Historically, the doctrine of privity of contract prevented
third parties from claiming against auditors for negligently
prepared audited reports. The landscape changed with the
recognition of the tort of negligent misrepresentation and the
possibility that auditors could be held liable to anyone to whom
they were found to owe a duty of care. The concern arose that
auditors might be unfairly exposed to "liability in an
indeterminate amount for an indeterminate time to an indeterminate
class", a phrase memorably coined by U.S. Justice Cardozo.
In Canada, Hercules Managements Ltd. v. Ernst Young,  2
S.C.R. 165 ("Hercules Managements") was hailed as an
answer to these concerns about auditors' indeterminate
liability. The plaintiff shareholders brought claims against the
companies' auditors for negligently prepared statutory audit
reports upon which they claimed to have relied, causing them
damages. The Court considered whether the auditors owed the
shareholders a duty of care and applied the two-stage Anns test;
whether a duty of care exists will depend on (a) whether a prima
facie duty of care is owed, and (b) if so, whether that duty should
be limited or negated by policy considerations.
Under the first stage of the test, the Court considered whether
the auditors had a sufficient relationship of proximity to the
plaintiffs for them to have reasonably relied on the auditors'
work. The court found that a prima facie duty of care existed. This
element of the test will be satisfied in the majority of cases
brought by shareholders against a company's auditors.
Under the second stage of the test, the Court considered the
policy concern that inevitably arises in such cases - the
"spectre of indeterminate liability". A limiting
mechanism was needed to avoid this risk. The auditors would
owe a duty of care to a third party plaintiff only where: (a) the
plaintiff is known to the auditors or is a member of a limited
class of plaintiffs known to the auditors; and (b) the plaintiff
relied on the auditors' statement at issue for the precise
purpose or transaction for which it was made.
In Hercules Managements, the Court held that the prima facie
duty of care owed to the shareholders was negated for policy
reasons. Despite the fact that the plaintiffs were
members of a limited class, they had not relied on the audited
financial statements for the precise purpose for which they were
prepared. Rather, they used the statements for their own personal
investment decisions. Therefore, the auditors were not liable to
The legacy of Hercules Managements has been a broad protection
afforded to auditors against claims made by parties with whom they
had no contract. Nevertheless, subsequent cases have shown the
shortcomings in the Hercules Managements analysis in cases having
very different facts.
In Irwin v. Alberta Veterinary Medical Association, 2015 ABCA 396, the Alberta Court of Appeal found that the "ABVMA" failed to afford procedural fairness to a veterinarian undergoing an incapacity assessment.
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