CAT-I

Liability of Auditors to third party in India

Submitted to- Submitted by-

Ms.Hiral Mehta Vinamra Agrawal
Faculty ,NUSRL Semester- IX
Roll No.- 302
Liability of Auditors to third party in India
INTRODUCTION

There are tremendous changes in new Provisions under the Companies Act, 2013 with
respect to Auditors as compared to the old Companies Act, 1956. The new Act intents to
improve Corporate Governance and to further strengthen regulations. The Onus and
responsibilities of Auditors becomes cumbersome. Lot of responsibilities imposed under the
Act & Rules. Perusal of the provisions with respect to Auditors clearly reveals that, Auditor
should not listen to managements advice during the finalization of accounts and it should be
purely independent finalization and financial statement should reflect true and fair view of
the business Otherwise auditor will be held responsible. This is because not only the
company and management but also the third party relies on the auditors to paint a true picture
of the company.

Auditors Liability

Generally in case of third party there are two pieces of civil law of particular significance to
the audit profession; contract law and the law of tort. These establish the principles for
auditor liability to clients and to third parties; respectively. Under contract law parties can
seek remedy for a breach of contractual obligations. Therefore shareholders can seek remedy
from an auditor if they fail to comply with the terms of their duty and under the law of tort
auditors can be sued for negligence if they breach a duty of care towards a third party who
consequently suffers some form of loss.

Under the Companies Act the auditors liability has been made strict therefore an auditor must
fully realize his moral obligations to third parties and in view of the fact that the reports made
by him are likely to be relied on, he must use his utmost skill and care that the statements
issued do reflect the true and accurate state of affairs and free from any ambiguity. To protect
the interest of third party Section 147 of the companies act imposes a penalty on the auditors
for non-compliance of sections with payment of fine if the default is wilful.
An auditor is liable to make good the loss the members or investors of a company may suffer
as a result of the negligence on his part in the due performance of his duties. If there is fraud
on his part, the auditor will be liable in tort. Claims may arise from the auditor failing to
detect defalcations or discover errors that may have put the company to loss. For the auditor
to be held liable for fraud, it is necessary to prove the following facts-
1. The statement signed by him was untrue in fact, 2. That the auditor knew that it was untrue
or was recklessly ignorant whether it was true or not, 3. That the statement was made with the
intent that the other party should act on it, 4. That the other party did act in reliance on it and
suffereddamage.
The Companies Act also imposes criminal liability on any person who intentionally makes a
false statement through any return, report, certificate, balance sheet, prospectus, statement or
other documents. The auditor who makes a false statement in his report that the balance sheet
presents the true and fair view of the company's financial affairs is also liable. The
shareholders of the company have mainly to depend upon the good faith and efficiency of the
auditor appointed to check the accounts and certify the balance sheet of the company. It is of
the highest importance that auditor's should perform their duties with scrupulous care, skill
and vigilance to ensure that no transaction is illegal or improper and if he has reason to
believe so, he must report it. Thus, the auditor must certify what he does not believe to be
true and he must take reasonable care before he believes what he certifies to be true.

In India there have hardly been cases related to auditors liability to third party. The first case
was in UK, Caparo Industries Plc v Dickman 1. In the case Caparo pursued the firm Touche
Ross following a series of share purchases of a company called Fidelity plc. Caparo alleges
that the purchase decisions were based upon inaccurate accounts that overvalued the
company. They also claimed that, as auditors of Fidelity, Touche Ross owed potential
investors a duty of care. The claim was unsuccessful; the House of Lords concluded that the
accounts were prepared for the existing shareholders as a class for the purposes of exercising
their class rights and that the auditor had no reasonable knowledge of the purpose that the
accounts would be put to by Caparo. It was this case that provided the current guidance for
when duty of care between an auditor and a third party exists

Further in India in case of Commissioner of Income Tax v. G.M. Dandekar 2the statements
of account having been found to be wrong, the Income-tax department took up the matter
against Mr. Dandekar and filed a complaint with the Institute of Chartered Accountants of
India. When the matter was subsequently considered by the Madras High Court it was held
that Mr. Dandeka was under an obligation to perform auditing with due skill and diligence;
if he did that; it would be difficult to see what further obligations he had in the matter and in

1
(1990) UKHL 2
2
(1952) IIMLJ 493
the favour of whom. The Accountant is under a duty to prepare and resend correct statements
of account of the assessee and he should, of course, neither suggest or assist in the
preparations of false accounts. Therefore the auditors liability towards third party was
established.

Conclusion

Therefore we can see that as and when the laws have developed more liabilities have been
imposed on the auditors. The reasons for this are manifold as through the years the need for
same has been realised. When the auditors are not held liable there are repercussions as the
third party cannot make anyone liable for the loss they have suffered, therefore it is important
for the above provisions to exist so that the auditors perform their work with due care and
diligence.