Supreme Court sets out liability for auditors

The Supreme Court of Canada has laid out the scope of responsibility for auditors following a 4-3 decision that found that Deloitte & Touche was negligent in performing a statutory audit and failing to uncover fraud committed by Livent Inc.’s management.

Supreme Court sets out liability for auditors
Steve Popoff says a recent SCC ruling shows ‘shareholders are going to have to rely on actual duties that are set out in the statutes.’

The Supreme Court of Canada has laid out the scope of responsibility for auditors following a 4-3 decision that found that Deloitte & Touche was negligent in performing a statutory audit and failing to uncover fraud committed by Livent Inc.’s management.

Livent was forced into receivership. The court found that a duty of care was owed by the auditor to its client, but it also supported protections for auditors against misrepresentation claims by shareholders.

In Deloitte & Touche v. Livent Inc. (Receiver of), SCC 2017 63, the court as a whole found that Deloitte breached its duty when it failed to discover and expose Livent’s fraud in the audited statements that it prepared. However, the dissenting judges did not agree that Deloitte should be liable for virtually all of the losses that Livent suffered in the period after.

“The duty of auditors is to the corporate client and does not extend, absent special circumstances, to shareholders,” says Allan Coleman, partner at Osler Hoskin & Harcourt LLP in Toronto, who was not involved in the case.

“In that sense, it circumscribes the scope of the auditor’s duty.”

In this particular case, Coleman says, the factual circumstances were clear that the decision was predicated on the majority’s finding that, had Deloitte not been negligent in the audit, the shareholders and innocent directors would have exercised their power of supervision in order to ensure that Livent filed for bankruptcy when they found out, rather than continuing to incur subsequent losses. He says the decision clarifies the scope of potential liability that auditors face to the client in circumstances where the auditor is found to be negligent and has caused the client to incur losses.

Steve Popoff, partner at Blaney McMurtry LLP in Toronto, who was not involved in the case, says that a future case with different facts could go in a different direction.

“The most interesting thing that I found in the case was the fact that the dissent was saying, we’re looking at commercial reality. . .” says Popoff, adding that firms undertaking these audits could have significant liability and the dissenting judges felt they were not prepared to make them an insurer for every claim.

Coleman says there was a tension between the majority and the minority decision about where the risk of loss should fall in cases where you have fraudulent actors in the senior management of the company, with the minority seeming to suggest that it should rest with the fraudulent actors, and the majority stating that auditors are compensated handsomely for their work, and as part of that they should be expected to incur greater risk if they are negligent.

“How will those risks be allocated in practice?” asks Coleman.

“Does that mean that auditors will require higher levels of insurance, which will then have a greater cost to the audit firms, which will then be passed on to the client in the form of greater fees?”

Coleman said that the concern of the minority was spreading the risks of the actions of the fraudulent actors around to everyone, but that doesn’t necessarily mean that the majority was not alive to the commercial realities.

“The dissent and the majority had a different view as to the appropriateness of the commercial reality of the fact that if you increase the risk of auditor liability that it will have the corresponding allocation of that risk around all audit clients,” says Coleman.

Popoff notes that the SCC ruled that Livent’s receiver could bring the claim, and that there was a duty of care based upon the retainer, but that Livent couldn’t bring a claim against the auditor for the “comfort letter” that was part of the work on Livent’s securities offering while the company found more financing to extend their operations.

“What it means is that shareholders are going to have to rely on actual duties that are set out in the statutes — the common law may not help you,” says Popoff.

“There’s a long-standing doctrine that shareholders aren’t owed a duty of care by the auditors in certain circumstances, so they have to claim for economic loss under the Securities Act and the remedies under that.”

Coleman adds that because the “comfort letter” was not part of the statutory audit and was part of a unique contract that was not part of the losses that were being alleged in this case, it was not intended to provide shareholders with information that would allow them to fulfil their supervisory responsibility.

Coleman says there was some ambiguity in the language of the decision that could be interpreted to say that there was no duty of care.

“I think what they’re really saying is there’s no duty of care that is related to the type of losses that are being alleged here,” says Coleman.

“I think if you read it all together, what they’re saying is that you have to analyze the duty of care that exists with respect to the nature of the work that’s being undertaken and the purpose for which it’s undertaken.”

Thomas Slade, partner with Supreme Advocacy LLP in Ottawa, says the key takeaway from the decision for all professionals is that they need to be clear with clients about the services they are undertaking to provide.

“By carefully defining the scope of responsibility, a professional can limit their liability,” he says.

Slade notes that at the SCC, accountants’ groups were particularly concerned about the possibility of being exposed to indeterminate liability.

“The court took the wind out of the sails of this argument finding that it is nothing more than a residual policy consideration,” says Slade.

“This decision will be seen as constraining the floodgates argument in future negligence cases.”

Coleman says it will be very interesting when a case arises in the future where there is a situation where the negligence of the auditors didn’t cause the company to continue to exist when it might have simply declared bankruptcy as Livent did, but he would rather have sent that company down a path it might not otherwise have taken.

“The devil will be in the details in future cases that are less clear-cut on the facts as to how those losses would be proved to have been caused by the auditors,” says Coleman.

Counsel for Deloitte did not provide comment, while counsel for Livent’s receivers did not respond to a request for comment.

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