Liability of an auditor to third parties:
So far we were discussing the liability of an auditor to the company, now we shift to another vital question as to how far he is liable to those who are creditors, bankers, lenders, debenture holders and other persons or institutions having dealings with the company but are outsiders.
If they suffer any loss by relying on the Balance Sheet or other Statement or Documents signed by him, can he be held liable for damages so caused to any of them?
ADVERTISEMENTS:
The answer is obviously, ‘No’. An auditor is never appointed by the third party and as such, he has nothing to do with such a party. There is virtually no contract between the auditor and the third party.
“The auditor owes no duty of care to anybody but his client and he cannot be held responsible for any loss suffered by third parties though negligence may be proved.” –
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Candler vs. Crane, Christmas & Co. (1951):
ADVERTISEMENTS:
According to the judgement given in the case of Le Livre & Dannes vs. Gould (1893) it becomes clear that the Court cannot hold an expert responsible for negligence unless a fraud is established against him.
It should first be proved that:
(i) The statement signed by him was untrue in fact;
(ii) The person making it knows that it was untrue or was recklessly and consciously ignorant whether it was true or not;
ADVERTISEMENTS:
(iii) The statement was made intentionally for the plaintiff to act upon it; and
(iv) The plaintiff acted in reliance to it and suffered damages.
Thus, only in case of fraud in the court of Law against an auditor, he can be held liable for damages. Whatever the case, he should exercise reasonable skill, care and tact.
Briefly, it can be stated that an auditor owes no duty towards third parties. He is liable only when he has knowingly committed some fraud and due to this, they are put to some damages.
Under the Hedley Byrne case, it was indicated that actions for professional negligence may arise if financial loss is suffered by third parties.
However, the legal position in India on the issue of the liability of an auditor to third parties has changed under section 63(1) of the Companies Act, 1956 subject to the conditions as laid down under sub section (2) of the said Act.
Under the circumstances, an auditor can be held liable for the damages to a third party if the auditor had authorised the issue of such a prospectus which contains misleading statement. The situation was different prior to the introduction of the Companies Act, 1956.
Conclusion:
It would be needless to repeat and reproduce the decisions given above but it can be laid down here that there are no universal and firm norms or principles on the basis of which the liability of an auditor to third parties can be in particular defined and established.
Circumstances differ, the regulations of Articles of Association vary and more so, the terms of contract between an auditor and his client vary widely. Hence, it does not seem feasible to lay down uniform laws and rules in this regard.
However, to make an auditor liable for the loss suffered by any third party by relying on his report and taking action thereafter, some principles normally accepted can be enunciated and they are:
(i) It is proved that the auditor showed negligence in his duty and as a result, the third party suffered a loss, and/or
(ii) His report is fraudulent.
Thus, some liability may arise when the auditor performs his duty knowing that his work would be relied upon by some third party which may suffer financial loss as a result thereof.
But it has always to be remembered that an auditor must be honest. He must exercise reasonable care, caution and skill. Unless he is fully satisfied, he must not certify as correct the Profit and Loss Account or Balance Sheet or any other Statement.
What amount of care and skill will be reasonable will depend upon the circumstances of an individual case.
It is certain that if the negligence is proved in the Court and the company is put to a loss as an effect thereof, he will be liable for damages.
He must be honest and submit his report after scrutiny of accounts in a free and frank way. This is all that he can do.