The case, decided on a motion for partial summary judgment, addresses two very important issues in the development of auditors' liability jurisprudence in Canada:
- The duty of care owed by auditors to lenders of the client under a Hercules Managements analysis in circumstances in which the auditors have a very close relationship with the client and are familiar with the bank's financing arrangements. In this case, there was no duty of care despite the motions judge's findings of fact that the auditors knew that the audited financial statements would be used by the company to obtain financing, that the credit agreement required the company to provide the audited financial statements to the lenders, that the lenders had copies of the audited financial statements and the audit opinion, that the lenders would rely upon them, and that the auditors did not include a disclaimer of reliance in the engagement letter. Significantly, the motions judge found that all auditors know that lenders will rely upon their audit opinions.
- The liability of members of an international association of independent accounting firms where only one member was involved in the audit. In this case, there was no duty of care owed by the member firm which promulgated auditing standards used by the auditing firm but which had no involvement in the audit and had no relationship with the lenders. Nor was there any vicarious liability because the member firms operated independently.
Although the defendants raised the defence of ex turpi causa, it was not at issue on the motion.
On August 11, 1997, Philip Services Corp. (“Philip”) signed a credit agreement to borrow U.S. $1.5 billion from a syndicate of 39 lenders led by, Canadian Imperial Bank of Commerce (“CIBC”).
Defendants Deloitte & Touche and certain affiliates and successors (together, “Deloitte”) were the auditors of Philip. In making the loan, CIBC relied upon the audited financial statements of Philip for the years ended December 31, 1996, and December 31, 1997, and the Deloitte audit opinions dated February 28, 1996, and February 26, 1997.
Deloitte was the Canadian member of an international association of independent accounting firms, which included defendant Deloitte Touche Tohmatsu formerly known as Deloitte Touche Tohmatsu International, a Swiss verein (“Deloitte International”). Deloitte is legally distinct from its members and is not organized or operated as a partnership. Member firms are not partners, agents, representatives, subsidiaries, or branches of Deloitte International. Deloitte International developed a manual of standards and practices to be used by all firm members for the performance of audit engagements. The manual provided that letters of engagement could provide restrictions on the use to be made of audited financial statements. The engagement letter between Deloitte and Philip contained no such restriction.
Deloitte had a close relationship with Philip. It maintained an office at Philip's premises. Many of Philip's senior management were former Deloitte partners. Deloitte regularly attended audit committee meetings of the Philip board of directors. Deloitte knew how much Philip borrowed under its credit facilities, whether or not Philip had borrowing capacity under those facilities, and Philip's need for increasing credit due to its acquisition strategy. Deloitte reviewed the credit agreements annually as part of its audit process, so each year it knew the terms (including the provision of audited financial statements) and the consortium of lenders (which changed over time). The lenders argued on the summary judgment motion that Deloitte was also providing counsel and advice to Philip about financing its operations and acquisition plans; however, the motions judge found that Philip took no such advice from Deloitte. The motions judge said that while Deloitte's audit work and tax advice provided information to inform Philip's business plans, and while Deloitte needed to know about Philip's business plans to prepare the audit opinions, Deloitte's role was not that of business advisor or consultant. Deloitte's role was limited to performing statutory audits.
On April 22, 1997, two months after the release by Deloitte of its 1997 audit opinion, Deloitte learned of Philip's plans to seek a U.S. $1.5 billion credit facility to finance its expansion plans and it knew that lenders would review the audited financial statements before making the loan. Deloitte attended a May 7, 1997, Philip audit committee meeting, at which time it was advised that Philip had negotiated a U.S. $1.5 billion facility underwritten by CIBC, Wood Gundy, and Bankers Trust to be in place by mid-August and, in the meantime, the company had obtained bridge financing to December 31, 1997. Deloitte provided no advice and was not consulted about these loans.
On May 29, 1997, CIBC issued a commitment letter to Philip and, in July, Deloitte accompanied CIBC and Phillip on a trip to allow CIBC to visit various Philip sites. However, the motions judge found that the only interaction between Deloitte and CIBC was as travelling companions. Deloitte knew why the trip had been organized for CIBC, but CIBC did not know why Deloitte was present for the trip and obtained no information or advice from Deloitte.
On July 11, 1997, Philip and CIBC made a presentation to a group of bankers as part of its efforts to syndicate the loan. Deloitte was present to obtain information relevant to the following year's audit. Deloitte had no involvement in the presentation.
On August 11, 1997, the credit agreement was signed – there were 39 lenders in the syndicate, including CIBC. The credit agreement contained a compliance certificate signed by Deloitte. However, at no time was there any communication between CIBC and Deloitte in connection with Deloitte's review of the Philip financial statements or how the loan should be structured. CIBC did not ask Deloitte to do any work for the syndicate of lenders. CIBC did not ask Deloitte's permission to rely upon the audit opinions for the purpose of deciding whether to make the loan. However, the motions judge found that Deloitte knew that the financial statements would be used by Philip to obtain financing, that the credit agreement required Philip to provide the audited financial statements to CIBC, that CIBC had copies of the audited financial statements and the audit opinion, that CIBC and the other members of the syndicate would rely upon them, and that Deloitte did not include a disclaimer of reliance in its engagement letter. Significantly, the motions judge found that all auditors know that lenders will rely upon their audit opinions. Further, the motions judge found that CIBC and the other lenders did in fact rely upon the audited financial statements in making the loan.
In March, 1998, an accounting fraud was discovered and Philip re-stated its financial statements. Ultimately, Philip defaulted on the loan, became insolvent, and was re-structured. The syndicate of lenders lost U.S. $524 million.
In 2000, Philip's Receiver and Manager, CIBC, and High River Limited Partnership (which had purchased some of Philip's debt from members of the leading syndicate) commenced actions against Deloitte and Deloitte International. The claim by the Receiver and Manager against Deloitte is for breach of contract and negligence. The lenders brought a class action against Deloitte and Deloitte International for negligence, negligent misrepresentation, and fraudulent misrepresentation with respect to the 1995 and 1996 audits. The two actions were later consolidated.
Deloitte and Deloitte International moved against the lenders for partial summary judgment for dismissal of the negligent misrepresentation claim on the basis that the auditors owed no duty of care to the lenders. No motion was brought with respect to the claims made by the Receiver and Manager.
(a) Claim against Deloitte
For the purpose of the motion only, Deloitte conceded that its work was negligent. Therefore, the sole issue before the motions judge was whether it owed the lenders a duty of care. The motions judge found that on that issue alone, there was little evidence in dispute because of the admissions made by Deloitte about its knowledge. The motions judge found that there was no duty of care because, applying the test set out by the Supreme Court of Canada in Hercules Managements:
- Deloitte did not know the identities of the members of the syndicate of lenders. It knew only that there would be a syndicate of lenders, not the size or composition of them. Only knowledge of the identities of the members of the syndicate by Deloitte would address indeterminacy concerns. Deloitte did not have that knowledge until August, 1997, months after it had issued its February, 1997, audit opinion.
- Deloitte did not conduct its audit or issue its audit opinion for the purpose of having the audited financial statements read by the lenders. Knowing that the lenders would rely upon the audited financial statements was not sufficient to address concerns about indeterminate liability. Between 1994 and 1997, Philips loans had increased from about U.S. $200 million to U.S. $1.5 billion for the purpose of acquisitions of almost 50 businesses and there were other efforts to raise capital as well, including issuing shares and divestitures of businesses.
There was no significance to the fact that Deloitte did not disclaim liability for the use of the audited financial statements; one need not disclaim a liability that one does not have. Further, the motions judge found that the alleged misrepresentations in the audited financial statements that were said to be breaches of the duty of care occurred before there were even discussions with CIBC for the U.S. $1.5 billion loan. Those discussions began in April, 1997, two months after the audit opinion was issued.
(b) Claim against Deloitte International
Deloitte International had no relationship with CIBC and played no active role in the audits. It made no representations to CIBC and CIBC did not rely upon anything Deloitte International did. It owed no duty of care to CIBC.
Further, the motions judge found that there was no basis for a finding of vicarious liability. The evidence was that there was no principal/agent, employer/employee, or partnership relationship between Deloitte and Deloitte International