Legal worries for auditors

The House of Lords is expected to decide this month whether to give the Audit Commission leave to appeal against a Court of Appeal decision that public sector auditors have a duty of care to the local authorities and NHS trusts they audit. Following that judgment, a breach of that duty appears to give rise to a right to a legal action for negligence.

The Court of Appeal's decision arose from a case involving West Wiltshire District Council, after the council received three critical district audit reports, which concluded that the council had exceeded its powers in giving contracts, without properly tendering them, to former staff who had set up computer software and property development companies with the approval of the authority.

West Wiltshire, encouraged by the district auditor, subsequently sought the recovery of money from eight former officers, including the treasurer. The officers claimed they were not liable because councillors had approved the action, district auditors had been aware of the action, and officers had relied on advice from the auditors. The court decided that district auditors did have a duty of care to the authority, but did not have a duty of care to the individual officers.

That judgment has not been welcomed by either the District Audit Service, which oversees external audits on behalf of the Audit Commission, or by the private sector auditors who undertake some district audits.

The local authority associations are less worried by the judgment. Martin Pilgrim, finance under-secretary at the Association of Metropolitan Authorities, says: "We wonder why local authorities should seek advice from the district auditor anyway, it is not their role. If it is a matter of law, then the local authority should seek its own legal advice, which may be different from the auditor's."

Local authorities, particularly smaller districts, have increasingly relied on advice from district auditors, in part to avoid having to pay for the opinion of counsel. Many authorities would regret it if they were no longer able informally to sound out the district auditor on the legality of a course of action before proposals were put to members.

Eddie Oliver, managing partner for infrastructure and government practice at KPMG, which undertakes district audit work, says: "As auditors we are well used to the legal liabilities that we carry, and our conceptual starting point is that there should be no conceptual difference between the private and public sectors. But there are lots of practical differences.

"Historically, the way auditors treat public sector clients is different from the way they treat private sector clients. They are franker in the public sector.

"If there was a change in the perception of our liabilities, the result would be to make us more cautious. That would not be helpful for anybody.

"In West Wiltshire, the officers were arguing that they had consulted the district auditor all the way along. If we felt that by doing so we became liable, we would be less likely to give advice."

John Layton of Price Waterhouse, who is on the Audit Commission's legal issues working party, says: "The auditor to a local authority has not had a duty of care to councils or people working for councils. The West Wiltshire case has caused this to be questioned. It is arguable that they do have a duty of care, except where they are acting in a quasi-judicial function. The courts will entertain such an argument if advice caused a loss to be incurred.

"We don't want to take any action worrying too much whether we may have litigation taken against us. I was very comfortable not having a duty of care. [District] auditors have very powerful powers available. They can stop decisions being made, can direct councils to obtain a judicial review, can take the view that action is unlawful, can ask courts to recover money from members and officers where there is wilful misconduct and loss.

"As a consequence, many councils do seek auditors' views when taking action, regardless of the legal advice obtained themselves, because auditors do often take a different legal view, and those views are sometimes supported by the courts - which emphasises the need to consult with an auditor in advance."

Mr Layton points out that Parliament gave district auditors powers to intervene, as distinct from just criticising subsequently, when councils were using so-called "creative accountancy" to avoid government spending controls. "Before then, we were always acting after the event; now we are acting before the event as well."

If the House of Lords does not overturn the West Wiltshire decision, several other councils will seek compensation from district auditors for losses incurred after taking their advice. Shelley Thornton, senior technical manager of Cipfa, the Chartered Institute of Public Finance and Accountancy, says: "It could open up a can of worms. There is the question of whether not having a duty of care to individual officers is overturned. That would be a significant extension of liability."

Some local authorities welcome the greater constraints that district auditors may now have to operate under. John Sinnott, chief executive of Leicestershire, says: "Anything that makes district auditors think of the consequences of their actions is welcomed. District auditors and the Audit Commission have become all too ready to criticise and to lose sight of their responsibilities. Perhaps we might also expect auditors to think of how in their duty of care they might help local authorities rather than hinder them."