Auditor’s Liability1

SRIVATSAN.S

BC0150027

Introduction:

‘The auditor is a watchdog and not a bloodhound’. This phrase is a very conflicted phrase in
accordance with the modern company law. The companies Act, 2013 make the auditors a
bloodhound rather than a watchdog. In the default of such duties toward the company would
result in liability that the auditor would owe to the company. These liabilities that are stated in
the companies act only a minimal remedy to the victim. Hence the victim suffering last more
than the punishment that the wrongdoer receives.

This research paper would deal with the theories of liabilities that is stated by two different
jurist, having two different ideas about liability. John Finniss, one of the jurist talk about the
concept of liability in a natural law perspective and John Salmond, a positivist idea on what
and how a liability should be determined.

1. Legal system

A legal system is the community as a whole which obeys an authority morally and legally in
this case which is the law.

1.1. There is a legal obligation to obey the law, which imposes a legal liability within
each other of the community

Most laws are not so direct instead they create a stable society in which people have the
freedom and ability to pursue the basic goods. Before, It is aid that each person is free to
choose the specific details of how they achieve the basic goods – in the same way, the
authors of the law are free to choose the specifics of the legal system. As long as the legal
system is in service to the basic goods and in accordance with practical reason, it is a
morally ‘good’ legal system. Of course, some legal systems will be better than others. A
society deciding between legal systems is equivalent to an individual deciding between
conflicting moral decisions

1 P L Davies and S Worthington, Principles of Modern Company Law, 799-853(9th ed., 2014)
 Finnis also brings in the concept of “Unjust Laws”, in his view unjust laws are laws that
are morally wrong, but are legally valid. So, he states that these need not be followed
morally as they are morally flawed, but they have a legal obligation to be fulfilled, in
case of default they would be liable face the sanctions.

1.2. There is a moral obligation to obey the law, which imposes a moral liability within
each other of the community.

This phrase explains one part the theory stated by Finnis, where he states that it is an
obligation to act reasonably, in other words to act morally by engaging to a special
exercise of the divine will, whereby God commands that good be done and refrain from
doing the evil. But then a question arises on why the authorities will needs to be followed
by the inferiors will, which Finnis has also answered in his book with reference to the
Suarezian tradition , where he states that “ The grounding of ethical obligation in god’s
will become a prize specimen amongst conceptual fallacies collected for exhibition in
elementary philosophy books”

It is moral and a legal obligation for the auditors to visit the company to check on the
authenticity of the financial accounts that are being made. But certain auditors fail to follow
this provision and inform the company that they are coming on a check of their accounts. Hence
such default should be made liable.

2. Communities Liability

Many community are interlinked and form a society. This means that the working and
development these communities would result in the overall development of the society. And
the default of one community to another owes its liability to another. For instance, Assume
that the certain interest groups such as directors and auditors are communities and the
company as a whole is a society. Therefore the auditors when makes an audit report
fraudulently, they are supposed to be held liable looking into the intention of the auditor. In
reference with this concept of communities, John Finnis makes model of two society such
which is the perfect society and the imperfect society and their ways to achieve the common
good.
 2.1. Communities in a perfect society

According to Finnis a perfect society is when the authority or the law is made only in
accordance with the regulating and co-ordinating the community. The law doesn’t
provide any sanctions relating to the default of such laws. But looking into this flawed
idea of John Finnis, this is what according to him is society is supposed to be. But this is
only a hypothetical situation and will not be possible in a present society. In the society
of corporate world, it is impossible of it to exist because, there would be conflict of
interest within the communities. If the sanctions are not imposed these communities
would work for their own interest and will not be able to reach the common good.

2.2. Communities in an imperfect society.

Whereas, in the other more realistic model made by John Finnis, where there are certain
sanction that are needed to be fulfilled in case of default done by a community. This is
more appropriate to the present scenario because there are many wrongdoer, who don’t
default in fear of the sanction that are would be imposed on them. Looking into the
example stated above on the auditors and the director to give a report made on good faith
with no intention to harm the company or other interest groups of the company. In case
of default they will liable.2

3. Duty of care3

Carelessness is not culpable, or a means for a liability to be imposed, except in certain cases
where a person is required to certain amount of care. A duty of care in the corporate world
is the responsibility or the legal obligation of a person or organization to avoid acts or
omission to be likely to cause harm to others. The Duty of care owed by an auditor in
confirming a company’s financial statements correctly present its financial position.

3.1. Negligence

Negligence is a failure to use sufficient care, and this failure may result from variety of
factors. A negligent motorist for example may be carless in several different ways.
Through inadvertent he may fail to notice what is happening and what the probable

2
J. Finnis, Natural law and Natural Rights, 314-320 (2nd ed., 2011)
3 P J Fitzgerald, Salmond on Jurisprudence, 349-410 (12th ed., 2016)
 consequence of his conduct will be. In order to assess whether a man is guilty of
negligence, it must be looked into the seriousness of the danger to which his actions
expose other, to the degree of probability that the danger would occur and to the
importance of the object of the defendant’s own activity. In case of civil purposes the
law could take account of different degree of negligence. It could be provide that the
greater the compensation he must make to the plaintiff. Whenever a person is under a
duty to take any care at all, he is bound to take that amount of it which is deemed
reasonable under the circumstances; and such as absence of the care needed to be taken
would amount to culpable negligence

3.2. Due diligence

Due diligence is an investigation or audit of a potential investment to confirm all facts,

Firstly it must be noted that the possible standard of care that the law requires. The law
does not demand the highest degree of care of which human nature is capable. The law
demands not that which is possible, but that which is reasonable in view of the magnitude
of the risk.

It is the duty of the auditor to explain all the information stated in the auditor’s report, because
certain technical terms and concept will not be clear to a common man. Hence the auditor to a
company owes a duty of care to such people.

Conclusion:

4 Due Diligence, http://www.investopedia.com/terms/d/duediligence.asp, (last accessed; 29 April, 2017, 3:00

P.M.)
In the theory stated by John Finniss, in the natural law perspective. There is a moral obligation
firstly created to obey the law, and when this law is accepted as a whole, it creates a legal
obligation to obey the law. Finniss also states that the need of an authority for a community to
achieve a common good. The common good is a situation where each member of the
community can effectively pursue the basic good for themselves. The authority in the case of
Finniss theory is ‘law’, law helps in regulating and co-ordinating the community to reach the
common good. In order to reach the common good, the authority imposes certain liability over
the community such as the penal and remedial liability that is stated in the positivist perspective
by John Salmond in order to increase the deterrence of the community for the evil.

As the purpose of the authority is to make the community to reach the common good where
the community is deterred away from the evils, in order to look at in reality perspective, the
Companies act 2013, gives certain liabilities that are imposed on the auditors when the auditors
has failed to comply with the provision under the companies act such as S. 139, S.143, S.144

and S.145, they are fined for an amount that is not less than ₹25000 which might extent to

₹500000, the auditors would also be punishable with imprisonment for a term which extend to

1 year. The drawback to these provisions are that they don’t take into the account of the
intention of the auditors, thus it doesn’t fulfil the purpose of achieving the common good and
hence, the law or the authority needs to look into the intention and the damages caused to the
victims, this way the law would be made flexible, looking into the damages caused and the
compensatory value would be determined. Hence the damages would be equal to the
compensatory value.