Auditors’ liability suffered a significant setback late last year with the release of the Supreme Court of Canada’s decision in Deloitte & Touche v. Livent Inc. (Receiver of) (“Livent”)1. The effect of the Livent decision was to make Deloitte liable for the fraudulent mismanagement of Livent by its entire senior management, who acknowledged that they were attempting to fraudulently misrepresent matters to their own auditors, never mind the investors and creditors of Livent.

Fast forward to the release of the Ontario Court of Appeal’s decision in Lavender v. Miller Bernstein (“Lavender”),2 where the Court of Appeal recently applied the Supreme Court’s analysis of an auditor’s duty of care from Livent, yet concluded that the auditor, Miller Bernstein LLP (the “Auditor”), did not owe a duty of care to the plaintiff class of investors. The facts of Lavender are as follows.

Facts

The plaintiff class, represented by Barry Lavender, were investors in funds that were managed by the now defunct securities dealer, Buckingham Securities (“Buckingham”). Buckingham appropriated and used the unsegregated funds of the investors for its own purposes, and over $10 million was lost.

In 2001, the Ontario Securities Commission (“OSC”) suspended Buckingham’s registration and placed it into receivership on the basis that Buckingham had breached its regulatory requirements, including failing to segregate investor assets and maintain a minimum level of net free capital.

Under the statutory regime that existed at the relevant time, being the Ontario Securities Act,3 and the regulations thereunder (the “OSA”), a “Form 9 Report” had to be audited each year, and then filed with the OSC. These Form 9 Reports (“Form 9’s”), although prepared by Buckingham, were reviewed by the Auditor prior to filing. The Form 9’s represented that Buckingham segregated investor assets and maintained minimum levels of net free capital. This was false.

In 2005, a class action was filed against the Auditor on behalf of every person who had an investment account with Buckingham when Buckingham was placed into receivership (the “Class”). The Class alleged that the Auditor owed them a duty of care by virtue of the statutory scheme, being the OSA, and their involvement in auditing the Form 9’s.

The Decision of the Motions Judge

In 2010, the action was certified by consent on six common issues. In 2016, the Class made an application for summary judgment with respect to the first five common issues, which included the issue of the Auditor’s liability. The motions judge  granted summary judgment in favour of the Class on the question of the Auditor’s liability. Although his reasons were issued before the Supreme Court’s decision in Livent, the motions judge concluded among other things that:

  1. The Auditor owed a duty of care to the Class, under previously recognized legal analysis, to conduct an audit of Buckingham’s Form 9’s with the skill and care of a competent practitioner;
  2. The Auditor breached that duty of care;
  3. The Auditor’s breach of that duty caused damages to the Class.

The Decision of the Ontario Court of Appeal

On appeal, the Ontario Court of Appeal allowed the Auditor’s appeal and set aside the prior decision, finding that the Auditor did not owe the class members a duty of care. To reach this conclusion, the Court of Appeal was required to apply the Supreme Court’s duty of care analysis from Livent, being: (1) whether a duty of care exists initially; and (2) if so, whether there are residual policy considerations that justify denying liability.

This is the first appellate decision in Canada applying the Livent analysis to a claim of negligence against an auditor by investors. Importantly, the Court of Appeal in Lavender affirms a number of important principles flowing out of the prior caselaw and analysis:

  1. a clear distinction drawn between foreseeability and proximity;
  2. greater emphasis placed on a more demanding first stage of the test to determine whether or not a duty of care exists; and
  3. an acknowledgement that liability will rarely, if ever, be negated solely because of residual policy considerations after a properly applied proximity and foreseeability analysis.

The Court of Appeal found that the motions judge committed a legal error in failing to conduct a proper proximity analysis, and his finding that there was a relationship of proximity between the Auditor and the Class was unsupportable on the evidence. Further, the Court of Appeal found that the motions judge. stretched proximity beyond its permissible bounds. In support of this conclusion, the Court of Appeal held that:

  • The Auditor made no representations to members of the Class, most of whom never even knew of the Auditor’s existence or its involvement with Buckingham;
  • The Auditor did not undertake to assist the Class in making investment decisions;
  • There was a complete absence of reliance on the part of the Class;
  • The motions judge made palpable and overriding errors of fact in respect of the Auditor’s responsibility to file the Form 9 Reports (they were not obliged to file the Form 9’s), and their access to the names and accounts of each Class member (they had none);
  • The statutory scheme was not sufficient to ground a relationship of proximity;
  • The Class was seeking damages for pure economic loss, and that claim warranted more rigorous examination than other claims for negligence.

For these reasons, the Court of Appeal found that the claim against the Auditor failed at the first stage of the duty of care analysis as there was no proximity between the Auditor and the Class. It was therefore unnecessary for the Court of Appeal to consider question of reasonable foreseeability or whether any residual policy concerns negated the duty of care.

Conclusion

The Lavender decision is a positive development in the law for defendant auditors. Even with the application of the Supreme Court’s decision in Livent, the Auditor was held not to owe a duty of care to Buckingham’s investors. This, notwithstanding that Buckingham required an annual statutory audit and required the Auditor to audit the Form 9’s which contained the misrepresentations of Buckingham.

The Court of Appeal’s decision in Lavender provides welcome guidance on the scope of an auditor’s duty of care and confirms the high threshold for establishing liability against auditors for claims of pure economic loss by investors.

Footnote

1 2017 2 SCR 855, 2017 SCC 63

2 2018 ONCA 729

3 RSO 1990, c S.5

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