Auditor professional indemnity claims sit at an unusual intersection. The auditor's duty is narrowly defined by Caparo Industries plc v Dickman [1990] 2 AC 605, which still governs to whom a duty is owed. Once a duty is established, the recoverable loss is now determined by the counterfactual scope-of-duty test set out in Manchester Building Society v Grant Thornton UK LLP [2021] UKSC 20. The interaction of those two tests shapes reserving on almost every audit PI claim in the current market.
Caparo remains the starting point. The House of Lords held that an auditor owes a duty to the shareholders as a body — not to individual investors making investment decisions, not to potential purchasers of the company, and not to lenders relying on the accounts for credit decisions unless a specific assumption of responsibility is made. The auditor's statutory function is to enable shareholders as a class to exercise their governance rights over the directors.
Many audit-negligence claims therefore fail at the threshold: a lender or acquirer relying on the audited accounts, without more, is not owed a duty. Where the claim comes from the audited company itself, or from its shareholders in a derivative capacity, the duty question is usually straightforward.
Once duty is established, Manchester Building Society governs the loss inquiry. The Supreme Court restated and refined BPE Solicitors v Hughes-Holland [2017] UKSC 21, replacing the older "advice versus information" dichotomy with a single scope-of-duty question. The court asks what risks the professional took responsibility for, then applies a counterfactual: would the loss claimed have occurred if the information given had been correct? If yes, the loss falls outside the scope of duty. If no, it is recoverable, subject to causation, remoteness, and the SAAMCO cap.
Manchester Building Society itself concerned an accountant's negligent advice on hedge accounting — Grant Thornton in an advisory rather than audit role — so its resonance for accountants and auditors is direct. The Court of Appeal in Assetco plc v Grant Thornton UK LLP [2020] EWCA Civ 1151 had already applied the reformulated test to a statutory audit and upheld substantial recoveries where the auditor's negligence had allowed the company to continue trading and to pay unlawful dividends.
Scenario one — undetected fraud and continued trading losses. An auditor fails to detect a material fraud. The company continues to trade for two or three further years, accumulating operating losses that would not have been incurred had the fraud been detected on schedule. Under the pre-2017 approach, the question was whether the audit constituted "advice" on whether to continue trading — it rarely did — so recovery was capped at the narrow information-error measure. Under the counterfactual approach, the question is what the company would have done had the audit been performed competently. If the answer is administration or an orderly wind-down at the earlier date, the continued-trading losses fall within the auditor's responsibility.
Scenario two — undetected misstatement and unlawful distributions. The auditor certifies accounts that overstate distributable reserves. Dividends are paid that would not have been lawful on the true figures, and the recipients cannot be pursued. Here the counterfactual is cleaner: but for the clean opinion, the distribution would not have been made. The loss maps directly onto the risk the auditor took responsibility for.
The following example is illustrative and not based on any specific claim. Suppose an auditor issues a clean opinion on the 2018 accounts of a mid-market trading company. In 2021, undetected accounting fraud comes to light. During 2019 and 2020 the company continued to trade and accumulated £8m of further operating losses that would not have been incurred had the fraud surfaced in 2018.
Under the older test, the analysis turned on whether the audit was "advice" on continued trading. It almost never was, so recoverable loss was capped at the narrow information-error measure — often a small figure. Under Manchester Building Society, the question is what the company would have done but for the clean opinion. If the evidence supports administration in 2018 as the realistic counterfactual, the £8m of continued-trading losses falls within the scope of the auditor's duty, subject to the legal-responsibility limit and to ordinary contributory-negligence and mitigation arguments.
The shift from information-error capping to counterfactual reasoning has changed how PI insurers reserve on audit claims. Reserves that once sat in the low six figures can now sit in the seven or eight figures. Insurers respond to notification by pressing hard for early counterfactual evidence — board minutes, contemporaneous management accounts, alternative-scenario modelling — because that evidence, or its absence, drives the reserving band.
Auditors should treat the counterfactual as the central factual question from the moment a circumstance is notified. Preserving the documents that show what the directors would realistically have done on a corrected set of accounts is now as important as preserving the audit file itself. For related context, see the wiki entry on advice versus information and the scope-of-duty test. For sector-specific PI arrangements, see the accountants' PI insurance guide, the solicitors' PI insurance guide, and the IFAs' PI insurance guide.
Apex Insurance Brokers Limited is authorised and regulated by the Financial Conduct Authority. Firm reference number 724952. This entry is general information, not advice on any particular policy.