Canadian Underwriter

Supreme Court of Canada hears appeal from auditing firm over $118-million judgement arising from Livent fraud

February 15, 2017   by Canadian Underwriter

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If the Supreme Court of Canada upholds a Court of Appeal for Ontario ruling against Deloitte & Touche, corporate auditors “will be encouraged to resign an audit before they feel they can responsibly do so in order to minimize the risk of catastrophic damages,” Deloitte warns.

Canada’s highest court heard Wednesday Deloitte’s appeal of a judgement released in 2016 in favour of the special receiver for Live Entertainment Corporation of Canada Inc. The Supreme Court has yet to issue its ruling.

Livent – whose productions included Phantom of the Opera and Joseph and the Amazing Technicolor Dreamcoat – was founded in 1989 by Garth Drabinsky and Myron Gottlieb. Drabinsky and Gottlieb were sent to jail in 2009 after being convicted of two counts of fraud and one count of forgery.

Livent went into receivership in 1999, the year after it restated its financial results for 1996 and 1997.

The Court of Appeal for Ontario – in a separate ruling on the charges against Drabinsky and Gottlieb – found that a “variety of accounting techniques were used to fraudulently reduce expenses and thereby increase net income.” Those techniques included “deferring operating costs from the accounting period in which they were actually incurred to future accounting periods, transferring expenses properly associated with one project to another project and improperly transferring operating and preproduction costs to fixed asset accounts relating to theatre construction.”

In 2012, a special receiver and manager of Livent sued Deloitte on behalf of Livent.

Related: Supreme Court of Canada to hear appeal from Deloitte over $118-million judgment arising from Livent fraud

In 2014, the Ontario Superior Court of Justice found that Deloitte “failed to meet its professional standard of care” while auditing Livent. The court awarded a total of $118 million, comprised of $84.75 million in damages plus interest. That ruling was upheld on appeal.

“Deloitte should have remained firm in its resolve to sever its relationship with Livent at the end of August 1997 at the earliest, but no later than the end of Q3, or September 30th, at the latest,” Mr. Justice Arthur Gans of the Ontario Superior Court of Justice wrote.

In upholding this ruling, the Court of Appeal for Ontario erred by “ultimately permitting a thoroughly fraudulent corporation, whose directing minds deceived both its auditor and investors, to effectively be indemnified by its auditor for the disproportionate losses suffered by stakeholders,” Deloitte argued in its factum to the Supreme Court of Canada.

Interveners include Chartered Professional Accountants of Canada, which argued that “the legal and practical impact of an expansion of auditor liability will bring the likely consequences of indeterminate liability into sharp relief.”

Among the cases cited by CPAC and Deloitte were the 1997 Supreme Court of Canada ruling in Hercules Management Ltd. v. Ernst & Young.

Related: Appeal continues in $84-million negligence lawsuit against corporate auditors

Ernst & Young and Alexander Cox were sued in Manitoba, in 1988, by plaintiffs alleging negligent preparation of audit reports in the early 1980s, of Northguard Acceptance Ltd. and Northguard Holdings Ltd. Two of the plaintiffs were Northguard shareholders.

Northguard went into receivership in 1984. The shareholders’ lawsuits were dismissed, and that dismissal was upheld both by the Manitoba Court of Appeal and the Supreme Court of Canada.

“The policy principle underlying Hercules persists – the need for affordable audits conducted by willing auditors supported by available and affordable insurance,” Deloitte argued in its appeal to the Supreme Court of Canada of the judgement against Deloitte. “The result here puts all of those policy imperatives at risk. Auditors will be encouraged to resign an audit before they feel they can responsibly do so in order to minimize the risk of catastrophic damages”

Courts have “guarded against indeterminate liability” for accountants, CPAC noted, suggesting that expanding liability of auditors for firms in financial distress would have consequences.

“A liability regime is likely to emerge whereby auditors would become a de facto insurer, or guarantor, for the losses of a corporation’s stakeholders when the corporation cannot make them whole,” CPAC argued.

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