Select Committee on Treasury Appendices to the Minutes of Evidence

Annex D

Restriction of Liability in Contracts for Public Sector Auditing and Other Financial Assignments—Background Information

[NB: this is the annex to the letter to PFOs 6 dated May 1997]


  1.  By way of background, departments and bodies should be aware that the question of restricting liability was raised in Parliamentary questions in 1987 and 1988. The answers were, respectively, that "a contractor may be held responsible without limit for costs arising from any default which would otherwise fall on the public purse as a result of his action" and "under the standard conditions used in departmental contracts, a contractor may have unlimited liability for any costs arising from a default by him". The use of "may" in these answers gives a degree of flexibility and, although the model form of contract set out in CUP Guidance No 23 advises departments that the conditions should reflect the practice of requiring contractors to accept unlimited liability, it accepts that there might be circumstances where it might be considered advisable to limit liability.


  2.  For most categories of work undertaken by accountancy firms, departments or bodies are not prevented from negotiating with the firms over any proposal by them to restrict or cap their liability so long as the eventual outcome represents the best value for money and takes into account the wider interests of the department and taxpayers. "Value for money" will in all probability mean a substantially lower price, but the firm may offer some other benefits such as greater use of more experienced staff, or indicate a willingness to complete the contract in less time. The department will also need to assess the likely consequences of any loss suffered by a firm's negligence; the effect of the terms of any restriction of liability (are there overall financial limits or are certain risks excluded altogether irrespective of the degree of financial loss); and the level of professional indemnity insurance held by the firm. If a department is satisfied that there are value for money benefits in agreeing to a firm restricting its liability, it may negotiate with the firm on the terms of such restrictions.

Specific points

  3.  It is likely that most work undertaken by accountancy firms for departments and other central government bodies will fall into one of four categories—external audit work, internal audit work, consultancy and "due diligence". If a particular assignment falls outside these categories, or it is difficult to apply the general conclusions described above, departments should consult the Central Accountancy Team in the Treasury.

External audit

  4.  Section 310 of the Companies Act 1985 prohibits any capping of an auditor's liability in respect of extenal audit opinions given under the Act. Most entities within central government are not companies formed and registered under the the Companies Act (the exceptions include a small number of non-departmental public bodies and nationalised industries) and this particular provision of the Act will have only limited application. In theory, firms would be free to negotiate the terms of any assignment for the annual audit of most central bodies but, in practice, the Treasury considers it appropriate to apply the spirit of the Companies Act. Departments should not agree to any attempt by a firm to restrict its liability in the case of external audit work, ie the annual "certification" audit of the accounts.

  5.  The representatives of the Public Sector Limitation of Liability Working Group indicated that it was unlikely that any of the major firms would, in practice, seek to restrict their liability in the case of external audit work for unincorporated bodies within central government.

Internal audit

  6.  In cases where the whole of the internal audit function is contracted out to an accountancy firm, the nominated head of internal audit will be responsible for providing an assurance to the accounting officer on the internal control system. Although departments or bodies are not prevented from negotiating with firms over the terms of any restriction on their liability in the case of internal audit assignments, it seems unlikely that the interests of the department or the taxpayers in general would be best served by agreeing to any restrictions in these circumstances. Firms will need to produce very convincing evidence that accepting restrictions on their liability represents good value for money in view of the significance to the department or body of the assurances given on the internal control system and the potential for loss should the firm prove negligent.

  7.  However, there will be assignments in which the accountancy firm has no direct responsibility for providing the assurance on the internal control system—examples might include support to a Head of Internal Audit or provision of advice to an in-house audit team. The risk of potential losses in these circumstances is likely to be lower and there is a stronger case for accepting a restriction on liability—subject to the overriding considerations of value for money and safeguarding the interests of the department and the taxpayer in general.

  8.  In the case of assignments for internal audit work, departments are not prevented fron negotiating with firms on the terms of any clauses which restrict the firm's liability. However, the wider considerations of value for money must be taken into consideration and, in cases where the firm is responsible for providing assurances on the internal control system, it seems unlikely that the wider interests of the department and the taxpayer will be satisfied if restrictions are accepted.


  9.  Similar considerations to those described above apply also to consultancy work—which include advice from firms on privatisations and contracts under the Private Finance Initiative, and financial advisory work in general. Departments are not prevented from negotiating with a firm of accountants which wishes to include provisions which restrict its liabilities. Departments must be satisfied that there are value for money benefits and that the position of the department is safeguarded. In the case of some consultancy assignments, eg the design and implementation of computer systems, the risk of loss through negligence might be high and firms must put up a very strong case to justify the value for money aspects resulting from acceptance of a restriction of liability.

"Due diligence"

  10.  As due diligence work is involved with the investigation of companies usually on behalf of the providers of equity or debt finance, it seems unlikely that departments or central government bodies would be seeking to appoint firms for such assignments. The firms are making a concerted effort to introduce a standard contract for due diligence work which includes clauses which restrict their liability. A department tendering for due diligence work is not prevented from negotiating with firms over proposals to restrict their liability, but must take into account the wider interests of the department and the taxpayer in general, and be satisfied that the terms represent the best value for money. Although each case must be considered on its merits, it is thought unlikely that these wider interests would be served by agreeing to restrictions on liability.

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