The Livent litigation, which has received significant attention in Canada and elsewhere, came to a close on 20 December 2017 when the Supreme Court of Canada handed down its decision in Deloitte & Touche v Livent Inc  2 SCR 855 (Livent). The judgment is notable for its reasoning in respect of an auditor’s duty of care to detect wrongdoing, the application of the illegality defence of ex turpi causa in the context of statutory audits, and the quantification of loss on the basis of an increase in the net deficiency (IND) of company assets. A year on from the Supreme Court’s decision, the influence of the Livent litigation is seen in three recent judgments from Hong Kong and Canada. Whilst these decisions demonstrate that auditors will not escape liability simply because the plaintiff’s corporate agents have engaged in wrongdoing, they also emphasise the need for plaintiffs to carefully frame their case to succeed in an audit negligence claim.
The Livent decision
Livent collapsed into receivership in 1998 following the discovery of fraudulent financial manipulation by two of its directors. Livent brought tortious claims for economic loss against Deloitte, alleging that they had negligently prepared a clean audit report for 1997 and provided a letter of comfort in respect of a bond offering. In the Court of Appeal for Ontario, Deloitte was held liable and Livent was awarded damages of C$84.75 million (for commentary on Livent Inc v Deloitte & Touche  ONSC 2176, see our previous blog post here).
The Supreme Court of Canada by a 4:3 majority upheld the finding of liability with respect to the clean audit report, holding that the express purpose of the statutory audit was to assist Livent with the oversight of its management. However, the Supreme Court dismissed the finding of liability with respect to the letter of comfort. In preparing the letter Deloitte had not undertaken to assist in management oversight, so the letter could not reasonably be relied on for that purpose. Accordingly, the Supreme Court reduced the award of damages to C$40.425 million.
In reaching its decision, the Supreme Court:
In Days Impex Ltd v Fung, Yu & Co  HKEC 2269 (Days Impex) the Hong Kong Court of First Instance refused to strike out a negligence claim brought by the liquidators against two audit firms for issuing unqualified audit opinions and failing to detect a massive import/export fraud perpetrated by the company’s controlling shareholder and director. The Court relied on the Ontario Court of Appeal’s decision in Livent for the proposition that the illegality defence would not absolve an auditor’s liability to its own client in relation to fraud (Days Impex at ). Days Impex was handed down shortly before the publication of the Supreme Court of Canada’s decision in Livent, but that decision affirmed the Ontario Court of Appeal’s findings on the illegality defence. The Hong Kong Court did not refer to Livent with respect to the duty of care analysis, but consistent with Livent it held that an auditor’s duty is not so narrow as to be restricted to the provision of information and advice. The duty can extend to detecting material irregularities in the company’s accounting statements (Days Impex at ). It may even extend to reporting any fraud or suspected fraud to the company, and in some cases, to relevant regulatory or enforcement authorities (Days Impex at ).
Proceedings in Lavender v Miller Bernstein LLP  ONCA 729 (Lavender) arose when investors in a Canadian securities dealer launched a class action against its auditor, Miller Bernstein LLP, which had audited the securities dealer’s annual registration reports to the Ontario Securities Commission. The reports falsely stated the dealer had complied with regulatory requirements concerning the segregation of investor assets and minimum levels of net free capital. In fact, the dealer had breached regulatory requirements which caused it to be placed into receivership. Applying the Livent framework, the Court of Appeal for Ontario held that Miller Bernstein LLP did not owe a duty of care to the investors because a relationship of sufficient proximity was not made out. This was because the auditor had not made any representations to the investors and its work was submitted confidentially to the regulator (Lavender at -). The decision in Lavender emphasises the requirement that plaintiffs have actually and reasonably relied on negligent misrepresentations for the purpose they were made before a duty of care will arise.
In Fairfield Sentry Limited v PricewaterhouseCoopers LLP  ONCA 696 (Fairfield Sentry) the issue before the Court of Appeal for Ontario was the adequacy of evidence relied on to establish loss on an IND basis. The plaintiffs were companies fraudulently induced into investing in Bernie Madoff’s infamous Ponzi scheme. The plaintiffs claimed damages of $2.5 billion from their auditor due to its failure to uncover the fact that the plaintiffs had been defrauded. The defendants brought a motion for summary judgment, arguing that the plaintiffs were unable to establish any loss. Both the plaintiffs and the defendants adopted the Livent approach to calculating IND loss. The first instance judge accepted the evidence of PwC’s damages expert over the evidence of the plaintiffs and dismissed the claim. Significantly, the plaintiffs did not file any expert evidence to challenge PwC’s critique of their expert’s calculations, which the trial judge described as a “failure [by the plaintiffs] to put their best foot forward” and which had the effect that “certain arguments advanced by the Liquidators lacked evidentiary support” (Fairfield Sentry at ).
The dismissal was upheld by the Court of Appeal. In particular, the Court of Appeal found that, applying the Livent methodology of calculating IND, the first instance judge was right to conclude that the plaintiffs had not suffered any damages as their investments had gained and recovered a net value of $1.03 billion between the estimated and actual liquidation deficit dates (Fairfield Sentry at ).
Fairfield Sentry demonstrates the readiness of parties to adopt the Livent method of quantifying loss, but shows that courts will require loss to be established on the basis of sufficient evidence and a defensible valuation methodology.
Although it has only been a year since the Livent litigation concluded, it has already had an impact on audit negligence claims within Canada and elsewhere. For plaintiffs, the latest authorities demonstrate that auditors are not able to rely on the illegality defence to escape liability where they have failed to protect the company from the wrongdoing of its corporate agents. They also highlight that plaintiffs must take care to establish that they have reasonably relied on negligent misrepresentations for the purpose they were made. Where plaintiffs seek to quantify loss on the basis of an increase in the liquidation deficit, they need to ensure that their quantification has a sound evidentiary and methodological basis.