Tracing the Limits of Auditors’ Liability Post-Livent: the Ontario Court of Appeal Considers an Auditor’s Duty to Third Parties in Lavender v. Miller Bernstein LLP

Overview

In Lavender v. Miller Bernstein LLP [1], the Ontario Court of Appeal has overturned a lower court decision that imposed liability on an auditor for losses suffered by its client’s clients as a result of a negligently performed audit.  In reaching this result, the Court of Appeal applied guidance from the Supreme Court of Canada’s recent decision in Deloitte & Touche v. Livent Inc. (Receiver of) [2] for recognizing novel duties of care in the context of auditor’s negligence claims. As the outcome in Lavender illustrates, the principles articulated in Livent set a high bar for establishing that an auditor owes a duty of care to a party other than its own client, and in that way will serve to guard against the spectre of indeterminate liability.

Background

The defendant in Lavender was the auditor of a now defunct securities dealer. The plaintiffs were a class of investors who held investment accounts with the securities dealer, which was required by the Ontario Securities Commission (the “OSC”) to segregate the investors’ assets and maintain a level of free net capital. As part of its annual filings to the OSC, the securities dealer filed Form 9 reports that falsely stated it was in compliance with the regulatory segregation and minimum capital requirements. When the OSC discovered the breach of its regulatory requirements, it suspended the securities dealer’s registration and obtained an order placing the securities dealer into receivership.  Unfortunately, by the time the OSC intervened, the securities dealer had already used the unsegregated assets for its own purposes.  Its clients, the investors, lost millions.

Under the statutory regime that existed at the time, the Form 9 reports had to be audited each year in accordance with generally accepted auditing standards, as well as auditing standards published by the OSC. A class action against the auditor commenced on behalf of the investors was certified in 2010.  In 2017, the representative plaintiff moved for summary judgment on various of the common issues, including whether the auditor owed a duty of care to the class members when it audited the Form 9 reports.

Decision Below

In the Ontario Superior Court of Justice,[3] the motion judge—who did not have the benefit of the Supreme Court’s decision in Livent, which was released after his decision—granted summary judgment in favour of the class.  He held that the auditor owed the class a duty of care to conduct the audit of the Form 9 reports with the skill and care of a competent practitioner, which he further found it had breached.

At the outset of his duty of care analysis, the motion judge noted that the class’s claim was properly characterized as one of negligence simpliciter, rather than negligent misrepresentation, because at the relevant time the class members had neither seen nor relied on the Form 9 reports, which were kept confidentially by the OSC.  In a case of negligent misrepresentation, “the relationship between the plaintiff and the defendant arises through reliance by the plaintiff on the defendant's words.”[4] Here, while the class argued that its damages were caused by the auditor’s misrepresentations regarding the Form 9 reports, no class members had relied on the audited reports and so their claim sounded in simple negligence.  In essence, their argument was that, but for the auditor negligently signing off on the reports, the OSC would have intervened sooner before all of their assets were lost.  In advancing this argument, the class relied on the Court of Appeal’s 2013 decision in Lipson v. Cassels Brock,[5] which involved a class action against a solicitor.  In that decision, the Court of Appeal endorsed the view that in appropriate circumstances, a third party can advance a cause of action in negligence against a professional on the basis of a negligent misrepresentation made to another party, even in the absence of proof that the third party had relied on the misrepresentation.

As the negligence claim in Lavender raised a novel duty of care that did not fall within a previously recognized category, the motion judge appropriately undertook a full duty of care analysis within the Anns/Cooper framework, though without the benefit of the refinements to that framework subsequently provided by the Supreme Court in Livent.  Ultimately, he concluded that the auditor owed the class members a duty of care.  While acknowledging that the latter “never saw or even knew, at the time, about the Form 9s”,[6] he nonetheless found that “the defendant auditor as a matter of simple justice had an obligation to be mindful of the plaintiff’s interests when auditing and filing the Form 9 reports with the OSC.”[7]

Decision of the Ontario Court of Appeal

On appeal, a unanimous panel of the Ontario Court of Appeal overturned the motion judge’s decision and granted summary judgment in favour of the auditor, concluding that there was insufficient proximity between the auditor and the class members to ground a duty of care in negligence.[8]  As the class’s claim failed to pass the proximity hurdle at the first stage of the Anns/Cooper test, it was unnecessary for the Court to consider whether the class’s losses were reasonably foreseeable and whether any policy considerations might negate the imposition of a duty of care.

Using Livent as the “conceptual table”[9] for its proximity analysis, the Court observed that the relevant factors in determining proximity will vary depending on the circumstances of the case but may include “reliance, expectations, representations, property or other interests and statutory obligations.”[10] In this case, another important, though not necessarily determinative, factor endorsed by the Court was the absence of a personal relationship between the parties.[11]  In such circumstances, the Court affirmed the need to “inquire into whether the defendant’s actions have a close and direct effect on the plaintiff, ‘such that the [defendant] ought to have had the [plaintiff] in mind as a person potentially harmed.’”[12] Finally, citing Livent, the Court noted that in cases of pure economic loss arising from negligent misrepresentation or performance of a service, two factors will generally be “determinative”: (i) the defendant’s undertaking; and (ii) the plaintiff’s reliance.[13]

While the Court considered both the nature of the auditor’s undertaking and the class’s reliance as relevant factors which militated against the imposition of a duty of care, it cited the former as the “primary reason” for its decision,[14] with the absence of any reliance on the part of the class playing an important but supportive role.[15] That is, the limited scope of the undertaking, coupled with the lack of direct connection between the parties, weighed most heavily in the Court’s analysis. Importantly for the Court, the auditor did not make any representations to class members, nor did it ever undertake to assist the class in making investment decisions.  In addition, “the interposition of the OSC and [the securities dealer] between the Auditors and the Class rendered the relationship between the parties too remote to ground a duty of care.”[16]

Ultimately, the Court of Appeal gave five reasons supporting its decision that proximity was not established: (1) the limited scope of the auditor’s undertaking and lack of direct connection between the auditor and the class (which, as noted above, was the primary reason cited by the Court); (2) the absence of any reliance by the class on the auditor’s undertaking; (3) the fact that the motion judge’s analysis appeared to be based, at least in part, on a number of factual errors (for example, he incorrectly found that the auditor, and not the securities dealer, had filed the Form 9 reports); (4) the statutory context for the auditor’s undertaking, which the Court found “did not create a proximate relationship between the auditor and the class for the purpose of their investment decisions in relation to forms that they never saw”[17]; and (5) the need for courts to exercise “significant scrutiny” when deciding whether to recognize a novel duty of care in a claim for pure economic loss.[18]

Conclusion and Implications

The Court of Appeal’s decision in Lavender reflects a principled extension of the Livent framework to a claim against an auditor brought by third parties.  While novel duties of care must be determined on a case-by-case basis, Lavender confirms that the court’s analysis will be driven first and foremost by the nature of the auditor’s undertaking and the plaintiff’s reliance—irrespective of whether the claim is framed in negligent misrepresentation or simple negligence.  Other relevant factors may include the applicable statutory framework and whether the parties have a personal relationship.  Thus, the absence of a personal relationship with a third-party will not automatically preclude the imposition of a duty of care, but this remains an important factor militating against liability.  While auditors may take comfort from the outcome in Lavender, they should nonetheless take heed of the constellation of factors articulated by the Court of Appeal which could give rise to novel duties of care in future cases.

Case Information

Lavender v Miller Bernstein LLP, 2018 ONCA 729

Docket: C64207

Date of Decision: September 5, 2018

_____________________________________

[1] 2018 ONCA 729 [Lavender].
[2] 2017 SCC 63 [Livent].
[3] 2017 ONSC 3958.
[4] Hercules Management Ltd. v. Ernst & Young, 1997 CarswellMan 198, [1997] 2 S.C.R. 165 at para. 24.
[5] 2013 ONCA 165.
[6] 2017 ONSC 3958 at para. 20.
[7] Ibid.
[8] Lavender, supra note 1 at para. 73.
[9] Ibid at para. 24.
[10] Ibid at para. 61.
[11] Ibid at para. 62.
[12] Ibid.
[13] Ibid at para. 61.
[14] Ibid at para. 65.
[15] Ibid at para. 67.
[16] Ibid at para. 66.
[17] Ibid at para. 71.
[18] Ibid at para. 72.

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