partners with the time to run the institute and to influence policysaid:
All the failures we looked into would have been found if anyone other than the audit junior had looked at the bank statements.
Big firms are no longer carrying out audits. They audit in helicopters and circle clients from a few thousand feet and take pictures. No one gets out of the helicopter and kicks tyres. Its no longer audit, its more akin to due diligence.
We have supplied evidence to the Department that more than 60 per cent. of the staff carrying out audits admit to falsifying work under the pressure to provide the audit for the level of fees that has been cut to get the audit in the first place. We did not get much reaction from the DTI.
We are against the principle of limiting liability. It seems dangerous and not conducive to good audit. We are anxious to maintain the reputation of the profession, particularly those small and medium-sized audit firms that need to be brought into the market to make it more competitive, but which are excluded by the dominance of the self-perpetuating big four.
I have a great deal of sympathy with what has just been said by the hon. Member for Great Grimsby (Mr. Mitchell). The audit market is a guaranteed market, guaranteed by the state, and companies covered by the obligation must have an audit. There are very few audit firms. If we put the two togethera state basis and an obligation for the market, and a very small number of firmswe have the classic conditions for a monopoly, or in this instance an oligopoly. Members on both sides of the House have
commented on the position of small and, indeed, medium-sized firms trying to break into the market. They are in a very difficult position as a result of the structure created ultimately by the law. The hon. Gentleman mentioned the Law Commissions view, and I share some of its worries. There is a serious risk that the interests of third parties will be affected. I want an assurance from the Government that they do not intend to affect those interests.
What the Bill does looks entirely legitimate on the surface. The members of a company who are most directly interested in its welfare are allowed to contract with the audit firm to limit the audit firms liability. That appears to be a straightforward deal between two parties, and if it were there could be no objection to it: the parties would have worked out their own interests and the price would reflect the risks on both sides. The trouble with audit is that the companys members are not the only people involved.
Two other parties are obviously involved. Onethis classic case takes us back to the Caparo litigation, mentioned by the hon. Member for Newcastle upon Tyne, Central (Jim Cousins)is a takeover bidder or buyer of the business. If the audit firm could limit its liability with the company, a takeover bidder who took over the company could not then use it to obtain recourse against an auditor who had acted badly, because the company would still have limited rights against the auditor. The only recourse would be for the takeover bidder to act in his personal capacity, or the capacity of another company.
A similar case is that of creditors. Many of the examples given so far have involved insolvency. If an audit has resulted in a companys being worth much less than people thought it was worth and creditors find that they cannot get their money back, their problem will be that the liquidator or administrator is technically acting on behalf of the company. The rights of the creditors are therefore through the company, and the company has limited its recourse to the audit firm. The creditors will suffer because of an agreement made previously by someone else, namely, the shareholders. The shareholders agreement has an impact beyond their own interests.
There is obviously the possibility of creditors trying to obtain recourse outside the remit of the company, in their own right. That brings us to the crucial questiondo the Government intend limited liability agreements to affect the rights, such as they are, of third parties? Let me put it technically: do the Government intend to change the law of tort, or just to change the law of contract? It has to be saidthe hon. Member for Newcastle upon Tyne, Central mentioned thisthat even in the law of negligence, or tort, the rights of outsiders are limited. The Caparo case was followed by a series of other cases that make it very difficult for people to win in those circumstances, but it is not impossible. In the Morgan Crucible case, the plaintiffs won because the court thought that, given the special circumstances and the fact that specific extra representations had been made to the auditors, the audit firm was bound by those extra representations over and above the normal audit to the person who ended up losing outso it is possible. I want to hear
from the Government that their intention is not to rule out that possibility indirectly through the ability of auditors to limit their liability in contract to the company.
Vera Baird: As before with the modest quip made by my hon. Friend the Member for Great Grimsby (Mr. Mitchell) about Iraq, I shall not allow his rhetorical flow, whether it be about dark-suited accountants or escaping early doors to Norway, to move me away from the focus of the amendments. I shall go through them one at a time as speedily as I realistically can.
I sympathise strongly with the concerns expressed by my hon. Friends the Members for Newcastle upon Tyne, Central (Jim Cousins) and for Great Grimsby, but I hope to persuade them that we have here an appropriate balance. Their amendments Nos. 751 and 752 would delete the clauses that enable the auditor and the company to agree a limitation to the auditors liability, so the Bill would just reflect the current position that any attempt to do that is void and unenforceable. Their alternative route is, through new clause 86 and amendment No. 802, to extend the publicity given to liability limitation agreements. New clause 86 would do so by requiring proposals to be sent to shareholders of private companies, who would resolve to waive the need for authorisation, and to debenture holders as well as shareholders of all companies. Amendment No. 802 would require agreements and associated correspondence to be filed at Companies House. Amendment No. 763 would prevent liability limitation agreements being made that specified a monetary limita cap, as my hon. Friend the Member for Newcastle upon Tyne, Central put it.
Amendment No. 802 would modify one of the issues to which a court should have regard in considering whether a liability limitation agreement was fair and reasonable. Instead of looking at the auditors responsibilities under part 17, which is the audit part, it would look at the auditors responsibilities under the entire Bill. Let me deal with that one first. The amendment would have no effect because all of the responsibilities owed by the auditor of the company that could give rise to a claim by the company are in part 17.
Government amendment No. 648 removes subsection 550(4), which specified that members were to authorise a liability limitation agreement by ordinary resolution. The hon. Member for Putney (Justine Greening) asked me to say what the point of that was. It is just that the subsection is unnecessary because that is the effect of saying in clause 550(2) that the authorisation is to be by the company passing a resolution.
Let me go through how we deal with the points raised. The hon. Member for Cambridge (David Howarth) asked us to give an assurance that third parties were not affected. Yes, but as the hon. Gentleman has observed, third parties will seldom have a claim. However, if creditors can get recourse outside there is nothing in this change that ought to affect their ability to do so. It certainly is not our intention that that should be so.
The agreements will limit an auditors liability only if the company agrees to the limitation in the contract and it is authorised by the explicit decision of the shareholders or, in the case of a private company, the shareholders resolve to waive the need for approval. The Governments approach to the request made by my hon. Friend the Member for Newcastle upon Tyne, Central about regulation is that the safeguard is that there must be a shareholder resolution.
There is, of course, much more to be said. After the event, a court can decide, whatever the agreement was, that the limited amount payable by the auditor is not fair and reasonable and, if necessary, it is open to the court to impose a much higher amount, if that is called for. Those provisions were extensively debated in the other place, where there was widespread cross-party support for the policy approach and useful clarification of the drafting took place.
To put the point moderately, my hon. Friends have arguedI hope that I do justice to their argumentsthat the changes will reduce the incentive on auditors to do a good quality job. Let me reiterate that under the new provisions, auditors will not be able to exclude their liability altogether and it will always be open to the court to decide that the limitation is not fair and not reasonable and to impose a higher amount as it thinks fit. Civil liability, of course, is only one of the external incentives on auditors to do a good professional job. If they fall short, a range of disciplinary procedures are available and, although we do not want to go back there, we have just introduced a new offence for anyone who knowingly or recklessly causes an audit report to be misleading, false or deceptive.
Amendment No. 763, which prevents companies from agreeing a fixed sum as the limit of their auditors liability, amounts to the same argument. Any attempt to limit the liability to a specific financial amount will not be effective if the court decides that a larger amount is fair and reasonable and that the capped amount is not. There is also a power in clause 549(2) under which regulations could prevent limitation by fixed monetary amounts if, against our expectations, there proves to be a case for doing so in the light of experience.
New clause 86 and amendment No. 802 deal with the publicity given to liability limitation agreements. As the provisions are drafted, the company will have to write to its members to receive authorisation, except where members of a private company have decided to waive the need for approval, and the company will have to disclose its agreements under clause 552. The details of disclosure are to be fixed by regulations, on which, to respond to a question posed by the hon. Member for Putney, we will consult.
Mr. Douglas Hogg (Sleaford and North Hykeham) (Con): I am listening to the hon. and learned Lady, but can she help us with the claims of depositors with respect to banks? If a bank goes bust and the auditor should have picked up the fact that money was being filched by bank employees, but does not, what happens to the depositors? Does a liability limitation agreement pre-empt or prevent the depositor from being able to maintain a claim against the auditor?
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