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Deloitte Liable for Negligence in Auditing Practices; Decision to be Appealed to Supreme Court

In a 2016 decision, Ontario’s Court of Appeal upheld a Superior Court decision finding Deloitte liable in negligence for failing to meet their duties as auditor of Livent Inc. (“Livent”). Livent was a publically listed live entertainment company involved in the production of theatrical works such as The Phantom of the Opera, Show Boat, Kiss of the Spider Woman, Music of the Night and Sunsent Boulevard. Some time around 1998, it was discovered that Livent was insolvent, due in part to the actions of numerous high-level employees amounting to fraud and forgery. Livent filed for insolvency protection in Canada and the United States and was placed in receivership. Garth Drabinsky and Myron Gottlieb—creators and principals of Livent—were convicted of fraud and forgery and sent to jail. Livent’s creditors then sued Deloitte in negligence for their involvement in the fraudulent scheme that ultimately resulted in the downfall of Livent. At trial, Deloitte argued that the fraud was committed by Livent vis a vis the Officers of the company, thereby precluding Livent’s creditors from suing Deloitte due to the doctrine of ex turpi causa, which precludes a party from profiting from “illegal” or “wrongful” actions. The trial judge found that the doctrine of ex turpi causa did not apply to prevent Livent’s creditors from claiming from Deloitte in negligence and ordered Deloitte to pay Livent $84,750,000 plus interest. Deloitte appealed and lost.

Our Thoughts

The doctrine of ex turpi causa is a general legal doctrine preventing parties from profiting from “illegal” or “wrongful” actions. In the context of civil litigation, the doctrine allows judges to deny recovery in tort to a plaintiff if doing so would—in the opinion of the judge—undermine the integrity of the justice system. On its face, the ex turpi causa doctrine seems like a blanket power judges possess to deny actions because they think it “right” to do so. Through its application, however, the doctrine has been limited in its application to prevent actions wherein the plaintiff essentially seeks to “profit from an illegal or wrongful act, or to evade a penalty prescribed by criminal law.” The inquiry is predominantly one of public policy. It requires asking whether the administration of justice would be undermined by allowing the plaintiff to claim for damages arising out of their own illegal or wrongful act. As such, the inquiry is a highly contextualized one. In the case at bar, the trial judge decided that the question to be answered was: “whether their (Gottlieb and Drabinsky) fraud should be attributed to Livent for the purposes of applying the ex turpi causa doctrine.” After all, Gottlieb and Drabinsky left behind a slew of innocent shareholders and directors. Would it be fair to preclude them from suing Deloitte just because Gottlieb and Drabinsky committed fraud in their capacity as officers of Livent? The Superior Court of Justice and the Court of Appeal both answered in the negative.

The parties responsible for Livent’s fraudulent scheme—Gottlieb and Drabinsky—have been removed and would therefore not benefit from any award given by the court to Livent. Granting the application of the ex turpi causa doctrine in this case would essentially prevent Livent’s innocent shareholders and directors from claiming for damages because of the unilateral actions of some of the directors and managers. The Court of Appeal agreed with the trial judge in that this outcome is not acceptable, as it would prevent innocent parties from claiming for damages arising out of conduct that is otherwise negligent. The reasoning is instructive for future cases wherein courts are charged with the onus of determining whether to transpose the actions of directors or officers of a corporate entity to the corporation itself, in order to estop future actions on behalf of the corporation. This decision is also interesting in that it essentially extends the duty of auditors to third-party creditors in that creditors can sue auditors for negligence arising out of the audits the conduct for the corporation. Creditors and shareholders are granted some peace of mind in knowing that auditors will be held liable for failing to disclose fraud.

The Supreme Court of Canada has already accepted to hear this decision. It will be interesting to see whether the Court will adopt the reasoning of the trial judge in this case. No hearing date has been scheduled yet.

See: Livent Inc. (Reciever of) v Deloitte and Touche ONCA 2016

The above article is for general information purposes only and does not constitute legal advice. If you have concerns with regard to the foregoing issues, please make an appointment with one of our lawyers or a qualified legal practitioner elsewhere.