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Livent co-founder Garth Drabinsky is shown in Toronto on March 25, 2009. Livent's auditors were “negligent but wholly innocent” in the fraud that unfolded at the live theatre company and should not be required to bear a large proportion of the losses suffered by the company, the Supreme Court of Canada heard WednesdayCHRIS YOUNG/The Canadian Press

Livent Inc.'s auditors were "negligent but wholly innocent" in the fraud that unfolded at the live theatre company and should not be required to bear a large proportion of the losses suffered by the company, the Supreme Court of Canada heard Wednesday in a case that will prove pivotal for Canada's accounting industry.

Lawyer Peter Griffin, representing audit firm Deloitte LLP, urged Canada's top court to set aside lower-court rulings that found the accounting firm negligent in its work as Livent's auditor, arguing the decision to order $85-million in damages – now exceeding $130-million with accrued interest – was based on flawed legal analysis.

Mr. Griffin said he did not dispute that Deloitte was negligent in some of its audit work on Livent's 1997 financial statements, but said the Ontario Superior Court ruling in 2014 held the audit firm responsible for far too high a level of damages beyond the direct impact of the audit work. Deloitte appealed that decision to the Ontario Court of Appeal, but lost, and is now appealing to the Supreme Court.

Mr. Griffin also said the Ontario court erred in holding Deloitte responsible for a fraud conducted by Livent itself through its own senior executives.

"It cannot be correct that a company rife with fraud, led by notorious fraudsters, bears no responsibility for its loss, [but] the auditor, who was negligent but wholly innocent of the fraud, bears full responsibility," he said.

Livent, which staged shows such as Phantom of the Opera and Show Boat in the 1990s, collapsed in 1998, after new owners bought the company and raised concerns about accounting improprieties. Company founders Garth Drabinsky and Myron Gottlieb were convicted of fraud and sentenced to jail terms in 2009, but have since been released.

The Supreme Court's decision is expected to be pivotal for the accounting industry, which is warning that the direction set by the court could expose audit firms to more lawsuits whenever fraud occurs at a company.

Chartered Professional Accountants of Canada, a national organization for the accounting profession, was granted permission to intervene in the case, warning the Supreme Court that auditors could face excessive liability for wrongdoing and could be forced to resign at the first sign of trouble.

But lawyer Peter Howard, who is representing Livent, said the Supreme Court should not worry that the case will open floodgates of claims against auditors, noting Livent is the first auditor claim to succeed involving a publicly traded company since the Supreme Court ruled in 1997 on an auditor case involving Hercules Management Ltd.

He said Deloitte is fully covered by liability insurance for the costs awarded in the Livent case, and said the firm could have passed along some of the liability for errors by suing others involved with misleading auditors about the company, including former executives or underwriters, but chose not to do so. He said audit firms in the future could negotiate terms that limit liability.

"There's no policy reason for you to worry about floodgates," he said.

Most of the questions asked by the Supreme Court justices during Wednesday's hearing were about how to assess damages in the case.

Chief Justice Beverley McLachlin, for example, questioned where the line should be drawn between the costs Deloitte should pay because of auditor negligence in 1997, and any costs or losses that were due to bad business decisions made by management.

"That does trouble me. You could have companies getting money in a situation like this and being very unreasonable, even negligent, and it seems to me that it would be wrong to say the auditor is responsible for that," Chief Justice McLachlin said.

Mr. Howard said there is no "scientific precision" in awarding damages, but said the trial judge applied the correct tests and made his reasons clear about how he apportioned damages, only holding Deloitte responsible for a fraction of the losses suffered by the company.

The Supreme Court did not rule immediately on the appeal and will release a written decision later.