Auditor Liability: To Whom

Accountant's liability should not be extended to third parties: it can only arise as the result of a contractual relationship.

A duty of care is owed to third parties in circumstances where it can be reasonabley forseen that failure to take care mare result in physical injury.

Not duty of care is owed to third parties in the case of financial loss. Lord Denning's dissenting opinion set the precedent for a 'special relationship.'

A duty of care of care is owed to third parties for financial loss - where it can be shown that a 'special relationship' exists, i.e. where the auditor knows, or ought to know, that someone is going to rely on those accounts for some specific purpose.

For a special relationship to exist, the person giving the financial advice must not only know that someone is relying on his/her advice, but he/she mihgt be giving it in his/her profressional capacity.

Introduced the concept of 'within the reasonable contemplation' of the person giving the advice, in place of 'knowledge' that someone will rely on the adice and replaced 'special relationship' with a 'relationship of proximity or neighbourhood' thus extending the third parties to whome a duty of care arises.

Established that a duty of care is owed by auditors who could reasonably forsee that persons will rely on the audited financial statements for a particular type of investment decision. The Hedley Bryne principle of knowledge or reliance was extended to a test of reasonable forseeability.

Woolf J's jusdement seems to extend the Scott Group case from circumstances in which a takeover is reasonably forseeable to those in which any form of financial support appears likely to be needed (and reliance on audited financial statements could be expected), and limit it to those who can prive they relied on the audited accounts.

Caparo purchased a controlling interest in Fidelity, relying on the audited financial statements which reported a profit when Caparo felt it should have found a loss. Appealled to the House of Lords and held that auditors were liable to neither potential nor individual shareholders among others. They considered:
1. Should the auditors reasonably have forseen that economic loss would result from any failure to perform the audit with due care?
2. Was the relationship between Caparo and the auditors sufficiently close and direct to establish knowledge of Caparo as a person or member of a limited class of persons who would be likely to reply upon their report?
3. Would the imposition of liability or economic loss be fair, reasonable and just in the specific circumstances of the case?
This decision disapproved of the NZ decision is Scott Group v McFarane.

A NZ Case in which three justices held that forseeability of loss is one factor in deciding whether a duty of care by a professional exists, to be balance by policy consideration and other factors. For NZ auditors, this implied that they could not rely upon the ruling in Caparo to identify to whom the auditor owes a duty of care.

Lord Phillips rules that 'it is difficult to see howthe law can...hold an auditor liable when the entire shareholder body and...management is embodied in a single individual who knows everything' Minority view by Lord Mance: 'It is obvious...that an auditor cannot...defeat a claim for breach of duty for failing to detect managerial fraud...by attributing to the company the very fruad whih the auditorshould have detected.'

Twomax acquired a controlling intrest in a knitting company that the others had audied. They outlined they had relied on the audit opinion. There were various mistakes in the audited financial statements. Lord Steward relied on the Jeb case and decided that, although the auditors were not aware of the specific intention of the plaintiffs, they were aware of the fact that the knitting company needed capital. this made the situation forseeable and he awarded against the auditors.