Clause 14 - Limitation of local auditor’s liability

Local Audit and Accountability Bill [Lords] – in a Public Bill Committee at 9:45 am on 12th November 2013.

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Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government) 9:45 am, 12th November 2013

I beg to move amendment 118, in clause 14, page 10, line 46, at end add—

‘(8) The provisions of this section shall remain in force until five years after commencement and shall then expire unless continued in force by an order under subsection (9).

(9) The Secretary of State may by order made by statutory instrument provide—

(a) that all or any of those provisions which are in force shall continue in force for a period not exceeding 12 months from the coming into operation of the order; or

(b) that all or any of those provisions which are for the time being in force shall cease to be in force.

(10) No order shall be made under subsection (9) unless a draft of the order has been laid before and approved by a resolution of both Houses of Parliament.’.

I hope for some illumination from the Minister on the reasons behind the clause and a greater understanding of why it is needed. I also hope to find out how the audit market will operate for relevant authorities in the context of this Bill and in relation to the Companies Act 2006. I should warn my hon. Friends who might not have had their strong coffee this morning that the point is rather technical, but it is important, because we are uncertain about the effect of the clause.

I have read the Lords stages of the Bill. The Government’s argument, as I understand it, is that it is reasonable to allow auditors and the body they are auditing to make agreements limiting the auditors’ liability, and that that is in line with the Companies Act 2006 and arrangements in the private sector. Under the Companies Act, such limitations must be fair and reasonable.

Under clause 14(6), the Secretary of State may make regulations to

“make provision requiring a relevant authority that has entered into a liability limitation agreement to disclose such information about the agreement”.

He may also, under earlier subsections, make regulations about what the limited liability agreement may cover.

We have two concerns. The first is whether such agreements are necessary, which leads us to our sunset clause, which would require a review of the provision in five years. The second is about the effect of the clause in practice. How will such agreements emerge between auditors and relevant authorities?

The Government’s impact assessment and other documents show that the Audit Commission currently provides an indemnity to audit firms for certain aspects of their audit work, which covers irrecoverable legal costs. However, we know that the indemnity has been used only twice in the past five years. Why does the Secretary of State envisage that such a substantial clause is necessary in the Bill, given recent experience?

The Minister may be able to enlighten us. It would be interesting and helpful to know the amounts involved on the two occasions when the Audit Commission used the indemnity. Such questions were aired in the House of Lords, but answers were not forthcoming at the time. It would be helpful to understand what amounts we are talking about.

Critically, what we want to understand in the interests of the general public is how this will work for the relevant authorities. What benefits will come from these limited liability arrangements, which relieve auditors of their liability in respect of negligence, default or breach of trust? I refer back to the point made by my hon. Friend the Member for Derby North about cowboy auditors. As he said, of course we hope that the market will work effectively and that independent audit panels will be able to recommend to local authorities the appointment of audit firms that will be able to conduct effective independent audits, following the principles of sound public audit, and carry out that role in the way we would all hope.

Our concern, though, is if the market does not develop effectively and authorities around the country are not attractive to audit firms that make bids to provide audit services. There could then be a loophole whereby substandard auditing begins to take place around the country. None of us would want that to happen and I do not believe that that is in any way the Government’s intention. However, I hope that the Minister understands that we see that as a potential risk in terms of safeguarding the public’s interest. Agreements could be made that allow audit firms to provide an audit that is not effective and does not, for example, identify issues of maladministration or fraud, which we all hope would be properly identified in an audit report, but those firms would be indemnified against that. There are provisions on the matter later in the Bill, but does the Minister understand our concern? Perhaps he might reassure us that the provisions in the clause allowing the Secretary of State to introduce regulations about what can be within a limited liability agreement will safeguard against the prospect of substandard auditing.

Photo of Andrew Griffiths Andrew Griffiths Conservative, Burton 10:00 am, 12th November 2013

Would the hon. Gentleman clarify the wording that he used? He talked about a situation where an audit took place that did not pick up fraud being undertaken in a local authority. Surely by its very nature, that would be fraudulent on behalf of the auditors. Can he be clear exactly what he is alleging could take place?

Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government)

I thank the hon. Gentleman for his intervention. I hope that he understands that we are not seeking to make a controversial point. Indeed, we hope for reassurances. The reality could be that the limited liability agreement may allow an audit firm to conduct half a job. If I could test your patience, Mr Weir, with my friend the painter and decorator, which I hope will illustrate the point effectively, he always said to me: “I could charge you twice the amount and give you two good coats of paint, or I could come in cheap and give you one coat of cheap paint”.

Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government)

Let me finish the point. If the way that the market operates is such that companies are low-balling—the language that Mazars used—their bids to some authorities and using the limited liability agreements, they will provide some protection for the auditor if they miss something. We are not talking about motives. I want to be absolutely clear on that to the hon. Member for Burton. We are confident that the audit firms, which are part of national codes of practice, the auditors who are professionally qualified and the independent audit panels will seek to do the best job. However, we ask why anyone would think that the limited liability agreements are necessary if they are not to protect the audit firm in a situation where it has missed something, the audit has gone wrong and it finds that it is subject to legal challenge.

We argue that legal challenge is right, which is the point that the hon. Gentleman makes, that a relevant authority should be able to do that if the audit has not been carried out effectively and that the audit company should be subject to that process, rather than deals being signed around the country that limit its liability. Public audit is so important that we all have to be confident that it will be carried out in the fullest, most proper way and to the highest professional standards. That is why we do not necessarily consider—although we want to hear from the Minister— that limited liability agreements should be allowed.

Photo of Andrew Griffiths Andrew Griffiths Conservative, Burton

The hon. Gentleman is being generous in giving way. The argument that he makes about his decorator is entertaining, but surely he would accept that the difference between his decorator and an auditor is that an auditor has a fiduciary duty—a legal obligation —to seek such things out and not turn a blind eye or ignore them. When the hon. Gentleman makes an argument about fraud occurring in local authorities and being missed, that fiduciary duty would surely lead any auditor to do their job to the fullest extent.

Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government)

The hon. Gentleman makes an important point. I would argue that the fiduciary duty is such that we would not want that to be subject to some kind of exemption through a limited liability agreement, and that we would want it to apply properly. Why is the  limited liability agreement necessary? Given that it is so rarely used in the private sector under the Companies Act, given that most of the providers are limited liability partnerships in themselves anyway—thereby preventing personal liability for the auditors—and given that we all want to see high standards in operation, why do the Government think that it is necessary to introduce a substantial clause that would allow local authorities to limit liabilities by agreements with auditors? That is precisely the point.

Photo of Duncan Hames Duncan Hames Liberal Democrat, Chippenham

If the hon. Gentleman is keen to be clear that he is not questioning the motives of auditors, perhaps he would like to withdraw the term “cowboy”, which was introduced by the hon. Member for Derby North, and which he has furthered in the debate. These are professional people upholding professional standards, and it does his amendment no service for him to wallow in the name calling that his colleague introduced.

Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government)

I am sure that the hon. Gentleman’s intervention was intended to be helpful in furthering the debate, rather than it being some cheap political point—I am sure he is better than that. On cowboy builders, my hon. Friend the Member for Derby North and I join the hon. Gentleman in hoping that the market will operate effectively and that audit providers will operate to the highest standards. We would question, therefore, why a limited liability agreement is needed. If, as we all hope, there will be no cowboy operators and the Minister’s intention is not to allow for auditors to sign up to deals with local authorities that limit their legal obligations in future and limit the requirement on them to carry out the role according to the highest standards, we would question why the clause is necessary. Given the confidence of the hon. Member for Chippenham in the market, perhaps he will join us in questioning the Government on why clause 14 is needed, and if there is a Division on the proposal, I hope that we can count on his support.

The hon. Gentleman may feel unable to support us—I have noted his considerable finesse, as his colleagues do on the Government Benches, in not voting for policies that he supports—but perhaps he will go so far as to vote for the sunset clause that would require a review of the provision in five years. That seems a perfectly reasonable back-stop to ensure that, if the provision is not needed, it falls out of use, and that if it is needed, there is a review of how the clause is being used. We all want to ensure that it is being used to benefit the process of public audit and the general public.

I can see that there could be some beneficial use, which perhaps the Minister will set out for us. For example, we talked about barriers to entry in the market. Given the assurance of the framework in which auditors previously provided services to relevant authorities of the Audit Commission, and given that there have been two cases in which that assurance has been used in a helpful way, I assume, by auditors—I hope the Minister will tell us more about those two cases—this could be about removing barriers to entry, in which case, we would support it. It could even be about vexatious litigation, although I cannot see what party would bring forward such litigation because, under the clause as drafted, the limited liability agreement must be made properly between the relevant authority and the auditors. Therefore, I am unsure as to what party would challenge the way that the auditor carries out his role.

If reasonable explanations and clear evidence are provided and if we can get assurances about the way the Government will seek to limit the use of liability limitation agreements, that will be incredibly helpful. I hope that, on this occasion, however, the Minister will—I know that Governments tend not to like sunset clauses, but there appears to be, unless he can tell us differently, little evidence that the measure is necessary—feel confident enough to allow a sunset clause to be included in the Bill, so that the specific provisions in the clause can be renewed by statutory instrument in five years’ time if he is right that the measure is needed. If it is not needed, as we suspect may be the case, it will fall out of use.

Photo of Chris Williamson Chris Williamson Labour, Derby North

When the Minister responds, will he acknowledge that the clause, in my understanding, shows that the Government recognise that the market does not exist in some parts of the country? The clause is a means of stimulating the market. If that is the rationale behind it, it is important that he makes that clear as it suggests that a sunset clause would be appropriate in order to review the situation at some point and to take stock of how the provision is working.

Various aspersions have been cast on Opposition Members by some Government Members about our view of the present audit market. My hon. Friend the Member for Corby and I have corrected the record by saying that we are not casting any doubt on the existing professional auditing companies. Our concern is that the clause could result in ill-equipped companies taking on such business. It is not a question of turning a blind eye, as suggested by one Government Member earlier, but rather that, with the best will in the world, if an auditing company is inexperienced in auditing local authorities, that lack of expertise could result not in corners being cut or blind eyes being turned, but things simply being missed through lack of experience. We would not want to see an easyJet-style auditing system being introduced into the market. It would serve no purpose and would certainly not serve the council tax payers affected by such a company coming in to audit a local authority.

I hope that the Minister will clarify those points and will acknowledge that the recognition that the market does not exist in some parts of the country is the rationale behind the clause and that the clause seeks to stimulate the market. If that is not the reason, will he explain the clause’s purpose?

Photo of Brandon Lewis Brandon Lewis The Parliamentary Under-Secretary for Communities and Local Government

We debated under the previous clause—I am sure that the hon. Member for Derby North was listening, but he can always check Hansard—how the audit market is not restricted to the specific villages and towns where such companies work and how it is slightly more national than that and has been for some considerable time.

Amendment 118 would introduce a sunset clause to the provisions on liability limitation agreements. From what Members have said, I expect that the amendment builds on discussions in the other place, where if memory serves Lord Beecham spoke at length about such agreements. He raised questions about whether such agreements in the companies sector were in fact having  the desired policy effect, which is to reduce fees and help open up the market. He also pointed out the very limited take-up of such agreements by companies.

I understand that this amendment might be motivated by a desire to assess the impact and desirability of such agreements, and to take a view on clause 14 in that light, so it might help if I begin by clarifying the purpose and effect of clause 14, as Members have asked me to. I should explain to the Committee that it is not the effect or policy purpose of clause 14 to introduce or allow liability limitation agreements. It is already possible, quite aside from the Bill, for two parties to agree to limit their respective liability. The purpose of the clause, as with similar provisions in the Companies Act 2006, is to prevent any such agreements from unreasonably limiting auditors’ liability. It requires any liability limitation agreements to comply with regulations made by the Secretary of State. For example, as in the companies sector, we intend to provide that any agreement will be effective only as far as it is fair and reasonable.

Removing the clause, either now or through a proposed sunset provision, would do nothing to prevent an authority from entering into such an agreement with an auditor and would in fact mean that there were no safeguards or limits on such an agreement. Removing the clause would leave no protection on the extent to which auditors could limit their liability. I do not think for one moment that that is the intention of the hon. Member for Corby. Although it is reasonable for auditors to try to ensure that they are not held liable for losses beyond those for which they are directly responsible, I think we all agree that they should certainly be held responsible for any damages or liabilities for which they are properly responsible.

Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government) 10:15 am, 12th November 2013

My question is genuine, having listened to what the Minister has said. He suggested that if we removed clause 14, there would be no limit on the ability of an auditor to agree the limitation of liability. Could he tell the Committee how that would be lawful? The alternative interpretation is that it is clearly not lawful for an auditor to limit liability, but perhaps the Minister is saying that under the Companies Act, or some other provision, there would be under no restrictions on that. I think that is what the Minister is saying.

Photo of Brandon Lewis Brandon Lewis The Parliamentary Under-Secretary for Communities and Local Government

In effect, yes. The power is there for the two clients to make that kind of agreement, but this provision ensures that it stays within reasonable bounds—I hope to cover that in more detail in a second. The clause seeks to uphold the principle rather than undermine it, and therefore aims to achieve exactly what the hon. Gentleman is looking to achieve, from what he has said, and also what he wants to see in the market.

I also remind the Committee that it would be up to individual authorities to decide whether to enter into a limited liability agreement. They cannot be forced to do so, either by the Government or an audit firm. The Bill already requires authorities to seek advice from an independent auditor panel before entering into a liability limitation agreement. I hope the hon. Gentleman will be happy with those clarifications and feel able to withdraw the amendment.

Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government)

I thank the Minister for his response. We will withdraw the amendment at this point, although we consider a sunset clause to be a reasonable proposal and we might seek to raise the matter again on Report. I often ask the Minister to agree to undertake homework for the Committee. What I will do on this occasion is go away and seek to understand the point he makes, because if the sunset clause were adopted and the removal of limitations in five years’ time meant that we suddenly found there were no limitations on liability agreements in year 6—that is, because they were lawful—we would achieve precisely the reverse of what I wanted.

Photo of Brandon Lewis Brandon Lewis The Parliamentary Under-Secretary for Communities and Local Government

I understand the hon. Gentleman’s point. One thing I did not touch on was the two cases that he raised. If he will bear with me, I, too, will do some homework, in the spirit of joint ventures. We will try to get some information about the two cases he raised and pass it on to him.

Photo of Andy Sawford Andy Sawford Shadow Minister (Communities and Local Government)

I thank the Minister for that; it would be very helpful in understanding how and why this provision might be necessary in future. The point about the proposed five-year sunset provision is that if the clause were not used within five years, we might reasonably presume that it might not be used in future, but if in year 6 we found that we actually wanted these provisions in place, that would concern us all. However, on the basis of what has been a most helpful reply from the Minister, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 14 ordered to stand part of the Bill.