By Mindy Paskell-Mede
Illustration: R.L. Butterfield
 IT'S A LONG-STANDING PRINCIPLE THAT COURTS WON'T HELP SOMEONE BENEFIT FROM WRONGDOING, AND JUDGES IN TWO CASES STAND BY THAT
This spring, a court in England applying common-law rules and one in Quebec applying civil-law rules came to similar conclusions based on policy considerations. Both cases had common elements. Each plaintiff had alleged their accountants had negligently failed to detect fraud occurring at the client. In both cases, a company principal was assumed by the court, for purposes of the legal debate, to have acted fraudulently. The courts held where an accountant is negligent, he will be absolved of civil liability if the person suing him has, or is deemed to have, acted fraudulently. In short, both judges are applying a long-standing principle of law: the courts will not rule in favour of someone who would benefit from his or her wrongdoing.
The UK decision, a preliminary judgment in Barings Futures (Singapore) PTE Ltd. v. Mattar and others, was based on a hearing on the question whether a false letter of representation given an auditor could prevent the audit client, via its liquidator, from suing the auditor in negligence.
Although many of Justice Evans-Lombe's conclusions are not necessary for the rendering of his decision and therefore are of lesser value in setting legal precedent, they're worth noting, since such a thorough, reasoned analysis often becomes mainstream within a few years.
For purposes of this preliminary decision, the court assumed the auditors would eventually be found negligent in the conduct of their audit. However, the auditors counterclaimed that the company director, therefore the company, would be liable to them for fraudulently signing a false-representation letter. The damages in the two claims would be the same. And since fraud is more heinous than negligence, the claims would cancel out — something the judge considered first, in the interests of justice and judicial efficiency.
The judge easily concluded that a number of statements in the representation letter were false: the assertion that there had been no irregularities involving employees that could be material to the financial statements, that the financial statements had no material errors and omissions, that transactions with related parties and losses on sales and purchases had been properly recorded, and that all liabilities had been disclosed. The court also held because the person who signed the representation letter was the finance director, who had responsibility for preparing and maintaining financial records, it included an implied representation that he had reasonable grounds for making the statements.
The auditors did not allege that the finance director knew the representations were false. However, they argued he had no good faith or reasonable grounds for making them, because he knew too little about the organization. In their view, this careless disregard for the truth was equivalent to fraud. After reviewing portions of the incorporating legislation and auditing standards (not dissimilar to Canadian rules) and the auditing firm's internal guidelines, the judge concluded the final audit opinion would never have been signed without the representation letter. He agreed that the finance director's fraud would taint the firm. Further, he held that the fact the fieldwork had been completed without the auditors' finding anything amiss could contribute to an honest belief there were no irregularities but they could not, alone, form the basis of proper representations to the auditors.
The court decided that the finance director –– despite his limited knowledge of the accounts –– had sufficient reasonable grounds to sign the audit representation letter without being considered so reckless as to be deceitful. In other words, although the director may have been negligent, this was not sufficient to prevent the case from going forward.
The court nevertheless examined the legal issues surrounding the hypothetical scenario of a case in which the finance director would have been determined, on different facts, to have acted fraudulently. The judge dismissed arguments that the representation letter was a mere formality, given it is sought after fieldwork is completed. The main reason for this decision was that the prevailing standards and guidance indicated that refusal by the client to sign such a representation letter would have resulted in the auditor refusing to sign the audit opinion.
The finance director knew that the receipt of a signed letter was necessary for the audit. Therefore the court could conclude there was an intention to induce the signing of the audit opinion by giving the letter –– and that, in fact, the giving of the letter had induced the auditors to sign their opinion.
A second argument was whether the signing of the letter was a sufficient cause of the audit negligence suit. The audit client argued that had the auditor conducted the audit appropriately, the representation letter, based on the accounts as presented, would never have been requested. Despite his sympathy, the judge disagreed: "As a matter of common sense, it seems to me impossible to say that [the auditor's] signature of the accounts [which was the relevant transaction flowing from the fraud] was not a cause of their being sued for negligence, even though their negligent investigatory work may have been a more significant cause."
In short, auditors are sued for having signed an opinion, and if they can demonstrate that, but for the false representation letter, they would not have signed it, the courts cannot ignore this. The judge stated even if one considers the company's cause of action had accrued before the representation letter or audit opinion was signed, this wouldn't change his view. Although it's impossible to speculate what would have occurred if the auditors had not signed the opinion, one thing is probable: they would not have been sued.
The court also looked at the policy issues of this conclusion. The judge recognized that auditors should be accountable for their negligence, but he believed disentitling a person from benefiting from his fraud was a higher imperative. "Had I found [the finance director] to have been fraudulent," he stated, "it would be of concern to me that [auditors] were able to escape liability completely, as a result of a reckless representation letter written by the very management which had prepared the financial statements which [auditors] were appointed to verify and concerning whose conduct of the company's affairs [auditors] were appointed to provide shareholders with reliable intelligence. However, I must also take into account the policy rule allowing a victim who has been deceived to sue his deceiver. The judgment in Standard Chartered Bank expresses very clearly the policy of the common law in relation to deceit: Commercial fraud must be condemned. It can only properly be condemned by an award of the whole of the damage which the defendants intended to cause. Highwaymen in commerce forfeit the right to just and equitable treatment. In my judgment in the law of deceit there is to be no apportionment.
"Accordingly," the judge concluded, "I do not see that it is open to me to find, taking account either of a commonsense approach to factual causation, or of the policy of the rules concerned, that [the auditor's] signature of the audit certificates induced by the representation letters was not a cause of [the auditor's] liability."
On different facts and through a different procedural vehicle, a Quebec court dismissed an action against accountants, not acting as auditors, for much the same reasons. In the case of Toronto-Dominion Bank v. Gérard Mazur, judgment was rendered in May by Quebec Superior Court, dismissing Mazur's third-party action against his company's accountants. The principal plaintiff, Toronto Dominion Bank, sued Mazur for fraud that he allegedly committed as finance director of Canadian Children's Wear Ltd. TD claimed Mazur provided it with fictitious accounts receivable to support an inflated credit line, so it sued him for fraud, seeking recovery of amounts in excess of his personal guarantee. By way of third-party proceedings seeking indemnity, Mazur then sued his company's accountants, the basis of the argument being that they were negligent in not discovering the fraudulent transactions.
On a motion to dismiss, the court ruled for the accountants, holding that if the principal action were successful, the third-party action would be doomed to fail. Put simply, if the bank's suit were successful, this would mean the court had determined that Mazur had acted fraudulently, and by permitting him to pass on the liability to his accountants, he would in effect be keeping his ill-gotten gain.
Mindy Paskell-Mede, BCL, LLB, is a partner with the Montreal law firm of Nicholl Paskell-Mede, where she specializes in professional liability insurance. She is also CAmagazine's Technical Editor for Law. |
