This is a case of alleged audit negligence that seems to have gone largely unnoticed. But it has potentially important legal ramifications for auditors of regulated businesses. It is yet a further salutary reminder of the dangers of mission creep and the importance of the letter of engagement and its inclusion of a Bannerman Clause (see our article: Restrictions in TCs may not be enough to avoid liability to third parties).
The facts
The business (called Ickenham or ITG) had two largely separate divisions, LG2 and BTD.
LG2 had an ATOL licence issued by the Civil Aviation Authority ("CAA"). Substantial unrecognised liabilities had built up in LG2 of some £4.5m, from around 2014 onwards. The auditors changed and the new auditors reported on the unrecognised liabilities in LG2 in February 2019.
Separately, Ickenham had been trying to sell the other division, BTD, for some time before the audit and accounting issues in LG2 came to light.
Ickenham argued that the defendant auditors (Tiffin Green) had failed to spot significant and slowly accruing problems in LG2 over a number of years, from around 2014.
However, the damages sought were for the diminished value in BTD – which was not the business division in which the problems had, in fact, occurred. The case was that the sale process for BTD had been adversely affected by the audit issues discovered in the other business, LG2.
The judge found, as a matter of fact, that the sale process was not affected by the audit and accounting problems in LG2. There was therefore, not even "but for" factual causation. That, by itself was enough to dispose of the claim.1
However, the judge went onto make further, albeit obiter, remarks in the event he was wrong in in his factual findings.
Obiter: MBS purpose test applied to the audit of a regulated business
For the purpose of this obiter analysis, he assumed, contrary to his factual findings, that BTD was sold for a price below its true value and that Tiffin Green caused that loss of value. The context to this finding was that the LG2 business was a holiday business and required CAA approval to continue in order for its ATOL licence to be renewed.
Applying the purpose test following the Supreme Court decision in Manchester Building Society vs. Grant Thornton UK LLP [2021] UKSC 20 ("MBS") the judge made the following, obiter, findings.
"From 2016 the CAA required a company to appoint auditors accredited by the CAA. Auditors are accredited by the CAA because they are viewed as having a special expertise or experience in travel businesses. Prior to 2016 there was no such requirement but even in that period Tiffin Green held themselves out as having particular expertise in the travel business. The Tiffin Green engagement letter recognised this. Ickenham says that Tiffin Green therefore held themselves out as having a purpose in auditing the accounts that went beyond the normal purpose of auditors. The purpose was to assist Ickenham in maintaining its approval by the CAA." (our emphasis).
In its defence, Tiffin Green accepted that "The purpose of Tiffin Green's retainers were to prepare and audit ITG's financial statements in order, amongst other things to maintain (insofar as it was possible to maintain) ITG's accreditation by IATA and ATOL".
The judge went on to conclude that because they held themselves out as specialists in the travel industry, including in its letter of engagement, the auditors could be liable if the audited entity's regulated circumstances were to change negatively:
"If that was an accepted purpose then it seems to me that it is reasonably foreseeable that if Tiffin Green failed properly to carry out their obligations then that was likely to impact Ickenham's CAA approval. The reasonably foreseeable consequences of that impact might include the steps that Ickenham would be required to take to maintain its approval. To the extent that those steps caused loss to Ickenham whether by sale of assets at an undervalue or by incurring fees then it seems to me that Tiffin Green might be liable at law for those losses. That is the case on the tests set out both by Lord Leggatt JSC and the majority." 2
Comment
The obiter findings illustrate the purpose test approved by the Supreme Court in MBS being applied in a way that potentially extends the categories of losses claimable against auditors.
By expressly accepting that a purpose of the audit was to maintain LG2s regulated status, Tiffin Green opened the door to a finding that losses flowing from threats to that regulated status fell within the auditor's duty of care.
It is now accepted law that a Bannerman clause in a letter of engagement is effective to limit the scope of the auditor's duty of care to losses caused to the audited entity resulting from a negligent audit. However, as illustrated by this case, whether Bannerman clauses work in practice will be fact dependent and the dangers of unintentionally assuming duties beyond those of a standard audit should be fully appreciated.
[1] "In conclusion, in my judgment, Ickenham have not proved that the steps they took in 2019 would have been different from the steps they would have taken in 2014. They have not shown that in 2014 they had any options for internal or external funding that were not available in 2019. In other words, Ickenham has not proved that there was any difference between:
i) the position it would have been in if Tiffin Green had informed it of the Understatement in 2014, and
ii) the position it was in when the Understatement was actually discovered in 2019.
Accordingly, even if BTD was sold at an undervalue in 2019 in order to raise funds for Ickenham, Ickenham has not proved that Tiffin Green caused that loss. Ickenham was, in essence, always going to be in the situation in which it found itself, whether the Understatement was discovered in 2014, or 2019, or at any point in between."
[2] Para 118
