Auditors’ liability remains indeterminate after appeal court decision

By Margaret L. Waddell • Whether an auditor owes a duty of care to the lenders of a company it audits remains an open question after the Ontario Court of Appeal (OCA) overturned the summary judgment decision of Justice Paul M. Perell in CIBC v. Deloitte & Touche, 2016 ONCA 922.

On the summary judgment motion, Justice Perell dismissed the negligent misrepresentation claim brought by Philips Services Corp.’s lenders against the company’s auditor, Deloitte. He found that the auditors did not owe a duty of care to the lenders, finding that the spectre of indeterminate liability to an indeterminate class negated the prima facie duty of care that would otherwise exist, based upon the second stage of the Anns/Cooper test.

Court of Appeal disagreed

The Court of Appeal disagreed with the motion judge’s approach, leaving it to the trial judge to determine the duty of care taking into consideration the extent of Deloitte’s knowledge of the uses to which its audit would be put, based upon the complete factual matrix.

In this case, the lenders under a $1.5 billion credit facility brought a class proceeding against Philips’ auditors, Deloitte & Touche, alleging negligent and reckless misrepresentation after an accounting fraud at Philips was discovered in 1998.

The lenders alleged that they had relied upon Deloitte’s clean audit of the company in 1996 in advancing the loan. They pleaded that Deloitte knew or ought to have known that one of the purposes for which the audited financial statements was prepared was to facilitate Phillips securing additional financing to support its growth strategy.

The facts found by the motion judge on the summary judgment motion confirmed that Deloitte knew that Philips was required to produce its financial statements and auditor’s opinion to CIBC, the lead lender, for the purposes of the loan, and that CIBC relied upon them.

Owes prima facie duty of care

The OCA confirmed that the leading case on the issue of auditors’ liability for negligent misrepresentation remains Hercules Management Ltd. v. Ernst & Young, [1997] 2 SCR 165. That case confirms that an auditor will owe a prima facie duty of care to a person if the auditor should foresee that the person will reasonably rely on its audit opinion; but generally, the policy concern of indeterminate liability will negate the prima facie duty of care if the audit was not prepared for the use and reliance of that person.

However, the OCA emphasized that this is not an immutable rule. If indeterminate liability is demonstrated not to be a concern, then the duty of care will be recognized. Particularly, if the auditor knows the identity of the plaintiff — or importantly, if the auditor knows the class of plaintiffs (irrespective of knowing their exact identity) — and the auditor’s statements are used for the intended purpose for which they were made, or a purpose to which the auditor consented, then a duty of care will be recognized.

The OCA also recognized that “in Hercules, the reasons suggest that the Supreme Court remained open to the identification of other contextual factors that might sufficiently determine the scope of the defendant’s liability.”

No hard and fast rule

Given there is no hard and fast rule that an auditor is immune from liability to anyone other than the audited corporation and its shareholders for negligent misrepresentations in its audit report, the OCA concluded that the issue of the scope of Deloitte’s duty of care should be resolved at trial where the question of indeterminate liability can be fully reviewed on the particular record.

“In my view, the overriding question is whether indeterminate liability can be shown not to be a concern on the facts of the particular case. It may be shown by establishing that the auditor knows the identity of the plaintiff (or class of plaintiffs) and that the auditor’s statements were used for the specific purpose or transaction for which they were made,” the OCA wrote. “But it may be possible that indeterminate liability can otherwise be shown not to be a concern on the facts of the particular case.”

Strong message

The OCA has sent a strong message that whether an auditor will be found to owe a duty of care to anyone other than the addressees of the audit opinion is highly fact-driven.

There may be a wide range of circumstances that negate the concern expressed in Hercules about indeterminate liability to an indeterminate class. Hence, the courts should not be quick to dismiss claims asserted against an auditor by parties outside of the audit engagement.

The duty of care depends upon the objective knowledge or consent of the auditor of the purposes to which the audit report will be put, and there is no closed class of persons to whom the auditor may ultimately be found to be liable if the audit opinion contains misrepresentations.