Page 233 - DCOM204_AUDITING_THEORY

Unit 11: Appointment, Right, Duties and Liabilities of an Auditor

accepted without making probes and inquiries into the matter in great detail. The report must Notes
reflect the fact that they were suspicious of the functioning of the company and were given
explanations which were either satisfactory or not for them.
The Cannons of Foreseeability and Proximity

The law in relation to the auditor’s duty of care and the liability for negligent misstatement by
auditors has been subject of comprehensive analysis in England, in the case Caparo Industries Plc
v. Dickman. The court held that the auditors owe a duty of care to the members but not to
potential investors in the company. They owe a duty of care to the members because they are
under a statutory obligation to report to them and because the members have a corresponding
statutory entitlement to receive such a report. The Auditors have no duty of care to the lenders
and creditors of the company. This is an extension of the same logic which makes them liable to
members. The case has laid down the following propositions as regards the auditor’s duty of
care and liability: In cases of negligent misstatement, foreseeability that the plaintiff or someone
in a similar position will rely upon the statement is a necessary but not sufficient condition for
liability. In addition, it is necessary to establish a nexus or relationship between the parties
sufficient to create a duty of care. That relationship can only be determined by a close analysis in
each case. The label applied to such a relationship is ‘proximity’, but there is no single definitive
test. In some cases, it may be useful to consider whether there has been a voluntary assumption
of responsibility in the others, whether the relationship is ‘equivalent to contract’. The necessary
relationship exists between the auditors and the members because there is a statutory duty to
send reports to the later by the former and a corresponding entitlement of the members to
receive such a report. The relationship may also exist if the circumstances are such that the
auditors can be taken implied to have represented the accuracy of the accounts to the plaintiff,
and perhaps whenever they provide the accounts to the company with the intention, or in
knowledge that it is the company’s intention, that they are to be supplied to the plaintiff or to
persons in a class of which the plaintiff is one. It is not necessary that the auditors should have
any particular transaction in contemplation, or should intend the recipient of their report to rely
upon it in any such transaction. If the necessary relationship exists, it is enough if it is foreseeable
that the recipient of the report may rely upon it in some future transaction, whether contemplated
by the auditors or not, and whether with reference to his existing shareholding or not. The
necessary relationship does not exist between a company’s auditors and potential investors who
are not existing shareholders in the company. The fact that it is foreseeable that their report may
come into their hands and be relied upon by them is not sufficient in itself to create a relationship.

Did u know? In order to establish the existence of duty of care owed to the plaintiff, who
claims damages, by auditor who is alleged to have made a negligent misstatement, three
requirements must be satisfied. These are: (i) It must be reasonably foreseeable by the
defendant that the statement will be relied on by the plaintiff; (ii) There must exist the
relevant degree of proximity between the parties; and (iii) It must be just and reasonable
in all circumstances to impose a duty of care on part of the defendant to the plaintiff. This
however, leads us into the issue of liability to third parties.

Liability to Third Parties

There was formerly the prevailing view that there is no liability for negligent misrepresentation
made by one person to another who had relied upon it to his detriment, in the absence of any
contractual or fiduciary relationship between the parties or the fraud. This position was overruled
in Hedley Byrne & Co. v. Heller & Partners where it was held that in certain circumstances contractual

LOVELY PROFESSIONAL UNIVERSITY 227