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Court of Appeal of New Zealand |
Last Updated: 28 August 2018
IN THE COURT OF APPEAL OF NEW ZEALAND CA248/98
BETWEEN BOYD KNIGHT
Appellant
AND ROBERT MACE PURDUE AND HAROLD TEEUW MATTHEW
Respondents
Hearing: 1 March 1999
Coram: Gault J
Blanchard J Salmon J
Appearances: R Harrison QC and S F Lennon for Appellant
P F Whiteside for Respondents
Judgment: 23 March 1999
JUDGMENTS OF THE COURT
[1] I have read in draft the judgment prepared by Blanchard J. I am content to express my agreement with it. However, because we are disagreeing with the Judge in the Court below, I will add a few brief comments of my own.
[2] First I agree with, and have nothing to add to, Blanchard J’s conclusion that the investors did not establish that they relied upon the financial information in the company’s accounts in the prospectus which the auditors negligently reported to be accurate.
[3] Through the pleadings, the interlocutory proceedings, the trial and the judgment there has been a conspicuous lack of specificity in the scope of the alleged duty of care. There seems to have been confusion as to the claim actually advanced.
This can perhaps be highlighted by distinguishing between, on the one hand, negligence by failure to act so as to prevent the issue of the prospectus (negligent conduct) and on the other hand negligence by stating in the auditors’ report that the company accounts were accurate (negligent statement).
[4] I should state immediately that I have never been convinced that any different principles should apply as between negligent statements and negligent acts. But here it is essential to the proper analysis of the case to focus upon what is alleged to be the duty, and the breach causative of loss.
[5] It is the negligent conduct allegation that seems to be that primarily contended for by the investors. The third amended statement of claim alleges that the audit report included in the prospectus was wrong (admitted); that the auditors with reasonable care would have known or discovered the inaccuracies in the financial accounts certified in the report (admitted); that if they had known or discovered the inaccuracies they would not have given the report and the prospectus would not have issued (admitted). The duty of care of unspecified scope alleged to be owed to depositors in carrying out the audit and in subsequently preparing the audit report for the prospectus was said to have been breached by conduct of which 10 particulars are given. All are directed to the failure to exercise reasonable care in carrying out the audit. The whole tenor of the claim is that loss flowed to the investors not by their being misled by inaccurate information in the report but from the fact that the inaccurate audit report was given which resulted in the issue of the prospectus but for which they could not have invested.
[6] Consistently with that it was argued that it was sufficient to show “general” reliance on the audit report without proving that there was actual reliance upon the financial information which it certified as accurate.
[7] It seems the issue of whether to succeed the investors needed to establish general or actual reliance is really whether it was sufficient to establish reliance on the fact that the audit report was made without showing reliance on the information certified. That depends on the scope of the duty owed by the auditors to the investors.
[8] I have no doubt that upon assuming responsibility to give a report in terms of cl 36(1) of the Second Schedule to the Securities Regulations 1983, the auditors were under a duty to investors relying on the prospectus to exercise reasonable skill and care in stating accurately “whether or not, in [their] opinion the financial statements
... give a true and fair view of the state of affairs of the [company] ... and if they do not, the respects in which they do not”. But breach of this duty cannot avail investors who have not relied on the accuracy of information given.
[9] So the question is whether the duty upon the auditors was broader in scope and extended to the exercise of reasonable skill and care so as to prevent the issue of a prospectus by a company in breach of its permitted borrowing ratio. Any narrower duty would not assist investors who did not rely on the accuracy of the accounts.
[10] There is some analogy with the case of Deloitte Haskins & Sells v National Mutual Life Nominees Ltd [1993] UKPC 24; [1993] 3 NZLR 1. There the Privy Council held that the duty of the auditors was limited to reporting to the trustee for investors matters of which they had become aware in the performance of their duties if of the opinion they were relevant to the trustee’s powers or duties, and did not extend to exercising reasonable skill and care in ascertaining whether there were in fact any such relevant matters. That reflected the positive duty on the auditors under the securities legislation. It was held that no broader duty should be imposed under the common law. In the present case the duty on the auditors was to report whether or not the accounts were accurate and there is nothing in the relevant legislation suggesting that should be extended to ensure that the company was prevented from issuing a prospectus.
[11] I have reservations about resting my decision on the analogy with the Deloitte case. Their Lordships do not appear to have had their attention drawn to s65 of the Securities Act, and the decision seems to have placed the auditors in a better position because they were negligent in their underlying duty. But even if that case is distinguished by reference to the fact that the auditors in the present case undertook the giving of the report and so were obliged to ensure its accuracy, there still remains the context in which the report was required. As Blanchard J points out
that was for the purpose of providing advice or information to investors. Any duty of care must be related to that.
[12] In terms of the scheme of the legislation, the auditors would have discharged their duty to the objectors by reporting that the accounts in the prospectus did not give a true and fair view of the state of affairs of the company because they overstated shareholders’ funds by $1.15 million. In that event, liability for loss to investors who relied simply on the fact such a report was given and was included in a prospectus rather than on its contents would be absurd. Plainly it is the accuracy of the report as it relates to the financial statement that attracts the duty.
[13] The admission that no prospectus would have issued if the report had been accurate makes no difference. The determination of the company to issue a prospectus engages no duty owed by the auditors to the investors. But even if there were a duty of care to the investors not to provide the company with an inaccurate report the likely result of which would have been that a prospectus would issue, the investors would still face insuperable problems with causation and remoteness.
[14] It is not a sufficient test of remoteness of damage that “but for” a defendant’s negligence the loss would not have occurred: Bank of New Zealand v The New Zealand Guardian Trust Company Ltd CA95/98, judgment 18 December 1998 p23.
[15] Whether considered by reference to the kind of harm the duty extends to protect against, or by reference to foreseeability, it is necessary to contemplate loss suffered by investors who did not rely on the information in the accounts certified as accurate. As Lord Hoffmann said in Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd [1996] UKHL 10; [1997] AC 191,213 and 214:
Rules which make the wrongdoer liable for all the consequences of his wrongful conduct are exceptional and need to be justified by some special policy. Normally the law limits liability to those consequences which are attributable to that which made the act wrongful. In the case of liability in negligence for providing inaccurate information, this would mean liability for the consequences of the information being inaccurate.
...
I think that one can to some extent generalise the principle upon which this response depends. It is that a person under a duty to take reasonable care to provide information on which someone else will decide upon a course of action is, if negligent, not generally regarded as responsible for all the con+sequences of that course of action. He is responsible only for the consequences of the information being wrong. A duty of care which imposes upon the informant responsibility for losses which would have occurred even if the information which he gave had been correct is not in my view fair and reasonable as between the parties.
[16] Given the acceptance by Mr Whiteside that even if the auditors’ report had been in all respects accurate the investors would have recovered nothing more in the company collapse, liability for the consequences of the report being wrong would be of no benefit to the investors. There can be no warrant for holding auditors liable for inaccurate information where the loss did not flow from reliance on the accuracy of the information.
[17] I agree the appeal should be allowed and that the investors should not be permitted to recast their case.
BLANCHARD J
[18] The appellant firm, Boyd Knight, the auditor of a failed finance company, Burbery Mortgage Finance & Savings Ltd (Burbery), appeals against a judgment ordering it to pay damages to a class of persons, represented by the respondents Mr Purdue and Mr Matthew, who invested new funds with Burbery on secured debentures between 1 July 1988 and 10 August 1988 in response to an offer made in a prospectus issued by Burbery. The prospectus contained an audit report signed by the appellant. The respondents claim that Boyd Knight was in breach of a duty of care owed to them and to those they represent when making the report and allowing it to be used in the prospectus. The essential question on this appeal is the extent, if any, to which it was necessary at trial to prove reliance on Burbery’s financial statements to which the audit report was directed.
Facts
[19] Burbery’s business consisted of the borrowing of money from the public and on-lending it at a margin. As required by the Securities Act 1978 and the Securities Regulations 1983, from time to time it issued prospectuses. The one with which this case is concerned is Prospectus No. 11, which operated from 1 July 1988. The Perpetual Trustees Estate & Agency Co of NZ Limited (the trustee) was acting as trustee for depositors under a trust deed dated 1 October 1983. A critical ratio set by that deed was that Burbery’s total liabilities were not to exceed nine times its adjusted shareholders’ funds.
[20] The directors of Burbery were Mr Mervyn Burbery and his wife. He had been involved in the finance industry for many years and appears to have enjoyed a good reputation. But more recently Burbery had effectively become a lender of last resort, offering to the public and requiring from its borrowers very high rates of interest. Nearly 40% of its lending was to six borrowers. There had been significant defaults – arrears in excess of three months existed for more than 10% of Burbery’s total monetary assets. Worse still, however, and undetected by the auditors, Mr Burbery had committed frauds, creating fictitious loan accounts, as a result of which the shareholders’ funds (shown as $1.6 million in the consolidated balance sheet to 31 March 1983 which appeared in Prospectus No. 11) were overstated by $1.15million and total liabilities actually exceeded the limit imposed by the trust deed by about $15million. (Although it did not know of the fictitious loan accounts, the trustee was aware of what it called a “technical breach” of this ratio. It was mentioned in a letter from the trustee to the directors, a copy of which appeared in the prospectus, the trustee expressing itself as being “satisfied with the steps taken to rectify the position.”)
[21] As required by clause 36(1) of the Second Schedule to the Securities Regulations, Boyd Knight’s audit report, addressed to the directors of Burbery and included in the prospectus, read:
We have audited the financial statements of Burbery Mortgage Finance and Savings Limited as set out in pages 11 to 20.
In our opinion, the financial statements required by Clauses 16 to 31 of the Second Schedule of the Securities Regulations 1983 and required to be audited, comply with those Regulations and in accordance therewith give, using the historical cost basis, a true and fair view of the state of affairs of the Group as at the 31 March 1988 and of the results and changes in financial position of the Group for the year ended 31 March 1988.
The amounts stated pursuant to Clause 7(2), 7(3), 8(2), 8(3), and 12, where applicable, of the Second Schedule of the Securities Regulations 1983 have been correctly taken from audited financial statements.
[22] Boyd Knight has made two important admissions, namely, (a) that reasonable care on its part would have led to the discovery of Mr Burbery’s frauds before that date; and (b) that if they had been discovered the audit report would not have been given and the prospectus would accordingly not have been issued. It is clear from the evidence that, such was the magnitude of the company’s problems, no borrowing from the public could have occurred after discovery of the frauds because the Act and the Regulations could not have been complied with. The frauds were in fact detected only after the trustee appointed receivers on 10 August 1988.
[23] The persons represented by Mr Purdue and Mr Matthew all invested with Burbery for the first time during the currency of Prospectus No. 11. They managed to recover, on average, two thirds of their principal and sued for the balance and interest. The claims of unsecured creditors, who recovered nothing from the company, failed in the High Court and they have not appealed. It was held that they had not shown, through their representative, sufficient reliance upon the information contained in the audit report.
The pleadings
[24] The way in which the case was pleaded for the respondents assumed some importance. It is necessary to refer to some of the history of the pleadings and interlocutory applications.
[25] The original statement of claim did not allege reliance on the audit report. In February 1994 representatives were appointed for the classes of plaintiffs. An
amended statement of claim was then filed. It alleged that the plaintiffs and the depositors they represented had relied upon Boyd Knight in making their investments under Prospectus No. 11. A second amended statement of claim repeating this allegation was filed on 1 February 1995. In July of that year the plaintiffs applied for an order excusing all represented parties from making discovery. An affidavit in support deposed that it was not part of their case that there was reliance other than in the following respects:
[26] The deponent, one of the receivers, said that it was “not part of the Plaintiff’s [sic] case that the individual parties who are represented individually relied on the auditors in any way other than set out above”.
[27] Before the application relating to the limit of discovery was heard the plaintiffs filed a third amended statement of claim. It set out the audit report and pleaded that the financial statements of the company were inaccurate and did not give a true and fair view as stated in the report. The particulars given in support of this allegation referred to the creation of the fictitious loan accounts and an alteration made by Mr Burbery to the balance of them which had the effect that the loans ledger listing did not add up. It was then pleaded that these matters were or ought to
have been known to and discoverable by Boyd Knight by the exercise of reasonable care and that, if discovered, the firm would not have given an audit report. All these matters were admitted by the defendant. The plaintiffs then alleged the existence of a duty of care to them and all other depositors with the company under Prospectus No. 11. The duty of care was said to arise from:
[a] The forseeability that “if the Defendant was negligent in their audit damages would be caused to [the Plaintiffs] and the depositors they represent in that, if the Defendant had not been negligent, Prospectus No. 11 would not have issued and the investments.... would not have been made.”
[b] Having regard to:
[i] The purpose for which the audit report was made, namely compliance with the regulations and inclusion in the prospectus, and
[ii] The defendant’s knowledge of that purpose, and
[iii] The fact that “investors are entitled generally to rely on the carefulness of auditors to ensure their audit report fairly reflects the audit findings, and is in accordance with the Securities Regulations 1983 following which investments will be made” [emphasis added],
the plaintiffs and the depositors they represented were in a proximate relationship, and
[c] It was reasonable to impose a duty of care in the particular circumstances of the case.
[28] It was also pleaded that Boyd Knight was negligent in various ways relating to the carrying out of the audit as at 31 March 1988 and that as a consequence of the negligence the plaintiffs and the other depositors under the prospectus had suffered damages.
[29] The plaintiffs’ application relating to discovery was not heard until 28 May 1996 and necessarily focussed on the third amended statement of claim. The plaintiffs were resisting individual discovery by the represented investors on the basis that material in possession of those parties was not relevant to their case. They said that it was not part of their case that the individual parties relied on the auditors
in any way other than as summarised in the affidavit supporting the application. Chisholm J, in his oral judgment, recorded that:
The Plaintiffs say that their case is not advanced on the basis that individual investors relied on the certificate of the Defendants in making their investments after 1 July 1988. Their case is simply that but for Prospectus No. 11 there would have been no prospectus, no ability at law to receive the investments, and consequently no investments.
The Judge recorded a statement from counsel for the plaintiffs that the pleading did not suggest any individual or particular reliance but only a reliance of an indirect type, citing South Pacific Manufacturing Co Ltd v NZ Security Consultants & Investigations Ltd [1992] 2 NZLR 282, 297. While counsel had said that he could not discount the possibility that an investor might be called to give evidence relating to the issue of reliance, he had submitted that that did not alter the overall thrust of the plaintiffs’ case.
[30] In recording the submissions made by counsel for Boyd Knight, Ms Lennon, the Judge referred to her submission that the defendant was entitled to rebut the plaintiffs’ general allegation of reliance. She had claimed that the pleading could not have any meaningful purpose unless actual reliance underlay the pleading.
[31] Chisholm J concluded that the issue of reliance had been raised by the third amended statement of claim, in the portion of it which has been described above. It was pleaded in a general and hypothetical sense without reference to individual investors but, in the Judge’s opinion, the pleading was intended to link the reliance of investors to the carelessness of the defendant.
[32] He said that it was difficult to escape the conclusion that actual reliance was implicit in the pleading. But he then immediately said:
While the pleading refers to reliance in a general sense, the Defendant is, in my view, entitled to explore whether the documentation exists which may be relevant to the reliance question.
He was unable to conclude the documents held by the represented parties would be irrelevant to the issues involved in the proceeding and dismissed the application.
The trial
[33] When the matter came on for trial before Chisholm J in April 1998, however, Mr Whiteside put his clients’ case on the basis that “a general reliance by investors is all that is required to be established...”. The only evidence from a depositor from the class represented by Mr Purdue came from Mr Purdue himself. In his one page brief of evidence he said that he obtained a copy of Prospectus No. 11 and noticed particularly the audit report. “That audit report, confirming the accuracy of the accounts, influenced me to place this investment with Burbery”. He had also spoken to the managing director of Burbery’s landlord who had told him that Burbery was an excellent tenant. He also said that the satisfactory audit report had persuaded him that Burbery was a suitable company for his investment. In his equally brief additional evidence in chief, which was directed to an allegation of contributory negligence made by Boyd Knight against him and the other investors, Mr Purdue spoke of enquiring about Mr Burbery’s character. He had seen no need to make enquiries of the trustee about Burbery’s commercial activities. Because of the identity of the trustee, “I figured that was an additional security”. In cross- examination he said that the basis upon which he had reached the conclusion that this investment was in “the low risk area” was the track record of the company, and that it had audited accounts and Perpetual as its trustee. He was then asked about aspects of the information in the prospectus, including the letter from the trustee referring to the breach of the trust deed ratio. Mr Harrison QC took Mr Purdue to the financial statements, asking him whether he noted and had been concerned by certain matters: a substantial increase in Burbery’s borrowings (current liabilities), the high proportion of its loans maturing within twelve months, the level of arrears in excess of three months and the substantial proportion of advances owing by the six largest debtors. Mr Purdue understandably did not claim reliance on any of these matters. He was then asked:
You said it was the audit report that persuaded you that Burbery was a suitable company for you to invest in. What was it about the audit report that gave you that degree of persuasion? Then and even now there are people looking for money for investment and if they don’t have to comply they don’t have to have an audit. So you always do what I did, find out from the market if they are reputable, have a track record, then check the audit report, those 3 things were what satisfied me that I should put my money in.
....
What did the audit report tell you about the underlying nature of the Burbery operations?...It told me they were satisfied about the accounts.
There was no re-examination of the witness.
[34] In counsel for the plaintiffs’ closing submissions he continued to assert that a duty of care could be established on the basis of general reliance. But:
If, contrary to my submissions, actual reliance is required, then judgment should be entered for the two plaintiffs who have given evidence of actual reliance and the proceedings adjourned in respect of all the other represented plaintiffs so that those who choose to do so can give evidence of actual reliance.
(The other plaintiff referred to was a representative of the unsecured creditors.)
The High Court judgment
[35] Chisholm J referred to the statutory regime governing the issue of prospectuses, noting that in s65 of the Securities Act it is provided that nothing in the Act limits or diminishes any liability that any person may incur under any rule of law or enactment other than the Securities Act. He referred to certain features of the statutory regime relevant to any duty owed by auditors to investors suffering economic loss:
Unless the investors are entitled to rely upon the accuracy of the Audit Report in this way, it is difficult to see how its inclusion in the prospectus could serve any worthwhile purpose.
The overall impression the Judge said he gained was of a close relationship between the auditor and investors.
[36] Having extensively reviewed the authorities, the Judge was of the opinion that imposition of a duty of care in this case would not cut across the principles expressed in them. He then turned to a consideration of the question of reliance and, after a discussion, concluded that if a duty of care was to be imposed in this case it should incorporate a requirement for the plaintiffs to prove “actual reliance on the incorrect information in the audit report”. Reliance on the prospectus generally would be insufficient because that would amount to a watering down of the “traditional concept of actual reliance”.
[37] The Judge then discussed policy considerations which also needed to be assessed. In his opinion a duty of care in this case would be compatible with the
statutory framework. It would enhance the provision of accurate information relevant to investment decisions. Indeterminate liability was not a concern. Liability could arise only once the report had been incorporated in a prospectus which had been issued and then only if the incorrect information in the audit report has been relied upon by the plaintiffs. A common law duty of care based upon actual reliance would confine the auditor’s liability to losses arising from the inaccurate information provided causation could be proved and the losses were not too remote. It was difficult to see how the common law damages would be seriously out of line with the statutory liability imposed upon the company or its officers. Because a plaintiff would have to establish the necessary causative nexus between the report and the loss, liability would not arise if the loss was attributable to an investment decision rather than the erroneous audit report. He referred to the potential for disproportion between audit fees and potential claims, but noted that an auditor’s participation is voluntary and any perceived risk can be waived before consent is given to the inclusion of the report in the prospectus. Apart from that, the Judge said, the relationship between audit fees and risk could carry little weight in the context of the claim in tort, especially when it was open to the auditor to set fees taking into account risk factors. In Chisholm J’s opinion, policy considerations did not exclude the imposition of a duty of care in this case.
[38] The Judge proceeded to review the history of the proceeding, which has already been narrated, stating that in his opinion “the pleadings do not preclude the plaintiffs from proving actual reliance”. He believed that had continued to feature as a key issue right up to and during the hearing. If that had not been the situation Mr Purdue and the other plaintiff witness would not have given evidence about their personal reliance on the audit report.
[39] The Judge then considered whether actual reliance need be proved by each member of the represented class. He thought that to so require would entirely negate the whole purpose of the representation order. The represented parties were therefore entitled to rely upon the proof presented by the named plaintiffs. But the other side of the coin was that they would also fail if the necessary proof were not forthcoming from that quarter.
[40] Moving to the question of whether the plaintiffs represented by Mr Purdue and Mr Matthew had proved actual reliance, Chisholm J referred to passages from Mr Purdue’s evidence, saying that he accepted it and that Mr Purdue had proved to his satisfaction that he had placed actual reliance on the information contained in the audit report.
[41] The Judge was satisfied that the plaintiffs had established that the defendant's negligence had caused them loss – that it had done more than merely creating an opportunity for their loss to be incurred. If Boyd Knight had performed its duty, Burbery would have gone into receivership by 1 July 1988, no prospectus would have issued, and no investment would have been made by the plaintiffs. Complete or partial loss of the investment was a foreseeable result of the negligence. There were no intervening factors.
[42] A loss of $750,930.20 had been proved (the aggregate loss for all plaintiffs represented by Mr Purdue and Mr Matthew, including themselves). However the Judge concluded that there should be a 50% reduction in the amount to be recovered because of contributory negligence by the plaintiffs. Contributory negligence on the part of Mr Purdue had to be attributed to the represented members in his class. He was in a position, as a financial planner, to identify warning signs apparent from the financial information and had not done so. It must have been apparent to him that the relatively high return represented a higher than average commercial risk. On the face of the information in the prospectus Burbery was “towards the lender of last resort end of the market”. There was a relatively high risk associated with its investments. There was the question of the borrowers’ arrears which “carried a strong warning”. There was the disclosure in the financial statements that nearly 40% of the loans were to six entities. There was the indication in the prospectus that the company had been in technical breach of its trust deed borrowing ratio. Finally, it was apparent that the company was obliged to repay very large sums within the next twelve months.
[43] Judgment was given in the sum of $375,467.60 together with interest. Both sides have appealed, the respondents' cross-appeal being confined to the finding of contributory negligence.
The duty of care
[44] The auditors of a company owe to it a duty of care to perform their auditing functions in accordance with relevant professional standards. But, in general terms, in so doing they do not assume a responsibility to anyone other than the company, and through it, its shareholders. They owe no duty to present or future creditors or to those who may be contemplating investing, or further investing, in the company’s debt or equity securities, whether by purchase or subscription. In Caparo Industries PLC v Dickman [1990] 2 AC 604 the House of Lords found that auditors who had certified company accounts which misstated its profitability had no liability to a person who had purchased shares in the market after reading the accounts. Lord Bridge of Harwich remarked (p624-5) that it would be wrong to hold an auditor under a duty of care to anyone who might lend money to a company by reason only that it was foreseeable as highly probable that the company would borrow money at some time in the year following publication of its audited accounts and that lenders might rely on those accounts in deciding to lend. His Lordship approved what he described as the masterly analysis made by Denning LJ (as he was then) in his famous dissenting judgment in Candler v Crane, Christmas & Co [1951] 2 KB 164, 180-81, in which he said that accountants owe a duty to their employer or client and “to any third person to whom they themselves show the accounts, or to whom they know their employer is going to show the accounts, so as to induce him to invest money or take some other action on them”. But they owe no duty to “strangers of whom they have heard nothing and to whom their employer without their knowledge may choose to show their accounts.” The test of proximity in these cases is: “did the accountants know that the accounts were required for submission to the plaintiff and use by him?”(p181) And, Denning LJ added, the duty applies in such a case “only to those transactions for which the accountants knew their accounts were required.”(p182) The duty extends only to “the very transaction in mind at the time.”(p183)
[45] Their Lordships approved a passage from the judgment of Richmond P in this Court in Scott Group Ltd v McFarlane [1977] NZCA 8; [1978] 1 NZLR 553 in which these words are found:
The question in any given case is whether the nature of the relationship is such that one party can fairly be held to have assumed a responsibility to the other as regards the reliability of the advice or information. I do not think that such a relationship should be found to exist unless, at least, the maker of the statement was, or ought to have been, aware that his advice or information would in fact be made available to and be relied on by a particular person or class of persons for the purposes of a particular transaction or type of transaction. I would especially emphasise that to my mind it does not seem reasonable to attribute an assumption of responsibility unless the maker of the statement ought in all the circumstances, both in preparing himself for what he said and in saying it, to have directed his mind, and to have been able to direct his mind, to some particular and specific purpose for which he was aware that his advice or information would be relied on. In many situations that purpose will be obvious. But the annual accounts of a company can be relied on in all sorts of ways and for many purposes. It would be going too far to treat accountants as assuming a responsibility towards all persons dealing with the company or its members, in reliance to some greater or lesser degree on the accuracy of the accounts, merely because it was reasonably foreseeable, in a general way, that a transaction of the kind in which the plaintiff happened to become involved might indeed take place. (p.566)
[46] Richmond P had taken the view that there was no reason to differentiate auditors from accountants. He referred, in another passage approved in Caparo, to the requirement in the Companies Act 1955 for a copy of the balance sheet and auditor’s report to be annexed to the annual return and thus available to the public, and continued:
But on reflection, this only means that the auditor of the accounts of a public company knows that the accounts and his report will become available to the public generally and, consequently, may be relied on by one or more members of the public, to some greater or lesser degree, as the basis of some business transaction. It is not suggested, however, that the Companies Act imposes any statutory duty of care as between auditors and members of the public who rely on the accounts. In the case of a company whose shares are listed on the stock exchange the auditor will also know that under the stock exchange rules a copy of the accounts must be made available. He knows, too, that shareholders will receive copies of the accounts and that the company itself may well make copies available to business institutions and individuals for various purposes. In the end all these matters merely add up to the fact that the auditor of a public company will necessarily have in his contemplation the possibility that the accounts may be relied on in all sorts of ways by persons other than
the company and its members. This, as I have said, is not sufficient to bring about a ‘special relationship.’” (p.568)
[47] Essentially the same position as in Caparo has since been taken by the Supreme Court of Canada in Hercules Managements Ltd v Ernst & Young (1997)
146 DLR (4th) 577 and by the High Court of Australia in Esanda Finance Corporation Ltd v Peat Marwick Hungerfords (Reg) (1997) 142 ALR 750. These decisions emphasise that a duty of care will not be found to exist on the part of a defendant where damages are claimed for economic loss only, unless it was foreseeable that the plaintiff, acting reasonably, would rely upon, information emanating from the defendant and the circumstances were such that the defendant should have expected the plaintiff to do so. This Court took the same position in Brownie Wills v Shrimpton [1998] 2 NZLR 320,324. To the extent to which the statement of claim directly relied upon negligence in the performance of the audit on the part of Boyd Knight the claim was therefore bound to fail.
[48] Any alleged duty of care said to arise because an auditor signs an audit report to enable an issuer company to comply with the Securities Act must be considered with this background in mind. In the case of a statutory duty, the scope of the duty is determined by deducing the purpose of the duty from the language and context of the statute (Banque Bruxelles SA v Eagle Star Insurance Co Ltd [1996] UKHL 10; [1997] AC 191, 212).
[49] In Deloitte Haskins & Sells v National Mutual Life Nominees Ltd [1993] UKPC 24; [1993] 3 NZLR 1 the Privy Council placed a narrow construction, some might say a surprisingly narrow one, on the auditor's duty towards the trustee under s50(2) of the Securities Act, saying that the effect of the decisions in the courts below, which were reversed, “was to impose upon the auditor a common law duty more extensive than that imposed by the Act” (p.7). There is a need, therefore, to give close consideration to the form of the report required by the regulations in order to determine the extent of the responsibility assumed by the auditors in signing and delivering it for incorporation in a prospectus.
[50] The philosophy of the Securities Act is that investment decisions in relation to offers to the public should be made only upon a basis of adequate information
about the issuer. To be adequate it obviously must be up to date, sufficiently comprehensive and, of course, accurate in the sense of expressing a true and fair view. To this end the Act and the Regulations made under it prevent the issue by a fundraiser of equity, debt and participatory securities to the public, or any member of the public, without registration and use of a prospectus incorporating audited accounts drawn up as at a recent date. The Act also requires appointment of a trustee or statutory supervisor whose task is to provide certain safeguards for would-be investors. The Deloitte case concerned an alleged duty of auditors towards the trustee, said by their Lordships to have a “primary responsibility” towards depositors.
[51] For a debt security, clause 36(1) requires a prospectus to contain a copy of a report by a qualified auditor stating whether or not the prescribed audited financial statements comply with the regulations and in accordance with the regulations give a true and fair view of the state of affairs of the “group” (the issuer and guaranteeing subsidiaries) as at the date thereof and of the results and changes in the financial position of the group for the period to which those statements relate.
[52] An auditor giving such a report must know full well that in order to raise funds from the public the company is obligated to give the document in which it appears to investors and will do so as part of a process to encourage them to invest. The audit report will obviously give comfort in relation to the financial statements. I have no doubt that these factors give rise to the necessary closeness of relationship between the auditor and those who invest on the strength of the prospectus, so that the auditor owes them a duty to be careful in the giving of the certificate. He or she knows what sum is being raised by the issuer. I agree with Chisholm J that there is no indeterminate liability. The harder question is as to the nature of the duty, when and to whom it is owed. On this question the common law background which I have been discussing and the respective roles of the auditor and trustee are of importance.
[53] Lord Bridge remarked in Caparo that:
It is never sufficient simply to ask whether A owes B a duty of care. It is always necessary to determine the scope of the duty by reference
to the kind of damage from which A must take care to save B harmless. (p.627)
And Lord Oliver of Aylmerton said:
It has to be borne in mind that the duty of care is inseparable from the damage which the plaintiff claims to have suffered from its breach. It is not a duty to take care in the abstract but a duty to avoid causing to the particular plaintiff damage of the particular kind which he has in fact sustained. (p.651)
His Lordship later commented:
In seeking to ascertain whether there should be imposed on the adviser a duty to avoid the occurrence of the kind of damage which the advisee claims to have suffered it is not, I think, sufficient to ask simply whether there existed a “closeness” between them in the sense that the advisee had a legal entitlement to receive the information upon the basis of which he has acted or in the sense that the information was intended to serve his interest or to protect him. One must, I think, go further and ask, in what capacity was his interest to be served and from what was he intended to be protected? ....Before it can be concluded that the duty is imposed to protect the recipient against harm which he suffers by reason of the particular use that he chooses to make of the information which he receives, one must, I think, first ascertain the purpose for which the information is required to be given.(p.652)
[54] When auditors furnish a report for inclusion in a prospectus they express an opinion about the financial statements of the company which they have audited: they confirm the accuracy of those statements, in the sense of that word used above. However, they are not called upon to make any comment on the state of the company’s affairs. They undertake no duty to assess for would-be investors whether it is creditworthy. Their duty is to inform, not to give advice. The record shown by the financial statement speaks for itself. The true and fair view may be one of prosperity or poverty. The report therefore has no context for anyone who has not read the accounts. Without such a reading the report tells the reader nothing except that the company has a set of accounts which comply with the regulations and present a true and fair view. In so far as such a report refers to a true and fair view, it is almost meaningless unless read in conjunction with the figures in the accounts. It must follow, it seems to me, that in so certifying the accounts the auditors cannot be taken to have accepted an obligation to an investor who has not read and relied
upon them. Reliance, and a consequential duty of care, cannot be asserted, as it were, in a vacuum. There must first have been a specific influence of the financial statements on the mind of the investor. It is not enough for the investor to say that, without troubling to look at the accounts, he or she relied in a general way upon the statutory scheme, making an assumption that an investment is sound or the issuer creditworthy because there was a trustee playing a supervisory role in connection with the prospectus and an auditor had furnished the report required by the Regulations.
[55] It would be casting upon an auditor a burden going even beyond anything suggested for the unsuccessful plaintiff in Caparo if this Court were to hold careless auditors liable for the accuracy of figures which were not directly relied upon by plaintiff investors. Since the purpose of the legislation is to ensure information is available to investors, so that they can make their own assessment of the prospects of the issuer, it would be exceeding the statutory scheme if the Court were to find auditors responsible for inaccuracies in information which was not utilised by an investor. There is no room in this context for an indirect reliance which Cooke P adverted to in a rather different case (South Pacific Manufacturing Co Ltd v New Zealand Security Consultants & Investigation Ltd [1992] 2 NZLR 282, 297). And, like the British Columbia Court of Appeal in Kripps v Touche Ross & Co (1992) 94 DLR (4th) 284, I find no attraction in the doctrine of reliance on the integrity of the market which has been developed in some jurisdictions in the United States. It is quite contrary to the position taken in Caparo.
[56] In circumstances in which, if the true position had been revealed, the accounts could have been corrected and a prospectus would probably still have issued seeking the investment a plaintiff investor must, I think, show reliance on a particular item or items in the financial statements which were inaccurate. It must be proved that, if the true and fair view in that regard had been known to the plaintiff, the investment decision would have been different. For, if the inaccurate material was not an influence on the investor, how can it be alleged that the investor would not have gone ahead with the investment? The loss suffered on the investment would not then be attributable to the uncorrected inaccuracy of the report. The plaintiff therefore cannot say that he or she was worse off because the
information was wrong. “A duty of care which imposes upon the informant responsibility for losses which would have occurred even if the information which he gave had been correct is not in my view fair and reasonable as between the parties” (Banque Bruxelles Lambert SA v Eagle Star Insurance Co Ltd [1996] UKHL 10; [1997] AC 191 at 214, per Lord Hoffman).
[57] A broader approach is permissible where it is proved or, as here, admitted that if the accounts had been accurate no prospectus would have been issued and no investment could then have been made – in other words, that “but for” the inaccuracy there could have been no loss to a new investor. But even in such circumstances the limited scope of the duty of care must be remembered. In such a case there must at least be a reliance on the basic features of the financial statements
– the results they show (profit level, balance of shareholders’ funds and, perhaps, the current assets/liability ratio). There must be evidence that these features were considered by the plaintiff and, taken as a whole, relied upon. The investor must prove that he or she paid attention to the content of the financial statements and noted these basic features – that it was not simply a case of glancing at the accounts, but in reality failing to consider them and, instead, relying in a general way on the fact that the investment offer was being made pursuant to a prospectus and that the Regulations put some safeguards in place.
Absence of reliance on accounts in this case
[58] Earlier in this judgment (at para [16]) I described the evidence given on behalf of the class of plaintiffs by Mr Purdue. The trial Judge set out in the judgment a small portion of the testimony and said that he accepted it as proof of actual reliance on the financial statements. He did not say how he arrived at this conclusion other than mentioning that Mr Purdue is by occupation a financial planner and that it was “not surprising that he paid particular attention to the information contained in the audit report and that the satisfactory audit report persuaded him that Burbery was a suitable company in which to invest.” [Emphasis added].
[59] Having carefully considered the evidence in question, I must respectfully disagree with the view taken by the Judge. Mr Purdue claimed to have relied upon the audit report, but, except in relation to the matters to which he was referred in cross-examination, he did not assert that he had read, let alone relied upon, the accounts or any particular features of them. He did not even say that he had made himself aware of matters such as profitability and shareholders’ funds. He made no reference to any financial ratios. It is clear from the cross-examination that, to the extent that Mr Purdue may have looked at the accounts, he was blind to matters which might have caused alarm to a careful investor. In fact, so plain were the warning signs that I find it difficult to credit that someone who styles himself a financial planner would have overlooked them if he had considered and relied upon the financial statements. It is my reading of Mr Purdue’s evidence that he was asserting only an indirect or general reliance, having taken comfort from the role of the trustee, the fact that an auditor was a part of the process and certain inquiries which he had made. He did not actually rely on the financial statements.
[60] I am of course hesitant to differ from the views of the trial Judge but as Mr Purdue has expressly claimed reliance upon the existence of the audit report rather than upon a perusal of the financial statements backed up by the comfort of such a report, this is a matter of interpreting what the witness actually said rather than differing from the Judge on the credibility of the witness. In view of the evidence given by Mr Purdue actual reliance on the accounts is not to be inferred, as was done in the Kripps case in British Columbia ((1997) 89 BCAC 288).
A further opportunity?
[61] Indeed, it seems to me that because of the way in which the matter was pleaded, the way in which the pleading was explained in the affidavit filed on behalf of the plaintiffs for the discovery hearing, the way in which the plaintiffs’ counsel put their case at that hearing and the way in which their case was put in opening and closing submissions at the substantive hearing, it emerges that the plaintiffs were not trying to prove the kind of actual reliance upon the financial statements which I hold to be a necessary ingredient of a claim of the kind they have brought. Chisholm J seems to have had some hesitation about exactly what kind of reliance was being
alleged in the pleadings. In the light of his interlocutory judgment it would have been unfair, if the representative plaintiffs had tried to prove actual reliance upon the financial statements, for that opportunity to have been denied to them at trial. But the opportunity was given and not taken. It was only in closing that their counsel sought, as a fallback position and almost, it would seem, as an afterthought, to have the hearing adjourned so that the persons represented by Mr Purdue could have the opportunity of separately presenting evidence of actual reliance. But that was quite contrary to the way in which the case had been run.
[62] It was also quite contrary to the intention evinced in the application for the representation order. No attempt was made to have that order discharged or varied. It was intended to obviate the need for separate evidence from each member of the class. That course appears to have been adopted for the very reason that the plaintiffs were intending to prove only reliance of a general kind upon the audit report. But, contrary to the view taken by the Judge, I am unable to see how a representative could possibly give evidence on behalf of other investors about how each relied upon the financial statements. Some might have thoroughly considered them, some only skimmed through them and some might not have bothered to read them at all.
[63] The plaintiffs had throughout taken the position that a proof of general reliance would be sufficient to establish their claim. In my view, now that it has been held that actual reliance needed to have been proved, it would be fundamentally inconsistent with the course of the proceedings if the request for a further hearing were to be granted.
Result
[64] The Court being unanimous, the appeal is allowed and the plaintiffs’ claims and their cross-appeal dismissed. The appellant is to have costs on the appeal of
$5,000 together with reasonable disbursements, including travel and accommodation
costs of both counsel, as fixed by the Registrar. It will be for the High Court to fix costs in that Court.
SALMON J
[65] I have read in draft the judgments of Gault and Blanchard JJ. I agree with what they say and have nothing which I can usefully add. I agree with the form of the orders in the judgment of Blanchard J.
Solicitors
Duncan Cotterill, Christchurch, for Appellant Wynn Williams, Christchurch, for Respondent
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URL: http://www.nzlii.org/nz/cases/NZCA/1999/347.html