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Livent theatre executive Garth Drabinksy leaves a downtown Toronto courthouse after sentencing in August, 2009.Kevin Van Paassen/The Globe and Mail

An Ontario judge has awarded $85-million in damages to the creditors of long-defunct theatre company Livent Inc., ruling the firm's auditors at Deloitte & Touche were negligent in their reviews of the company's 1997 financial statements.

The critical ruling, released late Friday, marks a rare victory for creditors in a lawsuit against its auditors.

Shareholders and creditors in Canada have faced an uphill battle suing auditors due in large part to a 1997 Supreme Court of Canada decision involving Hercules Management Ltd., which set out narrow parameters for such lawsuits to succeed.

In Livent's case, however, Ontario Superior Court Justice Arthur Gans said he found evidence that Deloitte auditors were negligent and breached their "duty of care" to investors.

"I am at a loss to understand how Deloitte could have signed a clean audit opinion for 1997," Justice Gans wrote in his 118-page decision.

Justice Gans said Deloitte auditors "seemed to turn a blind eye to the warning signs" about a controversial transaction in 1997 to sell air rights to develop a

condominium-hotel above Livent's Pantages Theatre in Toronto, and also said the auditors' work on another controversial decision in 1998 to record $27.5-million of writedowns "left me breathless."

"I shudder to think it was all about the $50,000 fee they received for the review engagement undertaken as a precursor to the October [1997] underwriting or the $95,000 fee charged in respect of the 1997 audit," he wrote.

Jeannie Tsang, a spokeswoman from Deloitte, had no comment on the ruling Sunday.

"We need the time to read and consider the decision to decide on our next steps," she said.

The creditor group filed the lawsuit in 2002 – four years after Livent's collapse – but it has wound through the courts slowly and was delayed for years by the criminal case involving Livent's founders, Garth Drabinsky and Myron Gottlieb.

Mr. Drabinsky and Mr. Gottlieb were found guilty in 2009 of orchestrating a fraud that saw Livent's financial statements misstated every quarter from 1993 to 1998. They were sentenced to five years and four years in prison respectively, but have since been released on parole.

Livent's creditors were seeking $450-million from Deloitte in their original lawsuit, but Justice Gans awarded $84.75-million in damages based on concerns about the audit for the 1997 fiscal year.

He has asked both sides to make arguments to him about how to assess interest on the amount and how to award costs for lawyers' fees. Both have the potential to significantly increase the size of the award against Deloitte.

Justice Gans ruled Deloitte's work on Livent's audits up to 1995 "did not cross the balance of probabilities finish line" to find negligence, and said errors he found with the 1996 audit did not "cause any compensable harm" to investors.

His negligence ruling hinged on the audit of Livent's books for 1997, which was the firm's last full year of operations before concerns were raised by new owners in 1998, and especially on the Pantages air-rights deal with Dundee Realty Corp.

He said that if Deloitte had taken a stronger stand to oppose problems involving the Pantages deal in the summer of 1997, concerns about the company's accounting problems could have come to light far earlier.

"I have first concluded that Deloitte should have pulled the plug on its relationship with Livent at the end of August or, at the very least, September 1997," he said.

"In my view, had matters come to a head on either of those two dates, then Deloitte would have been obliged to make 'full and frank' disclosure not only to the audit committee but to the regulators, the results of which would have put Livent in the position it found itself in 11 months hence."

Richard Ross, who headed the creditor group suing Deloitte, said he was pleased with Friday's ruling but had not yet reviewed the details of the ruling with the group's lawyers.

"We are gratified that Justice Gans has confirmed Livent's assertion that Deloitte was negligent in the performance of its audits and has declined to accept Deloitte's position that they should not be held liable for this negligence," he said in a statement Sunday.

The Deloitte audit was conducted by a series of different accountants in part because Mr. Gottlieb insisted in 1997 that the audit partners be changed on the file because he was upset about their handling of the Pantages deal. Justice Gans noted in his ruling that this meant Deloitte changed the whole audit team "virtually from top to bottom."

Justice Gans is highly critical of Mr. Drabinsky and Mr. Gottlieb, saying his lengthy review of events at the company suggested "both gentlemen were equally complicit" in the deception. In the criminal trial, Mr. Gottlieb received a slightly shorter sentence because the judge ruled Mr. Drabinsky was the controlling mind of the company.

Justice Gans said the case is "replete with hubris," demonstrated by the many occasions in which Mr. Drabinsky and Mr. Gottlieb thought their fraud would never be detected.

"During the course of the trial, I heard examples of the frauds that left me shaking my head, both at the brilliance of the schemes and the unbridled gall of the participants," Justice Gans wrote.

Justice Gans also noted he was not persuaded that the two co-founders "set out to defraud the world" when they founded Livent, but in retrospect "it would seem that the consequences of their actions were almost preordained."

He acknowledged Deloitte & Touche and some of its senior partners were "casualties of a monumental fraud," but he rejected arguments from the firm that it should not be sued because the fraud was conducted by Livent itself, through its senior officers, so it is not fair that the firm can then file a lawsuit for its own actions.

The lawsuit in the case was filed by Livent's special receiver on behalf of creditors, although the creditor group led and financed the litigation.

Livent initially reported a loss of $44-million for 1997, but the amount was later corrected to a loss of $99-million following a lengthy review after accounting concerns came to light. Livent's $11-million profit for 1996 was restated to a loss of $18-million.