Liability of auditors to third parties

NotesCBE

Third parties and negligence

If the auditors have been negligent, it is possible that a third party may also have a claim against the auditors even though they do not have a contract with them.

Third party negligence claims

The three requirements for a third party negligence claim are the same as they are for the company:

  1. Duty of care
    There existed a duty of care enforceable at law. (This may not be the case without a contract.)

    Judges do not consider that auditors owe third parties a duty of care. It is only in exceptional circumstances that such a duty arises.

    The exceptional circumstances which judges have referred to are when an auditor knows that a third party is relying on the audited financial statements.

  2. Negligence
    In a situation where a duty of care existed, the auditors were negligent in the performance of that duty, judged by the accepted professional standards of the day.

  3. Damages
    The client has suffered some monetary loss as a direct consequence of the negligence on the part of the auditors.

An illustration

If a director tells the auditor that the bank will rely on the audited financial statements, or if someone says to the auditor that she will purchase new shares on the strength of the audited financial statements.

The auditor is entitled to try to disclaim liability to those people, for example, by writing to them and stating that the audit report is only for the purposes of the shareholders and that they do not admit legal liability to anyone else. 

If the third party tried to bring a negligence claim, a judge would have to determine whether such a letter had legal effect.

NotesCBE