A Brief Account – a synopsis of our annual round up

Auditors

Corporate insolvencies have been on the rise which have triggered claims against auditors and heightened scrutiny by the Financial Reporting Council and the ICAEW.

The FRC’s annual enforcement review highlights the significant rise in sanctions against audit firms and in particular arising out of failures to exercise proper professional scepticism and insufficient audit evidence. A claim against the auditor can be an easy opportunity to claw back lost funds if negligent conduct or fraud can be established. Auditors won’t escape if they have “assumed a responsibility” even if no direct duty was owed to those who have lost out. So, what’s to be done? 

Moves are afoot to address greater accountability for big businesses and the dominance of the "Big 4". These include Government plans to overhaul the audit sector and replacing the FRC, and setting up a new regulator, the Audit Reporting and Governance Authority (ARGA) with increased enforcement powers. This is likely to come into effect in 2024. There are high hopes that the ARGA will shake up the audit industry to drive change for the better and try to reverse the criticisms and bad press surrounding the world over audit in recent years. In fact since our webinar, the FRC announced last month a minimum standard for audit committees on companies within the FTSE 350. This guidance is focussed on improving standards around the appointment and oversight of external auditors.

Insolvency Practitioners “IPs”

Claims against IPs have been slowly on the rise largely driven by the economic downturn. However, claimants face significant hurdles in making out claims given the nature of an IP’s appointment.

Whilst IPs accept appointments personally, they typically have wide statutory and contractual authority to make decisions which insulates them from claims.  

Most claims we see are against administrators. They are officers of the court and bound by one of three statutory objectives:

1. To rescue the company as a going concern
2. Achieve a better result for the company’s creditors as whole than if the company was wound up
3. Realise some/all of the company’s property to make a distribution to one or more secured or preferential creditors

Administrators don’t face personal risks, but they do owe fiduciary duties to a business which include loyalty, honesty, impartiality and good faith. Integrity lies firmly on their shoulders and is continually scrutinised. They are agents of the Company, whereas the liquidator’s duty is simply to collect and realise assets, distributing proceeds to the creditors.

Helpfully, courts are reluctant to interfere with commercial decisions taken by IP’s. The case of Re Edengate Homes (Butley Hall) Limited (in liquidation) [2022] EWCA Civ 626 is a good illustration. In that case, the liquidator’s decision to assign substantial claims to a litigation funder was accepted as reasonable given the absence of evidence to the contrary.

Equally, in Nicholson V Hardy [2021] EWHC 1311 (Ch), a creditor challenged the liquidator’s conclusion on advice that the claims the company had were not worth pursuing. They sought an order for the liquidator to contribute to the assets of the company, but the claim was struck out. The court found in favour of the liquidator who owed no duty to share the legal advice obtained and no obligation to pursue claims without funds to do so. A useful outcome for insurers? Indeed so, as any advice secured by the liquidator does not have to be disclosed to others.  

Finally, the case of Absolute Living Developments is a helpful reminder of the defence arguments to raise where it is alleged assets have been sold at an undervalue. Here, the creditors claim for injunctive relief was rejected. The court also concluded that unless the contrary were illustrated, a liquidator is presumed to be acting professionally, honestly and competently. 

The key takeaway for Ips and their PI insurers is to ensure that they are taking advice in good time. Equally, when they have an important decision to make, to be mindful that they can always explain with conviction the rationale for their decisions.

Policy Coverage and Disciplinary Themes

Cover for accountants is often referred to as “gold plated” and, it is. Strict terms limit insurers’ rights to decline. There are stipulations for firms around the level of cover (usually £1.5 million) and a provision for defence costs on top, rather than inclusive of an excess. Any firm with under 50 principles must obtain cover in accordance with the minimum terms.

However, these policies come at a cost. Smaller firms may find themselves unable to renew, within the Assigned Risk Pool at high cost or seeking a dispensation from the ICAEW for a non-compliant policy. Larger firms with a smaller number of principles might equally face very high premiums. This is especially relevant for new firms formed from ‘top 20’ firms who source cover on different terms.

The ICAEW is carrying out a review of the minimum terms of cover and stress testing their fitness for purpose, so watch this space over the next few years.  

Disciplinary Themes

Increasingly, there are a number of complaints to ICAEW which mirror the civil claim made. While the costs of legal representation are not always covered (certainly not under the MTC), insurers will sometimes fund the disciplinary investigation to ensure consistency.

Given the recent events involving the Big “4” accountancy firms, which have involved a relentless series of audit prosecutions, this will undoubtedly increase the beady eye approach by the FRC and ICAEW. We anticipate they will be monitoring audit work carried out by a wider range of firms generally as a result.

The ICAEW quality assurance department found last year a quarter of their 1,000 sampled audits were inadequate and we suspect mistakes and errors will likely be picked up more regularly by QAD. We anticipate a rise in cases in the short term and more civil claims, especially if there is a deeper economic downturn, in the longer term. However, the hope is for a much greater increase in standards of audit overall.

In Summary

Given the huge public focus on auditors and economic downturn we predict a growing number of claims against IP’s and auditors. Accountants and IP’s can expect greater scrutiny, together with disciplinary investigations running parallel to civil claims. We await with interest the impact of ARGA and the outcome of any proposed changes to the MTC.