Canada: Auditor Held To Owe Duty To "Client's Clients"

Last Updated: September 12 2017
Article by Bevan Brooksbank

Most Read Contributor in Canada, October 2017

In Lavender v. Miller Bernstein LLP, Justice Belobaba heard a motion by the representative plaintiff for summary judgment on several of the common issues certified in the class proceeding against the defendant auditor. The disposition of the motion turned on the question of whether a duty of care arose between Miller Bernstein and the class members who held investments with the auditor's client, a defunct securities dealer. Such a duty was found by Justice Belobaba, with the motion being decided in favour of the representative plaintiff.

The facts of the case are straightforward, and concern the failure of a securities dealer, Buckingham Securities ("Buckingham") to segregate investor (class member) assets and maintain minimum net free capital in breach of regulatory requirements. The Ontario Securities Commission ultimately placed Buckingham in receivership, yet the unsegregated assets had by that time been appropriated resulting in a loss to the class members. In the course of subsequent OSC proceedings, it was admitted that materially untrue statements had been made in "Form 9" reports, which were to be audited and filed with the OSC to confirm the asset segregation and minimum capital. The Form 9s had been audited in the material years by Miller Bernstein ("MB").

A class action was commenced in 2005, and subsequently certified, on behalf of investors in Buckingham, alleging that MB had breached its duty of care owed to class members through its negligent audit of the reports filed with the OSC. In short, the class allegation was that losses had been sustained which, but for MB's negligent audit of the Form 9s, would not have arisen since accurate Form 9s would have alerted OSC and precipitated an earlier intervention.

On the summary judgment motion, there was little dispute over several of the common issues, such as causation or whether Buckingham had in fact failed to comply with regulatory requirements. Rather, the central point of contention was whether a duty of care was in fact owed to class members by MB. Justice Belobaba embarked on the established Anns-Cooper analysis, namely to determine i) whether the facts disclose a sufficient level of foreseeability and proximity to establish a prima facie duty of care, and ii) if so, whether there are residual policy considerations that would justify declining to impose liability in tort.

On the first stage of the test, the Court held the question was simply whether "the defendant may be said to have had an obligation to be mindful of the plaintiff's interests in going about his business." The facts supported a prima facie duty of care. While the class members had little meaningful contact with MB, the auditor knew the Form 9s were used by the OSC to police securities dealers and to protect investors, and MB understood the consequences to its "client's clients" if the segregation or capital deficiency information was misstated. Moreover, MB was retained by Buckingham to do an assurance audit and had access to the individual investor names and account details.

Moving to the residual policy concern stage, Justice Belobaba noted that the Court's primary concern when imposing a duty of care in cases of pure economic loss is the spectre of indeterminate or unlimited liability. However, it was determined that such a concern did not arise on the facts of the case. MB knew the identity of the class of plaintiffs, and the auditor's statements were used for the specific purpose for which they were prepared. As such, MB was aware of the narrowly circumscribed class of people to whom it could be liable for a negligent audit, and also its potential monetary liability through knowledge of the investments at issue.

As a result, the Court held in favour of the representative plaintiff with respect to the common issues concerning the omissions of Buckingham, the duty owed by MB, and the auditor's breach of that duty through the preparation of negligent audit reports.

Interestingly, while the representative plaintiff was largely successful the ultimate outcome remains to be seen. The plaintiff failed to put before the Court evidence of class members' actual losses, nor a proposed methodology for making such a determination. Belobaba J. noted that clarification would be needed in light of the fact, inter alia, that Class members received a court-approved distribution from the Receiver in 2005.

Justice Belobaba reaffirmed that expert evidence speaking to estimated aggregate losses was of not assistance, as actual loss is a precondition to liability in tort, and aggregate damages under the Class Proceedings Act cannot be used to establish actual loss/liability. Consequently, whether liability is ultimately established, and recovery obtained for class members, will depend upon any further evidence proffered.

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