Best practice for limiting liability to clients

Accountancy firms often seek to limit their potential liability to their clients by including limitations or exclusions of liability in their engagement letters. While this is good risk management practice, it must be done carefully and effectively.

Restrictions or exclusions that go too far may unreasonably reduce liability – and if struck out, could leave liability unrestricted.

Caps on liability and other exclusions

The most common approach is to limit a firm’s liability in the engagement letter to a fixed amount (often described as a ‘cap’ on liability). Caps can be negotiated or non-negotiated, and may apply as aggregate limits upon liability, or may cap the amount of each separate breach or claim.

Alternatively, it is possible to seek to exclude liability for certain types of loss altogether. Common examples are:

• exclusion of liability for indirect or consequential loss and/or loss of profits
• exclusion of liability arising from use of defective or deficient information provided by the client
• exclusion of joint and several liabilities (also referred to as ‘proportionate liability’, ‘net liability’ or ‘net contribution’ clauses)
• exclusion of advice or services provided by third party advisers or specialists.

Firms may also seek to restrict or exclude certain types of liability that are also excluded under the firm’s professional indemnity (PI) policy, provided this is not inconsistent with the duties for which the firm is being engaged.

Determining fair and reasonable exclusions

In any negotiation, firms need to balance the importance of limiting liability against the risk of any limitation or exclusion being held to be unfair or unreasonable. Where that is the case, those limitations or exclusions may be considered unenforceable. This could leave firms with unrestricted liability, creating significant exposure to any potential claim.

Determining a fair and reasonable exclusion is dependent on circumstances. In deciding what negotiating position to adopt, firms should take into account the nature of the client, the appointment and remit and the overall commercial risk analysis.

Crucially, firms cannot seek to exclude liability entirely to the client. The Consumer Rights Act requires that firms do not limit liability below the value of their fees for a particular matter. This represents a good minimum standard for all client engagements.

Where firms seek to place a cap on liability, these should be proportionate to the nature of the transaction and potential client loss (in some cases, the loss may well be capable of being higher than a multiple of the fees charged). A cap on liability set at a higher level is more likely to be enforceable, and thus to protect a firm, than a very low cap.

Recommendations for firms

Firms should take their own legal advice on the drafting of any clause that purports to limit liability. However, the following principles may be of assistance:

• Draft a limitation or exclusion clause to capture any basis upon which a claim might be made, including breach of contract and negligence.
• Where a formula is to be used for determining a limitation of liability, the basis for calculation should be made clear.
• Avoid using a formula that may appear to be inherently arbitrary because, for example, it does not take account of the nature of the client or the engagement.
• Avoid seeking to exclude or limit liability for loss that cannot legally be excluded or limited, such as liability arising from a firm’s fraud or from FCA regulated activity.
• Where caps on liability are introduced, it should be made clear whether the cap is an aggregate limit on liability, or applies separately to each breach or each claim; where possible, the client should be given sufficient time to consider the matter and/or take legal advice.
• Set out terms containing limitations or exclusions in separate parts of the engagement letter so that any provisions that are subsequently considered to be unreasonable may be removed without affecting the enforceability or sense of the wording that remains.
• Document any negotiations concerning engagement terms and keep a record of them on the relevant file.

Ultimately, any limitation of liability agreed with the client should be set out clearly in the engagement letter. Where a firm’s engagement letter comprises the firm’s standard terms, together with a covering letter, it would be sensible to draw attention to any cap by referring to it in the covering letter.

Catherine Davis – ACCA Relationship Manager, Lockton

If you have any questions about professional indemnity insurance, please contact your Lockton Account Manager for further advice or email ACCAaccountants@uk.lockton.com.

Lockton is ACCA’s recommended broker for professional indemnity insurance

Additional resources

Download ACCA’s engagement letter templates.