the limited liability of contractors leaves banks and
Mind the gaps
The potential recovery gap created by the mandatory
limitation of liability under professional standards
legislation is causing headaches as banks and insurers debate
who should carry this exposure.
Although schemes providing for the limitation of
accountants' liability have been in place in some
jurisdictions (eg New South Wales) for some time, it is only
since early 2008 that most States and Territories have
implemented accountants' schemes under legislation
similar to the New South Wales Professional Standard Act 1994 .
Although subject to a variety of exclusions, in general such
schemes provide for a maximum cap of $75 million in respect of
auditor liability and $20 million for other exposures.
Importantly, the relevant legislation generally prohibits
contracting out. Therefore, sophisticated clients, such as
banks, remain beholden to such limitations in their dealings
While such schemes are obviously welcome to accountants, they
can create issues where clients face exposures in excess of the
cap, which are allegedly caused or contributed to by their
auditor/accountant. The client's ability to pass the
liability to the accountant whose act or omission has given
rise to the exposure will be limited by the liability cap. This
gap in recovery may be transferred to insurers where they have
fully indemnified the insured and seek to exercise rights of
subrogation against the relevant professional.
A question of prejudice
Liability policies commonly contain conditions restricting
the insured's ability to limit its rights against third
parties as this would prejudice the subrogated recovery rights
of the insurer. Although it is possible to negotiate the
removal of such conditions, if they remain an issue could arise
as to whether entering into terms of engagement with an
accountant whose liability is limited by a scheme constitutes
contractually limiting recovery rights thus prejudicing the
rights of the insurer.
Given the mandatory nature of such limits, it would be
difficult for an insurer to assert that the bank has created a
situation that would not have existed but for the operation of
the contract. Nevertheless, this issue remains untested and
could result in banks being unable to recover any amount in
excess of the applicable liability cap where the insurer
asserts that its rights have been prejudiced through the bank
limiting its rights. Even where this issue is addressed in the
policy and the insurer confirms that the limitation of
liability will not prejudice any insurance recovery, insurers
faced with potentially unrecoverable exposure may seek to
factor this exposure into premium calculations.
Aggregation issues may also arise regarding how the cap
applies where there are multiple claimants, given the cap
applies to each "cause of action".
Addressing the guts
As the insurance renewal season approaches, banks should
ensure that their insurers will not seek to assert any
prejudice arising from entering into mandatory limited
liability arrangements with their service providers. Where such
limitations are voluntary, the insurer's specific
consent may be required to avoid it asserting that the bank has
prejudiced the its subrogated recovery rights.
Otherwise, the bank may be carrying an unintended and
Contractors and principals should ensure they have appropriate insurance coverage instead of relying on indemnity clauses.
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