The Tortious Liability of Auditors to Third Parties: A Reassessment

Transcription

1 The Tortious Liability of Auditors to Third Parties: A Reassessment K M Hogg BALLM (Qld). Lecturer in Law, T C Beirne School of Law, University of Queensland. Introduction In view ofthe recent decisions in R Lowe Lippmann Figdor & Franck v AGC (Advances) Ltd, l Columbia Coffee & Tea v Churchil[2 and Esanda Finance Corporation Ltd v Peat Marwick Hungerfords (Reg),3 the Australian law relating to the liability of an auditor to a person other than the audit client warrants reassessment. While there is no direct decision of the High Court on this issue, there is no reason why the law cannot be defined with clarity. An analysis of the High Court authorities relating to claims for economic loss and negligent misstatement reveals not only the relevant test to be applied to determine the liability ofan auditor to a third party, it also shows the weight that should be attributed to both the statutory obligations imposed on auditors by the Corporations Law and the various policy considerations raised by judicial and academic commentators. The relevant issues are discussed in two Parts. Part One considers how the High Court would deal with a claim brought by a third party against a negligent auditor. Part Two analyses the approach taken by the State Supreme courts in the three recent decisions. In the course ofthis analysis, it will be seen that the reasoning in Lowe Lippmann, Columbia Coffee & Tea and Esanda is either flawed or, at best, misleading. Part One: An auditor's duty to a third party - the High Court's approach The starting point for any consideration of the duty of care in a case of economic loss must be the High Court's proximity concept. Liability for foreseeable economic loss depends upon the existence ofthe requisite relationship ofproximity between the parties. Although the High Court has not directly decided the issue, it is apparent that in the context ofnegligent misstatement the relevant proximity factor is seen in tenus of the test formulated by Barwick CJ in Mutual Life and Citizens' Assurance Co Ltd v Evatt. 4 The weight of opinion in several High Court cases dealing with liability for negligent misstatement favours the Barwick test. 5 According to,this test, a duty of care in making a statement will arise in circumstances where the following elements are satisfied: 1 [1992] 2 VR 671 (hereafter'lowe Lippmann'). (Supreme Court of Victoria, Appeal Division). 2 (1992) 10 ACLC 1659 (hereafter 'Columbia Coffee & Tea'). (Supreme Court of New South Wales). 3 (1994) Aust Torts Rep (hereafter'esanda '). (Supreme Court of South Australia, Full Court). 4 (1968) 122 CLR 556 (hereafter'evatt'). In L Shaddock &Associates Pty Ltdv Parramatta City Council (1981) 150 CLR 225, it was unnecessary for the High Court to choose between this test and the narrower test laid down by the Privy Council in Evatt and, for reasons to be explained later, this test was not applied in San Sebastian Pty Ltd v The Minister (1986) 162 CLR In L Shaddock & Associates Pty Ltd v Parramatta City Council (1981) 150 CLR 225, 251, Mason J (with whom Aicken J agreed) accepted Barwick CJ's formulation as a 'statement of the conditions which give rise to a duty of care'. Later, in San Sebastian Ply Ltd v The Minister (1986) 162 CLR 340, Brennan J expressly adopted the test, while the majority joint judgment of Gibbs CJ, Mason, Wilson and Dawson JJ (at 356) took the view that the test had received majority endorsement by the Court in Shaddock.

2 80 KMHogg 1. the speaker realises or ought to realise that the recipient ofthe information and advice is relying on his or her skill and judgment; 2. the speaker realises or ought to realise that the recipient intends to act upon the information or advice in respect ofhis or her property or in connection with a matter ofserious orbusiness consequence; and 3. the recipient's reliance upon the information or advice provided by the speaker was reasonable. 6 The operation ofthis test in the context ofdetermining the liability of an auditor to a third party is best illustrated by a comparison with the tests formulated in other jurisdictions. Both the House oflords and the New Zealand Court ofappeal have directly decided the question ofthe scope ofan auditor's liability for negligent misstatement In Scott Group Ltdv McFarlane,? the New Zealand Court ofappeal, by a majority of two to one, 8 held that an auditor owed a duty of care in statement to the plaintiff company which undertook a takeover ofthe audit client in reliance upon the accounts prepared by the defendant 9 The defendant had no knowledge nor any reason to suspect, at the time of making the statement, that the company would be subject to a takeover bid. Nevertheless, the majority found that the relevant duty could be based on the fact that it was reasonably foreseeable to a person in the defendant auditor's position that the statement would be relied upon for that purpose. 10 Although the foreseeability test applied by the majority in Scott Group to determine the existence of the relevant duty of care has enjoyed support elsewhere,11 when the House oflords came to consider the issue ofan auditor's liability to a third party in Caparo Industries Pic v Dickman 12 it did not follow the lead of the New Zealand Court of Appea1. 13 The House of Lords formulated a much narrower test, insisting that at the time ofmaking the statement the defendant auditor have actual knowledge ofthe purpose for which the plaintiff relies upon the statement14 As it was found that the defendant auditors had no knowledge that the accounts would be relied upon for the purposes ofinvestment, the plaintiff company was unable to recover the loss suffered when it increased its shareholding in the client company in reliance upon the accounts which contained an overstatement ofthe value of the shares. There is, ofcourse, a clear divergence between the Australian law and the approach taken by the New Zealand Court of Appeal in Scott Group.15 As already indicated, the proximity concept is fundamental to the High Court's theory ofnegligence and itwould 6 Evatt (1968) 122 CLR 556, [1978] 1 NZLR 553 (hereafter the'scott Group'). 8 Woodhouse and Cooke IJ, Richmond P dissenting. 9 However, the plaintiff's action failed because it was found that no actual loss had been suffered in the takeover. In fact, the plaintiff had made a profit. to The evidence showed that while the company whose accounts were audited was rich in assets it had unimpressive earnings: see Scott Group [1978] 1 NZLR 553, per Cooke J. 11 For instance, in the Scottish case of Twomax Ltdv Dickson, McFarlane & Robinson [1982] SC 113, andjeb Fasteners Ltdv Marks Bloom & Co (A Firm) [1981] 3 All ER [1990] 2 AC 605 (hereafter 'Caparo'). 13 The doctrinal background to these cases shows that the refusal ofthe House oflords to follow the New Zealand approach was not surprising. The decision in Scott Group [1978] 1NZLR 553 was based on an application of the two stage test of liability laid down by Lord Wilberforce inannsv Merton London Borough Council [1978] AC 728, The increasing disillusionment ofthe House oflords with the notion ofa single theory of negligence in general, and the two stage formulation in particular, culminated in its decision in Caparo [1990] 2 AC 605. See K M Hogg, 'Negligence and Economic Loss in England, Australia, Canada and New Zealand' (1994) 43 International and Comparative Law Quarterly The House of Lords relied heavily on the dissenting judgment of Lord Denning in Candler v Crane Christmas & Co [1951] 2 KB 164. See, for instance, the judgment of Lord Bridge in Caparo [1990] 2 AC [1978]] NZLR 553.

3 Tortious Liability ofauditors 87 not countenance imposing liability solely on the basis offoreseeability ofharm. The High Court's test is obviously closer to the approach taken by the House oflords in Caparo. The requirement that the defendant have knowledge that the plaintiff intends to use his or her statement for the purposes of a particular transaction is clearly an element ofthe test of liability that would be applied by the High Court. There is, however, one important distinction between the Australian and English tests which relates to the nature of the knowledge possessed by the defendant. As pointed out, the House oflords insisted upon actual knowledge on the part ofthe auditor. However, the elements ofthe test formulated by Barwick CJ would be satisfied and the proximity requirement fulfilled if, eventhough the defendant had no such actual knowledge, the circumstances were such that the defendant ought to have known that the plaintiff intended to use the information and advice for a particular purpose. 16 Accordingly, it is suggested that the High Court would allow recovery by a third party against an auditor if the elements of Barwick CJ's formulation in Evatt were satisfied. This means that the plaintiff would have to establish that the auditor knew, or ought to have known, of the plaintiff's reliance upon the accounts and that this reliance was reasonable. The only other basis upon which a plaintiff may be able to establish a relevant duty on the part of the auditor is the following test laid down by the High Court in San Sebastian Pty Ltd v The Minister: 17 In cases of negligent misstatement, reliance plays an important role, particularly so when the defendant directs his statement to a class ofpersons with the intention ofinducing members of the class to act orrefrain from acting, in reliance on the statement, in circumstances where he should realise that they may thereby suffer economic loss if the statement is not true. 18 While, for reasons to be explained later, the San Sebastian testonly provides a limited exception to the operation ofthe general test formulated by Barwick CJ inevatt, itmay be ofsome assistance in determining the liability ofan auditor to a third party. In circumstances where there is no evidence ofknowledge or constructive knowledge on the part of the defendant of the plaintiff's reliance, liability could be imposed on the auditor on the basis that the relevant statement was made to the plaintiff, or a class ofpersons which included the plaintiff, with the intention ofinducing them to act in reliance thereon. The relevance ofthe statutory background andpolicyfactors In the absence of a direct decision by the High Court on this issue, much ofthe debate concerning the direction that our law will take has centred on the statutory duties and responsibilities ofauditors and various policy considerations. For instance, some commentators have pointed to the fact that the Corporations Law provides for a scheme of disclosure of the accounts of public companies. 19 The public nature of these documents has been used to argue that common law liability for any misstatement contained in the 16 For an explanation of the importance of this distinction and a discussion ofa case demonstrating the point, see M Davies, 'The Liability of Auditors to Third Parties in Negligence' (1991) 14 University ofnew South Wales Law Journal 171, (1986) 162 CLR 340 (hereafter'san Sebastian'). 18 Jd 355 per Gibbs CJ, Mason, Wilson and Dawson JJ. 19 R Baxt, 'The Liability of Accountants and Auditors for Negligent Statements in Company Accounts' (1973) 36 Modern Law Review 42 ('Baxt MLR'); R Baxt, 'The Liability of Auditors - The Pendulum Swings Back' (1990) 8 Companies and Securities Law Journal 249 ('Baxt C & SU'); G Gay & P Schelluch, 'The Auditor's Liability to the Company, Shareholders and Third Parties' (1991) 9 Companies and Securities Law Journal 59.

4 82 KMHogg accounts could be imposed on the basis ofthe reasonable foreseeability ofthe plaintiff's reliance.20 The statutory background to the question ofan auditor's liability has also been used to argue against the adoption of the narrow approach taken by the House of Lords in Caparo. 21 In defining the scope of the defendant auditors' liability, the House of Lords focussed on the purpose for which the accounts were prepared. Their Lordships decided that the accounts were not prepared for the information ofinvestors or potential investors in the company but merely 'to provide an account of the stewardship of the directors to the shareholders as a body'.22 As a result, it was found that the auditors had no actual knowledge ofthe plaintiff's reliance. Several writers have suggested that in light ofthe statutory scheme governing the provision ofaudits and company accounts in this country, it would be inappropriate to apply the House oflords' interpretation ofthe purpose ofan audit in the Australian context.23 On this basis, it has been argued that the 'conservatism'24 evident in Caparo should not be followed by our courts. 25 Without detracting from the merit ofsome ofthe arguments raised in this debate, it is suggested that there is little point in speculating as to the direction the High Court will take on the issue ofan auditor's liability to third parties. As already indicated, the High Court will impose liability on an auditor ifthe elements ofthe test formulated by Barwick CJ in Evatf2 6 are satisfied. It is more useful in this context to briefly consider the relevance ofthe statutory background to the operation of the High Court's test. As already seen, one of the elements of the Barwick formulation is the requirement that the plaintiff's reliance upon the defendant's statement be reasonable in the circumstances. In light of the disclosure requirements, it could be argued that any reliance upon a statement made in the audited accounts of a public company would be reasonable. After all, it might be said that the very purpose of the relevant enactment is to provide a statement upon which existing and potential shareholders and creditors can rely. It is suggested, however, that while the publication ofthe auditor's statement will be relevant, the High Court will not allow legislative motive to conclusively determine the question of reasonableness. Instead, the Court will look at all the circumstances ofthe case including the nature ofthe information relied upon, the purpose ofthe transaction for which it was used and whether the plaintiff had the opportunity to obtain or verify the information elsewhere. 27 In addition, it is suggested that the requirement that the defendant know, orhave the means ofknowing, ofthe plaintiff's reliance would not be satisfied simply by pointing to the fact that the auditor's report was disclosed to the public. The publication ofthe rele- 20 See, for instance, Baxt MLR, supra note 19, 49, and Baxt C & SU, supra note 19, Certainly, the Court of Appeal in Scott Group [1978] 1 NZLR 553 considered the public nature of the accounts upon which the plaintiff company relied as being an important factor in determining that reliance was foreseeable to a person in the position of the defendant auditor - see the judgment of Cooke J, and at 575 per Woodhouse J. 21 [1990] 2 AC [1990] 2 AC 605, 660 per Lord Jauncey. 23 Baxt C & SU, supra note 19, ; Gay & Schelluch, supra note 19, To adopt a term used by Baxt C & SU, supra note 19, Gay & Schelluch, supra note 19, did not suggest an alternative approach to the Caparo test, while Baxt C & SU, supra note 19, 255, appears to put forward a test based on foreseeable and reasonable reliance. 26 (1968) 122 CLR 553, Baxt C & SU, supra note 19, 255, has pointed out that while reliance by a major investor on the audited accounts of a public company may not be rea~onable and therefore not provide a sufficient basis for the imposition ofliability, the small, private investor is in a different position.

5 Tortious Liability ofauditors 83 vant documents may make a plaintiff's reliance reasonably foreseeable. However, the knowledge element of the Barwick test requires that at the time ofmaking the report the defendant be at least equipped with knowledge ofthe particular transaction for which the plaintiff uses the statement. Ifthe auditor knows no more than that the document will be made available to the public,28 then the only basis upon which liability to a third party29 could be established is by showing that the plaintiff was a person, or a member ofa class ofpersons, which the defendant intended to induce to act in a particular way in reliance upon the report. 3 0 In addition to the statutory background, it has also been suggested that the policy considerations relevant to an action involving a claim by a third party against an auditor should playa role in detennining the scope ofan auditor's liability.31 Again, there is little point in such speculation as the High Court is likely to take a common law rather than a profession specific approach 32 to liability in this context. In other words, liability will be determined by the application of principle rather than weighing competing interests. The High Court's approach will not operate to protect, for example, every investor who enters a transaction in reliance upon audited accounts. On the other hand, it does not preclude the possibility ofliability to a third party.33 Part Two: The recent Supreme Court decisions After providing a brief outline of the facts and decisions in Lowe Lippman, Columbia Coffee & Tea and Esanda,34 this part analyses the approach taken by the State Supreme Courts under the following headings: (i) Columbia Coffee & Tea: An assumption ofresponsibility in an Audit Manual? (ii) The application ofthe San Sebastian principle: Lowe Lippmann and Esanda. The Facts and the Decisions (a) Lowe Lippmann 35 At first instance, Vincent J36 held that the defendant auditor, Lowe Lippmann, who audited the accounts of a company called Lyvetta Weaving Mills Ltd owed a duty ofcare 28 M Davies, supra note 16, 194, ha~ suggested that the objective element of the knowledge requirement would allow the court to take into account matters such as current business factors: 'By introducing a degree of objectivity to the court's assessment, the "knew or ought to have known" approach has the advantage that it gives the court the opportunity to consider current business practice and commercial conditions in determining whether the auditor ought to have known that the audited accounts would be passed on to, and relied on by, third parties.' 29 Note, however, the decision in Caparo [1990] 2 AC 605 to the effect that an auditor would have actual knowledge of the shareholders' use of an audit report. 30 It is suggested that the circumstances in which it could be shown that an auditor made a statement in an audit report with the intention of inducing a class of persons to act in a particular way in reliance thereon would be very rare. 31 For instance, Baxt C & SU, supra note 19, suggests that a narrow and restrictive test of liability fails to encourage investment by not providing protection to investors, particularly small investors. 32 To adopt the term used by B Feldthusen, Economic Negligence (2nd ed, Toronto: Carswell, 1989). As Feldthusen suggests, a profession specific approach is not the best solution to the problems raised in this context. He contends (at 125) that it should not be preferred to the common law approach. 33 Accordingly, the High Court's approach may not be welcomed by auditors who, in light of recent massive settlements of claims by client companies (see report of settlement of claim with respect to the audit of Tricontinental by Peat Marwick Hungerford for $M136, The Sydney Morning Herald, January 26,1994,31) will argue that their liability should not be extended further to include a duty to third parties. 34 See supra notes [1992] 2 VR Supreme Court of Victoria

6 84 KMHogg in statement to the company's major creditor, the plaintiff finance company, AGC (Advances) Ltd. This decision was overturned on appeal by the defendant to the Appeal Division of the Supreme Court of Victoria. Although there was evidence that the auditor knew that the plaintiff company was going to rely on the audited accounts to review its loan facility to Lyvetta, the court held that no duty ofcare was owed to AGC.37 The principal judgment was delivered by Brooking J38 who held that there would be no liability for any loss suffered by the plaintiff in the absence ofan intention on the part of the defendant auditor to induce AGC to act in reliance upon the accounts. In reaching this conclusion,39 his Honour drew on the High Court's decision in San Sebastian. 40 (b) Columbia Coffee & Tea 41 In this case Rolfe J, in the Supreme Court ofnew South Wales, dealt with the question of whether the defendant auditors owed a duty ofcare to a company called Donyoke which had purchased shares in Columbia Coffee & Tea Pty Ltd ('Columbia'). Columbia had retained the defendant auditors to conduct its 1987 annual audit and an interim audit inlate The auditors had no actual knowledge that their reports would be used by the decision makers within Donyoke to detennine whether to purchase shares in Columbia. In fact, at the time the audits were prepared, Donyoke was not even in existence since it was not incorporated until Rolfe J found that a duty of care was owed on the basis of a statement contained in the defendant auditors' Audit Manual. However, the plaintiff company's action failed because it was unable to establish that there was any causal connection between the auditor's breach ofduty42 and the alleged damage. 43 (c) Esanda 44 This case involved an appeal from a decision 45 dismissing an application to strike out a plea of negligent misstatement from a statement of claim. The plaintiff, Esanda Finance Corporation, brought the action against the audit firm Peat Marwick Hungerfords which had audited the 1989 accounts ofa company called Excel Finance. It was claimed that in reliance upon these audited accounts, the plaintiff entered into certain transactions 46 which caused it to suffer a loss. On appeal, the Full Court of the Supreme Court of South Australia held unanimously47 that the relevant paragraphs ofthe statement ofclaim should be struck out as they failed to disclose a cause ofaction. 48 According to the pleadings, the plaintiff's contention ofnegligent misstatement was based upon the Statements ofaccounting Standards and the claim that the plaintiff's reliance was foreseen, or ought reasonably to have been foreseen, by the defendant auditors. The Full Court applied the reasoning in San Sebastian 49 and held that in the absence ofa plea that the defendants intended to induce the 37 The defendant virtually conceded negligence at the trial. 38 With whom Gobbo J agreed. Tadgell J delivered a separate judgment in which he also expressed his agreement with the reasoning ofbrooking J. 39 [1992] 2 VR 671, (1986) 162 CLR (1992) 10 ACLC It was claimed that the auditors had understated the creditors of Columbia. 43 (1992) 10 ACLC 1,659, 1, (1994) Aust Torts Rep Bollen J, Supreme Court of South Australia, (1993) Aust Torts Rep The plaintiff company lent money to companies associated with Excel, accepted a guarantee from Excel and purchased debts from Excel upon terms which included an indemnity against any shortfall. 47 The principal judgments were delivered by King CJ and Olsson 1. Millhouse J delivered a short judgment in which he expressed his agreement with the reasons given by his brother judges. 48 The plaintiff also brought a claim under the Fair Trading Act 1987 (SA), s (1986) 162 CLR 340.

7 Tortious Liability ofauditors 85 plaintiff company to act in reliance upon the accounts, the plaintiff's case could not succeed. (i) Columbia Tea: An assumption ofresponsibility in an Audit Manual? Rolfe J found that the auditors owed a duty of care to 'anyone who might reasonably and relevantly rely upon the accounts for the purposes of ordering their business affairs'.50as pointed out earlier, the action failed because the plaintiff company was unable to establish that there was any causal connection between the auditors' breach ofduty and the alleged damage. The decision not to allow recovery in the particular circumstances was correct. However, it is respectfully submitted that the reasoning is totally misconceived and based on a misunderstanding of the operation of the proximity principle and, in particular, the High Court's approach to liability for negligent misstatement. The court's decision on the duty ofcare was based on the fact that the defendant auditors' Audit Manual contained the following statement: It is the policy ofthe finn that any audit which we undertake will be conducted in such a way as will fulfil our responsibilities properly. This will involve a competent examination of the accounts and records to the extent required by the appointment, followed by a clear and forthright report as to the results ofthe audit. The use ofthe word 'responsibilities' in this statement rather than the word 'contracts' is deliberate. Itacknowledges that there will be interested parties who read and rely upon our reports, and this extends beyond the persons who employ us in the first instance orthose to whom the report is addressed initially. The court took the view that an assumption ofresponsibility on the part ofthe auditors flowed from this statement. According to Rolfe J, it showed that the defendants had accepted that their common law duty extended to persons other than the client company. His Honour stated: It was an acceptance, as I understand the words used, ofresponsibility to anyone who may reasonably and relevantly rely upon the audited accounts for the putpose ofordering their business affairs. 51 On this basis, it was concluded that there was an assumption ofresponsibility on the part of the auditors such as to give rise to a duty of care to Donyoke as a potential purchaser ofshares in the client conlpany, Columbia. 52 The fact that Donyoke was not incorporated at the time the relevant reports were undertaken was considered irrelevant, as the court took the view that the defendant's duty was wide enough to encompass 'those who might rely on the 1987 audit certificate in arranging their business affairs'.53 It is submitted that the recognition of the existence of a duty ofcare on this basis is open to question. 54 There is no High Court authority55 for the proposition that such a statement ofacceptance of 'responsibility'56 can constitute a sufficient basis for the imposition ofliability for negligent misstatement.57 As already seen, the requisite proximity in a case ofnegligent misstatement is found in the satisfaction ofthe Barwick formula- 50 (1992) 10 ACLC , Ibid 52 Ibid 53 Ibid 54 In the subsequent decision ofesanda, the Supreme Court of South Australia refused to follow the decision of Rolfe J on this point: see (1994) Aust Torts Rep ,61,156 per King CJ, and 61,166 per Olsson J. 55 For that matter, the writer knows of no case where a Commonwealth court has imposed liability on this basis. 56 To use that term in the sense it was defined in the statement quoted from the Audit Manual. 57 To the contrary, the High Court regards an assumption of responsibility as being 'imposed' by the law when the elements of the Barwick test are satisfied: Evatt (1968) 122 CLR 553, 570.

8 86 KMHogg tion or, in exceptional circumstances, the test laid down in San Sebastian. 58 Neither test was met on the facts of Columbia Coffee & Tea. 59 Rolfe J sought to justify his approach by reference to community standards and expectations. 60 His Honour stated: I believe the reasoning I have applied is consistent with the statements by the various members ofthe High Court that one must have regard to prevailing community standards and perceptions in detennining whether it is appropriate to impose a duty of care. 61 The comment that there is High Court support for such an approach is somewhat surprising. Although Rolfe J quoted at length from recent judgments of the Court, there is nothing in these passages that shows that the High Court regards community practice and standards as a relevant determinant of liability.62 To the contrary, the High Court's approach is to apply a principle: the proximity concept. In the context ofnegligent misstatement, the proximity principle requires the application of an established test of liability. The court's confusion as to the role of the proximity principle and its operation in a case of negligent misstatement may stem from the selection of quotations from High Court judgments upon which Rolfe J sought to rely. To begin with, his Honour quoted at length from the judgment of Brennan J in Hawkins v Clayton. 63 While the reasoning of Brennan J in that case would warrant consideration in a case dealing with the liability of a professional person to his or her client, it is submitted that the passage quoted by Rolfe J in which Brennan J criticises the proximity concept would do little to further the court's understanding of the operation of that approach. 64 In addition, authorities such as Hawkins v Clayton 65 and Sutherland Shire Council v Heyman 66 upon which the court relied are only of limited assistance in a case of negligent misstatement. While these decisions may be useful in furthering an understanding of the High Court's general theory of negligence, the starting point regarding liability for negligent misstatement must be the High Court cases dealing with that type of claim. 67 As already indicated, in Columbia Coffee & Tea, the court took the view that the plaintiff's case failed on the question ofcausation. Rolfe J rejected evidence presented on behalfofthe plaintiff to the effect that the directors ofthe plaintiff company had relied upon the audited accounts in making their decision to purchase shares in Columbia. 68 For this reason, the court decided that there was no causal connection between the defendants' breach ofduty and any loss suffered by the plaintiffcompany as a consequence ofits pur- 58 (1986) 162 CLR An application of the Barwick test fails because the requirement that the defendant, at the time of making the relevant statement, have actual or constructive knowledge that the plaintiff would rely upon it for the purpose of purcha()ing shares in Colwnbia Coffee & Tea was not satisfied. The San Sebastian test also fails because there is nothing to suggest that the defendant auditors made the statement with the intention of inducing the plaintiff company or its chief decision makers to act in reliance upon it. 60 There was expert evidence given by a chartered accountant as to the practice ofaccountants in considering and using audit reports: (1992) 10 ACLC 1, ld 1,671-1, Perhaps Rolfe J was referring to comments made by Deane J in Sutherland Shire Council v Heyman (1985) 157 CLR 424, 497, to the effect that the proximity approach is flexible enough to allow the common law to 'reflect the influence ofcontemporary standards and demands'. At no stage, however, did Deane J suggest that such factors provide sufficient basis for the imposition of liability. 63 (1988) 164 CLR Brennan J has constantly maintained his dissatisfaction with the proximity theory which, notwithstanding his Honour's dissent, must now be regarded as the orthodox approach to liability for negligence in Australia. 65 (1988) 164 CLR (1985) 157 CLR The reliance by both the court and counsel for the defendants upon the authority of the decision of the House of Lords in Caparo [1990] 2 AC 605 was, it is subn1itted, also ill founded. 68 (1992) 10 ACLC 1,659,1,672-1,673.

9 Tortious Liability of Auditors 87 chase of shares in Columbia. However, consideration of the fact that the plaintiff company did not act to its detriment in reliance upon the accounts should have been undertaken at the duty stage. As discussed earlier, the plaintiff's actual reliance upon the defendant's misstatement is a central feature ofthe test for determining the existence of a duty ofcare in negligent misstatement The fact that there was no actual reliance by the plaintiff company in Columbia Coffee & Tea should have totally precluded a finding that a duty ofcare was owed by the defendant. (ii) The application ofthe San Sebastian test (a) Lowe Lippmann 69 It is not surprising that reservation has been expressed both in academic commentary70 and judicial dicta 71 about the decision in Lowe Lippmann. It is submitted that both the reasoning ofthe court and the actual decision in Lowe Lippmann are open to attack on a number of grounds. To begin with, the court's application of the principle laid down in San Sebastian to the facts of the case before it is questionable. San Sebastian was a case involving a statement which had been made by the defendants to the public at large. 72 The situation that arose in Lowe Lippmann was entirely different to the facts of San Sebastian. 73 Although the audited accounts were prepared for the client company, Lyvetta, the defendant auditor knew that they would be communicated to and relied upon by the plaintiff finance company.74 However, Brooking J sought to justify the application of the San Sebastian test on the basis that the defendant auditor did not make the statement in response to an inquiry by the plaintiff. According to Brooking J, in both cases the statements were 'volunteered'.75 The fact that the audited accounts were prepared in response to a request by the client company and not the plaintiff did not, however, make the test laid down in San Sebastian the appropriate determinant of the existence of a duty of care. The correct test to be applied in such a case is the Barwick formulation outlined earlier. The reasoning ofbarwick CJ in Evatt confirms this view. When formulating this test, Barwick CJ used the term 'recipient' to describe a person in the position ofthe plaintiff. His Honour defined this term as follows: I have used throughout the description 'recipient' to cover both the case where the incorrect utterance is sought by a question or inquiry and the case where it is volunteered by the speaker. 76 Barwick CJ's comment that the situation where information or advice is 'volunteered' 69 [1992] 2 VR M Davies, 'Auditors' Liability to Third Parties: R Lowe Lippmann Figdor & Frank (afirm) v AGe (Advances) Ltd (1993) 1 Torts Law Journal Columbia Coffee & Tea (1992) 10 ACLC 1,659, 1, A proposal for the development of W0011oomool00 in Sydney, which was prepared by the State Planning Authority of New South Wales, was put on public display by the Authority and the Sydney City Council. Part of the proposal involved encouraging developers to buy land in the area with a view to building high density office blocks. 73 See also the explanation of the distinction between these two cases given by Davies, supra note 70, The court accepted that the auditor knew that AGC would probably rely on the report in reviewing its loan facility. A partner of the defendant firm was informed in a telephone conversation with an officer of AGe that the finance company required the audited accounts for review purposes. The defendant also knew through previous dealings with Lyvetta that AGC was its principal creditor: [1992] 2 VR 671, Id 679. Notwithstanding the telephone conversation mentioned in the previous footnote (note 74), Brooking J took the view that the accounts were volunteered because that conversation had no 'causal connection with the subsequent supply to AGC of the audited accounts': id 680. Brooking J stated that the defendant auditor only prepared the accounts to fulfil statutory and contractual obligations: id 682. As Davies, supra note 70, 117, points out, this was the only material respect in which the case differed from Hedley Byrne [1964] AC Evatt (1968) 122 CLR 553,

10 would be 'relatively rare' tends to suggest that he was only using this term to cover unsolicited information where there is no request by the plaintiff or any other person. While his Honour did not refer specifically to the situation where a statement is made in response to a request by one party but, to the defendant's knowledge communicated to and relied upon by a third party, it is nevertheless clearly encompassed in this definition. In addition, there is nothing in the reasoning of the court in San Sebastian to preclude the application of the Barwick formulation in a case like Lowe Lippmann. The joint judgment of Gibbs CJ, Mason, Wilson and Dawson JJ allowed only a very limited exception to the application of the Barwick test. The principle their Honours formulated is very narrow in its scope. It was devised in the context of the plaintiffs' appeal which was argued on the basis that the defendants owed them a duty of care in statement because a representation had been made with the intention of inducing them to rely upon that repreent tat ion.^^ The test was designed by the court in order to limit liability in circumstances where a statement was made to the public at large.78 In fact, the joint judgment made it quite clear that this was not the exclusive test of liability in a case of unsolicited information and advice. The following passage outlining the circumstances in which liability can arise from a 'volunteered' statement is important: The maker of a statement may come under a duty to take care through a combination of circumstances or in various ways, in the absence of a request by the recipient. The author, though volunteering the information or advice, may be known to possess skill and competence in the area which is the subject of the communication. He may warrant the correctness of what he says or assume responsibility for its correctness. He may invite the recipient to act on the basis of the information or advice, or intend to induce the recipient to act in a particular way. He may actually have an interest in the recipient so acting.79 Although some general comments about the significance of a request for information or advice were made in the joint judgment, there is nothing in their Honour's reasoning to suggest that the Barwick test would be inappropriate in a case like Lowe Lippmann. No definition was given of what was meant by the reference to the situation where there is no 'antecedent request or advice.'80 However, the High Court's acceptance of the suggestion made elsewhere8' that instances of liability for misstatement volunteered negligently will be 'rare' tends to indicate that the Court was alluding to a situation like San Sebastian where the statement is totally unsolicited. In any event, even if their Honours' comments about the significance of the absence of a request can be read as applying to a situation where a statement requested by another party is relied upon by the plaintiff, they still do not preclude the application of the Barwick test. The Court simply stated: The existence of an antecedent request for information or advice certainly assists in demonstrating reliance which is the cornerstone of liability for negligent misstatementf2 If, as this comment suggests, the only difficulty caused by the absence of a direct request by the plaintiff is the need to establish the requisite degree of reliance, then there is no reason why the Barwick test should not be applied in a case like Lowe Lippmann. The 77 See (1986) 162 CLR 340, 357 where the joint judgment sets out the appellants' submissions on this point. 78 The reasoning of the fifth member of the court, Brennan J, also confirms that the test applied in San Sebastian was only intended to provide a very limited exception to the application of the Barwick test. His Honour's approach was to adapt the Banvick test to circumstances where the statement is made with the intention of inducing the plaintiff to rely upon that statement: (1986) 162 CLR 340, Id 357 per Gibbs CJ, Mason, Wilson and Dawson JJ. 80 Their Honours simply distinguished Evatt (1968) 122 CLR 553 and L Shaddock & Associates Pty Ltd v Parramatta City Council (1981) 150 CLR 225, cases where the statement was made in response to a request made on behalf of the plaintiff: (1 986) 162 CLR 340, In Evatt (1968) 122 CLR 553, , and Lexnlead (Basingstoke) Ltd v Lewis [I9821 AC 225, San Sebastian (1986) 162 CLR 340, per Gibbs CJ, Mason, Wilson and Dawson JJ.

11 Tortious Liability of Auditors 89 relationship of reliance can be established by the fact that the defendant had actual knowledge not only that the statement would be communicated to a particular person but also that that person would rely upon the statement for a particular purpose.83 Subject to the additional element of reasonable it is suggested that the High Court would find a sufficient relationship of proximity to give rise to liability for any foreseeable harm.85 It is respectfully submitted that the insistence by Brooking J in Lowe Lippmann on the requirement of an intention on the part of the auditors to induce AGC to act in reliance upon the accounts is the result of a flawed interpretation of the reasoning in Sun Sebastian. In addition, it reveals a misunderstanding of the nature of common law liability for negligent misstatement. Liability is imposed for negligent misstatement on the basis that the defendant has assumed the responsibility for the exercise of reasonable care when speaking, or preparing to speak. The High Court has made it quite clear that this assumption of responsibility is imposed by the law.86 It does not depend upon any intention on the part of the defendant. As Barwick CJ explained in Evatt, what is necessary is that: The person giving the information or advice must do so willingly and knowingly in the sense that he is aware of the circumstances which create the relevant relation~hip.~~ Provided the facts of the particular case fall within the court's view of the circumstances in which an assumption of responsibility will be imposed, the defendant will be liable. As indicated earlier, the High Court takes the view, subject to the limited Sun Sebastian exception, that these circumstances will arise if the conditions of the Barwick formulation are met. Brooking J sought to justify his refusal to apply the Barwick formulation in favour of the imposition of the requirement of intention on the facts of the case in the following manner: If there were not some furtherrestriction, an auditor who intended only to fulfil his statutory duties and the contractual obligations he had assumed in light of those duties would face the danger of being sued by all sorts of third persons if, on the day before the audit report was signed, the company informed him of its intention to broadcast the audited accounts by distributing them to all those with whom it had or hoped to have business dealings. The auditor would then know, when he made his report, that the company intended to supply it to third persons, and it would apparently make no difference to the auditor's position if he had unavailingly protested when told of the intention to broadcast the accounts.88 In so far as this statement suggests that there are no steps that could be taken by an auditor to protect against liability, it is misleading. Presumably, the hypothetical audit referred to by Brooking J would not be required to be disclosed to the public as his Honour 83 That was the approach taken by the Supreme Court of New South Wales in Pisano v Fairfield City Council (1991) Aust Torts Reports where the plaintiff purchaser relied on as 31 7A certificate furnished by the defendant council to the vendor but communicated to and relied upon by the plaintiff to the defendant's knowledge. 84 It is suggested that it was reasonable in the circumstances for the creditor to rely on the auditor's statement of the value of the assets. 85 This was the basis on which Vincent J at first instance found for the plaintiff company. Davies, supra note 70, 1 19, comments that the defendant's insurer settled the case for an undisclosed amount after AGC sought special leave to appeal to the High Court of Australia. 86 Evatt (1968) 122 CLR 553,570 per Barwick CJ. The English courts have also questioned the notion that the assumption of risk must be 'voluntary': Caparo [IYYO] 2 AC 605; Smith v Bush [I AC Id Evan 570. This approach is evident in the English cases where an assumption of responsibility was found and liability imposed notwithstanding a statement in the form of a disclaimer of an intention not to be responsible to the plaintiff for the statement made. Seealso BTAwtralia Ltdv Raine & Horne [I NSWLR 221.

12 90 KMHogg said that the auditor only becomes aware of its communication to third parties when told by the company. In such a case, while 'protesting' to the company may be to no avail, as Brooking J suggests, a communication of a disclaimer to the known third parties could preclude a finding that a duty of care was owed to them. It has been pointed out elsewhere 89 that a disclaimer may not always protect an auditor. However, in the situation outlined it is suggested that liability would not arise because any reliance by third party, after the communication of the disclaimer of responsibility, on a report that is not to be made public would be unreasonable. 90 (b) Esanda 91 The actual decision reached by the Full Court ofthe Supreme Court ofsouth Australia in this case was correct. The plaintiff's case with respect to negligent misstatement was simply based on the existence ofthe Australian Accountancy Standards and the claim that the reliance upon the audited accounts was reasonably foreseeable. As already seen in relation to Columbia Coffee & Tea, a mere statement in an audit manual does not indicate an assumption of responsibility on the part of the auditor to a third party. Similarly, a set of standards cannot provide, on its own, the basis for the imposition of a common law duty ofcare. 92 The plaintiff's plea that the reliance upon the audited accounts was reasonably foreseeable, while a necessary element ofthe duty ofcare in statement, is also insufficient on its own to establish liability. The plaintiff must also establish proximity ofrelationship between the defendant auditors' alleged negligent misstatement and the alleged damage suffered. As already seen, in an action for negligent misstatement, such proximity is likely to be found only in the presence of the elements of the Barwick formulation, or alternatively, evidence of an intention on the part of the defendant to induce the plaintiff to act in a particular way in reliance upon the statement. As discussed earlier, the court in Esanda held that in the absence of a plea that there was an intention on the part of the defendant auditors to induce the plaintiff to act in reliance upon the accounts, the relevant paragraphs in the statement of claim should be struck out because they failed to disclose a cause of action. Like the Supreme Court of Victoria in Lowe Lippmann, the South Australian court based its decision on San Sebastian. Although, as will be submitted later, some of the court's reasoning in relation to San Sebastian provides a misleading impression of the Australian law relating to negligent misstatement, the application of San Sebastian in Esanda was not as indefensible as it was in Lowe Lippmann. Clearly, the facts ofesanda in so far as they are disclosed in the statement ofclaim are entirely distinguishable from the circumstances which arose in the Victorian case. In Esanda, the plaintiff did not claim that there was any knowledge on the part of the defendant auditors of its reliance upon the audited accounts. There is no suggestion in the pleadings that the defendants were told that the plaintiff company would be relying on the accounts for the purpose of the particular transactions entered into. Nor is there any suggestion that the defendants were equipped with knowledge ofcircumstances which should have made them aware of these transactions and the plaintiff's reliance upon the accounts for the purpose thereof. In Esanda, therefore, unlike Lowe Lippmann, the knowledge element of the Barwick test would not have been satisfied. Accordingly, in such a situation, it was not incorrect to apply the San Sebastian test. However, this does not mean that the reasoning of the court in Esanda was without its flaws. The High Court would not have applied San Sebastian as the exclusive determi- 89 Davies, supra note 16, ; Davies, supra note 70, See also, Davies, supra note 16, (1994) Aust Torts Rep See (1994) Aust Torts Rep , 61,156 per King CJ, and 61,166 per Olsson J.

13 Tortious UabilityofAuditors 97 nant of the validity of the plaintiff's statement of claim. Instead, it is suggested that the High Court would have based the decision to strike out the relevant paragraphs of the statement of claim, at least in part, on the ground that a plea of facts consistent with the elements ofthe Barwick formulation was absent. The Court would then, as an alternative basis for allowing the appeal, have applied the intention requirement laid down in San Sebastian. However, King CJ and Olsson J did not even mention, let alone apply, the Barwick test. 93 Instead their Honours presented the San Sebastian test as the only relevant principle to be applied in a case involving a claim by a third party against a negligent auditor. King CJ treated San Sebastian as laying down the exclusive test of liability in a case where a person who relied upon the statement was not the person,'to whom the statement had been directly addressed'.94 However, as pointed out earlier, the scope ofthe San Sebastian exception to the application ofthe general Barwick formulation is not this broad. There is nothing in either the judgment of Barwick CJ in Evatt or the reasoning in San Sebastian to suggest that the fact that the statement was not directly addressed to the plaintiff precludes the imposition of liability on the basis of the Barwick test. The problems with the approach taken by Olsson J are even more obvious. His Honour treated San Sebastian as laying down the relevant principle to be applied in all cases of negligent misstatement. The fact that Olsson J totally overlooked the test formulated by Barwick in Evatt is somewhat surprising in light of the considerable reliance upon, and extensive citation from, the judgments in San Sebastian. After all, that decision of the High Court clearly establishes the Barwick formulation as the general test for determining the existence of a duty of care in a case of negligent misstatement. Conclusion This paper has attempted to show that the High Court's approach to the liability of an auditor to third parties who rely upon the audited accounts of a client company can be clearly stated. As a general rule, the requisite proximity to give rise to the relevant duty of care will be found in the satisfaction of the test laid down by Barwick CJ in Evatt. 95 The operation ofthis test in the context of a third party's claim against an auditor is yet to be considered by the High Court. How the Court would deal in a particular case with the requirement that the defendant auditor have actual or constructive knowledge ofthe third party's reliance remains to be seen. We also have to await the Court's consideration ofthe circumstances in which a third party's reliance upon an audited account will be reasonable. The liability imposed on the basis of the High Court's approach may provide some comfort for investors and existing creditors. At the same time, there may be little joy~jor the already embattled auditors. 96 The impact of the imposition of this liability on either of the competing interest groups is not, however, a concern for the courts. The High Court's treatment of the issue of liability for negligent misstatement does not permit a profession specific approach. The difficulties encountered in the three recent decisions considered in this paper can be explained, perhaps, on the basis that the courts sought to find a solution to the issues raised in a particular professional context. 97 The problem with this approach is that it 93 King CJ dismissed the decision in Evatt on the basis that it only dealt with the circumstances in which a duty of care will be owed and not the class of persons to whom the defendant speaker will be liable: id 61,153. Olsson J, on the other hand, simply treated the decision in Evatt as an 'illustration of the general duty of care in its application to particular instances of negligent misstatement': id 61, Id 61, (1968) 122 CLR 553, See the article entitled 'Huge Liability Claims Spark Auditor Exodus', The Financial Review, March 2, See, for instance, the judgment of Millhouse J in Esanda (1994) Aust Torts Rep , 61,157.

14 92 KMHogg overlooks the fact that the High Court's theory of negligence liability centres on the application ofprinciple. Questions such as whether auditors should be protected from the imposition offurther liability or, alternatively, whether liability should be extended to encourage investment in Australian companies, are issues that the High Court should leave to Parliament.