Accountability highlights the legal and industry news affecting accountants and other financial professionals on a range of liability risk management issues.
FRC Appeal Tribunal overturns several of the charges made against Deloitte in the MG Rover case
Welcome news for Deloitte and for the wider profession as an FRC appeal tribunal (the Appeal Tribunal) has overturned eight out of the 13 findings of misconduct made against Deloitte by the disciplinary tribunal (the Disciplinary Tribunal) in September 2013, including the core findings of deliberate misconduct and failure to act in the public interest.
The reasons given by the Disciplinary Tribunal for its decisions had been extensively criticised on behalf of Deloitte and Maghsoud Einollahi (its former corporate partner) and (as the Appeal Tribunal's decision records), many of those criticisms were not defended by the Executive Council.
Indeed, the Disciplinary Tribunal had made adverse criticisms of the Deloitte Appellants that went beyond the case put by the Executive Council - including the findings that there had been deliberate misconduct and a disregard by the Appellants of their duties in breach of the Fundamental Principles and Statements.
The Disciplinary Tribunal's report (issued in September 2013) found that Deloitte and Mr Einollahi had failed to adequately consider the 'public interest' when advising MG Rover Group (MGRG) and its owners (the "Phoenix Four") on two transactions, known as 'Project Aircraft' and 'Project Platinum', in the period 2001 - 2002.
It also found that they had failed to identify and consider actual or potential conflicts of interest between the Phoenix Four and MG Rover; and had failed to consider or safeguard against the self-interest threat in accepting a contingent fee for the engagements.
The Disciplinary Tribunal had concluded that these findings amounted to misconduct under the Accountancy Disciplinary Scheme. Mr Einollahi was excluded from practicing for three years and handed a fine of £250,000. The Tribunal imposed a Severe Reprimand and a fine of £14 million on Deloitte.
Deloitte and Mr Einollahi sought permission to appeal the findings made against them. Leave to appeal against the adverse findings relating to Project Aircraft was granted in September 2013, although leave to appeal in respect of the Project Platinum adverse findings was refused. This latter decision was successfully challenged and the Appeal Tribunal therefore considered both the Project Aircraft and Project Platinum adverse findings and sanctions.
The Appeal Tribunal decisions
In relation to Project Platinum and Project Aircraft, the Appeal Tribunal allowed the appeals against the finding of misconduct that the Appellants failed to consider the public interest before accepting or continuing their engagement. They also did not accept that the Disciplinary Tribunal's Report identified misconduct by Deloitte and Mr Einollahi.
The Appeal Tribunal held that statements in the Guide to Professional Ethics (the Guide) did not "assist in giving guidance as to how the public interest is to be taken into account by an accountant, i.e. how any decision of his is to be affected beyond the requirement for him to act with integrity, honesty, objectivity and competence".
The Appellants had submitted that the charge of failing to take account of the public interest was unfounded and questioned how, beyond adhering to the stated requirements, the public interest ought to be taken into account. In overturning the Disciplinary Tribunal's decision on this issue, the Appeal Tribunal commented on the failure by the Executive Council to adduce expert evidence in support of the charge, nor did it answer the question: what did the Appellants do or fail to do by reason of their failure to take account of the public interest?
The Appeal Tribunal took the hypothetical example of a proposed takeover bid by a foreign company of a large UK manufacturer. The UK lawyers involved would undoubtedly be free to accept the instructions provided the proposed takeover and the work involved were lawful, that their proposed instructions involved no dishonesty or want of integrity, and they were competent to carry out the engagement.
As for the accountants, The Guide to Professional Ethics (the Guide) requires them to take account of the 'public interest' before accepting the engagement. The Appeal Tribunal accepted it was not clear how they should do that and to what extent? They queried; "How is the public interest to be ascertained? Is it in thmaintenance of a free market? Should the accountants assess whether the threatened factories have a real expectancy of continuation after their current ownership? Should they assess the possibilities of a friendlier takeover? Should they consult the Government of the day?"
The Appeal Tribunal went on to say that they regarded the suggestion (if it be made) that the accountants are not free to accept the engagement without considering the vague question as to whether the takeover is in the public interest, as absurd. They therefore concluded that the requirement in the Guide as to the public interest cannot alone form the basis of any charge that an accountant has been guilty of misconduct. The Guide had been interrogated and had been found to be "vague and unhelpful".
The Appeal Tribunal also allowed the appeal against the finding in relation to Project Platinum that the Appellants had misled MGRG into believing they were advising them when in fact they were advising the Phoenix Four. On the evidence the Appeal Tribunal accepted that MGRG was not in fact misled and found that the charge had not been proved.
All findings of misconduct made out in relation to Project Aircraft were overturned. The basis of these findings lay with the fact that MGRG received no benefit from its surrender of its tax losses. It had not been suggested that the failure to receive any benefit occurred as a result of any advice given by the Appellants, and it was accepted they played no part in obtaining or considering the advice that MGRG received from its independent legal advisers. There was therefore no duty on the part of the Appellants to address the conflicts faced by MGRG when it surrendered its tax losses. The Appeal Tribunal held that as there was no breach of duty the findings of misconduct must be set aside.
A further finding of misconduct had also been made as a result of the contingent fee that was payable to Deloitte in respect of its successful work on Project Aircraft. The Disciplinary Tribunal had made a finding of misconduct based on the fact that there did not appear to have been careful consideration - or any consideration - as to whether the contingent fee (either in principle or amount) was appropriate.
The Appeal Tribunal stated that it cannot be misconduct merely to fail to consider the appropriateness of a fee that is in fact appropriate. The Disciplinary Tribunal did not find that the fee had been excessive and it failed to address the Appellants arguments as to the basis upon which the fee was charged. As a result the finding of misconduct was overturned. Likewise on Project Platinum, although the fee was substantial, it had never been alleged by the Executive Council that it was excessive. As such, it should never have formed the basis for criticism - not least as that criticism was found to have been unsupported by evidence.
The Appeal Tribunal's decision is welcome news not just for Deloitte but also for the wider profession.
In allowing the appeals in relation to the findings that Deloitte and Mr Einollahi had failed to consider the public interest, the FRC has highlighted a lack of clarity in the ICAEW's guidance for accountants on how they should do that (over and above respecting the fundamental principles). They will continue to work with the profession to address this issue. Changes are likely to be made to the Guide as a result; the ICAEW having quickly acknowledged through its Chief Executive Michael Izza that the ruling "suggests there needs to be greater clarity for the accounting profession…".
A further hearing will take place in the coming weeks to decide whether (and to what extent) the fines originally imposed on Deloitte and Mr Einollahi will be reduced as a result of the Appeal. Given the Appeal Tribunal's findings, it seems both logical and likely that a substantial reduction could be made.
Successful damages claim requires causation to be proven
The case of Altus Group (UK) Limited v Baker Tilly Tax and Advisory Services LLP(1), Baker Tilly Tax and Accounting Limited (2) provides another clear illustration that damages for professional negligence can only be recovered where the negligence causes the damages claimed.
The claimant was a corporate member of an LLP that had been incorporated to purchase another business. That purchase gave rise to an asset in the existing LLP's accounts in respect of the goodwill of that business. Shortly after the acquisition the decision was made to amortise the goodwill over a five year period, concluding at the end of the third quarter of 2012. This would allow a deduction to be made against the claimant's profits.
The defendant was retained to prepare the claimants tax returns from 2007 to 2010. These were prepared on the basis that the deduction had been made and this allowed the claimant to carry forward a loss. Corporation Tax changes were introduced by the Tax Bill in December 2008 and were implemented as a result of the Corporation Tax Act 2009 (CTA 2009). The changes meant that the claimant could not carry forward a loss from the LLP for the period ending on 31 December 2009.
The defendants failed to advise the claimant of the changes and their effect on the claimant until October 2011. The claimant subsequently approached new tax advisors who proposed a restructure to mitigate their tax liability. The claimant did make attempts to implement the structure but it was subsequently abandoned during 2012.
The claimant alleged that the defendants ought to have advised it as to the effects of the corporation tax changes (those brought about by sections 1263 and 1264 of the CTA 2009) in January 2009. If it had been properly advised the claimant would - within about four months - have implemented a restructure and there would have been a substantial chance that the restructuring would have been successful in mitigating the claimant's tax liabilities. The claimant claimed damages for that loss of a chance.
The defendants denied they were under a duty to provide advice to the claimant on the changes until about mid July 2009, when they prepared the claimant's corporation tax computation for the period to 30 June 2009. They were not required to give that advice in January 2009.
The defendants contended that:
- the claimant would not have implemented the restructuring proposal even if they had received the advice in January 2009;
- in any event it would have taken eight or nine months to implement rather than the four months alleged;
- the restructuring would not have been effective to mitigate the claimant's tax liabilities and damages for the lost opportunity are irrecoverable; and
- HMRC would have successfully challenged the restructuring and as a result any damaged would be small or 'illusory' in any event.
Was this 'properly a loss of chance' claim?
The judge confirmed that where the breach of duty consisted of an omission, but absent any breach the benefit conferred on the claimant would have been dependent on the actions of a third party, the case would be analysed in two stages.
In the first instance the claimant must prove what he would have done if the breach had not occurred (on the balance of probabilities). Damages will then be assessed on the basis of the value of the chance that the third party would have acted in such a way as to confer the benefit. In this case this meant making a practical assessment as to whether the restructuring would have resulted in a tax saving for the claimant.
If the claimant could show that it would have implemented the scheme but for the defendants' breach of duty, the correct approach would be to assess the chance of the restructuring being successful - in the sense that it would not be subject to a successful challenge.
That would involve consideration of the prospects of HMRC bringing a challenge in the first place and an assessment of the prospects of any such challenge succeeding, which would be done by weighing up competing arguments for and against, but it will not necessarily involve any purported determination of the legal issues. The court would not undertake a detailed analysis as to whether the restructuring would actually have worked.
Breach of duty
The court confirmed the defendants had breached their duty in failing to advise the claimants on the changes brought about by the CTA 2009. In considering the claimants filing position for 2008 the defendants should have been aware of and considered the Corporation Tax Bill 2008 and they should have informed the claimant of the changes that would be implemented by the CTA 2009.
The changes would have had such an impact on the claimant's position in future years that the defendants - in holding themselves out as being a top-end and very large firm of specialist advisers - should have been aware of them and should have advised the claimant accordingly.
The court found that if the claimant had instructed the new tax advisers in 2009 it would have implemented the restructuring scheme. However, on the evidence before it the court did not accept that the claimant would have instructed the new tax advisers in 2009 at all.
The judge held that the claimant was likely to have approached different advisers as they were just about to be appointed as the Group's advisers on matters of UK tax at that time. The judge was not satisfied that those advisers would have given advice along the lines of the restructuring proposal. As a result the judge found that the claimant had not proved it would have implemented the restructuring proposal and it failed in the first stage of its loss of chance claim.
This case is another reminder that even if a professional adviser acknowledges a failure to advise as required, any claim for negligence will not succeed unless that failure causes loss. The case of Hirtenstein v Hill Dickinson LLP  is another recent example of the importance of causation in any negligence claim, as covered by us in Accountability in October 2014. For a claim in damages to succeed causation really is key.
Indemnity risks of discontinuing a claim and enforceability of contractual indemnities
The judgment in Renewable Power & Light Ltd v McCarthy Tetrault & Ors  looked at the court's approach to indemnity agreements for costs and losses suffered by one party in legal proceedings brought by the other. The claimant, Renewable Power & Light (RPL), discontinued mid-trial its whole claim, including its professional negligence claim against the third defendant, Grant Thornton. The court was left to determine Grant Thornton's counterclaim and costs.
Grant Thornton's counterclaim comprised two parts. The first was relevant only if RPL's allegations of professional negligence against it were found to be true. This was, of course, never tested because RPL withdrew its claim against Grant Thornton.
Nevertheless, Grant Thornton submitted to the court that this first part of the counterclaim should not be dismissed but rather that the court should make "no order" in relation to it. The reason for this was cautiousness; Grant Thornton wanted to protect itself as far as possible from any reactivation of the claim, and this would be easier to do if the relevant part of its counterclaim was still live. The court agreed to this request and stayed that part of the counterclaim.
The second part of the counterclaim required more attention from the court to the agreements which existed between the parties. Grant Thornton claimed that, if found not liable in negligence, it would be entitled to costs, fees and expenses related to defending the claim, to be assessed on an indemnity basis. Grant Thornton relied on two clauses in two separate contracts between it and RPL as follows:
Clause 6.1 of the Grant Thornton Contract (Clause 6.1)
In clause 6.1, RPL agreed to indemnify Grant Thornton from and against any and all claims and losses of whatever nature suffered by Grant Thornton which relate to or arise from Grant Thornton's engagement under the agreement. The clause specifically stated that all costs, charges and expenses (including legal fees) in connection with investigating, dealing with or defending any claims would be indemnified.
The only proviso to clause 6.1 was that Renewable Power would not be liable for costs to the extent that they were found by a final judgment to have occurred as a result of a criminal or fraudulent act by, or negligence of, Grant Thornton, or in circumstances under which an indemnity is prohibited under statutory rules.
Clause 8.3 of the Placing Agreement
This clause was similar to clause 6.1. It confirmed RPL's agreement to indemnify Grant Thornton against any or all claims or losses (etc) arising (directly or indirectly) in connection with Grant Thornton's performance in connection with the agreement. This clause also included within its list of scenarios (under which Grant Thornton may incur costs or losses) the circumstance whereby Grant Thornton is 'establishing any claim for indemnification under the foregoing provision'.
The court clarified that the description of costs within both clauses should be interpreted as 'reasonable costs reasonably incurred'.
The court found that Grant Thornton was entitled to an indemnity for its costs incurred in defending the proceedings brought against it - subject to those costs being reasonable costs and being reasonably incurred. The burden of establishing any unreasonableness would be on RPL.
The proviso to clause 6.1 did not apply because there was no judgment, final or otherwise, which had found that costs were incurred as a result of an act or negligence by Grant Thornton, nor was there any statutory rule which prevented the indemnification claimed. The court considered whether it could be said that either clause did not apply to a claim made against Grant Thornton by the other contracting party (rather than by a third party) but concluded that there were no express words to that effect and it was not appropriate to imply that limitation. Furthermore, any doubt as to whether the indemnity obligation extended to the costs of the counterclaim was eradicated by the closing words of clause 8.3.
RPL was ordered to make payment on account of Grant Thornton's costs in the sum of £1.5 million.
In general if a claimant discontinues a claim he should bear the defendant's costs - unless the court orders otherwise. The fact that a contractual indemnity was in place made the cost position even clearer. Grant Thornton proved its entitlement to an indemnity. As to quantifying the amount of the indemnity, the court directed a detailed assessment of the costs on the indemnity basis.
This case serves to underline the value of including indemnities of this sort in contractual terms. Unlike limitations and exclusions of liability they are not subject to the 'reasonableness test' and will generally be given effect to (as drawn) by the courts.
Government response on implementing the reduced disclosure requirements of the EU Accounting Directive
On 27 January 2015, the Department for Business Innovation & Skills (BIS) issued its response to the consultation on implementation of the reduced disclosure requirements on small companies under the new EU Accounting Directive (Chapters 1 to 9), which ran between 29 August and 24 October 2014
The Government confirmed that in implementing the provisions of the new Accounting Directive, its priority is to maintain the integrity of and confidence in the UK's accounting and financial reporting framework. In summary it will:-
- Adopt the maximum thresholds available to determine the size of small companies - which will allow 11,000 medium-sized companies to access the small companies regime;
- Reduce the number of mandatory notes required of small companies to 13 - rather than the 17 most small companies are currently required to provide;
- Allow small companies to prepare an abbreviated balance sheet and abbreviated profit and loss account - if approved by all of the company's shareholders;
- Give companies in the same group as a public company - which is not a listed company - access to the small or medium sized companies regimes;
- Provide companies with the opportunity to use alternative layouts when preparing their profit and loss account and the balance sheet - provided that the information given is at least equivalent to the information otherwise required by the standard formats;
- Require that where the useful life of goodwill cannot be reliably estimated that it shall be written off over no more than 10 years - in exceptional circumstances;
- Require that information on subsidiaries included with the consolidated financial statements is only provided as a note to those statements;
- Remove the requirement for micro-entity companies to prepare a Directors' Report; and
- Permit the use of the 'equity method' in individual company financial statements.
The Government will not, however, amend the definition of net turnover to include other sources of income, although they are continuing to discuss the position of charitable companies with the Charity Commissioners on this issue.
Action will not be taken to de-couple the link between the small company thresholds for accounting and audit purposes. The Government view is that the same thresholds should continue to apply for both audit and accounting, although the Government is seeking stakeholder views on whether new separate lower thresholds should be introduced for the small companies audit exemption.
A draft Statutory Instrument implementing the Directive has been laid before Parliament - The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015.
FRC Consultation - Auditing and ethical standards - Implementation of the EU Audit Directive and Audit Regulation
The FRC has issued a consultation document on 'Auditing and ethical standards - Implementation of the EU Audit Directive and Audit Regulation', seeking views on how the mandatory requirements should be implemented and which of the optional requirements should be adopted.
BIS has also issued a discussion paper on the implications of the EU Audit Directive (the Directive) and Audit Regulation (the Regulation). Together the two papers propose changes within the UK system to give effect to the EU legislation, as well as to improve the system generally.
Many of the points within the FRC consultation relate to its ability to set and manage more stringent standards than those required under the EU system. By way of example, its proposals include:
- that it retains the right to set additional standards in areas not covered by International Standards on Auditing (ISAs), and to add to those standards where national law or the credibility of financial statements requires;
- that some (but not all) of the more stringent requirements currently applicable to public interest entities as defined in the EU should be extended more broadly; and
- that the 70% cap in the EU regulation on non-audit services be extended to include services provided by network firms, and to apply from an earlier start date.
The consultation invites views on these and other points before 20 March 2015.
FRC Report - Developments in Corporate Governance and Stewardship in 2014
The FRC has issued its corporate governance and stewardship monitoring report for 2014 and has confirmed its belief that the overall quality of corporate governance in the UK is high, although some poor practices exist which are capable of triggering major failings in governance.
The report provides an assessment of corporate governance and stewardship in the UK during 2014. In reviewing the impact and implementation of the UK Corporate Governance and Stewardship Codes (the Governance and Stewardship Codes respectively) the FRC's assessment includes the following:
- there has been an increase in compliance with the Governance Code, although those who choose not to comply need to ensure they explain why;
- there have been improvements in the quality of disclosures by audit committees and more companies are retendering their audit contracts;
- the risk management guidance introduced by the 2014 updates to the Governance Code need to be given time to see if they are being followed;
- boards have a responsibility to shape the culture of a business and assess whether that culture is followed consistently throughout the business;
- boards also need to be frank about their capabilities to address threats to the long-term success of the company;
- there are signs that following the Stewardship Code has become best practice, although too many signatories still fail to follow through on their commitment to the code;
- asset managers need to commit to adopting and reporting against the Stewardship Code;
- there are mixed reports about proxy advisors - their advice needs to take full account of company circumstances and explanations.
The report confirms that in 2015 the FRC will look further at the issues of corporate culture and behaviours, the application of the UK Stewardship Code and the role of proxy advisors.