Auditors at it again
By Jerome Veldsman
Deloitte & Touche v. Livent Inc., a judgment of the Canadian Supreme Court (the Apex Court) on 20 December 2017, dealt with the liability of an auditor for failing to uncover fraud.
Livent produced and staged performances in theatres that it owned in Canada and the USA. To enhance Livent’s success, its directors manipulated the company’s financial records for 1996 and 1997. Deloitte was Livent’s auditor. Deloitte never uncovered the fraud.
In August 1997, however, Deloitte identified irregularities in the reporting of profit from an asset sale. Deloitte did not resign. Instead, for the purpose of helping Livent to solicit investment, Deloitte helped prepare, and approved, a press release issued in September 1997, which misrepresented the basis for the reporting of the profit. In October 1997, Deloitte provided a comfort letter for a public offering.
New equity investors appointed new management, who discovered the fraud in 1998. The financial statements for 1996 and 1997 were restated, resulting in a significant downward adjustment of reported income; the Livent share value fell from USD 6.75 to USD 0.28 per share; and Livent filed for insolvency protection. Livent (effectively its shareholders) sued Deloitte in tort (delict) and contract.
The Court of first instance held that Deloitte had been negligent in respect of (1) the 1997 clean audit and (2) the services in relation to the solicitation of investment; and awarded damages to Livent for breach of its duty of care, and alternatively for breach of contract, totalling USD 84 750 000. Deloitte appealed, and Livent cross-appealed, but both were dismissed. Deloitte then appealed to the Supreme Court, with some success.
The five Judges all agreed that Deloitte was not liable for the increase in Livent’s liquidation deficit which arose from negligent services in relation to the solicitation of investment, as such services were not related to Deloitte’s obligation to assist Livent’s shareholders in overseeing management. In addition, the concomitant loss was not a reasonably foreseeable consequence of the negligence.
Three of the five Judges held that Deloitte was liable for the increase in Livent’s liquidation deficit which arose from negligent services in relation to the 1997 clean audit. In addition, the concomitant loss was a reasonably foreseeable consequence of the negligence. In such regard, they assessed that Livent had suffered damages in the amount of USD 40 425 000.
There are differences in the Canadian and South African approaches to assessing negligence and damages in respect of auditors. This brief article is not the place for a discussion in such regard.