Auditor liability under common law includes breach of contract and liability to third parties. Important concepts include foreseeability, negligence, and the implications of different types of users of the financial statements.
Common-Law Liability to Clients: Breach of Contract
When a client contracts with an auditor to perform specific services, a contract is drawn up that says the services will be performed in accordance with professional auditing standards and will be completed on a timely basis. Auditors are expected to fulfill these contractual responsibilities to clients. Auditors can be held liable to clients under contract law and/or under common law for breach of contract, and they can be sued under the concepts of negligence, gross negligence, and fraud. Breach of contract may occur when there is nonperformance of a contractual duty. Causes for action against the auditor for breach of contract may include, but are not limited to, the following:
● Violating client confidentiality
● Failing to provide the audit report on time
● Failing to discover a material error or employee fraud
● Withdrawing from an audit engagement without justification
A client seeking to recover damages from an auditor in an action based on
negligence must show that the auditor had a duty not to be negligent. In determining
this duty, courts use as criteria the standards and principles of the profession,
including professional auditing standards and financial accounting
principles. Liability may be imposed for lack of due care either in performing
the audit or in presenting financial information. The auditor must have breached
that duty by not exercising due professional care. The client must show there
was a causal relationship between the negligence and damage. The client must
prove actual damages. The amount of damages must be established with reasonable
certainty, and the client must demonstrate that the auditor’s acts or
omissions were the cause of the loss. See the Auditing in Practice feature
“Moss Adams and the Meridian Mortgage Funds Fraud,” for an example of a
case in which the audit firm was sued for breach of contract.
The remedies for breach of contract include the following:
Common-Law Liability to Clients: Breach of Contract
When a client contracts with an auditor to perform specific services, a contract is drawn up that says the services will be performed in accordance with professional auditing standards and will be completed on a timely basis. Auditors are expected to fulfill these contractual responsibilities to clients. Auditors can be held liable to clients under contract law and/or under common law for breach of contract, and they can be sued under the concepts of negligence, gross negligence, and fraud. Breach of contract may occur when there is nonperformance of a contractual duty. Causes for action against the auditor for breach of contract may include, but are not limited to, the following:
● Violating client confidentiality
● Failing to provide the audit report on time
● Failing to discover a material error or employee fraud
● Withdrawing from an audit engagement without justification
A client seeking to recover damages from an auditor in an action based on
negligence must show that the auditor had a duty not to be negligent. In determining
this duty, courts use as criteria the standards and principles of the profession,
including professional auditing standards and financial accounting
principles. Liability may be imposed for lack of due care either in performing
the audit or in presenting financial information. The auditor must have breached
that duty by not exercising due professional care. The client must show there
was a causal relationship between the negligence and damage. The client must
prove actual damages. The amount of damages must be established with reasonable
certainty, and the client must demonstrate that the auditor’s acts or
omissions were the cause of the loss. See the Auditing in Practice feature
“Moss Adams and the Meridian Mortgage Funds Fraud,” for an example of a
case in which the audit firm was sued for breach of contract.
The remedies for breach of contract include the following:
- Requiring specific performance of the contract agreement
- Granting an injunction to prohibit the auditor from doing certain acts, such as disclosing confidential informatio
- Providing for recovery of amounts lost as a result of the breach
When specific performance or an injunction is not appropriate, the client is entitled to recover compensatory damages. In determining the amounts of compensation, courts try to put the client in the position in which it would have been had the contract been performed as promised. The auditor can use the following arguments as defenses against a breach of contract suit:
- The auditor exercised due professional care in accordance with the contract.
- The client was contributory negligent.
- The client’s losses were not caused by the breach
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