If under the Law of Agency. Thus,
If the auditor performs his duties according to the instructions and accounts as correct and reports accordingly. Naturally, the money-lenders of the business believe the accounts as certified by him to be true and correct. If there is any mistake or irregularity left in the financial records, they hold the auditor liable.
The auditor is not liable unless a clear charge of negligence against him is proved in the Court of Law and the business subsequently suffers a loss. It does not mean that he should not perform his duties skillfully and carefully.
He must exercise reasonable care, skill and prudence in all circumstances without exception. He does have a moral responsibility towards outsiders and hence, he should be honest in his dealings. He must, therefore, not sign the Balance Sheet which he does not believe to be true.
Thus, if the auditor adheres to the instructions of his client word by done his work negligently and has not obeyed the instructions given to him and, consequently, the business has been put to a loss.
The Liability of a Company Auditor:
A Company auditor is appointed under the Companies Act, 1956, and hence, his position differs from that of one appointed by a private concern. His appointment, remuneration, rights and duties, liabilities and responsibilities, etc. are defined -and laid down by the Companies Act.
His liabilities may be kept under the following heads:
1. Liability for Negligence:
An auditor appointed by a company is expected to safeguard the interests of the shareholders and, as such, he performs his duties as an agent of the shareholders. He must exercise his reasonable care and diligence in the performance of his duties as lay down under the statute.
If he fails to do so and as a consequence thereof, the principal suffers a loss, the auditor is held liable to make good the loss under the Law of Agency. Thus, he can be compelled to compensate loss caused to the company resulting from his negligence.
But it has to be remembered that the auditor cannot be held responsible to compensate the loss if his negligence is proved without, in any way, causing loss to the company.
He is liable for damages if the company has suffered any loss due to his negligence in the performance of his duties as was held in the case of Liverpool & Wigan Supply Association Ltd. (1907). The situation can be briefly put as given here under:
An auditor is not liable for-
(1) Loss without Negligence and
(2) Negligence without loss
(1) Leeds Estate Building & Investment Society vs. Shepherd (1887):
It was held in the case that if an auditor is found negligent in the performance of his duties as an auditor, he is liable for damages. In this case, the auditor could not see that:
(i) The Articles of Association has not been fully complied with, and
(ii) Dividends have been paid out of capital.
Decision – “It is the duty of the auditor not to confine him merely to the task of ascertaining the arithmetical accuracy of the Balance Sheet, but to see that it is a true and accurate representation of the company’s affairs. It was no excuse that the auditor had not seen the articles when he knew of their existence.
The Statute of Limitations has been pleaded on his behalf, and the plea had not been resisted so that his Liability would
be limited to the dividends paid within six years of the commencement of the action.”
(2) Irish Woolen Company Ltd. vs. Tyson and others (1900):
In this case it was held that an auditor, who by reasonable case and skill could detect falsification of accounts, is liable for dividend paid out of capital due to such falsification.
Decision-In the course of his judgement, Holmes, L. J. said : “There is no doubt that both the suppression and carrying over of invoices would have been detected if the auditor had called for the creditor’s Statement of Accounts upon which payment was ordered, and compared them with the Ledger.
I do not understand how the carrying over of the invoices could have escaped detection by the accountant who should have used due care and skill and who was not a mere machine. The invoices carried over were ultimately posted to the Ledger.
It they were posted on their true dates, it would be at once apparent that they were not entered in at the proper time. If they were posted under false dates, why was this not detected when the Ledger
Accounts were checked with the invoices for these reasons. I am of the opinion that if due care and skill had been exercised, the carrying over and suppression of invoices would have been discovered and the auditor is liable for any damage, the company has sustained from the understatement of liabilities in the balance sheet.
(3) London Oil Storage Co. vs. Seear Hasluck & Company (1904):
It was held that an auditor, who fails to verify the existence of assets as shown in the Balance Sheet of the Company, is liable for damages but assessment of such damage is dependent on how far the negligence of the administration is contributory to such loss.
“The plaintiffs must satisfy you that the damage has been occasioned to whatever extent you think it was occasioned, by the breach of duty on the part of the auditor….. You must not put upon him the loss by reason of theft occurring afterwards or before but you must put upon him such damages as you consider in your opinion were really caused by his duty as an auditor of the company.
(4) Arthur E. Green & Company vs. the Central Advance & Discount Corporation Ltd. (1920):
It was held that an auditor is guilty of negligence, if he fails to detect time-barred debts within the schedule of debtors.
An auditor may, thus, be liable for the previous losses, and he may also be held responsible for the consequential losses. In fact, damages which are the direct result of negligence are only recoverable. Remote damages are not recoverable.
On the question of consequential damages, the accountant of England referring to the Armitage vs. Brewer & Knott wrote:
“The case gives a footing disadvantage to the profession in applying the principle of consequential damages to audit claims. Thus, if an auditor omits to detect the defalcation by an employee and in the following year, before there is chance of any further audit, the employee emboldened by having escaped detection embezzles a larger sum, is the auditor liable both for the original embezzlement which he failed to detect and for the subsequent losses to the employer as well?”.
“A mere mistake will not render a professional man liable for the consequence, but of the negligence was of the type where omission was to detect a fraud which by the exercise of a reasonable care an accountant would have detected, then we are inclined to think that a jury would take into account the consequential losses in their award of damages.
On the other hand, of the auditor’s failure to detect defalcation was not blameworthy, and he could not reasonably be expected to detect such a defalcation, then he might not, in our opinion, be liable.
Thus, to hold the auditor liable for negligence, the following three things must be proved:
(i) That he was negligent,
(ii) That, as a result of his negligence, the client suffered a loss, and
(iii) That the loss was suffered by the person to whom the auditor owed a duty.
The company may indemnify the auditor for any expense that he incurs in defending himself provided the judgement was in his favour.
2. Liability for Misfeasance:
As an auditor is held for damages caused to a company on account of his negligence, similarly, he is negligent in the performance of his duties if he commits a misfeasance, i.e. a breach of trust or duty. Misfeasance implies a wrong done.
If an auditor does something wrongfully in the performance of his duties resulting in a financial loss to the company, he is guilty of misfeasance. The Directors, Managing Agents and other officials of a company may also be held liable for misfeasance.
Where the consent of a person is required to the issue of a prospectus and he has given such consent, he shall not be liable as person who has authorised the issue of the prospectus. However, he remains liable in respect of an untrue statement, if any, purporting to be made by him as an expert.
As such the expert remains liable for untrue statements by him and included in the prospectus with his consent as if he has authorised the issue of the prospectus.
This section provides for the civil liability of an auditor for mis-statements in the prospectus of the company.
If in the course of winding up of a company, it appears that any officer (including the auditor) of the company has misapplied or retained or become liable for any money or property of the company or has been guilty of any negligence or breach of trust in relation to the company, he can be held liable for damages caused to the company.
(1) London and General Bank Case (1895):
An Auditor is liable for misfeasance (Section 543 of the Companies Act) if he fails to bring to the notice of the shareholders in clear terms, the unsatisfactory state of affairs of the company when he himself had not been satisfied.
In the course of the judgement, Lindley, L. J. said –
“It is no part of an auditor’s duty to give advice either to Directors or Shareholders as to what they ought to do. His business is to ascertain and state the true financial position of the company at the time of the audit and his duty is confined to that.
But then comes the question:
How is he to ascertain such position? The answer is: By examining the books of the company. He must take reasonable care to ascertain that they do. Unless he does this, his duty will be worse than a farce.”
“Such I take to be the duty of the auditor:
He must be honest, that is, he must not certify what he does not believe to be true and he must use reasonable care and skill before he believes what he certifies is true……”
(2) Kingston Cotton Mill Co. Ltd. (1896):
An auditor is not liable if in the absence of suspicious circumstances, he relies on trusted officials of the company.
In the course of the judgement, Lopes, L. J. remarked:
“An auditor is not bound to be detective or, as was said, to approach his work with suspicions or with a foregone conclusion that there is something wrong. He is a watch-dog and not a blood-hound. He is justified in believing tried servants of the company in whom confidence is placed by the company.
Auditors must not be made liable for not tracking out ingenious and carefully laid schemes of fraud, when there is nothing to arouse their suspicion and when these frauds are perpetuated by tried servants of the company and are undetected for years by the Directors.”
(3) The city Equitable Fire Insurance Co. Ltd. (1924):
It was held that an auditor is liable for misfeasance if he omits to verify investments and accepts the certificate of a stock broker in lieu. An auditor is liable only when he accepts the certificate for investments from persons who are not in the usual course of their business to hold others’ securities and are not trustworthy, irrespective of the fact that they are Bankers, Sale-Deposit Company or stock-Brokers.
(4) Republic of Bolivia Exploration Syndicate Ltd. (1913):
It was held in the case that it is the duty of the auditors to ascertain the scope of their work from the Articles and the statutes, and on case of damages suffered by the company on account of misleading Balance Sheet, the onus to show that the damage is not caused by their negligence is on the auditor.
The auditors are prima facie responsible for such loss but its extent depends on the circumstances of each case.
(5) The Westminster Road Construction & Engineering Co. Ltd:
If an auditor fails to utilize the evidence reasonably available from which the overvaluation of work-in-progress could be detected, he is liable for negligence. He must make full use of the evidence available and the acceptance of certificate without question in such a case is amounting to negligence.
(6) Union Bank (In liquidation), Allahabad (1925):
It was held that the Directors, who have trusted a dishonest Manager, were guilty of misfeasance and the auditor was similarly held liable.
It is nothing to him whether dividends are properly or improperly declared, provided he discharges his own duty to the shareholders. His business is to ascertain and state the true financial position of the company at the time of the audit and his duty is confined to that if he fails in his duty, he will be jointly and severally liable with those who are responsible for the management of the company, although he is not guilty of any dishonesty.”
(7) L. Hudson vs. Official Liquidator of Dehradun-Mussoorie Electric TV Amway Co. (1930):
It was held that under the Act, where auditors pass over illegal payments without demanding explanation and the facts disclose that there are deliberate absentisms from performing plain and manifest act and payments and think over the real meaning of dubious transactions, they are guilty of misfeasance unless there is anything to the contrary in the Articles of Association.
3. Criminal Liability:
As is stated earlier, an auditor is an officer of the company and in that capacity; he is liable for his acts of omission/commission which can be construed as an offence under the provisions of the Companies Act. Penalties for such offences may be imprisonment and/or fine.
Legal Position :
Where a prospectus issued after the commencement of this Act includes any untrue statement, every person who authorised the issue of the prospectus shall by punishable with imprisonment for a term which may extend to two years or with fine which may extend to five thousand rupees, or with both, unless he proves either that the statement was immaterial or that he had reasonable ground to believe, that the statement was untrue.
For the purpose of this section, an auditor may be punished if he authorised the issue of the prospectus.
If an auditor’s Report is made, or any document of the company is issued or authenticated otherwise than in conformity with the requirements of sections 227 and 229, other than the auditor, who signs the report or signs or authenticates the document, shall, if the default is willful, be punishable with fine which may extend to one thousand rupees.
The auditor of a company is required to give assistance to an Inspector appointed by the Central Government to investigate the affairs of the company. If he does not do so, he is punishable with imprisonment up to six months or with fine up to Rs. 2,000 or with both.
When on the basis of the report submitted by an Inspector, the Central Government takes action and prosecutes any person connected with the affairs of the company, the auditor is required to assist the prosecution. If he does not do so, he is guilty of contempt of Court and punishable.
In the course of winding up of a company, the auditor is subject to a private examination of the Court and is required to return to the Court any documents in his possession. If he fails to appear before the Court, he can be arrested.
The auditor of a company, on the application of the official Liquidator, can be publicly examined in the High Court. The notes shall be taken down and be signed by the auditor. Such notes may be used in evidence against him in any civil or criminal proceeding.
If an auditor destroys, mutilates, alters, falsifies or secrets, or is privy to the destruction, mutilation, alteration, falsification or secreting of any books, papers or securities or marks, or is privy to the making of any false or fraudulent entry in any register, book of account or document belonging to the company, he shall be punishable with imprisonment for a term which may extend to seven years, and shall also be liable to fine.
The Court may direct the Liquidator of a company in winding up to prosecute the auditor if he is found guilty of any criminal offence in relation to the company.
If the auditor of a company makes a statement in-any Return, Report, Certificate, Balance Sheet, Prospectus, etc., which is false in any material particularly knowing it to be false or omits any material fact knowing it to be material, he shall be punishable with imprisonment for a term which may extend to two years and shall also be liable to fine.
If any person (including an auditor) intentionally gives false evidence upon any examination on oath or solemn affirmation authorised under the Act; or in any affidavit, deposition or solemn affirmation, in or about the winding up of any company under the Act or otherwise in or about any matter arising under the Act, he shall be punishable with imprisonment for a term which may extend to seven years, and shall be liable to fine.
Under the Indian Penal Code
Section 197 of the Indian Penal Code (IPC) lies down:
“whosoever issues or signs any certificate required by law to be given or signed or relating to any fact which such certificate is false in any material point, shall be punishable in the same manner as if he gives a false evidence.”