A company can limit the amount of its auditor’s liability only through a liability limitation agreement under sections 534 to 536 of the Companies Act 2006. The agreement can cover just one financial year, must be authorised by the members by resolution, and can never cut the auditor’s liability below what a court considers fair and reasonable under section 537.

Why can a company not simply cap its auditor’s liability in the engagement letter?

Section 532 of the Companies Act 2006 makes void any provision that exempts an auditor, to any extent, from liability for negligence, default, breach of duty or breach of trust in relation to the company occurring in the course of the audit of accounts. It also catches any provision by which the company directly or indirectly indemnifies its auditor, or the auditor of an associated company, against that kind of liability. It does not help to put the clause in the articles or a side letter: section 532(3) applies whether the provision is in the articles, in a contract with the company or anywhere else.

There are only two exceptions. Section 533 lets a company indemnify the auditor for the costs of defending proceedings where judgment is given in the auditor’s favour or the auditor is acquitted, or where the court grants relief under section 1157. The second exception is a liability limitation agreement that meets sections 534 to 536. The general rules on capping liability for other accountancy work are covered in our guide to limiting liability in engagement letters; this page deals only with the statutory route for audits.

What is a liability limitation agreement?

Section 534(1) defines it as an agreement that purports to limit the amount of a liability owed to a company by its auditor in respect of negligence, default, breach of duty or breach of trust occurring in the course of the audit of accounts. Two points follow from that wording.

  • It limits the amount, not the existence, of liability. The auditor is still liable; the agreement sets a ceiling or a method for fixing the figure.
  • It governs claims by the company only. ICAEW’s helpsheet on these agreements points out that they do not address claims by third parties such as lenders or investors, which depend on whether the auditor owed them a duty of care at all.

An agreement that complies with the rules is also taken outside the reasonableness controls of the Unfair Contract Terms Act 1977. Section 534(3) disapplies section 2(2) and section 3(2)(a) of that Act in England, Wales and Northern Ireland, and the equivalent sections 16(1)(b) and 17(1)(a) in Scotland. The statutory fair and reasonable test in section 537 takes their place.

What terms must the agreement contain?

Section 535(1) sets two firm conditions. The agreement must not apply to acts or omissions in the course of the audit of accounts for more than one financial year, and it must specify the financial year to which it applies. A single agreement covering three years of audits is therefore not possible; a fresh agreement and a fresh authorisation are needed each year.

Beyond that, section 535(4) says it is immaterial how the agreement is framed, and the limit need not be a sum of money or a formula specified in the agreement. ICAEW gives three common approaches:

  • proportionality, where the auditor pays only the share of the loss that reflects its own responsibility;
  • a fixed monetary cap; or
  • a cap linked to a formula, such as a multiple of the audit fee.

The FRC has published Guidance on Auditor Liability Limitation Agreements, aimed at directors, which explains what an agreement should cover, provides specimen clauses and sets out the approval process. ICAEW notes that the FRC guidance records the view of a number of institutional shareholders that they would be likely to approve only agreements based on proportionality. For a listed company, a proportionate clause is therefore the realistic starting point.

How do the members authorise the agreement?

Section 536 sets out the routes, and they differ between private and public companies. The principal terms of an agreement are those specifying, or relevant to determining, the kinds of acts or omissions covered, the financial year concerned and the limit on the auditor’s liability (section 536(4)).

Company type Before the agreement is made After the agreement is made
Private company A resolution waiving the need for approval, or a resolution approving the principal terms A resolution approving the agreement
Public company A resolution in general meeting approving the principal terms A resolution in general meeting approving the agreement

Section 536 does not specify the type of resolution, so under section 281(3) an ordinary resolution is enough unless the articles require a higher majority or unanimity. A private company can pass it as a written resolution, as section 281(1) allows, and ICAEW confirms that the annual member approval can be given this way. The waiver route is only open to private companies and is the lightest touch, but it still has to be passed before the agreement is signed.

Can the members change their minds?

Yes, within limits. Under section 536(5) the company may withdraw its authorisation by ordinary resolution at any time before it enters into the agreement or, once the agreement has been made, before the start of the financial year to which it relates. That right applies whatever the agreement itself says. Once the financial year has begun, the authorisation can no longer be withdrawn under this section.

How does the fair and reasonable floor work?

Section 537 is the main safeguard. An agreement cannot limit the auditor’s liability to less than the amount that is fair and reasonable in all the circumstances, having regard in particular to the auditor’s responsibilities under Part 16 of the Act, the nature and purpose of the auditor’s contractual obligations to the company, and the professional standards expected of the auditor.

If the agreement sets a lower limit, it does not fail altogether. Section 537(2) says it takes effect as if it limited liability to the fair and reasonable amount. In deciding what is fair and reasonable, the court must ignore anything arising after the loss was incurred and anything affecting the chances of recovering compensation from other people liable for the same loss (section 537(3)). That last rule stops an auditor arguing that its share should be smaller simply because another wrongdoer is insolvent or hard to pursue.

What must the company disclose?

Section 538 lets the Secretary of State require disclosure, and regulation 8 of the Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) Regulations 2008 (SI 2008/489) does so. A company that has entered into an agreement must disclose in a note to its annual accounts:

  • the principal terms of the agreement; and
  • the date of the resolution approving the agreement or its principal terms or, for a private company, the date of the resolution waiving the need for approval.

The note goes in the accounts for the financial year the agreement covers. If the agreement was made too late for that to be reasonably practicable, the disclosure goes in the next following annual accounts instead (regulation 8(2) and (3)).

How might an agreement look in practice?

Illustration only. A private trading company with a 31 December year end appoints a new audit firm in March 2026. The firm proposes an agreement covering the audit of the year ending 31 December 2026, under which its liability to the company is limited to the share of any loss that a court finds just and equitable having regard to its responsibility for it.

  1. The directors circulate a written resolution approving the principal terms: the kinds of acts and omissions covered, the 2026 financial year, and the proportionate basis of the limit.
  2. The members pass it as an ordinary written resolution, and the agreement is then signed alongside the engagement letter.
  3. The 2026 accounts include a note giving the principal terms and the date of the resolution.
  4. In 2027 the process is repeated for the 2027 audit, because the 2026 agreement cannot stretch into a second year.

If a misstatement caused by a fraud later costs the company money and the court finds the auditor 20% responsible, the company recovers that share from the auditor, provided the court regards it as no less than fair and reasonable under section 537.

What mistakes come up most often?

  • Treating the agreement as a standing term of the engagement letter. It must be limited to one specified financial year and authorised again for each audit.
  • Signing first and forgetting the members. Without authorisation under section 536 the agreement falls back under section 532 and is void.
  • Omitting the accounts note required by regulation 8, which leaves the accounts incomplete when the directors come to approve and sign them.
  • Assuming the cap protects against lender or investor claims. It covers liability to the company only.
  • Directors recommending an agreement without giving members enough information. ICAEW’s legal opinion indicates that directors who put the information needed for an informed decision before the members should not, by that alone, increase their own liability, but they should still weigh fairness, alternative terms and the cost of changing auditors.

An agreement does not change the auditor’s duties or independence obligations, which continue under the FRC Ethical Standard, and it has no effect on the rules for appointing and removing auditors.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.