Lavender Haze Lifts: Court of Appeal Clarifies Auditor’s Duty of Care

On September 5, 2018, in Lavender v. Miller Bernstein LLP (Lavender), the Court of Appeal for Ontario (Court of Appeal) overturned a lower court decision that an auditor had a duty of care to its client’s clients. In doing so, the Court of Appeal applied the principles articulated by the Supreme Court of Canada (SCC) in Deloitte & Touche v. Livent Inc. (Receiver of) (Livent), which was released after the initial decision in Lavender. We discussed the Livent decision in our December 2017 Blakes Bulletin: SCC Affirms Duty of Care but Reduces Auditor’s Damages in Livent Decision. The Court of Appeal’s decision in Lavender clarifies the extent to which an auditor may owe a duty of care to parties other than its own client, and supplements the growing body of post-Livent case law that recognizes the high threshold for imposing a duty of care in a claim for pure economic loss.

BACKGROUND

The decision under appeal related to a summary judgment motion brought in the context of a class action by the clients of a defunct securities dealer against the dealer’s former auditor. The class alleged that the auditor negligently audited an annual registration renewal form required to be filed with the Ontario Securities Commission (OSC) to confirm compliance with securities regulatory requirements (Form 9). The class alleged that because of this negligence the OSC was deprived of information that would have caused it to intervene in the dealer’s operations and prevent the class’s losses.

The action was certified on consent. The relevant common issues included questions as to whether the auditor owed a duty to the class and, if so, whether it breached that duty.

The class moved for summary judgment on these questions, amongst others. The motion judge granted summary judgment, holding that the auditor owed the class members a duty of care in its audit of Form 9 and that the auditor fell below that standard of care. The auditor appealed the decision.

DECISION

The Court of Appeal allowed the auditor’s appeal, setting aside the judgment below and granting summary judgment in favour of the auditor on the basis that it owed no duty of care to the class.

In arriving at its decision, the Court of Appeal applied the analytical framework set out by the SCC in Livent, which refined the prior Anns/Cooper analysis. Under this two-stage framework, a court must first ask whether the facts establish a prima facie duty of care. This involves establishing both reasonable foreseeability and proximity — distinct concepts that must be considered separately. If necessary, the court will then proceed to the second stage where it asks whether residual policy considerations justify denying liability in tort.

In Lavender, the Court of Appeal focused on the proximity analysis in the first stage of the Livent framework. It held that the motion judge made a legal error by conflating the questions of proximity and foreseeability. The Court of Appeal conducted its own proximity analysis and concluded that proximity was not established.

The Court of Appeal reaffirmed that, in cases of pure economic loss arising from negligence or negligent misrepresentation by professional service providers, the scope of the defendant’s undertaking and the plaintiff’s reliance on that undertaking are determinative of proximity. It found that the evidentiary record before the motion judge did not support a finding of proximity, and provided the following support for this conclusion:

  • The auditor’s undertaking was of limited scope. It undertook to audit a form that the dealer then provided in confidence to the OSC. The interposition of the OSC and the dealer between the auditor and the class rendered the relationship between the parties too remote to ground a duty of care.
  • There was admittedly no reliance by the class on Form 9, which was filed confidentially and not intended to inform or induce the class.
  • The motion judge based his determination on factual findings that amount to palpable and overriding errors. For example, he based his decision, in part, on an incorrect finding that the auditor had filed the Form 9 directly with the OSC, when in fact it was the client’s obligation to make the filing. The motion judge also relied on a finding that the auditor would have known the names and accounts of the class members when the record revealed that the identities of clients and their accounts changed regularly.
  • The applicable statutory scheme, which provided context for assessing proximity, did not create a proximate relationship between the auditor and the class for the purpose of the class members’ investment decisions.

The Court of Appeal held that the class members’ claim did not stand up to the significant judicial scrutiny that must be applied when determining the existence of a duty of care in the context of a claim for pure economic loss. In view of its finding on proximity, the Court of Appeal determined that it did not need to consider reasonable foreseeability, or residual policy considerations.

IMPLICATIONS

The Court of Appeal’s decision in Lavender is significant for at least two reasons. First, it will likely have a dampening effect on negligence claims brought against auditors by parties other than their own clients.

Second, and more broadly, the decision emphasizes that plaintiffs seeking to establish a duty of care in a claim for pure economic loss must meet a high threshold that requires careful consideration of not only the scope of the auditor’s undertaking, but also the degree of reliance by plaintiffs and applicable statutory schemes. This aspect of the decision will be of interest to underwriters, securities dealers and other advisers and service providers who may become secondary targets to class action litigation in scenarios where an issuer defendant is insolvent or judgment-proof.

For further information, please contact:

Andrea Laing                 416-863-4159
Ryan Morris                  416-863-2176

or any other member of our Litigation & Dispute Resolution group.

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