On Sept. 5, 2018, the Ontario Court of Appeal (the "Court") released its decision in Lavender v. Miller Bernstein LLP, clarifying the scope of an auditor’s duties to non-clients. Applying the principles set out by the Supreme Court in Deloitte & Touche v. Livent Inc (Receiver of), the Court overturned the decision of the Ontario Superior Court and found that the defendant auditor did not owe a duty of care to a class of individuals that was not the audience for the report reviewed by the auditors, and who did not personally rely upon the relevant misstatements. In making its decision, the Court or Appeal emphasized that establishing a duty of care in cases of pure economic loss is a significant threshold to pass.
Background and Lower Court Decision
The Superior Court's decision allowed a motion for summary judgment in a class action proceeding brought by the clients of Buckingham Securities Corporation, a former securities dealer, against Miller Bernstein LLP, Buckingham's auditor. The claim was based on misrepresentations regarding Buckingham's compliance with statutory segregation and minimum capital requirements made on its Form 9 Reports. The class had been certified on consent and the motions judge was tasked with deciding six common issues. The crux of the common issues was whether the auditor owed a duty of care to Buckingham's clients, and if so, whether the auditor breached that duty. Justice Belobaba applied the Anns/Cooper analysis and found that the auditor owed a duty of care to the plaintiff class and that the duty was breached. The auditor appealed from that decision.
Decision of the Court of Appeal
The Court of Appeal unanimously allowed the appeal and granted summary judgment in favour of the auditor.
The Court's reasons focused solely on the issue of proximity. The Court determined that there was insufficient proximity to establish a duty of care. Relying on the principles set out in Livent, the Court held that Justice Belobaba had extended proximity too far. In conducting its analysis, the Court made five key points:
- The scope of the auditor's undertaking in completing the annual renewal forms did not extend to assisting Buckingham's clients supervise Buckingham or make investment decisions. As such, there was an insufficient connection between the auditor's undertaking and the loss claimed by the plaintiffs;
- The plaintiffs had never seen the documents containing the misrepresentation and had not relied on those documents. Further, the documents prepared by the auditor were not intended to inform or induce Buckingham's clients into making investment decisions;
- The obligation to file the Form 9 Report rested with Buckingham (not the auditor) and the auditor did not have knowledge of the names and accounts of every member of the class;
- The statutory scheme in place weighed against a finding of proximity. The statutory scheme required only that Buckingham segregate investor assets, maintain a "minimum level of net free capital", and file an audited Form 9 Report with the OSC. The Court found that nothing in the statutory scheme supported a finding of proximity between the auditor and Buckingham's clients; and
- Cases seeking to establish a duty of care for pure economic loss will "warrant more rigorous examination". The Court emphasized the Supreme Court of Canada's statement that "significant scrutiny" is required to determine whether a duty of care for pure economic loss should be recognized.
There are many people who are injured when companies make material misrepresentations. However, Livent and Lavender make it increasingly clear that even if an auditor's negligence is a factor in those injuries, rarely will the auditor have a sufficiently proximate relationship with any party other than the company itself. This may seem inadequate to shareholders and others who believe that audits are not performed with sufficient rigour, and may lead to more derivative actions seeking to hold auditors accountable for losses suffered by their audit client. In addition, while the decision in Lavender narrows the scope of an auditor's duty of care in the context of claims made by third parties, the decision leaves open the possibility that an auditor could be found to owe a duty of care to third parties where a more broad undertaking is established and/or found to exist. Therefore, auditors should be cautious in how they view and define their undertaking when retained by clients.