It sometimes happens in practice that auditors proceed to examine a company’s annual financial statement before they are formally selected by the competent authority of the company. Can this practice have negative consequences?
Under Art. 66(4) of Poland’s Accounting Act, the selection of the entity to review and examine the financial statement of a unit is made by the body that will approve the financial statement, unless otherwise provided by the unit’s statute or articles of association or other provisions applicable to the unit. The act also clearly states that the selection may not be made by the director of the unit (a term defined in Art. 3(1)(6) of the Accounting Act, depending on the legal form of the unit—in the case of a company, the management board).
But this is apparently not clear to everybody. Some companies have an unlawful provision in their articles of association indicating the management board as the competent authority for selection of the auditor to examine the company’s annual financial statement. But the purpose of examining the financial statement is to receive a report and written opinion from the auditor on whether the financial statement fairly and clearly presents the financial situation and results of the unit, in compliance with the Accounting Act and the adopted accounting policy. The objectivity of the examination could be affecting by permitting the director of the unit to select the auditor, as the director of the unit may have a personal interest in the outcome of the audit.
Accounting Act Art. 64 specifies the entities whose financial statements must always be audited and those which may be subject to audit if certain criteria are met, e.g. relating to the total assets, revenue, or number of employees.
The most typical example in practice is examination of the financial statement of a limited-liability company where the body authorised to approve the financial statements and to appoint the auditor is the shareholders’ meeting. In that case, the selection of the auditor is made by adopting a resolution indicating the entity which will examine the financial statement. However, it is up to the management board to conclude the actual contract with the auditor, as the entity hiring the auditor is the company (Accounting Act Art. 66(5)).
Audit without resolution
As mentioned in the introduction, it sometimes happens that the management board of the company signs a contract for examination of the financial report and the auditor proceeds to conduct the examination before a resolution appointing the auditor is adopted—typically in the case of companies regularly using the same auditors year after year.
It should be mentioned here that Art. 17 §1 of the Commercial Companies Code provides that if the code requires a resolution of the shareholders’ meeting or the supervisory board for a legal act to be performed, the legal act performed without the required resolution is invalid. However, Art. 17 §2 addresses the issue of consent to such an act.
Selective application of Art. 17 §1 only in instances where the code refers to a “resolution” (uchwała) by a body, and Art. 17 §§ 2 and 3 only with respect to “consent” (zgoda), under a literal interpretation, would defeat the clear legislative intent and lead to results contrary to the rationale behind this provision. Thus Art. 17 (particularly §§1–2) should be viewed as a whole and will also apply where the code or the company’s articles of association require consent to a specific action, or a resolution (A. Opalski (ed.), Commercial Companies Code, Warsaw 2016).
The selection of the auditor is made in the form of a resolution of the shareholders’ meeting, which also constitutes consent to the company’s conclusion of a contract with the auditor. For this reason, a contract made by the company with the auditor without a resolution of the shareholders’ meeting consenting to the company’s legal act is invalid under Art. 17 of the Commercial Companies Code. There is a possibility to ratify the act through subsequent adoption of the required resolution, within 2 months after the company concludes the contract, and in that case the resolution will be effective retroactively from the time the contract was concluded.
Improper selection of auditor = inability to pay out a dividend
In light of the foregoing, it should be indicated that if the resolution on selection of the auditor is not passed within the statutory period, the auditor will not be duly appointed, and under the Accounting Act, the examination of the company’s financial statement performed by the auditor will not constitute an audit of the annual financial statement for purposes of subsequent approval by the shareholders’ meeting.
This can lead in turn to further consequences. Under Art. 53(3) of the Accounting Act, distribution or coverage of the net result by units required under Art. 64(1) to have their annual financial statements audited may occur upon approval of the financial report by the relevant body, preceded by issuance of the auditor’s opinion on the financial statement, with or without reservations. Distribution or coverage of the net financial result without meeting this condition is invalid by operation of law.
If a dividend is paid out to the company’s shareholders on the basis of an invalid distribution of profit, it will constitute a payment contrary to law, with the consequences set forth in Art. 198 of the Commercial Companies Code. Shareholders who receive such a payment from the company will be required to refund it, and the members of the management board responsible for the payment will be jointly and severally liable for the refund, together with the shareholders.
It should be added that if an examination of the company’s financial statement is carried out by an auditor that has not been properly appointed, the company will also be required to incur the expense of commissioning another audit of the financial statement.
Łukasz Śliwiński, Marta Strykowska, M&A and Corporate practice, Wardyński & Partners