The Link Between Economic Crisis and Financial Fraud
Common intuition about human behaviour in desperate times is confirmed by research which shows that levels of fraud typically increase during economic crises or downturns, including fraud committed by companies’ employees or officers. Andrew Flynn, associate, and Sinead O’Callaghan, partner at legal practice Cooke Young and Keidan write
The impact of the global financial crisis on levels of fraud committed generally has been documented, and it seems only reasonable to assume that similar phenomena will be observed during the current pandemic and its economic fallout.
Some company directors may become increasingly desperate to either shed problematic parts of the business or secure much-needed cash injections. In doing so, they may take things too far in terms of how they present the company financially and/or the company’s prospects going forward to prospective buyers or bidders.
As is often the case during troubled economic times, such directors may not ordinarily have acted dishonestly, and may often rationalise their behaviour as ‘bending the rules’ to survive, perhaps believing they are truly acting in the best interests of their fundamentally sound company. If this scenario comes to pass, we can expect in due course to see an increase in litigation related to business sales focused on fraud and misrepresentation as well as warranty and other contractual claims.
Professional advisers need to be especially vigilant during such fraught times to ensure that they are not inadvertently caught up in such wrongdoing, and risk facing being held financially liable for some of the losses.
Leaving aside intentional wrongdoing by professionals, claimants frequently look at whether they are able to pursue professional negligence claims against their accountants and auditors, given that they are generally considered to be ‘deep pocket’ defendants with the benefit of insurance cover – although fraud is often excluded from such cover.
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By GlobalDataProfessional advisers are no doubt very aware of the risk of being found culpable in respect of such claims if they have acted negligently and failed to take reasonable care in discharging their professional duties. The law is more deferential to professionals than others in determining whether they have been negligent; speaking very broadly, it is necessary to show that the particular professional has made an error which no reasonable member of the profession would have made in the circumstances. However, whether an accountant was negligent in failing to spot and flag any particular accounting misstatements will almost always be a highly fact-sensitive question, and likely subject to expert evidence in any litigation or arbitration. So too will the question as to what proportion or type of the claimant’s losses the accountant can fairly be held responsible for.
Documented disclaimers
The best way for professionals to try to mitigate such risk is using clearly drafted disclaimers in their documentation. It is, of course, common practice to expressly disclaim any responsibility to third parties; the standard ICAEW language seeking to achieve this in statutory audit reports has been held to be effective by the English courts.
Naturally, if the accountant performing due diligence has the prospective purchaser as its client, it will probably be unable to do this in practice, although it can of course seek to restrict the amount and types of losses that would be recoverable in its engagement documentation, provided that in the particular circumstances these limitations of liability do not fall foul of the Unfair Contract Terms Act 1977.
In terms of ensuring the professional duties, to whomever they are owed, have been adequately discharged, it is largely a matter for the accountancy profession to determine what can be reasonably expected. Care should be taken in the engagement documentation to clearly define and limit the scope of the accountant’s work if appropriate e.g. is the accountant to merely sense-check the financial documentation provided or does this extend to statements made by the directors as to the company’s likely future performance? Is the accountant expected to proactively request further information or documentation as it thinks necessary to reach an opinion on the company’s assets and liabilities, which may not all be captured in the financial statements?
Any lawyer with expertise in this area will tell you that every case is unique and outcomes can be hard to predict, with different evidence, witness dynamics and contexts. As a professional adviser, the best way to protect yourself is to keep your professional distance and have your role clearly set out in the relevant documentation with appropriate exclusion and limitation of liability provisions.
If in doubt, it is always worth investing in specialised advice on the drafting of these terms to maximise their effectiveness in any subsequent litigation or arbitration.