The Court of Appeal has recently considered whether accountants who reported to the Law Society on the accounts of a firm of solicitors, in accordance with the requirements of the Solicitors Act 1974, owed a duty of care to the Law Society in its capacity as the regulator of solicitors and as trustee of the Compensation Fund.

Accountancy firm KPMG prepared the annual reports on the accounts of Durnford Ford, a solicitors' firm in East Sussex. Such reports were intended to alert the Law Society to possible improprieties, which would enable it to intervene early and protect the fund that it maintains.

In 1992 the Law Society discovered that the senior partner and a junior partner had defrauded some clients, who then made claims on the compensation fund and received payments totalling £8.5m. The Law Society sued KPMG for negligence in respect of its reports on the 1989, 1990 and 1991 accounts. A preliminary issue was ordered to establish whether KPMG owed a duty of care to the Law Society as trustee of the fund and in respect of those payments made by the fund.

The Vice Chancellor, Sir Richard Scott, applied criteria identified by Lord Bridge in Caparo Plc v. Dickman [1990] 2 AC 605 at 617-619: reasonable foreseeability of damage; sufficient "proximity" between the party owing the duty and the party to whom it is owed; and imposition of the duty of care, which would be reasonable in all the circumstances.

The Vice Chancellor concluded that each requirement was met but recognised that "the chain linking the want of due care to the claims on the compensation fund may have been broken". The Vice Chancellor also accepted that there had to be an appropriate control mechanism limiting the recoverable economic damage:

the liability will be restricted to payments to solicitors' clients whose money had been wrongly misappropriated;

lthe consequences of the report would be spent by the time the Law Society received the following year's report.

The Law Society said KPMG owed a duty of care. The Court of Appeal accepted that as KPMG had submitted, it was possible for a duty of care to be owed in relation to one of the functions of the Law Society. Lord Woolf said it did not always follow that because a duty was owed by an accountant preparing a report to the Law Society as regulator, another duty was also owed to the Law Society as trustee, particularly where one is a public law function and the other a private law function.

KPMG said there were two transactions between any allegations by them and the losses suffered by the Fund: the deposit by the client of his money with the solicitor and the Law Society's decision to meet the claims made by the clients on the fund. KPMG argued that neither transaction came within the Caparo test. Woolf dismissed this because the issue was not whether any duty was owed by KPMG to the solicitor's clients but to the Law Society as trustee of the fund. Lord Woolf also rejected the contention that because intervention by the Law Society was the exercise of a public law duty, no private law duty could be owed to the Law Society.

KPMG also argued that if a duty of care was found, no useful purpose would be achieved in doing so because that would transfer a liability of solicitors to accountants. However, the Court of Appeal found that if it is reasonable that accountants should be liable, it would be wrong to deny the fund the right of recovery against them, especially if it is open to accountants to limit or disclaim their liability.

The Court of Appeal rejected submissions that it was unfair for the fund to be in a better position than, say, the Solicitors' Indemnity Fund (SIF) exercising its rights of subrogation when defences of contributory negligence by the solicitors might be available to accountants.

Finally, the Court of Appeal considered whether control mechanisms relied upon by the Vice Chancellor did provide enough protection for reporting accountants. It indicated that there might be an argument that the scale of the losses is beyond anything that the accountants could have reasonably foreseen.

Subject to any application to the House of Lords, this case firmly establishes that a duty of care is owed by accountants reporting under the Law Society Act. An analogous duty seems likely to extend to other regulatory bodies where a similar compensation structure exists. There are a few crumbs of comfort.

There is nothing in the Solicitors Act 1974 that prevents accountants from seeking to disclaim or limit their liability to solicitors or to the Law Society in respect of their reports.

The Court of Appeal specifically left open the issue of contributory negligence by the Law Society and there might be cases where its failure to intervene promptly cannot be blamed on accountants. There might be cases where the scale of the losses is so unforeseeable as to limit the damages recoverable from accountants, but the Court of Appeal has not given any examples.

Stuart Hall is a partner and Jane Scott is an assistant solicitor in the professional liability and commercial litigation department at Barlow Lyde & Gilbert.