Contents

Chapter 8
Liability of professional service providers and advisers

Options for providing relief

8.12This section will specifically examine the options for reform in respect of the liability of service providers and professional advisers, where CER factors may be highly relevant.

8.13The nature and coverage of the options discussed below reflects our principal recommendation that joint and several liability should remain the primary rule. The reasons for retaining joint and several liability are as applicable to adviser and service provider defendants as they are generally. To be jointly and severally liable, advisers and service providers must still be held to have caused or contributed to, and be causally responsible for, a plaintiff’s loss. If they were not, then they would not be liable in the first place. We have therefore concentrated on options that do not fundamentally change or negate the joint and several liability of each defendant,129 these being:

Option one: retain status quo

8.14As with other businesses, advisers and service providers already have a number of tools available to help reduce the potential impact of a liability. Subject to any statutory or other restrictions, they can:

8.15We are aware that not all of these tools will be available to all defendants or be effective in all circumstances.130 But in general, properly advised contract parties will be able to negotiate to protect their respective interests in limiting their liability.
8.16A common criticism of this current state of affairs is that it works best when parties have relatively equal bargaining power and access to information. Despite the theoretical freedom to negotiate risk allocation arrangements as part of an overall contract proposal, a stronger party may present its limitation proposals on a take-it-or-leave-it basis. An adviser or service provider who wants to secure a contract may have little choice but to accept what is offered. This use of relative contracting strength may either limit, maintain or transfer each party’s potential liability.131

8.17The status quo nevertheless has simplicity and does not require any additional regulatory intervention. Parties can influence their own situation, within relatively broad business and some statutory parameters.

8.18However, in light of the continuing availability and affordability of suitable insurance and market conditions, especially where trans-Tasman markets exist, options other than the status quo need to be considered.

Option two: enhanced status quoTop

8.19This option would retain the same general range of tools for advisers and service providers to reduce their potential limit of a liability, but provide scope for legislative interventions to improve the effectiveness of some of these opportunities.

8.20A productive area in this regard could be lifting or reducing statutory restrictions on contractual limiting of liability. Section 61 of the Securities Act 1978, for example, is a very specific prohibition on indemnities or insurance for company directors, officers and auditors.132 Other Acts, including the Fair Trading Act 1986 (FTA) and the Consumer Guarantees Act 1993 (CGA), currently contain provisions of general application prohibiting contracting out of liabilities under each Act.
8.21The CGA does allow contracting out for business transactions. In contrast, business, professional and commercial parties cannot currently exclude the operation of the false or misleading conduct provisions in the FTA. This restriction tends to discourage and limit the effectiveness of other legitimate agreements to contract out, for example, an agreed limitation or exclusion of liability for contractual misrepresentation or negligent misstatement. But this position is changing. The Consumer Law Reform Bill133 was passed in December 2013 and will add new sections 5C and 5D to the FTA. While section 5C will expressly confirm the broad prohibition on contracting out, section 5D will allow an exception for business-to-business contracts.134
8.22There is clearly scope for statutory restrictions on contracting out of liability to be revisited. Assuming the proposed amendments to the FTA proceed, they will strike a fair balance between contractual freedom and guarding against a dominant party abusing its strength in contract negotiations. Beyond our support of this useful improvement, we do not propose any amendments to other statutory provisions that limit contracting out. We indicated in our Issues Paper that proposing amendments to such restrictions are beyond the scope of this review,135 and that is still the case. The place or continuing need for such provisions should be assessed when relevant statutes are revisited and any amendment must fit within the particular statutory and policy context that applies. Thus, a decision to amend the prohibition on auditors seeking or being granted indemnities by their issuer or FMC reporting entity clients must be determined as part of the overall scheme of audit and financial market regulation.
8.23In any case, we are not convinced that further efforts to loosen statutory constraints on negotiating limitations would be fruitful. There has already been a decline in statutory constraints. Further, allowing greater freedom to negotiate contracts does not guarantee parties will achieve results that both agree with. Negotiations remain open to the impacts of potentially unequal bargaining strength and interference from non-parties. In the case of auditors in the United Kingdom, opposition from United States regulators and local institutional investors made changes to companies legislation largely ineffective.136 If the provisions had been able to function as designed, auditors and their clients could have negotiated contractual limits on liability, subject to complying with applicable Companies Act provisions. There is every reason to expect that institutional investors in New Zealand could take a similar stand.

Option three: capped liabilityTop

8.24This option involves the maximum liability of members of a qualifying group or groups being capped, either directly in statute, or by an industry scheme approved under an enabling statute. The liability of a service provider or adviser who is held liable, usually in contract or negligence, will be limited by a set dollar amount, or by a set multiplier, and with an upper dollar limit setting the maximum possible liability. For example, in some Australian states, engineers are subject to one of four levels of cap, from not more than $1.5 million to no more than $20 million, depending on a firm’s income. The schemes also allow for a higher cap to be set for a firm that has income above $20 million.137
8.25We noted in our Issues Paper that caps for professional defendants’ liabilities are often promoted or used where there is a prospect of catastrophic liability resulting from the catastrophic collapse of a client.138 The argument is that some level of protection from open-ended liability is needed to encourage professionals to enter and remain in the sector, and to keep insurance costs affordable. The example provided by the Enron collapse, and the fatal damage that was done to Enron’s auditors Arthur Andersen, demonstrates that catastrophes can lead to unsurvivable liability for affected advisers or service providers. In the wake of Enron it has been asserted that any further catastrophic collapse, accompanied by loss of one of more international professional services firms, could damage whole economies. Capping of liability is therefore argued as necessary in the public interest, to protect business confidence and avoid damage to economic infrastructure.
8.26As a result of the Enron experience, capping is often advanced as being necessary for major audit firms, especially those who audit the largest corporates and are potentially most at risk of being caught by a catastrophic collapse.139 Capping schemes have also been proposed and implemented for various other professional groups, most notably in Australia. Professions that have or have had schemes in place in one or more Australian states include auditors, other accountants, barristers, solicitors, IT or computer consultants, valuers, engineers and surveyors.140

8.27Capping is a potentially strong option for providing relief for some professionals but we consider that the arguments for and against capping liability are not necessarily the same for each profession. The case for auditors is strongly influenced not only by the “catastrophic collapse” argument, but also by emerging trans-Tasman competition. In the next sections of this chapter we consider in more detail the case for capping and, in particular, the capping of auditor liability.

129But see ch 5 and our recommendations to allow some relief from the full effects of joint and several liability to minor defendants.
130For example, auditors are currently prohibited by the Securities Act 1978, s 61 from obtaining an indemnity from or being provided with insurance by their audit client, for any negligence or related liability arising from their engagement. A similar provision, Financial Markets Conduct Act 2013, s 529 will continue this prohibition when the Securities Act is repealed. The effectiveness of a general disclaimer of responsibility, while available in theory, is likely to be highly fact-specific – it may be difficult to effectively disclaim responsibility when the particular engagement was expressly to provide some mixture of assurance and certification to an identified class of third parties.
131One submitter discussed this phenomenon in an Australian proportionate liability context. In some states it is possible to contract out of proportionate liability. Tenderers have frequently found that agreeing to joint and several liability, in contract, is made a condition for securing the deal. Of course, this only shows that market freedom is working, albeit in the opposite direction to the interests of parties who wish to limit their liability. In contrast, see also [8.20]–[8.22] below regarding proposed loosening of the Fair Trading Act 1986 prohibition on contracting out, which may nevertheless allow some protection to a party with lesser bargaining power who may have little choice but to agree to a limitation provision proposed by a stronger party.
132Above n 130.
133Consumer Law Reform Bill 2011 (287–2).
134Section 5D will allow an exception for business-to-business contracts; where each party is acting “in trade” the parties may, so long as certain conditions are met, agree to contract out or limit some Fair Trading Act responsibilities, including the duty to avoid false or misleading conduct. A court can later determine whether a particular agreement is fair and reasonable. If not, the limitation will be unenforceable. The potential for agreed limitations to be struck down in this way may create uncertainty, but the proposed amendment should significantly improve the general ability of parties to agree between themselves the extent and limits on their potential liabilities to each other in an area that broadly overlaps common law misrepresentation/misstatement liability.
135Issues Paper, above n 127, at [3.30].
136Under the Companies Act 2006 (UK) parties may negotiate “Liability Limitation Agreements” (LLAs) as long as they meet various statutory requirements. LLAs have proved unpopular with institutional investors who have “insisted” that LLAs only be used to institute proportionate liability for auditors. The refusal by United States regulators to accept audit engagements that include LLAs for companies listed in the United Sates as well as the United Kingdom has further reduced the impact of the option.
137Professional Standards Councils “Engineers Australia (Vic) Scheme” (Notified 19 October 2012) <www.psc.gov.au>.
138Issues Paper, above n 127, at [3.21].
139For example, in 2008 the European Union recommended that member countries adopt one or more of: proportionate liability, statutory or contractual capping: see European Commission Recommendation 2008/473/EC concerning the limitation of the civil liability of statutory auditors and audit firms (5 June 2008). However, apart from the contracting out provisions included in the Companies Act (UK), these proposals have not yet generated significant national responses.
140As approved by or notified to Professional Standards Councils of Australia, see “Schemes” <www.psc.gov.au>.