Accountants can be   liable to Law Society
Law Society v KPMG Peat Marwick and Others

 Before Lord Woolf, Lord Chief Justice, Lord
 Justice Ward and Lord Justice Clarke

 Judgment on June 29, 2000 (reported in The Times, 6 July 2000)

 Accountants who prepared reports on  solicitors' accounts, which assisted the Law Society in deciding whether to exercise its  powers of intervention in solicitors' practices, owed a duty of care to the Law Society, as  trustee of the compensation fund, and could be liable in damages for payments made from the fund as a result of their negligence.

 The Court of Appeal so held in a reserved judgment dismissing the appeal of the defendants, KPMG Peat Marwick, Stephen Ingleby Cawley and Neil Spencer Chapman, against the decision of Sir Richard Scott, Vice-Chancellor, in the Chancery Division (The Times November 3, 1999; [2000] 1 All  ER 515) on a preliminary issue declaring that they had owed a duty of care to the claimants, the Law Society, as trustees of the compensation fund, in preparing reports on the accounts of Durnford Ford, a firm of solicitors.

 Mr Gordon Pollock, QC and Mr Rhodri Davies, QC, for the defendants; Lord Goldsmith, QC and Mr Matthew Collings for the Law Society.

 THE LORD CHIEF JUSTICE said that under the Solicitors Act 1974, the Law Society and its council were responsible for the regulation of the solicitors' profession.

 The Act required the Law Society to maintain and administer the compensation fund.

 The purposes for which grants were made from the compensation fund included grants to  relieve loss or hardship suffered in consequence of dishonesty on the part of a solicitor, in connection with that solicitor's  practice.

 In general, section 34 of the Act required every solicitor to deliver to the Law Society a report
 signed by an accountant unless the council was satisfied that it was unnecessary for him to
 do so.

 The report had to contain the information prescribed by rules made by the council and
 the accountant was required to indicate whether he was satisfied that during the period
 to which the report related, the solicitor had complied with the rules.

 The preliminary issue had arisen in proceedings relating to the collapse of a firm
 of solicitors called Durnford Ford. KPMG had been retained by Durnford Ford to prepare
 their annual reports.

 The report for the year ending May 31, 1989 was prepared by Mr Cawley and the report for
 the year ending May 31, 1990 was prepared by Mr Chapman. The reports had been sent by
 the defendants to the Law Society. The fees of  KPMG had been paid by Durnford Ford.

 On May 6, 1992, the Law Society had commenced an investigation into Durnford Ford. On May 31, 1992, the firm had stopped practice. It was then found that Graham Durnford Ford, the senior partner, together with another partner, Digby Bew, had defrauded a number of the firm's clients.

 As a result, some 300 clients of the firm had made claims on the compensation fund and
 substantial payments, amounting to some £8.5 million, were paid out of the fund.

 As trustee of the compensation fund, the Law Society had commenced proceedings against
 the defendants. The Law Society alleged that:  (i) KPMG, when preparing the accountant's
 reports for the years 1989 and 1990, were negligent and acted in breach of the duty of care which they owed to the Law Society when examining the books and accounts and other records of Durnford Ford for the years 1989 and 1990; and  (ii) if KPMG had qualified the report as they
 should have done, the Law Society would have exercised its statutory power of intervention and thus put to an end the dishonesty of Mr Ford and Mr Bew which would have reduced the amount which was paid out by the compensation fund.

 Mr Ford and Mr Bew were prosecuted and convicted of a number of counts of theft arising out of the misappropriations.

 The defendants denied that they were negligent. They disputed that there was any causative connection between the alleged negligence and payments made out of the compensation fund. They also denied that they owed any duty of care to the Law Society in its capacity as trustee of the compensation fund.

 In his judgment, the Vice-Chancellor had applied the three criteria which had to be met for there to be a duty of care identified by Lord Bridge of Harwich in Caparo Industries plc v Dickman ([1990] 2 AC 605, 617-618), namely: reasonable foreseeability of damage; a relationship of sufficient proximity between the party owing the duty and the party to whom it was owed; and that the imposition of a duty of care was just and reasonable in all the circumstances.

 The Vice-Chancellor had also referred to the passage in the speech of Lord Oliver of Aylmerton in Caparo (at p638), where he listed the circumstances which should exist in order to establish the necessary relationship of  proximity between the person claiming to be owed the duty and the adviser.

 The Vice-Chancellor had concluded that each of those requirements was fulfilled in the present case, at least for the purposes of deciding the preliminary issue but he recognised, however, that "the chain of causation linking the want of due care to the claims on the compensation fund might have been broken".

 The Vice-Chancellor accepted that there had to be an appropriate control mechanism limiting the recoverable economic damage. He identified two limiting factors:  (i) the liability would be restricted to payments to the solicitor's clients whose money had been wrongly misappropriated from the client's accounts; and  (ii) the consequences of the negligent preparation of the report would, for the purposes of tortious recovery, be spent within a relatively short time by the receipt by the Law Society of the following year's report.

 The Law Society had submitted that it was obvious that the accountants owed a duty of care. It was a very plain case falling within the categories of situation identified by Lord Devlin in Hedley Byrne & Co Ltd v Heller & Partners Ltd ([1964] 465, 528-529) where the situation was equivalent to contract.

 His Lordship would not regard it as self-evident that a duty was owed. The Law Society, whether acting directly or through the council, had a number of distinct functions.

 It was possible for a duty of care to be owed in relation to one of the functions of the Law
 Society and not in relation to other functions.

 The correct approach was to examine the question of whether the accountants owed a duty of care to the Law Society in relation to its responsibilities to protect the compensation fund against the well established test laid down in Caparo.

 In considering whether a duty of care existed as a matter of private law, no distinction could be drawn between the council and the Law Society. The council was no more than the executive arm of the Law Society.

As the issue here was whether any duty was owed to the Law Society as trustee of the compensation fund, it was on the Law Society and its role in relation to the compensation fund which it was necessary to concentrate.

 The intervention by the Law Society, which an adverse report could trigger, protected both
 the public and the compensation fund.

 The information available to the accountants made it clear that the reports were required so that protective steps could be taken. It was obvious that if protective action was not taken because a report did not draw attention to non-compliance with the account rules, that could have adverse consequences on the fund.

 It could well be correct, as the defendants had submitted, that those situations where a duty of care to protect against economic loss had been previously held to exist were all concerned with a potential commercial transaction, but no difference in principle arose because it was here regulatory action which the Law Society would have taken.

 The threefold approach identified by Lord Bridge in Caparo could still be readily applied to the present situation and when it was applied, it could be readily seen that the requirements were fulfilled.

 No difficulty arose from the fact that, if the Law Society intervened, it would be exercising a regulatory or public law activity whereas the duty which was owed to the Law Society was a private law duty.

 There was no reason why there should not be a private law duty owed to the Law Society, the performance of which would assist it to perform its public duty.

 The important point here was that, if the duty existed, it was owed to the Law Society in its
 capacity as trustee of the fund. It was in that capacity that the damages would be recovered so that they could be used to reimburse the fund for the sums which it had had to pay out due to the negligence of the auditors.

 The final argument advanced by the defendants was that no useful purpose would be achieved in creating a right of action in favour of the compensation fund against the accountants. As the fund was financed by the solicitors' profession, all that would be achieved by establishing a duty would be to transfer a clearly established liability of the solicitors' profession to a liability of the
 accountants' profession.

 Furthermore, the existence of liability would often be difficult to establish without expensive
 litigation. They contended that it was the policy of Parliament in setting up the fund that the loss should be borne by the solicitors' profession as a whole.

 In his Lordship's judgment, it had to be accepted that whenever the courts established that a duty of care arose for the first time, that could lead to litigation.

 However, if it was fair, just and reasonable that the accountants should be liable for the loss to
 the fund then such consequences had to be  accepted.

 It was surely for the Law Society in the context of any particular case to decide whether it wished to take the risks that litigation inevitably involved. If it did so, assuming that the auditors were responsible for the loss, it was not for the auditors to complain about the expense involved.

 If there was a liability it was always open to the auditors to limit any liability for costs by
 accepting the appropriate responsibility for their lack of care.

 It was also open to them to make it clear that they disclaimed responsibility for any lack of care in the preparation of the audit. That might, however, not be acceptable to the Law Society.

 His Lordship had come to the same conclusions as the Vice-Chancellor and would dismiss the appeal.

 Lord Justice Ward and Lord Justice Clarke agreed.

 Solicitors: Herbert Smith; Wright Son &