Auditors Failed to Strike Out Liquidators’ Claim for Negligence
The
Days Impex Case
In a recent decision of Days
Impex Ltd v Fung Yu HCA1035/2014 (unreported, 24 October 2017) (the “Days Impex Case”), the Court of First
Instance (the “CFI”) refused to
strike out a negligence claim brought by the liquidators in the names of the
Plaintiffs against two audit firms for failing to detect a massive fraud at the
two Plaintiffs.
The CFI held that an auditor’s duty is not as
narrow as to be restricted to the provision of information and advice. The duty
can extend to detecting material irregularities in the company’s accounting
statements. It may even extend to reporting any fraud or suspected fraud to the
company, and in some cases, to relevant regulatory or enforcement
authorities.
The Facts
The Plaintiffs are two private companies in
liquidation. The Plaintiffs engaged the 1st Defendant as their auditors between
2005 and 2011. The 2nd Defendant was the practice successor of the 1st
Defendant.
The Arguments
It was the Plaintiffs’ case that the Defendants had
breached their duty owed to the Plaintiffs by signing off unqualified “clean”
opinions on the status of the Plaintiffs’ accounts and by failing to detect and
report the massive import/export fraud which the controlling shareholder and
director had caused the Plaintiffs to commit.
The Defendants applied to strike out the
Plaintiffs’ claim in its entirety on the grounds that the Statement of Claim disclosed
no reasonable cause of action, and it was an abuse of process.
The arguments between the parties were mainly on the
law regarding the scope of auditor’s duty, the defence of attribution and
illegality and causation. The CFI noted that the difficult points of law in an
area were in the process of developing.
The Decision
The CFI found in favour of the Plaintiffs and
refused to strike out the claim. The analysis of the Court raises the following
important principles:-
1.
the scope of
auditor’s duty; and
2.
whether
attribution or the illegality defence would absolve an auditor’s liability.
The Scope
of Auditor’s Duty
In respect
of the auditors’ duty, the CFI found that, in appropriate cases, an auditor’s
duty may extend to detecting material irregularities in company’s accounting
statements, and in appropriate cases the duty may even extend to reporting any fraud he detected during the
course of his work for a client, and, in some circumstances, to relevant
regulatory and enforcement authorities.
In reaching
this conclusion, the CFI considered Sasea
Finance Ltd v KPMG [2000] 1 All ER 676 in which the English Court of Appeal, having regard to the Auditing Guidelines (Feb 1990 edn) in
England, held that where an auditor suspects that management may be involved
in, or is condoning, fraud or other irregularities, the duty to report to
authorities overrides the duty of confidentiality to the client. The auditor
was to report directly to a third party without the knowledge or consent of the
management. The CFI commented that “what
said in Sasea Finance about an auditor’s duty to “blow the whistle” is
also apposite to Hong Kong.”
The
Plaintiffs relied on the similar guidelines to the Auditing Guidelines issued by the Hong Kong Society of Accountants. In view of the authorities, the CFI held that “it is highly arguable that an auditor’s
duty is more than just providing information and advice on his client’s
financial statements“.
The Court
further held that it was at least arguable that the interests of the creditors
require protection and should be factored
into the scope of duty of an auditor when his client company is insolvent or
near to insolvency.
The
Attribution or Illegality
With regard to the rule of
attribution, the general position is that knowledge and actions of a
director will be attributed to the
company, although questions of attribution are sensitive to the particular
facts and this principle has been held not to apply in circumstances where what
is in issue is the company’s knowledge of wrongdoing by a particular director.
It has been argued
for the negligent auditors (as in the controversial English Supreme Court case
of Stone & Rolls
Ltd v Moore Stephens [2009] 1 AC
1391) that as it was the company who committed the fraud through its director,
it could not turn around to sue the auditor for the director’s fraud (which was
attributed to the company). In other words, the company who committed the
illegal act could not sue on it.
In
determining whether attribution or the illegality defence was applicable, the
CFI made reference to the decision
of the Supreme Court of Canada in Livent
Inc v Deloitte & Touche (2014) ONSC 2176 in which it was held that
neither attribution nor the illegality defence would absolve an auditor’s
liability to its own client in relation to fraud.
With
regard to the illegality defence, the CFI cited the recent decision of the
English Supreme Court in Patel v Mirza
[2016] 3 WLR 399. The court in that case adopted a policy and fact
based approach, and moved away from
the previous rule-based. On that basis, the CFI ruled that the present case was not “a plain
and obvious one for striking out without any consideration of the evidence“.
Implications
The legal
issues regarding the scope of auditor’s duty and the applicability of attribution
and illegality are yet to be
resolved by the court. However, the CFI’s analysis in respect of an auditor’s
duty to detect fraud or material irregularities mean that such claims could not
be struck out easily. Auditors would be facing greater risk because of this
decision.
For enquiries, please contact our Litigation
& Dispute Resolution Department: |
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E:
insolvency@onc.hk T:
(852) 2810 1212 19th Floor, Three
Exchange Square, 8 Connaught Place, Central, Hong Kong |
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Important: The law and
procedure on this subject are very specialised and complicated. This article is just a very general outline for
reference and cannot be relied upon as legal advice in any individual case.
If any advice or assistance is needed, please contact our solicitors. |
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Published by ONC
Lawyers ©
2017 |
