Recent years have witnessed increasing academic and professional debate over the equitable nature of auditor liability and the potential risk that a successful lawsuit against the auditor could serve to bring down one of the major audit firms. As a result, Regulators in the European Union and Australia have enacted legislation limiting auditors’ liability in order to ensure the viability of the audit market. The question arises as to whether these significant changes to the legal systems in the European Union and Australia would be deemed appropriate for implementation in South Africa. Austria, Germany, Greece, Belgium, Slovenia and Australia have audit liability caps. Legislation whereby an agreement could be agreed upon between the company and the auditor has been introduced in the United Kingdom. In respect of the United Kingdom, Austria, Germany, Greece, Belgium and Slovenia, there is legislation limiting the liability of the auditor.
The South African government needs to amend legislation as a matter of urgency. The first area deals with the Limited Liability Partnership (LLP) and the second deals with the Limited Liability Agreement (LLA).
Limited Liability Partnership (LLP)
Section 19 (3) of the Companies Act 71 of 2008 has the impact of ensuring that audit firms and auditors in South Africa operate as unlimited liability companies in which all assets of the auditing firm, as well as personal assets of the partners/proprietor, are at risk if the firm were found to be liable in a court of law. ln respect of a partnership this has the effect that a “rogue” auditor can bring down not only an entire firm but an entire firm network, as innocent partners are held accountable for the actions of guilty colleagues.
There is no valid reason to ignore this fact and require auditors to practice in a form mandating unlimited liability. The denial of limited liability for auditors puts them at a competitive disadvantage against other sectors in the business world, by inhibiting their ability to raise capital and protect their assets. Furthermore, by denying a liability cap, auditors are required to answer for the sins of their peers and accept the business risks of their clients. Company directors and shareholders are not personally liable for the negligence of their employees. Shareholders of a company that is not a personal liability company have limited liability. Why are auditors singled out merely because they provide a service rather than a product? This question cuts to the essence of the issue of unlimited joint and several professional liability. The personal nature of offering services should not prevent professionals from limiting their liability for negligent acts. South African law and policy makers have either ignored or denied the interests of professionals in protecting their personal assets from seizure because of someone else’s negligence.
“The limited liability company is a necessary vehicle for returning to a level of sanity regarding the legal status of professionals in our society. To deny these individuals the legal protection they deserve is unfair, inefficient, and irresponsible.”
Therefore it is recommended that the Section 19 (3) of the Companies Act 71 of 2008 be removed. This is not based solely on what has transpired internationally, but has as its root the principle of equity, a term espoused by the Constitution of South Africa.
Limited Liability Agreement (LLA)
By introducing LLAs into the South African legal system, it would have the effect of overturning a fundamental principle of company law enshrined in successive companies’ legislation for almost eighty four years, which precluded a company from relieving the auditor from liability for these Preaches of duty.
Where a person is appointed as auditor by the company itself, the relationship between the company and the auditor will be one of contract. As the relationship between the registered auditor and the company is one of contract; this relationship should not be limited to the legal duties and responsibilities of the auditor, but must also include the liability of the auditor. Company law in South Africa should permit LLAs between the company and its auditors. The only piece of legislation preventing the LLA is S 46 (8) of the Auditing Profession Act 26 of 2005. Section 46 (8) could well be perceived to be not aligned with the Constitution of South Africa.
The real utility of the LLA regime is the contractual freedom it grants audit firms and companies to evaluate and allocate commercial risk in performance of the statutory audit. Clear and precise LLAs provide the audit firm with valuable protection against large scale damages claims, which could lead to its dissolution or exit from the market for audit services, or inflict serious commercial damage on it. The general principle is that an LLA should only be properly authorised if shareholder assent to its principal terms has been obtained and that consent has not been withdrawn.
The duration of an LLA should be fixed at one financial year and would require annual renewal. Transparency is achieved by the requirement for LLA principal terms to be included as a note attached to the company’s annual financial statements or in the directors’ report. Section 46 (8) of the Auditing Profession Act 26 of 2005 must be amended to allow for the LLA and permit the courts to determine whether this sort agreement is contrary to public policy and not enforceable. This recommendation is based on the principle that LLAs can only limit liability to what is fair and reasonable. What is fair and reasonable must left up to the courts to decide.
Conclusion
South Africa is ranked above all other countries in the world when it comes to its audit quality regime, and is therefore more than ready to embrace the LLP and the LLA. A striking feature of regulatory systems is that existing regulations can tend to be more willingly accepted than proposed new regulations – the latter being seen as too controversial, risky, one sided and applicable only in certain circumstances or generally just unproven. It is forgotten that this was just how the regulations in place today were probably once viewed (when initially proposed) and yet they somehow managed to make it onto the statute book or the official regulatory code.
Finally, it could be argued that, as a subject, both auditing and regulation need to break free in South Africa from what can be quite conservative shackles. The main objective of this exploratory study was to learn from the difference and to consider new ideas and approaches. ln this respect, it is important for law makers and regulators in South Africa to understand that the Achilles’ heel of any regulatory system is not likely to be a lack oversight but a lack of foresight.
Reference: Professor Steven Firer CA(SA)