South Africa: Auditor’s Liability : Judgment Of The SCA In Axiam Holdings Ltd V Deloitte & Touche Under Case Number 303/04

Last Updated: 10 June 2005
Article by Harold Jacobs and Robert Haak

FROM THE WRITERS

The Supreme Court of Appeal delivered a judgment last week (1 June 2005), which will have far reaching implications in the context of an auditor's duty of care to third parties.

Deloitte & Touche ("Deloittes") were appointed to conduct an audit and prepare the annual financial statements for the year ending 31 March 1999. On 1 July 1999 Deloittes issued an Auditor’s Report which included a certificate containing the following:

"We conducted our audit in accordance with the South African Auditing Standards. Those standards require that we plan and perform the audit to obtain reasonable assurance that the annual financial statements are free of material misstatements…

In our opinion, these annual financial statements fairly present, in all material respects, the financial position of the company at 31 March 1999 and the results of its operations and cash-flow for the period then ended in accordance with generally accepted accounting practise and in the manner required by the Companies Act".

The appellant contended that, the statements prepared for the 1999 year failed to fairly present the financial position of the company that Deloittes, in conducting the audit and completing the financial statements, failed to comply with the requisite professional and reasonable skill and care and failed to comply with generally accepted accounting practise and that Deloittes, therefore conducted the audit and certifying process of the 1999 statements negligently.

During February 2000, two companies ("the third parties") concluded agreements with the company. It was argued for the appellant that at the time, Deloittes were aware of the negotiations and that the 1999 statements and audit opinion would be relied on by the two companies in that process. It was further argued that "Deloitte knew, alternatively, could in the circumstances reasonably have been expected to know, that the two companies, in deciding to conclude the agreements, would rely on the 1999 statements and Deloittes audit opinion and knew, alternatively, could in the circumstances reasonably have been expected to know that the 1999 statements contained the misstatements and misrepresentations referred to above".

It was then argued that in the premises Deloittes owed the two companies a duty to warn them that the 1999 statements and the audit opinion were incorrect, alternatively to warn them that they had not conducted the audit properly and that they should not rely on the 1999 statements and the audit opinion. Deloittes failed to issue these warnings and it was argued that such failure was negligent and constituted a representation within the meaning of Section 20(9)(b)(ii) of the Public Accountants and Auditors Act 80 of 1991 that the financial statements were accurate and fairly represented the financial position of the company at the end of March 1999.

It was contended that due to Deloittes' breach of the aforesaid duty an amount of money was paid to the company in terms of the agreements referred to earlier. The amounts are irrecoverable.

Deloittes excepted to the cliam of the summons on the following basis -

  • the conclusion that Deloittes owed the two companies a duty in law did not follow on either of the premises set out in italics in the paragraph above;
  • its failure to warn the contracting companies was insufficient in law to constitute a representation within the meaning of Section 20(9)(b)(ii) of the Public Accountants and Auditors Act 80 of 1991.

An exception is a procedure whereby a litigant contends that a pleading is bad in law. In this case, Deloittes contended that the appellant's claim did not give rise to a claim in law.

In the judgment it was held that although it is not an un-useful purpose having regard to English law and to the law in other common law countries for reassurance that we are not out of step with global norms as applied in the commercial world, we should not lose sight of what is ultimately required being "an assessment, in accordance with the prevailing norms of this country, of the circumstances in which it should be unlawful to culpably (probably) cause loss." (Minister of Safety and Security v Van Duivenboden 2002 6 SA 431 (SCA) at para 16)

In applying the principle set out in Standard Chartered Bank of Canada v Nedperm Bank Limited 1994 4 SA 747 (A), one would be loathe at exception stage, to hold that it is inconceivable that an auditor who knew of the misstatement in the 1999 statements and audited opinion and who also knew that the two companies in concluding the agreements, would rely on the correctness thereof, would not have a duty to speak.

The essential allegations in the alternative claim (relied upon by the appellant) are as follows -

  • "Deloittes could in the circumstances reasonably have been expected to know that the 1999 statements and the audit opinion were inaccurate and did not fairly present the company’s financial position;
  • Deloittes could reasonably have been expected to know that the two companies would, in concluding the agreements, rely on the correctness of the 1999 statements and the audit opinion;
  • in the premises, Deloittes owed the two companies a duty to warn them of the inaccuracies and of its failure to properly conduct the audit of the 1999 statements;
  • Deloittes had breached this duty by not so warning the two companies;
  • the failure to warn the two companies constituted a representation within the meaning of Section 20(9)(b)(ii) of the Public Accountants and Auditors Act 80 of 1991 to the effect that the 1999 statements were correct as certified by the audit report and opinion.
  • In consequence of the representations aforesaid, the agreements were concluded and the amount of R241 069 222,43 was paid for which Deloittes is now liable."

Section 20(1) of the Public Accountants and Auditors Act 80 of 1991 sets out the standard of diligence required of an auditor before reporting or providing an opinion that financial statements fairly reflect the affairs of an undertaking. Section 20(9)(a) refers to the negligent performance of duties by an auditor "’in respect of an opinion expressed…or report or statement…"

Our law firmly recognises that a negligent misrepresentation will give rise to delictual liability provided all the necessary elements of such liability are satisfied. There can be a misrepresentation by silence. Unless there is a duty to speak or act, silence or inaction as such cannot constitute a misrepresentation.

The appellant’s alternative claim relies on a negligent misstatement by omission to the effect that Deloittes’ prior negligent certification was correct. Section 20(9)(b)(ii) enables a third party to sue an auditor if, after such a negligent certification, it represents in any way that it was correct.

In general, auditors have no duty to third parties with whom there is no relationship or where factors set out in the Standard Chartered Bank case are absent. The court held that in considering whether a defendant acted unlawfully in relation to a third party, i.e. in breach of a legal duty, the nature, context, purpose of the statement and knowledge thereof are considered and so is the relationship between the parties.

The SCA held that "the important factual implication is that a reasonable person in Deloittes position would, at the stage of the alleged events, have known of the defects in the report. On that basis one is justified in saying that the conclusion could well be drawn at the trial that, possessed of such knowledge, the reasonable person would not have kept silent but have expressed at least a reservation as to the reliability of the report. Although the implication of the criterion of a reasonable person concerns the negligent aspect of liability, from which the legal duty element is quite separate, the provisions of Section 20(9)(b)(ii) of the Act provide a clear pointer that a negligent representation falling within its terms is indeed wrongful.

Whether the representation by silence alleged in this case does fall in this Section’s terms depends on whether there was a duty to speak. In other words the duty relied on for there having been a representation will be the same duty relied on for the allegation for wrongfulness."

As to the existence of the duty to speak, a court apprised of all the factors and circumstances on the framework of the allegations made in the particulars of claim, and on final evaluation, might find that the defendant’s ignorance of its negligent report is no bar in concluding that it bore the alleged duty (Minister of Law and Order v Kadir 1995 1 SA 303 (A) at 318H-I). The SCA proffered that it must be remembered that we are dealing with a situation where the legal convictions of the community could well consider it unacceptable that an auditing firm which issued a seriously negligent report should escape the legal duty to speak with care concerning that report simply because it was, possibly even negligently, ignorant of the negligence of its report.

The SCA held therefore that it cannot be found at exception stage that the defendant’s (Deloittes) alleged omission to speak was not wrongful. Furthermore, the Court held that it was premature to decide whether a legal duty could be said to exist in that this duty would be required to be determined at the end of a trial process.

The Appeal was upheld and is now the most current precedent whereby third parties other than the company or shareholders might hold the auditors liable for misstatements, even where auditors are not aware of the misstatements but ought reasonably to have detected them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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