Professional liability: formula sheet

Key formulas

Four elements of negligence

Duty of care + Breach + Causation + Recognised loss = Negligence

The claimant must prove all four. If one fails, the claim fails.

Caparo three-part test

Foreseeability + Proximity + Fair, just and reasonable

Used to decide whether a duty is owed to a third party. Foreseeability alone is not enough.

Standard of care

Standard = a reasonably competent auditor, with ISA compliance as the key benchmark

Non-compliance with ISAs is strong evidence of breach, not automatic proof.

Causation test

But for the breach, would the loss have occurred?

If yes, the breach did not cause the loss.

Burden of proof

Claimant proves negligence on the balance of probabilities

This is the civil standard, lower than the criminal standard.

Elements of negligence

Duty of care + Breach + Causation + Loss = Negligence claim

All four must be shown. A third party usually fails at the duty stage.

Caparo three-stage test

Foreseeability of harm + Proximity + Fair, just and reasonable to impose a duty

A general framework, not a universal test. For audits, the key question is the purpose of the report: did the auditor know it would be used by this party for this purpose?

Hedley Byrne special relationship

Skill/knowledge + Known reliance for a known purpose + Reasonable reliance = Duty for negligent statements

The adviser must assume responsibility for the advice.

Contract v tort

Contract: client only, based on the engagement terms. Tort: any party who can prove a duty.

Third parties have no contract with the auditor, so they must use tort.

Joint and several liability

Claimant can recover 100% of the loss from any one liable party

The auditor bears the risk that other parties cannot pay.

Proportionate liability

Auditor pays = total loss × auditor's percentage of responsibility

The court apportions responsibility among all those at fault. Local law decides if it applies.

Liability cap

Auditor pays = lower of (actual loss attributable to the auditor, agreed cap)

Applies only to the contracting client, and only where the law permits caps.

Elements of a negligence claim

Duty of care + Breach of duty + Loss caused by the breach (causation)

The claimant must prove all three. A firm's defence often attacks one of them.

Risk management cycle for a firm

Prevent (acceptance, quality management) → Respond (complaints, claims) → Transfer (PII insurance)

Use this as the structure of a written answer.

Audit assurance level

Audit = reasonable assurance, not absolute assurance

This is the core point when explaining the expectation gap.

Insurance claim position

Insurer payout = covered loss and defence costs − excess, subject to policy limit and exclusions

Use only if the question gives figures. Payout cannot exceed the limit.

Quick revision

• Negligence needs a duty of care, a breach, causation and loss.
• The standard is that of a reasonably competent auditor, judged against ISAs and professional standards.
• Compliance with ISAs is strong evidence of care but not a complete defence.
• The client is owed a duty under the engagement terms.
• Third-party duty depends on foreseeability, knowledge of the purpose and local law.
• Say clearly that the law differs between jurisdictions and avoid stating one rule as universal.
• Limitation tools include engagement letter terms, liability caps and disclaimers, and each has legal limits.
• Contributory negligence by the client may reduce damages.
• Good documentation is the best evidence of the work done.
• Quality management, review and consultation reduce the chance of a claim.
• Professional indemnity insurance covers claims but not unlimited loss, and excesses and exclusions apply.
• Always end with a specific recommendation tied to the scenario.

Common mistakes

• Saying the auditor owes a duty of care to everyone who reads the accounts. Fix: Apply all three Caparo parts. Say that proximity and fairness usually limit duty to third parties.
• Treating any misstatement not found as proof of negligence. Fix: Ask whether a reasonably competent auditor following ISAs would have found it. Refer to the actual procedures performed.
• Saying auditors are liable to anyone who relies on the accounts. Fix: Always apply the full Caparo test and ask what the report was for.
• Treating Caparo as meaning auditors never owe a duty to third parties. Fix: Say it is narrow, not absent. Duty can arise where the auditor knows of a specific use and the claimant is identified, as in ADT v BDO.
• Saying a liability cap protects the firm against all claimants. Fix: State that it binds only the client who signed it. Third parties are not covered.
• Saying an LLP removes all personal liability for partners. Fix: Say it protects innocent partners' personal assets. The negligent partner and the firm's assets remain exposed.
• Saying PII removes the need for quality control. Fix: State that PII only transfers financial loss. Quality management prevents the claim and protects reputation.
• Listing generic points without using the scenario. Fix: Quote scenario facts and say why each one matters, such as missing review evidence on a high-risk client.

Exam tips

• Show the four elements as separate points. Examiners award marks for each element, so a clear structure protects your marks.
• For third-party claims, spend most of your effort on duty of care. That is where the discussion marks usually are.
• Link each breach to a specific ISA principle and a fact in the scenario. Generic standards without application earn little.
• Be balanced. Offer the claimant's argument and the auditor's defence, then reach a conclusion. This earns professional skills marks for analysis and judgement.
• When advising the firm, add practical steps: documentation, engagement letter wording, liability limitation and insurance.
• Always state first that third parties sue in tort because they have no contract. It earns an easy mark.
• Link each case to a fact in the scenario. A name with no application earns little.
• Look for facts signalling knowledge of use: meetings, letters, comfort given, the auditor being told the purpose.