Harris Scarfe Limited (Receivers and Managers Appointed) (in Liquidation) v Ernst & Young (Reg) - [2005] SASC 113

SUPREME COURT OF SOUTH AUSTRALIA
(Civil: Application)
HARRIS SCARFE LIMITED (RECEIVERS AND MANAGERS APPOINTED) (IN LIQUIDATION) & ORS v ERNST & YOUNG (REG) & ORS
Judgment of The Honourable Justice Bleby
30 March 2005
PROCEDURE - SUPREME COURT PROCEDURE - SOUTH AUSTRALIA - PRACTICE UNDER RULES OF COURT - PLEADINGS
Action for damages in negligence, breach of contractual duty of care and misleading conduct – Application for leave to file further amended statement of claim – Whether proposed amendment discloses no reasonable cause of action, has tendency to cause prejudice, embarrassment or delay or does not comply with rules as to pleadings – Whether pleading discloses necessary causal connection between alleged wrongful conduct and plaintiffs’ alleged loss – Requirements for causal link – Inadequacy of “but for” test – Question of fact to be answered by reference to commonsense and experience – Whether temporal link only alleged – Whether reliance adequately pleaded - Purpose and requirements of pleadings – Consideration of specific pleading complaints – Application granted subject to further minor adjustments.
Fair Trading Act 1987 s 56; Supreme Court Rules r 2A.08, r 46.09, r 46.18(a), r 46.18(b), r 46.18(c), r 46A.02, r 46A.03, r 46A.05(2) and r 50.03(a); Corporations Act 2001 (Cth) s 554 and s 563B, referred to.
Alexander v Cambridge Corporation Ltd (1987) 9 NSWLR 310; Galoo Ltd (In Liquidation) v Bright Grahame Murray [1994] 1 WLR 1360, distinguished.
Sew Hoy & Sons Ltd (In Receivership and in Liquidation) v Coopers & Lybrand [1996] 1 NZLR 392, discussed.
Hall v Eve (1876) 4 Ch D 341; Nader v Urban Transit Authority of New South Wales (1985) 2 NSWLR 501; Williams v Australian Telecommunications Commission (1988) 52 SASR 215; March v E & MH Stramare Pty Ltd (1991) 171 CLR 506; Duke Group (In Liquidation) v Arthur Young (No.13) (1991) 5 ACSR 212; Bennett v Minister for Community Welfare (1992) 176 CLR 408; Medlin v State Government Insurance Commission (1995) 182 CLR 1; Arthur Young v Tieco International (1995) 182 LSJS 367; Southern Cross Airlines Holdings Ltd v Arthur Andersen & Co (Unreported, 27 March 1998, Federal Court of Australia, Cooper J); Pricewaterhouse v Kwan (2000) 3 NZLR 39; Sheahan (As Liquidator of SA Service Stations) v Verco [2002] SASC 68, considered.

HARRIS SCARFE LIMITED (RECEIVERS AND MANAGERS APPOINTED) (IN LIQUIDATION) & ORS v ERNST & YOUNG (REG) & ORS
[2005] SASC 113
BLEBY J:
Introduction

The first plaintiff, Harris Scarfe Limited (Receivers and Managers Appointed) (In Liquidation), was a department store retailer. The second plaintiff, Harris Scarfe Wholesale Pty Ltd (Receivers and Managers Appointed) (In Liquidation) was a wholesale purchaser of stock on behalf of Harris Scarfe Limited. The third plaintiff, Harris Scarfe Holdings Limited (Receivers and Managers Appointed) (In Liquidation) was the holding company of the first two plaintiffs. All three companies went into receivership on 6 April 2001 and were placed into liquidation on 3 January 2002. I will refer to them collectively as “Harris Scarfe”.
The fourth plaintiff, ANZ Banking Group Limited, was the financier to Harris Scarfe, its loans being secured by registered mortgage debentures over the assets of Harris Scarfe.
The first defendant, Ernst & Young, is a firm of chartered accountants which was responsible for the audit of the accounts of Harris Scarfe for the year ended 31 July 1996 and for the half yearly review and audit for the year ended 31 July 1997. The second defendant, Coopers & Lybrand, was another firm of chartered accountants which, after amalgamation with another firm, became the third defendant, PricewaterhouseCoopers. Between them those firms were responsible for the half-yearly reviews and audits of Harris Scarfe for the years ended 31 July 1998 and 31 July 1999.
The plaintiffs have brought an action against the defendants claiming damages for negligence, breach of contractual duty of care and misleading conduct in breach of s 56 of the Fair Trading Act 1987 (SA). In essence, the plaintiffs allege that at all material times from the year ending 31 July 1996 Harris Scarfe’s head of accounting instigated an overstatement of assets (primarily inventory and plant), an understatement of liabilities (primarily creditors and accrued expenses/provisions) and expenses, with a consequential overstatement of profits and net assets by way of adjustments to the financial records of Harris Scarfe.
The effects of the manipulation were substantial. It is alleged, for example, that in the first year, the year ending 31 July 1996, the accounts showed an operating profit of $3.471 million, whereas in reality there had been a loss of $4.076 million. The net assets of Harris Scarfe were said to be overstated by $32.179 million and reserves were said to be overstated by $21.555 million.
It is alleged that in each of the financial years in question the respective auditors provided reports which certified that the financial statements of Harris Scarfe were properly drawn up so as to give a true and fair view of the state of affairs at the relevant time and the profit and cash flows for the relevant financial year, and were drawn up in accordance with the provisions of the Corporations Law and in accordance with applicable accounting standards “and other mandatory professional reporting requirements”. It is alleged that the audits were carried out negligently in that they failed to identify what in fact was the true financial position in each of the respective periods. It is not necessary for present purposes to rehearse the particulars of those allegations.
The structure of the statement of claim, apart from the general pleas as to engagement of the defendants, their contractual relationship and alleged duty of care, is to allege a breach of contract, breach of a duty of care and misleading conduct in respect of each of the relevant six monthly accounting periods for which the respective defendants were responsible, to allege loss and damage suffered by the plaintiffs and that that loss and damage was caused by the relevant act or default of the respective defendants. Particulars of the calculation of the loss in respect of each relevant six month period is contained in a separate document.
The application
The elements of the statement of claim which I have so far described are contained in a proposed further amended statement of claim which the plaintiffs now seek leave to file together with three further documents alleging amended particulars of loss against each of the three defendants. For convenience I will refer to the proposed further amended statement of claim as “the statement of claim”. Leave to amend is opposed by the defendants on the ground that the proposed amendment discloses no reasonable cause of action against them (Rule 46.18(a) Supreme Court Rules), and by the second and third defendants on the further grounds that the amendment has a tendency to cause prejudice, embarrassment or delay in the proceedings (Rule 46.18(c)) and that they do not comply with the rules as to pleadings (Rule 46.18(b)).
The nature of the pleading
The primary thrust of the defendants’ argument is that the pleading cannot be sustained because it fails to disclose the necessary causal connection between the alleged wrongful conduct of the defendants and the loss alleged by the plaintiffs. It is therefore necessary to consider in more detail the nature of the plaintiffs’ allegations. Because the allegations relate to each of a number of six monthly accounting periods, and because the allegations in respect of each of those periods are very similar, it is convenient to discuss the pleading as it relates to the first defendant for the year ending 31 July 1996. What is said about this pleading relates also to the pleadings concerning the other accounting periods.
Paragraphs 27 to 42 inclusive plead the inaccuracies in the accounts for that year. Paragraphs 43 to 45 inclusive plead the effect of those inaccuracies on the financial statements and that they were not true and fair. Paragraphs 46 to 53 plead particulars of the performance of the audit work, particulars of negligence, breach of contractual duty and misleading conduct.
Paragraph 54 is important. It pleads that by reason of the breaches of contract, negligence and misleading conduct of the first defendants, the directors of Harris Scarfe believed that the relevant audited financial statements were true and correct, that they continued to employ, trust and rely upon the chief financial officer who had been responsible for the mis-statements in the accounts and continued to trust and rely upon Harris Scarfe’s management in managing the business of Harris Scarfe. There follows a detailed pleading as to the state of belief of the directors as a consequence of the first defendant’s audit report. In short, it is alleged that the directors believed that Harris Scarfe was in a sound financial position, with good financial performance, that it was achieving certain gross profit margins, that it was achieving positive store contributions for most stores, that Harris Scarfe’s net asset value was substantially more than it was in fact and that there was sufficient profit and retained profit to declare and pay dividends to shareholders. It is also alleged that the directors continued to rely upon the auditors to confirm the information provided to the board by management.
Paragraph 55 is also important. It alleges that by reason of the matters pleaded in paragraph 54 the directors continued to trade all aspects of Harris Scarfe’s business in the same manner as previously. Particulars are given. In summary, the plaintiffs allege that, in reliance on the mistaken beliefs induced by the auditors, the directors:
·Maintained and adopted certain budgeted gross profit margins which were consistent with previously reported gross profit margins;
·Pursued a policy of expansion of business by the acquisition or opening of new stores, including investment in e-commerce, and the expansion and improvement of existing stores, and assessed the viability of those proposed transactions by reference to the information contained in the audited and reviewed financial statements;
·Made decisions regarding the financial performance of existing stores and State and head office operations, including decisions to maintain trading in the same manner as previously, and did not direct management to change management practices;
·Declared and paid dividends to shareholders;
·Increased Harris Scarfe’s indebtedness to ANZ, noteholders and creditors;
·Had no occasion to consider and were denied the opportunity of taking various steps, including the appointment of an administrator.
Paragraph 56 alleges that contrary to the beliefs, understandings and conduct pleaded in paras.54 and 55, the true facts, of which particulars are given, were not in fact as the directors believed. Paragraph 57 alleges that by reason of the first defendant’s conduct ANZ held certain beliefs as to Harris Scarfe’s performance. Those beliefs are particularised. Paragraph 58 alleges that by reason of those beliefs ANZ continued to afford financial accommodation to Harris Scarfe, made further lending to Harris Scarfe and had no occasion to consider, and was denied the opportunity to take, various steps, including stopping further lending and appointing a receiver.
Paragraphs 60 to 62 plead what Harris Scarfe and ANZ would have done if the first defendant had carried out their audit activities with reasonable care, skill and diligence. Among other things it is alleged that ANZ would have stopped further lending to Harris Scarfe pending an independent review of its business operations and financial position and would not have made further lending to Harris Scarfe. ANZ would have appointed a receiver or receiver and manager of the secured assets and the directors would have appointed an administrator over Harris Scarfe. Alternatively, they allege that a liquidator or receiver would have been appointed by the court on application of a creditor, shareholder, or other interested parties. It is then alleged in para.63 that the administrator, liquidator or receiver (“the controller”) would have:
·Traded the business on a conservative basis whilst investigating the best method of realisation of, and marketing, the business or assets of the business;
·Retained consultants to advise on appropriate strategies to maximise returns from the assets of the business; and
·Sold or disposed of the assets of Harris Scarfe pursuant to the advice of the consultants.
Paragraph 64 pleads that by reason of the facts pleaded in paras.54 to 60, the financial position of Harris Scarfe deteriorated and the plaintiffs suffered loss and damage.
In the separate document giving particulars of loss, the loss alleged is $143.283 million. It is alleged that that loss comprises the difference between:
(1)The net asset deficiency of Harris Scarfe, as at April 2001 (when the receiver was in fact appointed), of $150.400 million; and
(2)The net asset deficiency of Harris Scarfe as at September 1996 of $7.117 million.
The particulars allege that the figure for net assets as at September 1996 assumes that a controller would have been appointed at that time and takes into account the estimated costs of realisation of the assets of Harris Scarfe at that time. Particulars indicating the calculation of that loss then follow.
It is important to note that the calculation of the plaintiffs’ loss assumes the appointment of a controller if the true financial state of Harris Scarfe were then known, and the orderly realisation of Harris Scarfe’s then assets. Until a controller was in fact appointed in April 2001 it is alleged that the net asset position of Harris Scarfe deteriorated substantially. What is claimed by way of damages is, in effect, the total trading losses sustained by Harris Scarfe from the date when the true position ought to have been revealed until the time when it was in fact revealed, a controller was appointed and the assets were in fact realised.
The defendants’ causation argument
For the purpose of their argument the defendants were content to adopt the summary of the plaintiffs’ case contained in one of their outlines of argument.
“Stripped to its bare essentials, the plaintiffs’ case is that by reason of the defendants’ breaches of duty, the directors of Harris Scarfe and ANZ formed various mistaken beliefs as to the financial performance and position of the Harris Scarfe group. If they had known the true position, then the directors and ANZ would have taken various steps which would have resulted in the Harris Scarfe group being placed in the hands of a controller at an earlier point of time. Instead, by reason of the mistaken beliefs, Harris Scarfe not only continued to trade until April 2001, but also continued to trade in a particular manner – that is, in a manner substantially similar to that in which it had traded in the past. In other words, the trading decisions, strategies and policies which resulted in the Harris Scarfe group being in the financial position it found itself in April 2001 were a result of the mistaken beliefs induced by the defendants’ breaches of duty.”
By claiming the whole of the trading losses sustained by Harris Scarfe during the relevant period, the defendants assert that the claim, as particularised, is bound to fail because the plaintiffs have failed to identify particular losses in respect of particular transactions and to connect them to the alleged wrongful conduct of the defendants. Furthermore, they argue that the necessary causal connection is not alleged by asserting that Harris Scarfe continued to trade merely because the directors thought that Harris Scarfe was in a healthier financial position than it really was.
The principal authority on which the defendants rely is Alexander v Cambridge Corporation Ltd (1987) 9 NSWLR 310. In that case the plaintiff, Cambridge Credit Corporation Ltd (“Cambridge”) sued the defendants, its auditors, for losses it claimed to have suffered as a result of the defendants’ breaches of contract in connection with their annual audit of Cambridge for the financial year ended 30 June 1971. The trustee of Cambridge’s Debenture Trust was formally joined as plaintiff, although it had no relevant interest in the case. The accounts prepared for the year ended 30 June 1971 failed to make provision for a number of failed investments and irrecoverable debts, in circumstances where provision ought to have been made for at least $7 million. Most of Cambridge’s working capital consisted of funds raised by way of unsecured notes and debentures. Had the accounts been adjusted to include the appropriate provision as at June 1971, it would have placed Cambridge in breach of certain borrowing ratios in the debenture trust deed. Under that trust deed the trustee for debenture holders would then have had the power to appoint a receiver. The trial Judge found that, had the accounts for the year ended 30 June 1971 included the appropriate provisions, the trustee would have in fact have appointed a receiver by September 1971.
Through its officers and particularly the managing director, Cambridge was well aware of the facts that gave rise to the finding that provision should have been made for its doubtful debts and investments.
Cambridge made profits in 1972 and 1973 and gained an increase in shareholders’ funds of $6.5 million between 30 June 1971 and 31 December 1973, after paying dividends and taxes. The company continued to trade in the business of land development. It bought, developed and sold various parcels of land. It borrowed large sums of money, raised capital, made modest profits and paid dividends. It entered into many joint ventures in the real estate field.
However, there were also external events which adversely affected the business of land development. There had been a boom in land development which commenced prior to 1971, but that had turned into a slump. Cambridge was adversely affected by way of monetary policy intervention by the Commonwealth government, resulting in a credit squeeze. As a result of exceptional flooding in Queensland, the Queensland government prohibited the development of land subject to flooding. Significant holdings of land held by Cambridge were affected by that ban.
During the three year period from the auditors’ default in 1971 until receivership in 1974, Cambridge traded in breach of its borrowing ratios. The auditors failed to qualify their audit report in any year subsequent to 1971.
The net worth of the company in September 1971 was approximately minus $10 million. By September 1974 it was minus $67 million. In its action against the auditors Cambridge sought to recover its loss calculated by reference to the deterioration in the company’s financial position from September 1971 to September 1974, amounting to approximately $57 million, plus interest. By a majority (Mahoney and McHugh JJA, Glass JA dissenting), the New South Wales Court of Appeal held that the defendants’ breach of contract in relation to the June 1971 audit was not a cause of the losses which Cambridge sustained.
The manner in which Cambridge pleaded its case was significant. At no stage did it assert that it relied on the certificates of the auditors or on their failure to qualify the accounts. It sought to rely on the finding that, if the trustee had known of the true financial position and the breaches of the ratios, it would have put Cambridge into receivership in September 1971. As McHugh JA (as he then was) said, at 358:
“Reliance by the trustee on the certificates issued in October and November 1971 is basic to Cambridge’s case. This leads to the paradox that, although the trustee relied on the certificates, it is not making any claim for damages; while Cambridge which did not rely either on the certificates or the events constituting the breach of contract, is the party claiming damages. What is more, if damages are recovered by Cambridge, they will go to pay the creditors as at September 1974, most or all of whom probably did not rely on the 1971 accounts or certificates in making their investments.”

Mahoney JA began (at 317) by stressing the somewhat unusual basis upon which the proceeding had been conducted, namely that Cambridge’s claim was based solely on the breaches of contract which arose in the audit of the accounts for the year ended 30 June 1971, and that the proceeding was conducted in a way which limited the issues which were to be determined and the evidence which was to be adduced in respect of those issues. At 319 he noted that no attempt had been made by Cambridge to link the defendants’ breaches to any particular item of loss or to the circumstances or state of the company’s affairs which caused the appointment of the receiver in 1974. The sole basis on which the causation issue was put was that had the breach not occurred, a receiver would have been appointed in September 1971, that the net worth of Cambridge in 1971 exceeded its net worth in September 1974, and that an amount equal to the difference was the loss caused by the defendants’ breach.
Mahoney JA discussed the nature of what he described as “interpersonal causality”, as opposed to physical causality or the “billiard ball” kind of causality, and the circumstances in which it might form a causal relationship in law. He did so by reference to what he had previously said in Nader v Urban Transit Authority of New South Wales (1985) 2 NSWLR at 516-518: see Cambridge Credit at 331-333. He then fell to consider whether the loss claimed by Cambridge was the result of the defendants’ breach of contract in the sense previously discussed. He said, at 333-334:
“In the broadest sense, that loss was a result of the defendants’ breach. If a defendant promises to direct me where I should go and, at a cross-roads, directs me to the left road rather than the right road, what happens to me on the left road, is, in a sense, the result of what the defendant has done. If I slip on that road, if it collapses under me, or if, because I am there, a car driving down that road and not down the right road strikes me, my loss is, in a sense, the result of the fact that I have been directed to the left road and not the right road.
But, in my opinion, it is not everything which is a result in this broad sense which is accepted as a result for this purpose in the law. Thus, if, being on the left road, I slip and fall, the fact alone that it was the defendant’s direction, in breach of contract, which put me there will not, without more, make the defendant liable for my broken leg. I say “without more”: if there be added to the breach the fact that, for example, the left road was known to be dangerous in that respect I may, of course, be liable. But, in relation to losses of that kind, the fact that the breach has initiated one train of events rather than another is not, or at least may not, be sufficient in itself. It is necessary, to determine whether there is a causal relationship, to look more closely at the breach and what (to use a neutral term) flowed from it.
In the present case, the company’s loss resulted from the defendants’ breach in the sense that the course of events vis-à-vis the company would have gone in a different direction had it not been for that breach. But that, I think, is not, or is not necessarily, sufficient. Thus, the breach allowed the company to continue in business. If its net worth had fallen because, for example, the main buildings it owned had been destroyed by an earthquake, I do not think that that loss would have been causally related to the breach which let the company continue in business.
It is therefore necessary to consider whether, in the present case, there is something more than the fact that the company continued in business.
…
Where what a defendant was to do was of this nature, for example, to warn, take precautions, or the like, what follows a breach has often been seen as the legal result of it: see, for example, Hart & Honore, Causation in the Law, 2^nd ed (1985) at 59 et seq. Thus, if a defendant promises to warn of danger and fails to do so, loss from that danger may be seen as the result of the defendant’s breach. But that is not the basis on which the company’s claim has been put and, having regard to the way in which the case has been conducted, the company is not, in my opinion, entitled to call in aid reasoning of that kind.”
His Honour noted that Cambridge did not argue that the breach exposed it to particular dangers which in fact occurred. It merely claimed that it was allowed to continue in existence. He noted that allowing the company to remain in existence does not, without more, cause losses from anything which is a danger incident to existing. He noted, at 335:
“In the end, the company’s case has been that the loss it claims was caused by the breach because, and because alone, the breach allowed the company to continue in existence. Some of the incidents flowing from its existence during 1971-1974 may be the results of the breach; some, for example, those flowing from earthquakes or the like, will not be. But the basis of the plaintiffs’ claim has been such that no inquiry is to be or has been pursued, for this purpose, into what in fact happened, why and the relationship of what happened to the breach. I do not think that that is enough to establish a causal relationship.”
Mahoney JA concluded his judgment with a discussion of the “but for” test of causality, rejecting it as an appropriate test to be applied in determining the existence of a causal relationship.
The approach of McHugh JA was rather different, but he arrived at the same conclusion. Having discussed at some length principles of causation in the law he concluded (at 352) that in both tort and contract the “but for” test “must be taken in this court to be the leading and, in all but exceptional cases, the exclusive test of causation”. He concluded, at 358:
“Accordingly, to establish a causal connection between a breach of contract and the damage which the plaintiff has suffered, he needs only to show that the breach was a cause of the loss. This is to be decided by the application of commonsense principles. In general, the application of the “but for” test will be sufficient to prove the necessary causal connection. But that test is only a guide. The ultimate question is whether, as a matter of commonsense, the relevant act or omission was a cause.”
In relation to the instant case he noted, as mentioned above, the lack of reliance by Cambridge on the certificate of the auditor and that the case for Cambridge on causation ultimately rested on the assumption that reliance by the trustee (not Cambridge) on the certificates of October/November 1971 continued throughout the trading period 1971-1974, even though a new certificate was given each six months and whenever a new debenture prospectus was issued. He continued, at 359:
“Moreover, Cambridge did not seek to prove that particular losses in respect of particular transactions were caused by the auditors’ certificates. It asserted that from the moment that the trustee acted on the auditors’ certificate and, as a consequence, did not put Cambridge into receivership, the auditors became the insurers of Cambridge’s trading fortunes. The argument went so far as to maintain that even though Cambridge may have prospered for years the auditors, subject to the Limitation Act 1969, were liable for any ultimate loss made by the company.”
McHugh JA then concluded:
“In the proved circumstances of this case, I do not think that the issue of the certificates by the auditors constituted a cause of Cambridge’s loss of $145,000,000 [this figure includes the claim for interest]. The existence of a company, as counsel for Cambridge conceded, cannot be a cause of its trading losses or profits. Yet that is what the case for Cambridge comes to. Except in the sense that the issue of the certificates induced the trustee not to take action against Cambridge and thereby permitted Cambridge to exist as a trader, the issuing of the certificates was not one of the conditions which were jointly necessary to produce the loss of $145,000,000. To assert in these circumstances that the issue of the certificates was a cause of the loss in my opinion is to depart from the commonsense notion of causation which the common law champions.”
The basis on which Cambridge Credit proceeded was unusual. It is not the basis upon which the plaintiffs in this case seek to proceed. The plaintiffs do not rely merely on their continued existence to establish that their loss arose as a result of the defendants’ alleged breaches. The plaintiffs here allege that there was a particular failure to warn of deliberate mis-statements in the various accounts that were audited. The mis-statements were such that, had the true position been revealed at each of the reporting stages, a decision would have been made by the plaintiffs or one of them to install a controller, resulting in the sale of Harris Scarfe’s business and assets. Harris Scarfe alleges that as a result of the defendants’ failure, and in reliance on the reports of the defendants, Harris Scarfe continued to trade, ANZ did not enforce its security but continued to lend money to Harris Scarfe and the plaintiffs made other decisions in reliance upon what were, in fact, false accounts. Harris Scarfe’s case is that those decisions would not have been made if the true position had been revealed. In other words, unlike Cambridge Credit, the plaintiffs do propose an inquiry into why the net worth of Harris Scarfe fell. They allege that decisions of a particular type were made in reliance on the accounts, being decisions which would not have been made if the true position were known.
Therefore, unlike Cambridge Credit, the allegations pleaded by the plaintiffs do not merely amount to reliance on the mere fact that the companies continued in business without reliance by the plaintiffs on the allegedly faulty audit report.
The plaintiffs claim that the accurate quantification of their losses is represented by the difference between the net asset value of Harris Scarfe at the time when the assets should have been realised and the time when they were in fact realised. That has the effect of attributing all losses sustained during that period to the fault of the defendants. However, to calculate the quantum of damages in that way is not to say that they are entitled to recover those losses merely because they continued in existence for that period and, by trading, suffered those losses. The plaintiffs allege that they suffered the loss because of their reliance on the various accounts in making what they claim were reasonable and prudent trading decisions. The method of quantification of the losses happens to be the same as in Cambridge Credit and, if successful, would have the effect of casting all losses incurred in that period at the feet of the defendants. However, they are not saying, as in Cambridge Credit, that merely because a loss was incurred after the act of negligence of the defendants, it was therefore recoverable.
It is difficult to know how else the plaintiffs could quantify their loss, given the assertion that the pattern and method of trading, the decisions to acquire more stores and the other decisions made in the course of conducting their business were decisions that were made in reliance on the accounts which, owing to the alleged negligence of the defendants, were grossly misleading.
It is possible that the plaintiffs could allege that particular dividends would not have been declared. They could allege that a particular store would not have been acquired and that a particular loss flowed from that acquisition. They could allege, as they do, that if they were aware of the true state of the finances, they would have made a number of other decisions. They could have attempted to trace the financial consequences of each of those decisions and compared them with what in fact happened. However, to do so would place an intolerable burden on all parties just in attempting to trace the financial effects of many individual and interacting decisions. It would place an impossible burden on anyone to analyse the effects that one decision may have had on others and how that ultimately affected the loss alleged to flow from an earlier decision. The law is not concerned with identifying every condition which may have caused or contributed to a particular result, let alone with attempting to perform an impossible exercise of attributing a particular component of a financial loss to any one of an infinite number of interacting causes or circumstances. As McHugh JA said in Cambridge Credit, at 350:
“The common law has followed the ordinary man’s notion of causation instead of the theories espoused by philosophers and scientists: Leyland Shipping Co Ltd v Norwich Union Fire Insurance Society Ltd [1918] AC 350 at 361, 362, 371; Fitzgerald v Penn (1954) 91 CLR 268 at 277. Windeyer J has said that this has created “a deep fission between law and logic”: National Insurance Co of New Zealand Ltd v Espagne (at 593). His Honour asked rhetorically: “How can one factor be logically more efficacious than another in producing a result for which both must exist?”. But as Windeyer J himself acknowledged the answer of the common law is that it is only concerned to determine whether a particular act or omission is so connected with a particular result that legal responsibility should attach to it. The object of the common law theory of causation is not the same as the object of a philosophical or scientific inquiry into causation.”
The plaintiffs allege that a range of business decisions were made and transactions were entered into by Harris Scarfe on the basis of beliefs concerning Harris Scarfe’s financial position and performance engendered by the negligent audit reports and reviews. As the plaintiffs submitted, the decisions necessarily involved a complex interaction between the various decisions made and transactions entered into over time. The opening of a new store may well affect the performance of an existing store. The decision concerning the operation of an existing store may affect other aspects of the operation of that store, of other stores and of the State and head office operations.
Whether the plaintiffs succeed at trial is a matter which will depend on the evidence to be led and whether it demonstrates the interdependent nature of the financial effect of those decisions and whether it can establish on the evidence that the proper basis of an assessment of the financial effect is a combination of the losses incurred over the relevant period. It may well be that the necessary reliance is not proved and that significant decisions were not related to the directors’ belief as to what the accounts show. It may be that the evidence shows, at least to some extent, that external factors adversely affected the profitability of the companies. That is a matter for evidence and the application of a necessarily broad axe in what may be a task of some complexity in assessing the plaintiffs’ damages. However, that is a matter for evidence. The fact that the task may be attended by some difficulty does not mean that the plaintiffs have failed to allege in their statement of claim the necessary causal connection between the negligence of the defendants and the losses suffered by the plaintiffs.
To allow the statement of claim to be filed substantially in the form proposed is not to determine questions of causation by applying the “but for” test to every situation. While McHugh JA was a strong advocate for the test in Cambridge Credit, he acknowledged that it had to be applied “in a practical commonsense way” (at 351). As he finally acknowledged in the passage quoted at 358, the test is only a guide. It has since been rejected as a definitive test, with causation being essentially a question of fact to be answered by reference to commonsense and experience, into which the consideration of policy and value judgments necessarily enter: March v E & MH Stramare Pty Ltd (1991) 171 CLR 506, Mason CJ at 515-517, with whom Toohey and Gaudron JJ agreed; Deane J at 522-524, with whom Gaudron J also agreed; Bennett v Minister of Community Welfare (1992) 176 CLR 408, Mason CJ, Deane and Toohey JJ at 412-413; Medlin v State Government Insurance Commission (1995) 182 CLR 1, Deane, Dawson, Toohey and Gaudron JJ at 6. The plaintiff in Cambridge Credit could only have succeeded if the “but for” test was the sole criterion. It demonstrates that something more is necessary. The plaintiffs’ proposed pleading in this case goes much further and alleges a causal link which commonsense indicates, if the relevant facts are proved, the necessary connection between the defendants’ negligence and the plaintiffs’ loss and damage.
The defendants also rely upon the decision of the Court of Appeal in Galoo Ltd (In Liquidation) v Bright Grahame Murray [1994] 1 WLR 1360. The factual situation was more akin to the facts of this case. In 1987 one of the plaintiffs, Hillsdown Holdings Plc, purchased 51% of the shares in Gamine Ltd, which in turn owned all of the shares in Galoo Ltd. Between March 1987 and January 1993, Hillsdown made loans totalling in excess of £30 million to Galoo and Gamine and, in May 1991, purchased a further 44.3% stake in Gamine. Hillsdown, Gamine and Galoo brought proceedings against the defendants, who were the auditors of Galoo from 1981 to 1991 and the auditors of Gamine from 1984 to 1991. It was alleged that the audited accounts for the years 1985 to 1989 and the draft audited accounts for 1990 contained substantial inaccuracies. It was said that if the defendants had performed their auditing tasks properly, it would have been clear that Gamine and Galoo were insolvent, that the companies would have ceased to trade immediately, and that subsequent losses would not have occurred. The claims of Galoo and Gamine for damages and breach of contract were struck out.
Paragraph 20 of the statement of claim pleaded:
“If [B.G.M.] had performed their duties properly and with reasonable professional care and skill the accounts of [Galoo and Gamine] for each of the years 1985-1990 and/or its [B.G.M.’s] report on those accounts would have shown that those companies instead of being profitable and having substantial assets, were in fact unprofitable and worthless. In these circumstances: (i) the insolvency of [Galoo and Gamine] would have been revealed and those companies would have ceased to trade immediately; (ii) [Galoo and Gamine] would not have accepted or continued to accept the advances or further advances from [Hillsdown] referred to in sub-paragraph (iii) below and/or incurred any other liabilities”. (See Glidewell LJ at 1368)
Paragraph 21 pleaded that Galoo and Gamine had suffered loss and damage “as a result of continuing to trade after they would otherwise have done”. Otherwise, no further relevant pleadings are quoted in the report of the judgment. The losses suffered by Galoo and Gamine were quantified by the difference between the net asset value at the time when the fraud should have been discovered and when it was in fact discovered.
From the pleadings quoted in the report of the judgment, there was no suggestion of any reliance by Galoo or Gamine on the report of the auditors. In this regard the report of the judgment is unsatisfactory, because in his summary of the pleadings Glidewell LJ said, at 1369:
“The second head of damage claimed by Galoo and Gamine is that they incurred trading losses as a result of relying on the negligent auditing by B.G.M. and thus continued to trade when they would otherwise not have done.” (Emphasis added)
It is not clear whether his Lordship’s reference to reliance on the negligent auditing of the defendants had any foundation in the pleadings or whether it was an unintended slip in the Judge’s reasons. The quotations from the pleadings and summary which followed suggests that it may have been the latter. Glidewell LJ continued, when elaborating on the second head of damage claimed:
“It can be expressed as follows: (a) if they had not acted in breach of their duty in contract or tort, B.G.M. would have detected the fraud during their audit of the 1985 accounts; (b) in that case, Galoo and Gamine would have been put into liquidation in mid-1986 and thus ceased to trade at that date; (c) if the companies had ceased to trade, they would neither have incurred any further trading losses nor paid the dividend in 1988; (d) therefore the trading losses and the loss caused by the dividend payment were caused by the breach of duty by B.G.M.”

Glidewell LJ (with whom Evans and Waite LLJJ agreed), having stated that for the purpose of English law the cause must be an “effective” or “dominant” cause of the loss, posed the question, “How does the court decide whether the breach of duty was the cause of the loss or merely the occasion for the loss?”. He continued at 1374-1375:
“The answer in my judgment is supplied by the Australian decisions to which I have referred, which I hold to represent the law of England as well as of Australia, in relation to a breach of a duty imposed on a defendant whether by contract or in tort in a situation analogous to breach of contract. The answer in the end is ‘By the application of the court’s common sense.’
Doing my best to apply this test, I have no doubt that the deputy judge arrived at a correct conclusion on this issue. The breach of duty by the defendants gave the opportunity to Galoo and Gamine to incur and to continue to incur trading losses; it did not cause those trading losses, in the sense in which the word ‘cause’ is used in law.”
The Australian decisions to which his Lordship referred were Cambridge Credit and March v E & MH Stramare Pty Ltd.
I do not consider that Galoo establishes any new principle. In that I am supported by the decision of the New Zealand Court of Appeal in Sew Hoy & Sons Ltd (In Receivership and in Liquidation) v Coopers & Lybrand [1996] 1 NZLR 392, McKay J at 399 and Thomas J at 408. The fact of the matter is that the pleadings, so far as they were quoted and paraphrased in the reasons for judgment, did not allege any causal connection between the negligence of the defendants and the losses sustained by Galoo and Gamine.
I consider that little additional help is to be gained from a consideration in detail of other cases relied on by the defendants. For example, mention was made of Pricewaterhouse v Kwan (2000) 3 NZLR 39, another case involving negligence of an auditor where the New Zealand Court of Appeal referred to the “crucial difference between causing a loss and providing the opportunity for its occurrence” (at 46) and the need for the plaintiff to show that the defendant’s negligence “constituted a material and substantial cause of their loss” (at 47), and that merely providing the opportunity for the occurrence of loss is not enough. There is no doubt about that proposition. It is clearly established by Cambridge Credit. However, for the reasons given, it does not apply to the plaintiff’s intended pleading.
Southern Cross Airlines Holdings Ltd v Arthur Andersen & Co (Unreported, 27 March 1998, Federal Court of Australia, Cooper J) is another case where the cross-claim of the respondent made no attempt to link the impugned conduct of the cross-respondent with the trading losses suffered by the claimant.
I do not consider it necessary to refer to other cases mentioned by the defendants in the course of their argument.
The contrast with cases like Cambridge Credit and Galoo can be seen in Sew Hoy & Sons Ltd (In Receivership and in Liquidation) v Coopers & Lybrand (supra), a case which supports the plaintiffs’ present contentions. The plaintiff in that case had carried on business as an importer, manufacturer and distributor of clothing. The defendants were the company’s auditors. The plaintiff alleged breach of the auditors’ duties in respect of the audit of the 1987 and 1988 annual accounts. It was alleged that the accounts showed an overstatement of the value of stock by approximately $2.2 million in 1987 and $3.9 million in 1988 with a corresponding overstatement of the surplus of assets over liabilities and of net operating profits in those years. When corrected, what the accounts showed as profits were in fact substantial losses. The plaintiff claimed that, as a result of the defendants’ breaches of conduct, the plaintiff continued to trade until 12 December 1989, with the result that it incurred additional losses of approximately $10.732 million calculated in the same way as the plaintiffs allege in this case.
The plaintiff pleaded that if the audit had been correctly carried out the plaintiff would have been able to take such steps as were necessary to avoid or minimise further trading losses. It was alleged that, had it known, it would have been required and able to take any one or more of the following steps (supra at 394):
“(a)Sale of all or part of its undertaking as a going concern or otherwise;
(b)Ceasing, downscaling or other restructuring of its operations to minimise ongoing trading losses;
(c)Realisation of stock and assets in an “unforced” manner;
(d)Invited its banker to appoint receivers.”
It alleged that as a result of the negligence those steps were not taken, the plaintiff continued to trade and incurred further losses.
An application to strike out the pleadings, although successful at first instance, was dismissed on appeal. As in this case, it was argued that the incurring of losses depended upon and was caused by the day-to-day decisions made in the subsequent conduct of the business, and that the fact of continued trading was insufficient to show the necessary causal link.
The essence of the plaintiff’s claim was stated by McKay J at 396-397:
“It claims only the losses caused by its decision to continue trading instead of ceasing to trade, not losses which resulted from other causes such as imprudent decisions in the course of trading. It claims that all the losses actually sustained fall into the former category. Whether it will succeed in proving this will be a matter for trial. It may succeed as to only part of its actual losses, or as to losses for a more limited period than has been claimed. The only causative link pleaded is that the losses were caused by the decision to continue to trade, and not to adopt one or more of the other courses available to it. It claims the losses inherent in the continuation of trading. It will be limited to the losses proved to have been so caused, to the extent that they exceed the losses that would have been incurred if the audit report had been qualified and the company had made the different decisions it claims that it would have made so that a different sequence of events would have followed.”
McKay J, having discussed the decision in Galoo at some length said, at 400:
“If a decision to continue trading is incapable of being in itself a cause of loss, so that any subsequent loss must be caused by other things, then the present claim would be untenable. If a decision to continue trading can itself be the cause of a subsequent loss, but only in the presence of additional factors, then those factors should be pleaded. This appears to be the basis of the Master’s judgment. The statement of claim pleads a true loss of $1.29m in 1987 and of $1.51m in 1988. It pleads that the audited accounts recorded profits in both years, by reason of the auditor’s negligence, as a result of which the company continued to trade. There is nothing to suggest that the losses were limited to some particular part of the business, such as an attempt to establish a market overseas, or to move into some new and specialised area of the clothing market. If that was the case, withdrawal from the particular market might have restored profitability. If the losses were spread over substantially the whole of the company’s activities, or if in any case the company continued to trade in the same manner as before, further continuing losses would seem almost inevitable regardless of other events or decisions.
How long such losses would continue, what steps might have been taken to correct the situation, at what stage such steps should have been taken and how soon they would have been effective will be issues at trial going to quantum. The plaintiff asserts that the negligence of the defendant caused its decision to continue trading in what was in fact a substantial loss-making situation, and that this decision was in itself a cause of loss. I see nothing untenable or unarguable in that situation. Only the losses so caused are claimed. No other causative links are relied upon, so it is unnecessary to plead other links. What has been pleaded will, if established, be sufficient to support a claim to damages. The fact that no other causative link is relied upon does not mean that the pleading is in other respects sufficiently particularised to inform the Court and the defendant of the cause of action. I will return to this question later.”
With respect, the same remarks can be applied to this case. McKay J considered that that conclusion did not conflict with any principle contained in Galoo. I agree. He then went on to deal with deficiencies in the particularisation of the loss in that case, a matter to which I shall return.
Henry J, at 404, provided a helpful summary as to what must be pleaded if a plaintiff in this situation is to rely on an accumulation of trading losses:
“The question which arises is whether a bare allegation that trading continued as a result of the breach is sufficient to link the breach with the trading loss subsequently incurred. It is this step in the plaintiff’s case which I think causes difficulty. Profits and losses from trading are not caused by the fact that trading is undertaken, which does no more than present the opportunity to make profits or incur losses. Profit and losses result from, and adopting a commonsense viewpoint are caused by, the incidents of trading and the circumstances which affect it. The plaintiff was trading at a loss for the year ending 31 March 1987. It is not suggested that loss was in any way due to the actions or omissions of the auditors. To incur trading losses for the ensuing years means in general terms that again expenditure exceeded income. The factors which caused or contributed to that result are not asserted. What the appellant must allege in an informative way is that the loss suffered is to be attributed, not merely to having traded, but to the breach of contract or duty of care.
If it is to be contended that one of the causes of loss was a mistaken belief either as to the stock value or as to the trading profitability in the preceding year, then that contention must be established, and therefore alleged, before liability will follow. For example it may be said the mistake led to some course of action being either taken or rejected, which then brought about a particular identified loss. But in my view to say that a decision by a person trading at a loss to continue trading can itself in the legal sense cause a further trading loss does not follow unless there is something more (such as inevitability) to link the loss to the fact of trading. It is the cause of the loss, and its relationship to the breach which is critical and which must be spelt out. If as was discussed in argument it is to be claimed that the loss is due to the decision to continue trading as before, ie in what unknowingly was a loss-making manner, then that must be pleaded and particulars given of the manner of trading persisted in which relate it to the alleged negligence.”
Thomas J spoke of the application of the commonsense notion of causation and the effect of Galoo at 408-409:
“Thirdly, the commonsense notion of causation which the common law champions does not provide a test of causation. An issue may be resolved, and no doubt should be resolved, by the application of common sense. But common sense is not in itself a test. The answer, of course, is not to abandon common sense, for that is a valuable adjunct to all judicial reasoning, but to cease to think of causation in terms of requiring a “test”. The basic question remains whether there is a causal connection between the defendant’s default and the plaintiff’s loss. Galoo provides, perhaps, a timely reminder that the answer to this question will not be resolved by the application of a formula but by the application of a Judge’s common sense. The Judge needs to stand back from the case, examine the facts closely, and then decide whether there is a causal link between the default and the loss in issue which can be identified and supported by reasoned argument.
In this regard, the mistake which is often made is to think that the question whether there is a causal connection between the defendant’s default and the plaintiff’s loss can be answered by a single question. The connection may not always be straightforward or direct and the issue is unlikely to be free from other factors. Thus, in this the case, it is an over-simplification to look for the causal link between the auditor’s deficient audit and the company’s trading losses in one step. If that approach is adopted it is all too easy to conclude that the negligent audit cannot have caused the trading losses subsequently incurred by the company. It might well have traded at a profit. There might well be other reasons to explain the trading losses. But if the matter is approached on a commonsense basis more questions are required. A series of steps will provide a more plausible basis for the alleged causal connection. Thus, it can be argued that the negligent audit led the company to believe that it was profitable when that was not the case and, as a result of that belief, to continue to trade. The company was given no cause to cease trading or to modify its trading pattern or activities. It therefore continued to trade in that manner, or on that basis, with the result that it incurred losses which it would not otherwise have incurred. Such a chain of causation is tenable and only requires proper particulars to constitute a reasonable cause of action.”
In commenting further on Galoo he said, with respect, correctly, at 409:
“Fifthly, there is little in Glidewell LJ’s judgment to explain his reasoning in reaching the conclusion that the breach of duty by the auditors did not cause the trading losses, apart from his tacit approval of the reasoning of the Deputy Judge whose judgment was under appeal. Glidewell LJ quoted the Deputy Judge at length (at p 329):
‘Trading losses … are losses which by their nature do not flow from whatever statement appears in the accounts as to the state of the company’s assets or profits; they flow from trading. If a company trades, it may suffer losses or it may enjoy profits, and those losses or gains depend upon a number of factors such as the prudence of the trading, market conditions, and so on. It does not seem to me that trading losses as such can possibly be attributed to statements as to the status of the company before that trading ever takes place.’
This reasoning also requires some qualification. To state that trading losses flow from trading is to state the obvious. The key question remains. Did the defendant’s default cause the trading to continue and, if it did, did it cause the trading losses which then eventuated. If it can be said that the company not only continued to trade, but continued to trade in a certain way as a result of the auditor’s breach and that the way in which it traded is responsible for the trading losses, it is at least arguable that a causal link is established. The mere fact that other factors might cause trading losses, such as imprudent trading or an earthquake at the plaintiff’s plant, does not mean that the trading losses cannot be caused by identifiable features in the business activities of the plaintiff. Whether or not that is the case is essentially a question of fact.”
Of the pleading then before him, Thomas J said, at 411-412:
“Standing back and examining the bare facts – bare because they are restricted to the pleading – it seems to me that, as a matter of common sense, the requisite causal connection exists. It is true that no simple or direct nexus between the breach and the trading losses may be advanced. But the nexus can none the less be traced by reference to a series of steps. The causation may better be described as a chain rather than a link and has been foreshadowed in my earlier observations relating to Galoo. The auditor’s breach caused the company to believe that it was operating profitably. This mistaken belief in turn led it to continue to trade in a way which was in fact unprofitable. It did not take the steps which it would otherwise have taken to cease trading or reverse or minimise the ongoing trading losses because it did not know those steps were required. If it had not continued to trade in the way which it did, based on the mistaken belief that the company was trading profitably, and had obtained the opportunity to cease trading or reverse or minimise the ongoing trading losses, it would not have incurred the further losses and deficit in its assets which resulted. Without doubt this chain of effects provides a tenable causal connection.”
Not only is that an accurate summary of the pleadings in Sew Hoy, it is also an accurate summary of the present plaintiffs’ case. A nexus is alleged by reference to a series of steps and decisions that the plaintiffs took or did not take based on their reliance on the accounts. The mistaken beliefs as pleaded by the plaintiffs led them to continue to trade in a way which was unprofitable. They did not take the steps which otherwise would have been taken because they did not know that those steps were required. Had they been fully informed they would have taken other decisions to prevent further trading losses.
Of the need for particulars Thomas J said, at 412:
“I do not agree, as suggested by the Master, that there would need to be, or should be, an open-ended inquiry into every dollar of loss to establish whether it flowed from the auditor’s negligence. Such an exercise would be unnecessary and oppressive. It is not an examination of each transaction which is required, but an articulation of the respects in which the company traded at a loss simply because the company believed that it was trading profitably. Such respects would focus on the company’s trading policy rather than on individual transactions apart, possibly, from any significant transaction which was, in itself, a factor which contributed to the trading losses claimed.
I will proffer an example purely in an effort to explain what I mean. If the company had purchased stock at a certain level or stock of a particular kind in the belief that such trading was prudent because of its purported profitability when, but for that belief, it would have considered it imprudent to do so, the purchase of stock at that level or of that kind would represent a feature of the company’s business activities which caused it to incur trading losses. It matters not that, if the accounts had been correctly audited or the accounts properly qualified, the company would have ceased trading altogether. The particulars go to those aspects of the company’s trading which resulted in it trading at a loss rather than at a profit while it did in fact trade and in it accruing an increased deficit as a result.”
This view accords with the view I have already expressed that a detailed analysis of each transaction that the plaintiffs entered into is not necessary. If, on the evidence, it is apparent that some extraordinary transaction or group of transactions were in themselves factors which contributed to the trading losses, then that may have the effect of reducing the plaintiffs’ claim.
The defendants in this case argued that the plaintiffs began the task of particularisation but failed to carry it through. For example, in para.55.8 of the statement of claim the plaintiffs allege that, in reliance on the audited accounts they declared dividends to shareholders. The complaint is that this is not particularised or quantified as an item of loss. They attack the pleading in para.55.9 which alleges that, as a result of the defendant’s negligence, the plaintiffs increased their indebtedness to ANZ. They further point out, correctly, that acceptance of a loan in itself cannot amount to a head of loss causing damage: Galoo (supra) at 1369; Sheahan (As Liquidator of SA Service Stations) v Verco [2002] SASC 68 at [103].

However, such attacks on the pleading miss the point of the pleading. The allegations in paras.55 and 58 are not pleaded as particulars of the plaintiffs’ loss. They are, nevertheless, central to the plaintiffs’ claims. They are pleaded, in each case, as particulars of how the plaintiffs continued to trade all aspects of their respective businesses in the same manner as previously. That is indicated by the opening words of paras.55 and 58 themselves.
To the extent that particulars of the increased indebtedness of Harris Scarfe are shown in the particulars of loss, the incurring of those debts themselves are not claimed as items of loss. Rather, they are claimed as some of the components in the calculation of an increasing net asset deficiency which, so the plaintiffs allege, was the result of continued trading on the false premise that they were provided with accurate accounts.
The claim by ANZ
The defendants argue that this claim suffer the same vice as that of the Harris Scarfe claim. They further argue that any losses of ANZ could only be maintainable if ANZ identified loans made after March 1998 and before March 2000, which were made in reliance on one of the audit reports which the plaintiffs allege was negligently prepared, and which would not have been made to Harris Scarfe had ANZ known the true position. They claim that the plaintiffs would need to particularise repayments made by Harris Scarfe and recoveries made by ANZ in respect of those loans, and would need to identify specific transactions entered into by Harris Scarfe after the auditors delivered one or other of the review and audit reports.
I disagree. The effect of ANZ’s plea is that, in reliance on the reports, ANZ continued to lend to Harris Scarfe. Harris Scarfe in the meantime, continued to trade and to make losses when it was already insolvent. ANZ was therefore unable to recover its loans beyond the value of the security it held. It may be that, on analysis, if the assets had been realised as the plaintiffs allege that they should have been, ANZ would still not have recovered the whole of its advances. It alleges that it would have. But if it would not have, that portion of ANZ’s loss would not be recoverable from the defendants. ANZ is entitled to allege that, as a result of its reliance on the audited accounts it too continued to make advances in the ordinary course of business. It is entitled to claim such of its unrecovered advances consequent upon the insolvency of Harris Scarfe less, of course, any amounts which ANZ would not have recovered if the assets had been realised in the manner in which the plaintiffs allege they should have been.
It does not matter that the unrecovered loans may have been made before the defendants became the auditors of Harris Scarfe. The objection to such a plea misconceives the plaintiffs’ claims. If the alleged negligence of the defendants caused the plaintiffs to take actions and to make decisions which ultimately rendered the ANZ loans, or a substantial proportion of them, irrecoverable, that will become a valid head of loss at the suit of ANZ, regardless of when the loans were made.
As the plaintiffs acknowledge, the secured debt of Harris Scarfe to ANZ is a component in the pleaded losses of both Harris Scarfe and ANZ. The fact that the claims overlap or include a common component of loss does not prevent each of them from pleading an entitlement to that component. How the amount actually recovered is adjusted between Harris Scarfe and ANZ does not concern the defendants. However, it would necessarily be a condition of the judgment, if the plaintiffs succeed, that they do not collectively recover the same amount twice.
Costs of realisation
The defendants object to the inclusion in the calculation of the losses claimed by Harris Scarfe the actual costs of realisation of the assets. The first objection is that certain components of those costs, namely priority payments, employee priority payments and costs of the receivers are costs incurred by ANZ and not Harris Scarfe. The plaintiffs’ response is that they are also costs which ANZ is entitled to charge and which it has charged to Harris Scarfe under the terms of its security. Once again, these are not amounts which can be claimed twice. In any event, the full amount is not claimed in that, in calculating the notional costs of realisation had the realisation taken place in September 1996, there is an offsetting amount. The plaintiff is entitled to claim that to the extent that that component of the liability has been inflated by the belated receivership, the increment in those costs represents a loss for which the defendants are responsible.
The second objection is to the inclusion of the net cash outflow during the period of the receivership. The defendants argue that that cannot be a cost attributed to them because it would have been incurred if the course of events which the plaintiffs allege should have been followed were followed. As I understand the plaintiffs’ particulars of loss for some reason a corresponding item does not appear in the estimated costs of realisation as at September 1996. If that is so there may be some substance in the defendants’ complaint. However, that is a matter for evidence at the trial and possible amendment of the plaintiffs’ particulars if so advised. It does not justify striking out the relevant particulars of claim.
The third complaint relates to the apparent arbitrary nature of the basis on which the costs of realisation are calculated. I do not consider that to be a valid objection in a case of this nature. It will no doubt be the subject of expert evidence, details of which will necessarily appear in experts’ reports to be exchanged well before trial.
The defendants’ claim for a declaration
The defendants have asserted some uncertainty or ambiguity in the plaintiffs’ proposed pleadings, or in their conduct, giving rise to a fear on the part of the defendants that the plaintiffs may change their course to rely on some other means of formulating a claim for damages. They claim that their fears are justified by a letter written by the plaintiffs’ solicitors to the first defendants’ solicitors on 7 July 2004 in which they asserted that the proposed pleading spoke for itself in alleging that at each of the relevant periods a controller would have been appointed and the business and assets realised. In the letter the plaintiffs’ solicitors also said:
“If either defendant’s case turns out to be that no controller would have been appointed and the court makes corresponding findings, the court will of course need to assess damages on that basis.”
The plaintiffs’ counsel had also made earlier submissions before me that if the defendants’ case was that no controller would have been appointed and the court were to find in the defendants’ favour, they would assert an entitlement to damages on an alternative basis, presumably on the assumption that Harris Scarfe would have continued trading. The defendants complain of that possibility where no alternative case has been pleaded by the plaintiffs. They claim that the plaintiffs are attempting to preserve the right to pursue an alternative case on behalf of the plaintiffs, even though they admit that no alternative case had been formulated in the proposed amendment.
Accordingly, the defendants argue that if leave is to be granted to the plaintiffs to file the statement of claim, the court should give a direction pursuant to r 50.03(a), Supreme Court Rules, consistent with the plaintiffs’ concessions, that no alternative case is open to the plaintiffs on the proposed amendment.
The defendants also argue that because the plaintiffs plead in para.64 of the statement of claim that, “By reason of the facts pleaded in paragraphs 54-60 the financial position of Harris Scarfe deteriorated and the plaintiffs suffered loss and damage”, that leaves the door open to allege, by way of alternative case, loss and damage by reason of the many transactions which were or were not undertaken in reliance on the audit reports, which transactions are pleaded in those paragraphs.
Rule 50.03 applies to this action because it has been designated a complex action under r 2A. Rule 2A.08 confers on a judge or master all or any of the powers in r 50.03.
Rule 50.03 relevantly provides:
“In proceedings to which this Rule applies, in addition to the exercise of any other power to make directions pursuant to Rule 55 or otherwise, the Court shall give all such directions as may seem desirable in the interests of justice and in order to secure a speedy and economical determination of the proceedings. Without limiting the generality of the foregoing, the Court may:
(a)Direct that the issues be defined by such means as the Court may think fit other than by the delivery of formal pleadings.”
The defendants submit that a direction should be made that the plaintiffs are confined to a case on the proposed amendment that a controller would have been appointed who would have sold or disposed of the assets of Harris Scarfe.
I do not consider that it is appropriate to act in accordance with r 50.03 for the purposes claimed by the defendants. That rule has its uses. It may enable early disposal of a particular issue; it may enable dispensing with some interlocutory steps such as discovery; it may enable particular issues to be defined by points of claim or defence or by affidavit. It confers a certain degree of flexibility in the more efficient resolution of commercial litigation. However, where, as in this case, the issues demand reasonably detailed and quite substantial pleadings, the conventional rules as to pleadings should apply.
The separate particulars of loss pleaded by the plaintiffs must be read in conjunction with the pleas contained in the statement of claim. The plaintiffs have not pleaded an alternative case in damages based on a trade on case. They have particularised their damages claimed and nailed their colours to the mast based on the appointment of a controller and asset realisation. That is what the plaintiffs plead was the consequence of the defendants’ negligence. They cannot, as part of their primary case without amendment to the statement of claim, then proceed to lead evidence at trial to suggest some other or alternative basis of their claim for damages.
There must be some doubt as to whether the plaintiffs could have pleaded such an alternative in the statement of claim in any event without rendering the pleading embarrassing and inconsistent. Had they done so, there is every possibility that the defendants would have applied to strike out the statement of claim on that ground. I consider that the defendants’ fears of having to meet an alternative and unpleaded basis for the assessment of the plaintiffs’ damages, based on this statement of claim, is unfounded.
However, the defendants may well, in their defence, deny the plaintiffs’ allegations that a controller would have been appointed if the true position had been known. But if they do so the defendants cannot merely plead in their defence a bald denial in the hope that it will succeed and that the plaintiffs’ claim for damages will collapse with such a successful plea.
Rule 46A.05(2) provides:
“The Defence must plead, but plead only:
(a)what parts, if any, of the Statement of Claim are admitted;
(b)the material facts relied upon to constitute any ground of defence on which the defendant bears any evidentiary or a legal onus of proof;
(c)such further material facts as are necessary to give other parties fair notice of the defendant’s case which they will have to meet;
(d)any defences in law; and
(e)any statutory provisions to be relied upon by the defendant.”
Paragraphs (b) and (c) are particularly relevant. If the defendants propose to assert that if the plaintiffs had full knowledge of the actual state of accounts they would not have appointed a controller, it follows that they must assert that some other course would have been followed. If it is that Harris Scarfe would have continued to trade, the defendants bear an evidentiary onus of proof in respect of that issue. They must plead the material facts on which they rely to raise that issue such as to give to the plaintiffs fair notice of the case which they will have to meet. That will almost inevitably involve a pleading, at least to some extent, of what the defendants assert would have been the financial consequences of trading on. They may wish to assert that the plaintiffs would have traded on in a particular way, would have pursued certain trading policies or would have taken other particular steps which would have had the effect of reversing the pattern of trading at a loss.
If that is the case then the plaintiffs, by means of their reply, may well wish to plead, in response to the defendants’ allegations, losses that would have resulted from the plaintiffs continuing to trade. That would not qualify in any way their primary assertion based on the controller case as pleaded in the statement of claim. I hesitate to speculate what the defendants’ pleas may be or how the plaintiffs may frame their reply, but provided that any new facts set up in reply are raised solely to meet the defence, it is not incumbent upon the plaintiffs, in their statement of claim, to anticipate that defence which may never be made: Hall v Eve (1876) 4 Ch D 341, Bramwell JA at 348. Rule 46.09 prescribes pleading an allegation of fact or a new ground or claim inconsistent with a previous pleading. Any plea in reply of the type I have discussed would not offend this rule: Duke Group (In Liquidation) v Arthur Young (No.13) (1991) 5 ACSR 212, Perry J at 216-217.
Similarly, I do not read any of the proposed pleadings in relation to ANZ as relying other than on the controller case. ANZ does not rely, in calculating its loss, on the making of particular advances in ignorance of Harris Scarfe’s true financial position. It merely says that, in reliance on the audited accounts, it did not appoint a controller when it could have, that it continued to lend money to Harris Scarfe until the true position was revealed and that, as a consequence, it was unable to recover any of its advances beyond the value of its then security.
Irrelevant allegations
The defendants argue that because of the way the plaintiffs put their case on loss and damage in the particulars of loss, the allegations in the statement of claim regarding the things which were or were not done in reliance on the negligent audit opinions are irrelevant. They say, for example, that it does not matter whether new stores were acquired or opened as alleged in para.55. It does not matter whether ANZ made further lending in reliance on the audit opinions as alleged in para.58. That is because, they argue, none of these activities is pleaded to be of any causal significance.
I disagree. It is necessary for the plaintiffs to allege what they did and what they did not do in reliance upon the defendants’ audit reports. It is not necessary to plead those transactions because the plaintiff alleges some particular identifiable loss flowing from them. It is necessary to plead them because they are the very particulars by which the plaintiffs allege how Harris Scarfe continued to trade, and how that trading, in the circumstances of their ignorance, gave rise to further trading losses and asset deterioration. It was particulars of this very nature that were said by the New Zealand Court of Appeal to be lacking in Sew Hoy & Sons Ltd (In Receivership and in Liquidation) v Coopers & Lybrand (supra). I refer in particular to the passage already quoted from the judgment of Thomas J at 412.
Specific pleading defects
The defendants allege a number of specific pleading defects by reference to particular paragraphs of the statement of claim. Before dealing with them it is helpful to recall the purpose of pleadings and the nature of their requirement under the present rules. In Williams v Australian Telecommunications Commission (1988) 52 SASR 215 King CJ said, at 216:
“The fundamental purpose of pleadings is to provide a structure or framework for the litigation designed to promote a just outcome. Pleadings achieve this purpose by performing two basic functions. The first is to define the issues between the parties thereby providing the basis for the determination of questions as to discovery before trial and admissibility of evidence at trial and of questions as to what the litigation has decided for the purpose of the Rules as to res judicata and issue estoppel. The second function is to give to the parties fair notice of the case to be made against them at trial thereby minimising the risk of injustice resulting from surprise. These fundamentals remain unaltered by the new Rules. Moreover, that general principle which governs the application of all procedural rules, namely that “rules and forms of procedure are not ends in themselves, but means to an end, which is the attainment of justice”, Union Bank of Australia v Harrison Jones & Devlin Ltd (1910) 11 CLR 492 per Griffiths CJ at 504, applies with undiminished force to the new Rules as to pleadings.”
Furthermore, in Arthur Young v Tieco International (1995) 182 LSJS 367 Lander J said, at 369-370:
“Although the purpose of pleadings is clear, the pleadings themselves must not become a burden. Whilst recognizing the due importance of pleadings and their role in the litigation process, they are not to be understood to be any more than statements of the case of the party; statements made with sufficient particularity to identify that case. The rules of procedure do not require a party to include particulars of any more than the case to be made. The rules require the pleader to be as brief as the nature of the case permits and further require that the material facts ought to be pleaded but specifically preclude the pleading of the evidence upon which those facts are to be proved. It is therefore necessary, as only the material facts are to be pleaded, that some judgment has to be made in respect of any particular pleading as to whether or not the facts which are said to be omitted are material facts for the purpose of the party against whom the pleading is directed understanding the case, which is identified against that party. It follows that having regard to the injunction that the pleadings be as brief as possible and that only material facts be pleaded, the law recognizes that some facts will not be pleaded because those facts do not identify the case that is raised against the party against whom the allegation is made, or further do not identify any issues or sub-issues to which that party ought to apply that party’s mind.
The rules do require that the pleading will contain particulars of the claim, and particulars under the Rules must be understood to be part of the pleadings. However, the rules make it plain that what is required is that there be sufficient particulars of the claim. It follows therefore, as well, that the rules contemplate that not all particulars which may be identified by a party need be pleaded.”
Those views apply with even greater force by virtue of the provisions of r 46A: see particularly r 46A.02 and r 46A.03.
With those principles in mind I turn to consider the defendants’ complaints of specific pleading defects, adopting the numbers assigned to them by the defendants.
Complaint 1: The defendants complained about the reference to “Harris Scarfe” in a number of paragraphs as meaning any one or two of the first three plaintiffs. They say it is vague and embarrassing as it applies to the claims of loss and damage, and that the plaintiffs should identify which entity suffered the alleged loss. The plaintiffs respond that each of the Harris Scarfe plaintiffs entered into deeds of cross-guarantee and have, in effect, suffered the same loss, and that in any event the plaintiffs’ claim has also been for consolidated losses in respect of the Harris Scarfe plaintiffs. So far as the identification of loss is concerned I do not consider that further identification of the plaintiffs is necessary. If identification of a particular plaintiff is necessary for the purpose of determining who undertook a particular action, then a discrete application can be made.
Complaint 2: The defendants allege that the plaintiffs’ plea in para.54.14 and others that the directors of Harris Scarfe believed that Harris Scarfe had sufficient profit and retained profit to declare and to pay dividends to Harris Scarfe’s shareholders is defective, in that there is no claim arising out of the payment of dividends, and it is vague and lacking in particularity. It will be apparent from what I have already said that there is no substance in this claim. There is no discrete head of damage claimed by the plaintiffs attributable to the declaration and payment of dividends. The plea relates to what the directors were allegedly induced to do in the conduct of the Harris Scarfe business, the loss being calculated by the deterioration in the net asset position contributed to by the payment of dividends.
Complaint 3: This complaint relates to the allegation in para.54.15 and others that the directors continued to rely upon the auditors to confirm information provided to the directors by management and to perform the auditor’s duties. The claims are said to be vague and embarrassing by reason of their generality. Specific complaints then follow in elaboration. In my opinion the complaints are adequately answered by the plaintiffs’ written submissions, the necessary particularity being found in other parts of the statement of claim.
Complaint 4: This complains of the plea in para.55 and like paragraphs where the plaintiffs allege, with some particularity, that the directors continued to trade all aspects of the Harris Scarfe business in the same manner as previously. For reasons previously given it is not incumbent on the plaintiffs, and indeed would be impractical and unnecessarily burdensome to have to plead every transaction entered into by Harris Scarfe and the effect of that transaction. It will be for the court to determine on the whole of the evidence whether the usual pattern of trading was maintained or whether there were other influences which impacted on the deterioration in assets of Harris Scarfe.
Complaint 5: Complaint is made to the plaintiffs’ reference to “accounts” in a number of paragraphs without specifying which accounts are being referred to. For the purpose of the relevant paragraphs “the accounts” are defined as meaning the monthly management accounts and audited and reviewed financial statements. Elsewhere in the statement of claim particulars are given of the alleged inaccuracies in these accounts. I fail to see any vagueness or embarrassment arising from that particular definition.
Complaint 6: Paragraph 55.4 of the statement of claim contains a particular of how it is alleged that the directors continued to trade. It is that in respect of proposed new stores, acquisitions or expansions the directors took certain actions and made certain decisions based on the information contained in the accounts. The defendants complain that the pleading is irrelevant, vague and embarrassing and because the proposed transactions are not specified or identified. I agree with the plaintiffs that these are matters of detail and of evidence, and will be apparent from documents provided on discovery.
Complaints 7 and 8: These can conveniently be dealt with together. The allegation is that the pleading regarding actions taken in respect of existing stores and in respect of State and head office operations are irrelevant, vague and embarrassing. As well as renewing complaints 4 and 5, the defendants claim that the “determinations” made in relation to those facilities contain no plea that any decisions would have been made differently. The allegations pleaded in these paragraphs are pleaded as conduct that caused deterioration in the financial position of Harris Scarfe and as conduct undertaken in reliance upon the mistaken beliefs induced by the audits. Given that the plaintiffs’ case is that if the truth had been revealed a controller would have been appointed, there would have been no decisions to have been made differently. I do not consider that there is any substance in this complaint.
Complaint 9: The complaint is that the pleading in para.55.7 and like paragraphs as to what the directors did in relation to investments in e- commerce business is irrelevant, vague and embarrassing, in that they are not particularised and suffer the defects made in complaints 4 and 5. There is no definition of what is “e-commerce business”, although it is provided in the plaintiffs’ response. I consider it should be incorporated in the pleading, and if those businesses were carried on by other companies in the group they should be specified and any necessary corporate and financial (e.g. guarantee) relationship pleaded. See also complaints 20 and 21 below. However, as with previous transactions, it is not necessary to specify every individual transaction.
Complaint 10: It is alleged that the pleading concerning dividends in para.55.8 and other paragraphs is irrelevant, vague and embarrassing because the dividends are not specified, it is not alleged that they were paid unlawfully or out of capital, and there is no allegation of any consequential loss or deterioration in financial position. This has already been sufficiently dealt with. It is not necessary to plead evidence. The complaint has no substance.
Complaint 11: It is alleged that the pleading regarding increased indebtedness of Harris Scarfe to ANZ, noteholders and creditors alleged in para.55.9 and similar paragraphs is irrelevant, vague and embarrassing on the ground that an increase in indebtedness cannot of itself be causative of loss, and that the increases are not particularised. The answer, as discussed above, is that these are not pleaded as particulars of loss but as one of the consequences of the plaintiffs’ reliance on the audit reports. Any further detail of the increase in indebtedness is a matter for evidence, notice of which will no doubt be given by means of discovery.
Complaint 12: Paragraph 57 of the statement of claim alleges that by reason of the breaches of contract, negligence and misleading conduct ANZ (para.57.2) “continued to accept Harris Scarfe’s management in managing the business of Harris Scarfe”. It is said that this is meaningless. I agree. The plaintiffs say that it should be given its commonsense meaning, namely that “ANZ had faith in the veracity of information provided by management and management’s ability to manage the business of Harris Scarfe”. If that is what the plaintiffs say it means, and if that is intended by way of contrast to what it is alleged that ANZ would have done as alleged in para.62.3.2 (lost faith in members of management and ceased to rely on information provided by management unless it was independently verified), then I think it should be pleaded.
Complaint 13: Paragraph 57.13 of the statement of claim alleges that by reason of the defendants’ conduct ANZ continued to rely upon Harris Scarfe’s auditors to confirm information provided to ANZ by Harris Scarfe and to perform the auditors’ duties. It is alleged that this and similar pleas are vague and embarrassing because of their generality. The answer to this objection is similar to that contained in complaint 3.
Complaint 14: The defendants allege that the plea in para.58.2 that by reason of the matters pleaded in para.57 ANZ made further lending to Harris Scarfe, is irrelevant, vague and embarrassing in that the further advances are not identified and there is no allegation of the nature of the deterioration in the financial position of the plaintiffs arising out of the further lending. This falls into a category similar to some of the objections already dismissed, including complaint 11.
Complaint 15: This complaint refers to a number of pleas contained in para.62 and similar paragraphs as to what would have happened if the plaintiffs had become aware of the defects in the accounts. Objection is taken that they are irrelevant because there is no pleading that they give rise to loss or damage. However, these pleas are not related to loss or damage. They plead the steps that would have been taken leading to the appointment of a controller and the cessation of further lending by ANZ. As mentioned above, it is alleged that the appointment of a controller would have resulted in a realisation of the assets of Harris Scarfe. This complaint has no foundation.
Complaint 16: Paragraph 62.3.3 alleges that ANZ would have appointed an investigative accountant “to independently review Harris Scarfe’s business operations and financial position”. It is said that this and similar pleas are irrelevant in the absence of any allegation as to the significance of the opinions that would have been expressed by the investigative accountant. As I understand it this is a plea of one of a number in a sequence of events which would have led to the appointment of a controller and ultimate sale of Harris Scarfe’s assets. It is to be inferred from that sequence pleaded that the advice of the investigative accountant would have given rise to the actions that the plaintiffs allege would have been taken thereafter. The content of the hypothetical advice will no doubt be a matter of expert evidence. This complaint is unfounded.
Complaint 17: Paragraph 62.2.4 and similar paragraphs allege that the directors of Harris Scarfe would have “maintained the operations of Harris Scarfe in a conservative manner”. It is alleged that the pleas are vague and embarrassing by reason of their generality. The plaintiffs respond that the expression has an obvious meaning which is “maintaining a course of trading which, so far as possible, preserved the assets of Harris Scarfe including not committing other than necessary capital or funds pending the further steps set out in the” statement of claim. I am not sure that the meaning is obvious. If that is the meaning to which the plaintiffs attribute the plea, then I think it should be pleaded in a form which fits appropriately with the rest of the relevant pleading.
Complaint 18: Paragraphs 63.2 and 63.3 allege that the controller would have retained consultants to advise on appropriate strategies to maximise returns from the assets of the business and would have sold or disposed of the assets of Harris Scarfe pursuant to the advice of those consultants. It is said that these pleas are vague and embarrassing or that alternatively the particulars of loss are vague and embarrassing, because the particulars of loss proceed on the basis of a hypothetical realisation strategy which is nowhere specifically identified. I consider that the hypothetical realisation strategies are a matter for evidence and will no doubt be revealed in reports of experts required to be exchanged well before the trial commences.
Complaint 19: Paragraph 64 of the statement of claim is the paragraph which alleges that by reason of the facts pleaded in paras.54 to 60, the financial position of Harris Scarfe deteriorated and the plaintiffs suffered loss and damage. It is alleged that that and similar pleadings are inconsistent, vague and embarrassing. I have already dealt with the substance of that objection and need say no more about it. It is not necessary, in the circumstances, to plead particular individual losses flowing from individual transactions.
Complaints 20 and 21: These complaints relate to paragraphs 18.2 and 18.3 of the amended particulars of loss as they pertain to all three defendants. These particulars refer to trade creditors of “Camworks” and “d-store”. The complaint of the defendants is that these are not plaintiffs. In response the plaintiffs assert, although this is not pleaded, that Camworks and d-store are subsidiaries in the Harris Scarfe group and that their liability is the liability of the group by virtue of deeds of cross-guarantee. The present pleading is deficient in that the relationship is not pleaded. It may not be necessary to amend this particular if a satisfactory amendment is made to deal with complaint 9.
Complaint 22: Paragraph 19.2 of the plaintiffs’ amended particulars of loss alleges that the net asset deficiency of Harris Scarfe is subject to future events, namely, in this case, any changed creditors’ figures upon formal proofs of debt (and interest on creditor’s claims). The defendants complain that there is no basis disclosed as to why interest other than under the Supreme Court Act can be recoverable, particularly on claims by creditors rather than on the plaintiffs’ claims. It seems to me that there may well be valid interest claims made by creditors of Harris Scarfe which will go to the calculation of the ultimate loss sustained by Harris Scarfe. The plaintiffs point out in response that an entitlement to interest on creditors’ claims arises under s 554 and s 563B of the Corporations Act 2001. Whether or not they will be proved or allowed in due course by the trial Judge is a matter for evidence. The pleading is not deficient.
Complaint 23: The defendants claim there is double counting for a period of 12 months in the amended particulars of loss claimed in paras.19.3 and 19.4. The plaintiffs acknowledge that the particulars erroneously refer to 2002 instead of 2003. That should be amended.
Complaint 24: Paragraph 19.5 of the amended particulars of loss alleges that the net deficiency of Harris Scarfe is subject to a future event, namely interest on the net asset deficiency (excluding interest bearing debt). The plaintiff acknowledges that this is encompassed in a claim for interest under the Supreme Court Act.
Complaint 25: This complains that the losses claimed by ANZ comprise part of the net asset deficiency claimed elsewhere by Harris Scarfe. That has already been dealt with above. It is not necessary to dwell further on this complaint.
Complaint 26: ANZ claims interest from 3 April 2001 to the date of judgment at its applicable facility rates on the principal monies outstanding (amended particulars of loss paras.29, 43 and 57). The defendants allege that the contractual rates of interest do not constitute the compensable loss of ANZ against the auditors and that there are insufficient material facts pleaded to give rise to a Hungerfords v Walker claim for compound interest. Whatever the basis or merits of the claim, I do not consider that it should be struck out of the statement of claim. Whether interest at the agreed rates is allowable will be a matter for determination by the trial Judge.
Conclusion

In my opinion the proposed further amended statement of claim discloses a reasonable cause of action. It is not materially deficient in its pleading of causation of the plaintiffs’ alleged losses other than in the relatively minor respects which I have identified in these reasons. The plaintiffs will have leave to file the proposed further amended statement of claim subject to some minor adjustments. I will hear the parties further as to costs and consequent directions.