Firms brace for negligence impact

COVID-19 EXPERT LEGAL INSIGHTS

23 November 2020

This article was first published by Accountancy Daily, November 2020.  You can read the article in full by clicking here (subscription required).

Accounting firms should be bracing themselves for a rise in professional negligence claims as a result of the Covid-19 pandemic.

Enforced and prolonged working from home since March has presented a number of challenges. In addition, in times of financial uncertainty and recession there is often a trend towards an increase in negligence claims as clients are more likely to challenge fees and advice and look to blame their advisers if “something goes wrong”.

As a starting point in respect of professional negligence claims, lawyers look at whether the accountant has acted with reasonable skill and care, judged by the standard of a reasonably competent accountant specialising in the field in question. Further they will look at what agreed in the written retainer or engagement letter between the accountant and his/her client. If an accountant also provides a statutory function such as an audit then it is also necessary to look at the statutory and regulatory framework when considering their duties.

We anticipate that Covid-19 related Professional Negligence claims will be seen in a number of areas including the below:

1. Audit 

The difficulties in physically attending a client’s site/office since March has been particularly problematic when it comes to audits. Challenges have included properly checking stock levels against a client’s records and undertaking face to face meetings to discuss issues with clients, through to making decisions on whether a company is a going concern.

The Financial Reporting Council (“FRC”) was alive to these concerns at the start of lockdown in March 2020 commenting that: “Some companies and auditors are also facing practical difficulties in preparing accounts and carrying out audits.  The FRC expects this will affect the way in which audit firms carry out their audit of those companies, given restrictions on travel, meetings and access to company sites in some jurisdictions...”

Further guidance was published by the FRC in April 2020 including a non-exhaustive list of factors that auditors should consider when carrying out an audit during the pandemic and a paper titled “Modifications of Independent Auditor’s Opinions and Reports” which confirmed the need for a modified audit opinion in circumstances where certain procedures cannot be performed as normal.

Both sets of guidance are essential reading for auditors wanting practical solutions to mitigate the risks which may arise carrying out an audit during Covid-19. They may also be helpful in crafting defence arguments relating to any negligence claims.

The FRC also published its end of year letter on 12 November 2020 which “features recommendations on reporting the impact of Covid-19, which will have a pervasive impact on corporate reporting.” Whilst the guidance is aimed at CFOs, CEOs and Audit Committee Chairs it is stated to be useful guidance for all preparers, reviewers and auditors

Some key points arising from the letter: (i) a recommendation that companies carefully consider whether they should lengthen their reporting timetables for 2020 (ii) the provision of disclosures that allow users to understand the impact of events and conditions on a company’s position and financial performance. Such disclosures should, where possible, clearly quantify the impact of Covid-19 on a company’s performance, position, and prospects (iii) the FRC strongly discourages the arbitrary splitting of items between Covid-19 and non-Covid-19 financial statement captions as they consider such allocations are likely to be highly subjective and, therefore, unreliable and (iv) Companies should apply existing accounting policies for exceptional and other similar items consistently to Covid-19-related income and expenditure.

 

2. Tax advice

This is an area where we already frequently see claims against accountants. The key question in determining negligence is whether the tax advice provided fell below the standard of a reasonably competent accountant and such claims can be tricky to defend. It is conceivable that claims could arise out of poor advice connected to the government’s emergency schemes such as the Coronavirus Job Retention Scheme's tax reliefs, business rates relief and VAT deferrals. As a result of the pandemic businesses have necessarily required advice very quickly and in a climate of fast-moving guidance.

Tax accountants wishing to properly protect themselves in respect of negligence claims should ensure that: (i) they have a written contract of engagement with their client which clearly sets out the scope of their work, (ii) they don’t advise on matters on areas outside of their expertise and (iii) that they record all advice in writing (including advice given over the phone).

 

3. Other risk areas

Meeting HMRC and Companies House deadlines has not always been smooth sailing during the pandemic either for reasons of home working or personnel being off work due to the virus. Failures of this nature may also result in negligence claims. These types of claims (i.e. where there is clear breach of duty because of a missed deadline) are often cases where there is no good defence to the alleged negligence and if a loss has been caused by an accountant failing to meet an important deadline then there is likely to be a successful claim in negligence.

Other risk areas are the increased likelihood of documents getting misplaced or lost when accountants take files or papers home. Confidentiality issues may arise from telephone conversations being overhead and personal laptops or computers being used. Data breach goes hand in hand with this. Given clients place considerable trust and confidence in their accountant, the consequences of any potential negligence in this area can be particularly costly and damaging.

The recent case of Watchstone who are suing PWC for c £63 million in respect of allegations that a senior employee leaked confidential information about a client to an investment banker working on a deal highlights how serious (albeit the allegations relate to an intentional leak of information) this issue can be.

We often see claims which could have been avoided had simple procedures been put in place. Accountants should ensure that they minimise risks by working electronically where possible and ensuring confidential papers are kept in the office and stored securely.

 

4. Fraud

The increased opportunity for fraudsters to flourish during the exceptional circumstances of the Covid-19 pandemic has been widely reported and it follows that accountants will no doubt see an increase in negligence claims relating to fraud.

This is most likely to impact auditors given their obligation to “exercise reasonable care” in detecting fraud as part of their duties.

Auditors can follow various steps to protect themselves and to ensure that where possible they are alert to potential fraud. Useful guidance can be found in ISA 240 (the auditor’s responsibilities relating to fraud in an audit of financial statements) in which the guidance confirms: “the auditor shall maintain professional scepticism throughout the audit, recognising the possibility that a material misstatement due to fraud could exist, notwithstanding the auditor’s past experience with the entity about the honesty and integrity of management and those charged with governance.”

If fraud is suspected the auditor should ensure proper procedures are followed including documenting any concerns and discussing this as appropriate at management level.

The FRC recently launched a consultation on the proposed revision of its auditing standard ISA (UK) 240 with the intention of making auditors’ obligations clearer in relation to fraud. When finalised the revised UK standard will be effective for audits of periods commencing on or after 15 December 2021.

 

Conclusion

This article covers just some of the risk areas for accounting firms in respect of Covid related potential negligence claims. Accountants should be aware that in order for a claim to be successful there are a number of hurdles for claimants to overcome including establishing a duty of care exists, establishing that the accountant breached that duty of care and proving that the alleged breach has resulted in a loss and one which was caused by the negligent act or advice (this is commonly referred to as “causation.”).

Each case will be fact specific but in our experience negligence cases often settle early (assuming the claim has any merit) and very rarely go to trial. That is because of the requirement to have professional indemnity insurance to cover such claims and so usually solicitors are engaged at an early stage to consider the merits of any potential claim. Both parties must also follow the Pre-Action Protocol for Professional Negligence which requires the parties to engage at an early stage on the facts of the dispute, potential breaches and losses arising from the claim.

Further information

Further information regarding how our specialist team of litigators act on behalf of individuals and businesses against professionals in cases involving negligent financial advice is available here.

You may also be interested in our Professional Negligence podcast series, which is available here.

 

About the author

Jemma Brimblecombe is a Senior Associate in our Dispute Resolution team. Jemma's specific areas of expertise include dealing with claims against professionals including solicitors, barristers, accountants and surveyors.

 

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