Court of Appeal Limits Auditor Liability to Non-Clients

On September 5, Ontario’s Court of Appeal released its decision in Lavender v. Miller Bernstein LLP,¹ which considered the duty of care owed by an auditor to non-clients. The Court of Appeal concluded that the auditor did not owe a duty of care to a class of individuals that were not the audience for the report prepared by the auditors, and who did not personally read or rely upon the relevant misstatements. A relationship of proximity—a precondition for imposing a duty on the auditors—was not established in the circumstances.

What You Need To Know

• Where there is an insufficient relationship of proximity between an auditor and non-clients, the auditor will not be found liable for damages to non-clients arising from the auditor’s misrepresentations.
• An auditor’s undertaking is critical to determining whether a sufficient relationship of proximity exists between an auditor and non-clients. Undertakings that are limited in scope and lack any connection between the auditor and non-clients may insulate auditors from liability to those non-clients.
• Reliance on an auditor’s misrepresentations by non-clients, whether intended or not, is also critical to determining whether a sufficient relationship of proximity exists. The absence of reliance by non-clients militates against a finding of liability.
• Claims by non-clients against auditors for pure economic losses will be subject to significant scrutiny by the courts.

Background

Buckingham Securities was a securities dealer whose operations were suspended by the Ontario Securities Commission (OSC). An order was made placing the dealer into receivership because it breached regulatory requirements by failing to segregate investor assets and maintain a minimum level of net free capital. In 2005, a class action was commenced on behalf of every person who held an investment account with Buckingham on the date that its operations were suspended.

Miller Bernstein LLP was Buckingham’s auditor (Auditor). In accordance with Buckingham’s regulatory obligations, the Auditor had, during the relevant time, audited certain required reports which Buckingham filed with the OSC. These reports confirmed that Buckingham was in compliance with segregation and minimum capital requirements imposed by regulation (Reports). Importantly, the Reports were filed with the OSC confidentially and were not made publicly available.

The action was certified on consent. One of the certified common issues was whether the Auditor owed a duty of care to the class.

The Summary Judgment Motion

The plaintiff brought a summary judgment motion which included the issue of whether the Auditor owed a duty of care to the class. The motion judge (who did not have the benefit of the Supreme Court’s decision in Deloitte & Touche v. Livent, which we summarized in “SCC: Auditors may be Liable for Losses Related to Audit Opinions”) found that it did. The motion judge’s analysis was twofold.

1. The facts disclosed a sufficient level of foreseeability and proximity. Although class members never saw or knew about the Reports, the Auditor “as a matter of simple justice” had an obligation to be mindful of their interests. Further, class members reasonably expected Buckingham and its Auditor to provide accurate and honest information to the OSC.
2. Policy concerns (including concerns regarding indeterminate liability) did not negate imposing liability, given that the auditor apparently knew the identity of the plaintiffs, its statements were used for the specific purpose for which they were made (in this case, to be relied on by the OSC) and Auditor knew its precise potential liability (being the sum of all class member accounts).

The Appeal

The Court of Appeal overturned the motion judge’s decision. The core issue for the Court of Appeal was whether the motion judge erred in finding that the Auditor owed a duty of care to the class.

Applying the framework set out in Livent, the Court of Appeal concluded that the Auditor did not owe a duty of care to the class because no relationship of proximity was established in the circumstances. The Court based its decision on the following findings:

1. There was an insufficient connection between the Auditor’s undertaking and the losses claimed. Buckingham had retained the Auditor to audit the Reports, which were then confidentiality filed with the OSC. Although the Reports were used by the OSC to monitor securities dealers (with a view to protecting investors), it did not follow that the audit of the Reports created proximity between the Auditor and non-client investors.
2. The interposition of the OSC and Buckingham between the Auditor and the class rendered the relationship between the parties too remote to give rise to a duty of care.
3. The evidence was clear that class members did not review or rely on any of the statements made in the Reports (which, as noted above, were confidentially filed by Buckingham).
4. The motion judge erred in making certain factual findings which undermined his proximity analysis. Whereas the motion judge found that the Auditor had been responsible for filing the Reports with the OSC, the evidence established that the Auditor had merely audited the Reports and that Buckingham filed them with the OSC in accordance with its regulatory obligations. The motion judge also erred in finding that the Auditor had access to the names and accounts of every member of the class.
5. The relevant statutory scheme militated against a finding of proximity given that it placed the obligation on Buckingham (and not the Auditor) to maintain net free capital, segregate investor assets and file its audited Reports with the OSC.
6. Significant scrutiny is warranted when deciding whether to recognize a duty of care of pure economic loss.

Finding that there was no proximity between the Auditor and the class in relation to the Reports was dispositive, such that the Court of Appeal did not go on to consider whether the harm suffered by the class was reasonably foreseeable or whether any residual policy concerns negated the duty of care.

The Court of Appeal’s decision is important, in that it sets clear limits on the extent of auditor liability following the Supreme Court’s decision in Livent. It establishes that auditors should not be viewed as obvious sources of compensation by class action plaintiffs, especially where the appropriate target of a claim is insolvent.

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¹ 2018 ONCA 729