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Home > Our Insights > Supreme Court of Canada Confirms Auditor Negligent & Liable for $40M in Livent v. Deloitte
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Supreme Court of Canada Confirms Auditor Negligent & Liable for $40M in Livent v. Deloitte

Published:

December 23, 2017

Author(s):

  • Harvey Morrison, KC

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Parents often threaten their children that if their behaviour did not improve they will get a lump of coal in their Christmas stockings. On December 20, 2017 a well-known accounting firm received just that from the Supreme Court of Canada, namely a judgment against it for over $40 Million – though the lump was only half the size it was initially. The Supreme Court’s decision in Livent v. Deloitte is an especially stark reminder of the importance to both clients and their professional advisors of a proper understanding of what a professional services firm is undertaking to do for its client. That understanding must be documented carefully to prevent disputes about the scope of the advisor’s undertaking from arising in the future. When the scope of the undertaking is clear, it is unlikely an auditor or other professional services can argue successfully it did not owe its client a duty of care in respect of services reasonably encompassed within that scope. In this case, the scope of the auditor’s undertaking was everything.

Livent was a well-known entertainment company that specialized in the vertical integration of live theatre productions.  As the Chief Justice of the Supreme Court noted, “it brought the entire enterprise, from production to performance, under one roof – a roof that Livent, as a proprietor of theatre properties, also owned.” To show Livent was a success, its two principal shareholders, Drabinsky and Gottlieb, and “their associates cooked the books.” From 1989 to 1998, Deloitte LLP acted as auditor for Livent and its predecessors. In 1997 the auditor helped Livent prepare and approved a press release that misrepresented the financial impact of a particular transaction and provided a “comfort letter” to support a substantial debenture underwriting. In 1998, the auditor provided a “clean” audit report with respect to Livent’s 1997 financial statements. Livent subsequently sued its auditor in negligence claiming that the auditor’s failure to detect the frauds of Drabinsky and Gottlieb caused Livent to suffer substantial losses. The trial court decided the auditor was negligent in respect of the press release, the comfort letter and the 1997 audit and ordered the auditor to pay approximately $84 Million to Livent.  The auditor appealed to the Ontario Court of Appeal, but failed. The auditor appealed further to the Supreme Court of Canada. The Court confirmed Deloitte’s liability – but reduced the damages award to $40 Million.

Negligence

A party that makes a claim against another based on negligence must establish four things:

  1. The defendant owed them a duty of care.
  2. The defendant’s conduct breached the applicable standard of care.
  3. The plaintiff sustained loss or damages.
  4. The damage was caused, in fact and in law, by the defendant’s breach of the standard of care.

The Supreme Court’s decision in Livent was concerned only with the first question: did the auditor owe a duty of care to Livent? Canadian courts use a two-stage analysis (the so-called “Anns/Cooper” framework) to determine whether a duty of care exists:

  1. Did a prima facie duty of care exist?
  2. If yes, are there are any “residual policy considerations” that should negate or limit the scope of the duty.

The majority of the Court provides a very helpful review of the principles governing how courts should apply this two-stage analysis. This Alert will focus on how a badly split Supreme Court dealt with the first issue, the existence of the duty of care. Four judges accepted that the auditor owed a duty of care to Livent, but decided it was only liable for the loss flowing from the negligently performed audit and not for the loss resulting from the press releases or the comfort letter; three would have held that the auditor was not liable for any of Livent’s losses.

Prima Facie Duty of Care

This stage of the analysis requires the court to ascertain whether the plaintiff and the auditor are in a relationship of proximity which is such a close and direct relationship that it would be “just and fair” to impose a duty of care. The courts have adopted a number of techniques to make that determination.

Prior Recognition of a Duty of Care. They first use a shortcut: if the relationship is the same or analogous to a relationship the courts have previously recognized as giving rise to a duty of care, the analysis need go no further and they accept a duty of care exists. Livent pointed to the Court’s earlier decision in Hercules Managements Ltd. v. Ernst & Young where the Court recognized that an auditor owed a duty of care to its client in the performance of a statutory audit. Livent argued that because the Court recognized a duty of care in that case, it necessarily followed that its auditor owed it a duty of care in this case. However, the majority of the Supreme Court said it was not as simple as that: the prior recognition of a duty of care was not to be accepted without question. A court must be attentive to the factors that justified the recognition of the duty of care in the earlier case. The court in the subsequent case must determine whether the relationship was “in fact, truly the same as, or analogous to, that which was previously recognized.”  Furthermore, the fact that a duty of care has been recognized between an auditor and its client does not mean that a duty of care exists for all purposes.

Full Proximity Analysis. If the case does not fit into an existing category recognizing a duty of care, the court must undertake a “full proximity analysis”: it must examine all relevant factors arising from the relationship between the plaintiff and the defendant, including “expectations, representations, reliance, and the property or other interests involved as well as any statutory obligations.” Where the claim is for negligent misrepresentation or performance of a service (the most common allegations in professional negligence cases), two factors are determinative: the defendant’s undertaking and the plaintiff’s reliance. Where the defendant undertakes to provide a representation or service in circumstances that invite the plaintiff’s reasonable reliance, the defendant becomes obligated to take reasonable care, and the plaintiff has a right to rely on the defendant’s undertaking to do so. These corollary rights and obligations create a relationship of proximity.

Scope of the Undertaking is Key. A key factor in this proximity analysis – and the determinative factor in this case – is the scope of the defendant’s undertaking of responsibility: if the plaintiff’s reliance falls outside the scope of the defendant’s undertaking of responsibility, it is necessarily outside the defendant’s duty of care.  In other words the “defendant cannot be liable for a risk of injury against which he did not undertake to protect.” Here, the scope of the auditor’s undertaking was determinative.

  • 1997 Audit. The auditor’s undertaking of responsibility with respect to the 1997 audit had the same purpose as that of the auditor found liable in the Hercules case: the provision of information to allow for effective oversight of management by the company’s shareholders. It therefore followed proximity was established between Livent and the auditor, and the auditor had a duty of care to Livent with respect to the 1997 audit.
  • Press Release & Comfort Letter. The Supreme Court’s analysis of the auditor’s responsibility in relation to the press release and comfort letter led to a completely different result. Livent asserted that if the auditor had not continued to assist it in soliciting investment through the press release and comfort letter but had instead resigned (because it had knowledge of the financial irregularities), Livent would have known its true financial state and would have avoided deterioration of its finances. Livent alleged it detrimentally relied on the auditor’s services rendered in connection with the press release and comfort letter to “artificially extend the life of the corporation”. The Supreme Court rejected this claim because Livent’s reliance was not tied to the solicitation of investment, but was a matter of oversight of management. The Court distinguished between what the auditor undertook in relation to the investment solicitation and what it undertook in relation to the 1997 audit. If Livent’s losses related to an inability to secure investment because of the auditor’s negligence, Livent could conceivably recover those losses. But losses relating to a lack of oversight of management that artificially extended the corporation’s life were not, because the auditor never undertook, in preparing the comfort letter and assisting in the preparation of the press release, to assist Livent’s shareholders in overseeing management. Livent had no right to rely on the auditor’s representations for a purpose other than that for which it undertook to act.

    Please contact your McInnes Cooper lawyer or any member of the Financial Services Team @ McInnes Cooper to discuss this topic or any other legal issue.


    McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.

    © McInnes Cooper, 2017. All rights reserved. McInnes Cooper owns the copyright in this document. You may reproduce and distribute this document in its entirety as long as you do not alter the form or the content and you give McInnes Cooper credit for it. You must obtain McInnes Cooper’s consent for any other form of reproduction or distribution. Email us at [email protected] to request our consent.

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  • Get Your SEDAR Profile: Changes to Private Placement Filing Requirements Effective May 24 & June 30, 2016

    Jun 6, 2016

    On June 30, 2016, amendments to National Instrument 45-106 Prospectus Exemptions and related changes to Companion Policy 45-106 Prospectus…

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    Publication
  • 3 Tips to Use “Forward-Looking Information” to Enhance Your Investor Relations

    May 31, 2016

    You’re on a tight timeline to issue a press release. You finish your draft and ‘cut & paste’ your standard “forward-looking…

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  • A Penalty by Any Other Name: Supreme Court of Canada Says Interest Rate Increase Triggered by Default, Whatever It’s Called, Infringes the Interest Act in Krayzel Corp. v. Equitable Trust Co.

    May 9, 2016

    On May 6, 2016, the Supreme Court of Canada decided that a mortgage imposing a higher interest rate in the event of default and reserving a…

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  • NS Poised to Take the Plunge into Pooled Registered Pension Plans (PRPPs)

    May 5, 2016

    NOTE: As of June 25, 2016, provincially regulated workers and employers in Nova Scotia, Quebec, BC and Saskatchewan can participate in Pooled…

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    Publication
  • 5 Key Changes to Early Warning Reporting System Effective May 9, 2016

    May 2, 2016

    Amendments changing the early warning reporting system take effect on May 9, 2016, provided all necessary approvals are obtained (except in…

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    Publication
  • New Early Warning Reporting System Exemptions for Certain Securities Lending Arrangements Effective May 9, 2016

    May 2, 2016

    Amendments changing the early warning reporting system take effect on May 9, 2016, provided all necessary approvals are obtained (except in…

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    Publication
  • From Watershed Decision to Watershed Law: Government Proposes Physician-Assisted Dying Law in Bill C-14 An Act to amend the Criminal Code and to make related amendments to other Acts (medical assistance in dying)

    Apr 15, 2016

    On April 14, 2016, Canada’s federal Justice Minister proposed legislation setting out the conditions that a person wishing to undergo…

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    Publication
  • The Small Business Deduction: Key Proposed Changes & Strategic Solutions

    Apr 12, 2016

    Federal Budget 2016 proposed to significantly reduce the benefit of and access to the Small Business Deduction. The Small Business Deduction…

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    Publication
  • Doing Business With the Public Sector: Key Confidentiality Risks & 3 Risk Management Strategies

    Mar 24, 2016

    When a business responds to a public sector Request for Proposal or Expression of Interest (both of which we’ll refer to as an RFP for these…

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    Publication
  • It Gets Worse: 5 Key Proposed Changes to Section 55 of the Income Tax Act

    Oct 23, 2015

    Subsection 55(2) of the Income Tax Act (Canada) is an anti-avoidance provision intended to prevent capital gains stripping by deeming an…

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    Publication
  • Tax Implications of Personal Services Businesses (PSB) Status & Strategies to Avoid It

    Oct 23, 2015

    Incorporation offers legal advantages to sole proprietors of small businesses, including certain tax advantages. However, when a corporation…

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    Publication
  • New Kid on the Block: Crowdfunding Joins Traditional Equity-Based Funding Options for Startups & SMEs

    Oct 19, 2015

    Access to sufficient capital to fund operations, research and development, and other costs is a key challenge for start-ups and for some small…

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    Publication
  • Invalidation of Bequest to Neo-Nazi Group as Against Public Policy Withstands Appeal

    Jul 30, 2015

    Note: On June 9, 2016, the Supreme Court of Canada dismissed the National Alliance’s application for leave to appeal the New Brunswick Court…

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    Publication
  • The Value of Hindsight – 3 Steps to Help Financial Advisors Avoid Client Claims and Complaints

    Mar 30, 2015

    Hindsight is 20/20. Lawyers can’t always predict the outcome of a legal claim. But when a dispute between an investment client and her…

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    Publication
  • No More Criminalization of Physician-Assisted Dying: The Ripple Effects of A Watershed Decision in Carter v. Canada (Attorney General)

    Feb 9, 2015

    NOTE: On April 14, 2016, the federal government proposed legislation setting out the conditions that a person wishing to undergo…

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    Publication
  • Thou Shalt Not Lie: SCC Recognizes New Duty of Honesty in Contract Law in Bhasin v. Hrynew

    Nov 14, 2014

    On November 13, 2014, the Supreme Court of Canada (SCC) effected a significant development in Canadian contract law by recognizing the…

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    Publication
  • The Top 5 Corporate Governance Best Practices That Benefit Every Company

    Sep 16, 2014

    This publication has been updated as at August 25, 2022. Many believe that only public companies or large, established companies with many…

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    Publication
  • Canadian Treaty Shopping Proposal Shelved Pending Final OECD Recommendation, First To Be Released September 16

    Sep 11, 2014

    The Canadian federal government has been concerned for some time about “treaty shopping” by non-residents – the practice of non-residents…

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    Publication
  • Estate Planning Solutions: 5 FAQs About Alter Ego & Joint Partner Trusts

    May 22, 2014

    This publication has been updated as at February 17, 2021. Trusts offer a very useful estate planning solution for a wide variety of special…

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    Publication
  • Share Purchase Transactions: Tips For Lenders

    Apr 29, 2014

    Lenders are often faced with a situation where a customer (Borrower) approaches them for funds to complete an acquisition of the shares of a…

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    Publication
  • Legal Update: Risky Trading – Insiders and Potential M&A’s

    Nov 1, 2013

    Recent decisions of securities regulators and amendments to Canadian securities laws demonstrate regulators' lowered tolerance for insiders who…

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    Publication
  • General Security Agreements: Tips & Traps

    Aug 28, 2013

    A general security agreement (GSA) is the most common form of personal property security used in the Atlantic Provinces to secure commercial…

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    Publication
  • Franchise Questions: What do I need to know about moving into new markets?

    Jun 7, 2013

    In Franchise Canada’s Spring 2013 “Viewpoints” feature, McInnes Cooper franchise lawyer Michael Melvin answers this question for…

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    Publication
  • Comment on Copthorne Holdings Limited V. The Queen

    Dec 16, 2011

    In a unanimous decision rendered by Justice Rothstein, the Supreme Court of Canada today dismissed the appeal of Copthorne Holdings Limited,…

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    Publication
  • DFO Announces that Corporations May Own Fishing Licenses

    Mar 7, 2011

    Effective April 1, 2011, the fishing licensing policy for the Atlantic Canada and Quebec inshore fishery will change to allow inshore fishing…

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    Publication
  • A Closer Look at the Regulations Under the New Brunswick Franchises Act

    Oct 1, 2010

    McInnes Cooper franchise lawyer Michael Melvin highlights some of the significant features of the Disclosure Documents Regulation and the…

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    Publication
  • What are electronic disclosure documents and why and how may they be used?

    May 31, 2010

    In Franchise Canada’s May/June 2010 “Ask A Legal Expert” feature, McInnes Cooper franchise lawyer Michael Melvin answers this question for…

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