Price Waterhouse v Kwan [1999] NZCA 311; [2000] 3 NZLR 39; (2000) 6 NZBLC 102,945 (16 December 1999)

Last Updated: 29 November 2011

IN THE COURT OF APPEAL OF NEW ZEALAND

CA 80/99

	BETWEEN	PRICE WATERHOUSE
		Appellant

	AND	P KWAN AND OTHERS
		Respondents

AND

	BETWEEN	PRICE WATERHOUSE
		Appellant

	AND	K D HUGHES per N M HUGHES
		Respondent

Hearing:	17-18 November 1999
Coram:	Gault J Keith J Tipping J
Appearances:	M R Camp QC and B A Gibson for Appellant P D Green for Hughes Respondents
	R J B Fowler for Kwan Respondents (given leave to withdraw)
Judgment:	16 December 1999

JUDGMENT OF THE COURT DELIVERED BY TIPPING J

Introduction

[1] The appellants (Price Waterhouse) were the auditors of the trust account of a firm of solicitors called Salek Turner & Cuttance. The respondents (the clients) invested money through the firm's nominee company. On the basis that they are unlikely to recover their investment from the nominee company or the solicitors, the clients have sued Price Waterhouse alleging that their losses were caused or contributed to by that firm's negligence. Price Waterhouse applied in the High Court to strike out the claim on the basis they owed no duty of care to the clients. Master Thomson dismissed that application and Price Waterhouse have appealed from his decision.
[2] The appeal is therefore primarily concerned with whether auditors of a solicitors' trust account owe a duty of care to clients of the solicitors who have invested money through the trust account by means of the solicitors' nominee company.

Submissions - in summary

[3] Mr Camp for Price Waterhouse argued that no duty of care is owed by auditors to solicitors' clients. The parties, he contended, should be confined to what he called "the contractual matrix". By this he meant that the client should sue the solicitors in contract, and the solicitors should sue the auditors in contract, with no right of action in tort being available to the clients against the auditors. This would have the effect, as Mr Camp accepted and indeed intended, that if the solicitors were insolvent the clients might be unable to recoup their losses unless the solicitors themselves, or their assignees in bankruptcy, chose to pursue the auditors who would then have the ability to raise issues of contributory negligence.
[4] Mr Camp raised, as a second issue, the effect of the decision of this Court in Boyd Knight v Purdue [1999] 2 NZLR 278, a case decided after the Master had delivered his judgment. This second issue is concerned primarily with matters of causation and the sufficiency of the nexus between the negligence alleged and the loss suffered. Mr Green contended that a duty of care in tort should be held to exist between Price Waterhouse and the clients. There was, he said, sufficient proximity between them, and matters of policy, including in particular the relevant legislative environment, supported the existence of such a duty. On matters of causation Mr Green acknowledged there were potential difficulties in the existing pleadings. After the hearing he tendered with leave an amended statement of claim designed to deal satisfactorily with that aspect of the case.

High Court judgment

[5] The Master addressed the same "contract only" argument as was presented to us. He relied in part on the judgment of Young J in Sievwright James & Co Securities Ltd v Borick (Dunedin CP20/94, 21 December 1998). That case dealt with a situation similar to the present. Young J held, on a strike out application, that the contention that auditors owed a duty of care to solicitors' clients could not be said to be untenable. The Judge discussed various policy considerations and reached the provisional view that they supported the asserted duty of care. The Master adopted Young J's approach. He also addressed causation issues but these do not need to be identified at this point.

Legislative environment

[6] It is desirable to examine first the legislative environment in which auditors of solicitors' trust accounts operate. That environment is of considerable relevance to the dual issues of proximity and policy which drive the conventional enquiry into whether it is fair, just and reasonable to impose a duty of care in a novel situation: see Attorney-General v Prince & Gardner [1998] 1 NZLR 262 (CA) at 268 and 291. Solicitors operate their nominee companies under, and in terms of, the Solicitors Nominee Company Rules 1988, promulgated by the New Zealand Law Society. The essential purpose and function of a nominee company, as indicated in Rule 5, is to hold mortgages and other securities upon a bare trust for the beneficial owners thereof. In that capacity the nominee company is the formal lender of the monies belonging to solicitors' clients, which monies would otherwise have been lent, either individually or in shares, in the name of the clients themselves.
[7] Under the heading "Internal Office Procedures" the Nominee Company Rules state:

1. Accounting procedures - strict adherence to all relevant provisions of the Solicitors' Trust Account Rules 1969, the Audit Regulations 1987 and the Solicitors Nominee Company Rules 1988 is essential.

It is thereby made clear that in the operation of their nominee companies solicitors must comply fully with the Solicitors' Audit Regulations 1987. The operations of the nominee company are effectively part of the operations of the trust account and liable to audit accordingly. The 1987 regulations are applicable to the present case, in spite of the coming into force on 1 April 1998 of the Solicitors' Trust Account Regulations 1998. The 1998 Regulations are materially different, but it is not necessary for present purposes to examine the differences. The 1987 regulations to which we shall refer simply as the regulations, were made pursuant to s91 of the Law Practitioners Act 1982. We will mention what we see as their salient features for the purposes of this case.

[8] Regulation 9 provides that no accountant shall be qualified for nomination by a solicitor as the auditor of that solicitor's trust accounts unless, in the opinion of the Council of the District Law Society, the accountant has and maintains adequate professional indemnity insurance. The power to regulate to this effect is expressly given in s91(1)(h) of the Act. The Council of the District Law Society may, in respect of any particular appointment, waive this requirement. This key provision features again in Regulations 11, 12, 16, 46 and paragraph 2 of the form of Audit Report specified in the second schedule. It must have been introduced in large part for the benefit of those liable to suffer loss if the auditors performed their duties in a negligent manner. It is the clients of solicitors who will ultimately carry the burden of such negligence if the solicitors themselves are unable, from insolvency or otherwise, to provide compensation.
[9] Auditors of solicitors' trust accounts are formally appointed by the District Law Society. The procedure is for the solicitor to nominate the auditor, having ascertained that the person or firm nominated is willing to act. The nominating solicitor must ensure that the consent in writing of the nominated accountant is forwarded to the District Law Society together with a statement by the accountant of the minimum amount of professional indemnity insurance that the accountant maintains - Regulation 12.
[10] Regulation 19 provides that, subject to any written agreement to the contrary between a solicitor and any person for or in trust for whom any money is received or held by the solicitor, the cost of auditing that solicitor's trust accounts shall be borne by the solicitor.
[11] Regulation 20 provides that the fact that the auditor is appointed by the District Law Society shall not absolve the auditor from his or her responsibilities to the solicitors by whom the auditor's fees are payable.
[12] Regulation 19 indicates that there can be agreement between solicitors and their clients providing that the client shall pay direct to the auditor an appropriate fee pertaining to that aspect of the auditor's work which concerns the client's affairs. If there were such an agreement, creating a relationship close to a contract between the client and the auditor, the auditor would, as Mr Camp accepted, have difficulty in contending that no duty was owed direct to the client. It is hardly convincing to hold that there is a direct duty in those circumstances, but no such duty if the audit fee is paid indirectly by the client, simply as part of the solicitor's normal overheads.
[13] There is the further point that an auditor who is appointed to audit a solicitor's trust account in the ordinary way, has rights of access to every facet of the trust account necessary for the proper conduct of the audit. If, in order to obtain a direct contractual relationship with the auditor, a client were to appoint his or her own pro tanto auditor, that auditor would not have the rights of access to the whole trust account which the general auditor possesses. There is no practical capacity for an individual client, by appointing an individual auditor, to obtain the sort of protection that a general audit provides. It is therefore natural that clients of a solicitors' firm will rely upon the general audit protection provided under the regulations rather than the much narrower focus that would be available if an individual auditor were appointed on an individual contract. Such a course would in any event be most unusual, whether taken under Regulation 19 or generally. It would also probably involve the client in duplication of expense.
[14] Regulation 54 requires the auditor to report forthwith to the District Law Society if at any time the auditor becomes aware of any of the matters referred to in the regulation, such as the failure of the solicitor to keep the trust account in a proper manner, the finding of some default, or anything else which the auditor considers should be communicated to the District Law Society.
[15] Regulation 63 places a duty on the President of the District Law Society to cause the matter reported by the auditor to be investigated by the Council of the Society. The Council is empowered by the regulation to conduct the investigation and if necessary to institute proceedings against the solicitor concerned. There is also a duty on the Council of the District Law Society to report to the New Zealand Law Society in terms of Regulation 64. While these processes may well have a disciplinary connotation, it seems to us that they are equally, if not more, concerned with requiring and empowering the District Law Society to take appropriate steps in the interests of those whose money may be at risk, as a result of the matters referred to in the auditor's report. In other words, there is a protective element in the District Law Society's role, as well as a potential disciplinary element. The purpose of the auditor's report, and the auditor's duty to make such a report in the stipulated circumstances, is to initiate steps both in the interests of the clients of the solicitor and in the interests of the good government of the profession.

Proximity

[16] Against that background, and in light of the relationships between the auditor, the solicitor, and the latter's clients, there is in our view sufficient proximity between the auditor and the clients to justify the imposition of a duty of care in tort, subject to such policy considerations as may suggest otherwise. The regulatory regime, under which audits of solicitors' trust accounts are conducted, confirms what is inherent anyway, that the purpose of the audit, at least in significant part, is to protect solicitors' clients from loss as a result of improper conduct in relation to the solicitors' trust account. If everything were intended to rest on solicitors' contractual duties to their clients, there would be less point in having an audit regime. It is axiomatic that if serious problems are encountered in the administration of a trust account, the solicitor or solicitors concerned may well be unable to compensate the clients for the losses involved. In our view, clients of a solicitor are entitled to rely generally on the audit regime, and specifically on the individual auditor to conduct the audit with due care and skill. Reasonable auditors will realise that such reliance is being placed upon them. They must accordingly be deemed to have assumed the responsibility envisaged by such reliance. In these circumstances we consider that the clients have shown, prima facie at least, that the proximity requirement for a duty of care in tort is satisfied. For strike out purposes there can be no doubt that there is a sufficiently arguable case for qualifying proximity.

Policy

[17] The primary focus of the argument lay in this area. It is desirable to address first Mr Camp's contention that the parties should be left to their claims in contract. This would mean that the clients could not sue Price Waterhouse because it is common ground there was no contract between them. The chain of contract was between client and solicitor, and then between solicitor and auditor. The proposition that only contractual relationships should be recognised in present circumstances seems to us to hark back to the days when it was thought that when there was a contract there could be no concurrent liability in tort. That stance has been firmly rejected in England and elsewhere: see the decision of the House of Lords in Henderson v Merrett Syndicates Ltd [1995] 2 AC 145, [1994] 3 All ER 506. The decision of this Court in McLaren Maycroft & Co v Fletcher Development Co Ltd [1973] 2 NZLR 100 (CA) might be thought to have some lingering effect precluding concurrent liability in tort and contract in New Zealand. That decision can now, however, safely be regarded as having been overtaken by later developments. It can no longer be taken as representing the law in New Zealand. The consequence is that a solicitor's client can sue the solicitor in both contract and tort, the latter subject to any relevant contractual restraints or limitations. The client is not confined to suing the solicitor in contract when a concurrent cause of action is available in tort. Thus the exclusively contractual chain for which Mr Camp contended breaks down at the outset. If the client can sue the solicitor in tort, there is no basis for saying that other potential tortious claims must be disallowed on the basis that the rights of the parties are to be confined to those arising in contract.
[18] Mr Camp endeavoured to support his contract only argument by reference to the judgment of Richardson J in South Pacific Manufacturing Co Ltd v New Zealand Security Consultants & Investigations Ltd [1992] 2 NZLR 282 (CA) and also to a paper written by Sir Ivor and published under the title "Law and Economics" (1998) 4 NZBLQ 64. We do not read his Honour as going as far as Mr Camp suggested. The fact that a claim is already available against another party in contract is relevant to whether a duty of care for the same damage should be found to lie on the defendant, but is by no means decisive. In the present case the contractual claim which the clients no doubt have against the solicitors may well be ineffective in practical terms. To hold that a party who enjoys sufficient proximity with A to raise a prima facie duty of care in tort should be confined to a contractual remedy against B, when the efficacy of that remedy is dubious, hardly seems a good policy reason for denying the existence of a duty of care in A. There may be circumstances in which the legislative or other environment governing the relationship of the parties supports the view that the presence of a contractual right against B militates against there being a parallel tortious right against A for the same damage. Such a conclusion might rest on matters of express or implied intention or on more general matters of policy. Such is not the position in the present case. On the contrary, policy matters, prima facie, favour there being a duty of care owed by auditors to solicitors' clients, rather than pointing in the opposite direction. It is possible that evidence might be called at the trial suggesting the contrary, but at this strike out stage of the proceedings it is impossible to say that no tenable case is raised for the asserted duty of care.
[19] Among further policy matters mentioned by Mr Green as supporting the duty of care was the fact that the auditors, as noted above, are effectively being paid indirectly by the clients. The principal purpose of the audit regime is to protect the clients. The number of potential plaintiffs is circumscribed by being limited to those with trust account investments at the time of the negligence. There is also the desirability of an effective sanction for negligence which would not necessarily be present if the liability of the auditors was to be limited to claims in contract by the solicitors or their assignees in bankruptcy, the latter being a cumbersome prospect in any event. Given proximity, it is difficult to see how Mr Camp's exclusive contract thesis can prevail against the weight of Mr Green's submissions. Mr Camp argued that the risk of the solicitors' insolvency should fall on the client, rather than the auditor. We do not find that point persuasive, the more so when the auditor has been negligent in a manner causing or contributing to the loss.
[20] Mr Camp also suggested that the District Law Society would not be liable if it negligently failed to act on an auditor's report, and thus caused loss to a client. The corollary, Mr Camp suggested, was that an auditor should not be liable to the client either. We do not necessarily accept Mr Camp's premise, but as the issue of the District Law Society's potential liability in such circumstances is not before us we prefer to say no more about it. But even if the premise were sound, it does not follow that the absence of liability in the District Law Society leads to the same conclusion as regards the auditor, particularly when the existence of appropriate professional indemnity insurance is such a significant feature of the legislative scheme.
[21] Mr Camp accepted that a major purpose of the audit regime was to protect investors, but he argued that this was no reason to impose a civil duty of care on the auditor in favour of the client. To accept this argument would, however, be likely to render auditors largely immune from claims for negligence, because neither solicitors nor the Law Society could make such a claim unless they could show a loss. The Law Society could only do so if sued by a client which, Mr Camp suggested, could not be done. The solicitors could only do so on the basis that the auditor should have picked up a default or problem within the solicitors' own practice causing loss to a client. The circumstances might well lead to a large element of contributory negligence on the solicitors' part. This would reduce the amount recoverable by the solicitors, who are likely, on the present hypothesis, to be insolvent anyway. Thus, contrary to Mr Camp's submission there is good reason both practically and in principle to impose a duty of care on auditors in favour of solicitors' clients. Otherwise the clients' loss, ex hypothesi caused by the auditor's negligence, may well go wholly or partially unremedied.
[22] Before leaving this topic we should indicate why we cannot accept several further submissions which Mr Camp made in support of his primary proposition. He argued that to allow a direct claim in tort by clients against the auditor would be "distortive" of the rights which the parties had bargained for. The principal reason was that such a direct right of claim would leave the auditors bearing the risk of the solicitors' insolvency. We can, however, see no basis for holding that there existed any bargain that the clients, rather than the auditors, would carry that risk. To rely on the so-called contractual matrix for that proposition seems to us to be highly artificial. There can thus be no distortion of bargained rights by holding in favour of the asserted duty.
[23] Mr Camp also relied on the decision of this Court in Kavanagh v Continental Shelf Co (No. 46) Ltd [1993] 2 NZLR 648. In that case a duty of care in tort was rejected because there was already an adequate remedy in contract, namely breach of warranty of authority. It was the alleged tortfeasor who was amenable to that cause of action. Here, there is no adequate remedy as between the client and auditor, unless a remedy in tort exists. The present is therefore a different situation. The tort claim contended for against the auditors here is not additional to an existing claim in contract. That was the essential point in Kavanagh's case, see 652 per Richardson J and 654 per Hardie Boys J.
[24] We have also considered the judgment of McHugh J in Esanda Finance Corporation Ltd v Peat Marwick Hungerfords [1997] HCA 8; (1997) 142 ALR 750, upon which Mr Camp placed considerable reliance. Esanda was a case where reliance was foreseeably placed on an audit report by a person to whom the auditors had not assumed any direct responsibility. The essential question was therefore different from that which arises in the present case. We do not find McHugh J's otherwise helpful list of features of assistance in light of that material difference, and in light of the legislative environment against which the present case falls to be decided.

Conclusion - duty of care

[25] For all the reasons canvassed we consider Price Waterhouse must fail in its contention that there is no tenable case for imposing the duty of care in issue. Indeed we consider there is a clear prima facie case for such imposition, which should be confirmed at trial unless there emerges some evidence providing policy reasons of sufficient force to lead to the opposite conclusion. The duty for which there is clear prima facie support can be framed quite simply. Causation issues are properly dealt with as a subsequent and separate enquiry and should not unnecessarily intrude into the formulation of the duty of care and its scope. An auditor of a solicitor's trust account owes to current clients of the solicitor a duty to conduct the audit with reasonable skill and care. The auditor is liable to such clients for any loss caused or contributed to by the auditor's failure to exercise such reasonable skill and care.
[26] The second aspect of the case is concerned with the proper approach to causation issues and to that topic we now turn.

Causation

[27] The statement of claim in the Hughes' case gave as particulars of Price Waterhouse's alleged negligence, a number of matters having no apparent connection with the investment of the Hughes' money or the audit related thereto. The basis of the claim, save for two allegations of a more direct kind, seemed broadly to be that if the auditors had taken appropriate care at times earlier than those relevant to the Hughes' investments, the solicitors' trust account would or should have been closed down. It followed in terms of the Hughes' allegations that their money would not have been lost, because there would have been no opportunity for the occurrence of the defaults which are later said to have occurred. In couching their claim on this basis, the Hughes claimants were stretching the proper concept of causation in this field beyond breaking point. They were seeking to apply a literal "but for" approach, which is not appropriate in claims based on tortious negligence.
[28] There is a material, indeed a crucial difference between causing a loss and providing the opportunity for its occurrence. The line between these concepts can often be difficult to draw but the distinction is vital. The point was addressed in the judgments delivered in this Court in Sew Hoy and Sons Ltd (in receivership and in liquidation) v Coopers & Lybrand [1996] 1 NZLR 392. Plaintiffs in this field must show that the defendant's act or omission constituted a material and substantial cause of their loss. It is not enough that such act or omission simply provided the opportunity for the occurrence of the loss. The concept of materiality denotes that the act or omission must have had a real influence on the occurrence of the loss. The concept of substantiality denotes that the act or omission must have made a more than de minimis or trivial contribution to the occurrence of the loss. Looking at the question in this dual way is both a reminder of the difference between opportunity and cause, and a touchstone for distinguishing between them. In some instances the words used have been material or (as opposed to and) substantial. It is preferable, for the reasons just mentioned, to focus on both concepts for they are each relevant to causation issues. No form of words will ultimately provide an automatic answer to what is essentially a question of common-sense judgment.
[29] The two particulars of negligence in the Hughes' statement of claim, which appeared on their face to be on the right side of the line, were that Price Waterhouse had:

18.46 Failed to ascertain that no authority had been given for the investment of the Hughes estate funds as set out in paragraphs 8 and 12 above.

18.47 Failed to ascertain that the contributory mortgage investments of the Hughes estate funds were not secured by way of registered mortgage as set out in paragraphs 10 and 11 above.

During the course of the hearing when these issues were being considered, Mr Green undertook to file a draft amended statement of claim drawing an appropriate causation line. This document has been received and Price Waterhouse has accepted that if its primary submission fails, and the claim remains alive, the proposed amendment will enable the case to proceed, subject to its right to seek further particulars. A similar exercise should be undertaken in the Kwan case but that can be left to such steps as may be necessary in the High Court.

[30] In light of the foregoing developments, it is unnecessary to say much about Price Waterhouse's reliance on the decision of this Court in Boyd Knight v Purdue (supra). We observe only that it is desirable to keep the question of the existence of a duty of care and its content conceptually separate from issues of causation. Whether a duty of care should be held to exist, and if so, its content and extent, are issues which are logically prior to whether a breach of that duty has caused the loss in suit. In Boyd Knight a duty of care was held to exist between the auditors and potential investors. The auditors had a duty to be careful when giving the certificates. It was at the causation stage that the investors' claim broke down. The absence of reliance by them on the financial statements meant that any carelessness by the auditors in giving the certificates was not a material and substantial cause of their loss. Boyd Knight is of no assistance to Price Waterhouse on the duty of care issue. It is of assistance on the causation issue. That has been reflected in what we have written above, and in the need for the clients to file pleadings properly particularised from the causation point of view.

Conclusion/formal orders

[31] For the reasons given the appeals fail and are dismissed. Any outstanding issues in connection with the pleadings are to be dealt with promptly in the High Court. Price Waterhouse is to pay costs to the Hughes respondents of $5000 plus disbursements to be fixed if necessary by the Registrar. The Kwan respondents adopted Mr Green's submissions and were given leave to withdraw. Price Waterhouse is to pay them costs of $500 plus disbursements to be fixed if necessary by the Registrar.

Solicitors
B A Gibson, WELLINGTON, for Appellant
Coopers, LEVIN, for Hughes Respondents
Phillips Fox, WELLINGTON, for Kwan Respondents