On September 5 the Court of Appeal for Ontario issued its decision in Lavender v. Miller Bernstein LLP, 2018 ONCA 729.
- The decision is now the leading judgment by Ontario’s highest court on the duty of care owed by auditors.
- The Court of Appeal held that an auditor does not owe a duty of care to account holders with a securities dealer simply by virtue of auditing the dealer’s annual registration renewal requirements filed with a securities regulator.
- The decision confirms that the legal determination of the class of persons to whom an auditor owes a duty of care at law will turn on the facts of each case, in keeping with the Supreme Court of Canada’s decision in Deloitte & Touche v. Livent Inc. (Receiver of), 2017 SCC 63.
In 2001, the Ontario Securities Commission (OSC) suspended the registration of a securities dealer and placed the dealer into receivership for failing to segregate investor assets and maintain a minimum level of net free capital.[i] Clients with investment accounts at the firm lost millions.
A class action was commenced on behalf of all clients with accounts at the securities dealer alleging that the dealer’s auditor negligently audited an annual registration renewal requirement filed with the OSC (known as Form 9 Reports). The dealer’s Form 9 Reports incorrectly stated that the dealer was in compliance with regulatory segregation and minimum capital requirements.[ii]
A motion judge of the Superior Court of Justice granted summary judgment to the class concluding that the auditor owed class members a duty of care in conducting audits of the dealer and that the auditor fell below the required standard of care.
The auditor appealed the summary judgment decision to the Court of Appeal.
Historically, courts applied the two-stage analysis outlined in Anns v. Merton London Borough Council,  A.C. 728 (H.L.) and Cooper v. Hobart, 2001 SCC 79, to determine the threshold question of whether a duty of care exists in negligence cases. The first stage of the test considers whether a prima facie duty of care exists based on a relationship of proximity and reasonable foreseeability of injury, while the second stage considers whether there are any residual policy reasons for denying liability notwithstanding a finding of duty in the first stage.[iii]
The Supreme Court of Canada’s 2017 Livent decision explained how the Anns/Cooper framework applies to define the duties of care owed by auditors. In that judgment, the Supreme Court reaffirmed that the applicable analysis comprises the following steps:
- The court will first determine whether a prima facie duty of care exists by:
- Examining whether the relationship between the auditor and the plaintiff falls within, or is analogous to, a previously established category in which proximity has already been found to exist. If a risk of reasonably foreseeable injury can also be shown—or has already been shown through an analogous precedent—the first stage of the Anns/Cooper framework is complete and a duty of care may be identified. If no established proximate relationship can be found, the court must undertake a full proximity analysis.
- To determine proximity, the court will examine the circumstances of the relationship between the auditor and the plaintiff—including expectations, representations, the interests involved, and any statutory obligations—to determine whether it is sufficiently close to impose a duty of care.
- If proximity is established, the court will determine whether the plaintiff’s injury was reasonably foreseeable by looking to whether the auditor should reasonably understand that the plaintiff would rely on its representations and whether such reliance would be reasonable in the circumstances.
- Where a prima facie duty of care is recognized, either through an existing category or on the basis of a full proximity and reasonable foreseeability analysis, the court must go on to ask whether there are any public policy concerns beyond the relationship of the parties, including the effects of recognizing a duty on other legal obligations, the legal system, and society more generally, that may negate imposing a duty of care.[iv]
Applying this analysis, the Court of Appeal vacated the judgment below, granted summary judgment to the auditor, and dismissed the class’s claim for negligence.[v]
The court held that the motion judge did not have the benefit of the Livent decision at the time the motion was considered,[vi] and as such the motion judge conflated the questions of proximity and foreseeability and made factual findings that amounted to palpable and overriding errors.[vii] Specifically, it found that the relationship between the auditor and the investors was too remote because it was attenuated by the intermediary relationship between the securities dealer and the OSC, and thus the motion judge’s decision stretched proximity “beyond its permissible bounds.”[viii]
The court also noted that the auditor made no representations to the investors directly[ix] and that there was no reliance (or even awareness of) the auditor’s functions by the investors.[x] For these reasons, there was no proximity or reasonable foreseeability to sustain a determination that a duty of care existed, and the court declined to conduct a second-stage policy analysis.
In reaching its conclusion, the court commented that negligence claims for pure economic loss require more heightened scrutiny than other negligence claims.[xi]
The court’s decision provides important guidance to auditors facing claims in negligence, and should be carefully considered by counsel in developing effective defence strategies. In particular, the decision appears to limit the liability of defendant auditors who make no representations to members of a putative class,[xii] whose existence or involvement with a dealer is unknown to investors,[xiii] or whose work product is not shared with plaintiffs or relied on by them in making investment decisions.[xiv]
The author wishes to thank law student Maha Mansour for her help in preparing this article.
[i] 2018 ONCA 729, at para. 1.
[ii] Ibid, at para. 2.
[iii] Ibid, at para. 29.
[iv] Ibid, at paras. 30-41.
[v] Ibid, at paras. 76-77.
[vi] The motion was argued on June 27 and 29, 2017, and reasons for judgment were issued on July 12, 2017. The Supreme Court of Canada’s Livent decision was not released until December 12, 2017.
[vii] 2018 ONCA 729, at para. 68.
[viii] Ibid, at paras. 25-26.
[ix] Ibid, at para. 65.
[x] Ibid, at para. 67.
[xi] Ibid, at para. 72.
[xii] Ibid, at para. 66.
[xiv] Ibid, at para. 67.