The Ontario Court of Appeal has upheld a landmark 2014 decision that ordered accounting firm Deloitte & Touche to pay $118-million in damages for negligence in its work as the auditor of failed live-theatre company Livent Inc.
The case has been closely watched in the legal community because it has been extremely difficult for investors to sue auditors when companies collapse amid allegations of fraud, and the Livent decision was seen as opening a new path for future claims against auditors in other cases.
Appeal court Justice Robert Blair ruled Friday that the original trial judge was correct in concluding Deloitte was negligent in its work on the audit of Livent’s 1997 year-end financial statements, as well as the interim statements for the second and third quarters of 1997.
“In my view, the record amply supports the trial judge’s findings that Deloitte was negligent in the conduct of the 1997 audit and the Q2 and Q3 1997 engagement,” he wrote in a decision supported by two other judges on the appeal panel. “Indeed the evidence to that effect is overwhelming.”
Justice Blair, however, rejected a counterclaim asking for greater damages to be awarded in the case, saying the original $118-million award was appropriate.
Ontario Superior Court Justice Arthur Gans ruled in April, 2014, that auditors at Deloitte & Touche breached their “duty of care” to investors.
He initially awarded $85-million in damages to the company’s creditors, but increased the amount to $118-million in a subsequent ruling that added interest costs onto the original award, stretching back to March of 1998 when Livent released its inaccurate 1997 financial statements.
In his original ruling, Justice Gans said that auditors “seemed to turn a blind eye to warning signs” about a controversial transaction in 1997 to sell air rights to develop a condominium-hotel above Livent’s Pantages Theatre in Toronto. He said he was “at a loss” to understand how Deloitte provided a clean audit opinion for 1997, and ruled that another decision to allow $27.5-million of writedowns in 1998 “left me breathless.”
Justice Gans’s decision was widely watched because Canadian investors have faced an uphill battle suing auditors, largely as a result of a 1997 Supreme Court of Canada decision involving Hercules Management Ltd., which set out narrow parameters for lawsuits to succeed.
The Livent decision, however, was seen as a break from that precedent, laying out a new path for aggrieved investors and creditors to succeed in lawsuits against auditors. Because the Hercules decision concluded that auditors owe a duty of care to the corporation that hires them – and not to shareholders or creditors directly – the Livent lawsuit was filed by Livent itself through its special receiver, although the creditor group led and financed the litigation and will receive much of the award.
Deloitte challenged the move in its appeal, saying the lawsuit was essentially filed by creditors in reality and not really the corporation. But Justice Blair rejected the argument, saying he had “no difficulty” in concluding the losses were suffered by Livent so it was the legitimate party suing.
He also rejected Deloitte’s arguments that the company had no right to sue because the fraud was conducted by Livent’s own senior executives, which meant the company itself essentially conducted the fraud and should not be allowed to sue over its own conduct.
Justice Blair said such a claim would effectively mean auditors could never be sued by a company for failing to act on evidence of fraud by executives, which would “risk undermining the public audit system.”
He said he agreed with Justice Gans’s original decision that blaming the company for fraud by its executives “would have the perverse effect of depriving the innocent participants” with a remedy for auditor negligence.
Justice Blair also agreed with Justice Gans’s conclusion that Deloitte should have resigned as Livent’s auditor in 1997 due to the number of problems it had identified at the company.
Deloitte spokeswoman Emily Richardson said the firm will review the appeal decision before deciding on its next steps.
“The Livent matter has been before the courts for a considerable period of time and we need time to carefully consider the recently released Ontario Court of Appeal decision,” she said in a statement. “The audit and legal issues in this case are exceptionally complex, and important not only to the audit profession but to the broader business community.”
Livent bondholder Richard Ross, who headed the creditor group suing Livent, said the group is “gratified” that the appeal court upheld the trial decision, and he hopes the case will soon be over.
“We hope that this will be the end of this legal saga and that some measure of compensation will now be available to the creditors for the massive losses they incurred in the Livent fiasco,” he said.
Livent staged live-theatre shows such as The Phantom of the Opera and Show Boat. The company collapsed in 1998 after new investors raised concerns about accounting problems they had uncovered at the company.
Founders Garth Drabinsky and Myron Gottlieb were found guilty in 2009 of orchestrating a fraud that saw Livent’s financial statements misstated in every quarter between 1993 and 1998. They were sentenced to five years and four years in prison, respectively, but have since been released.Report Typo/Error