Harris Scarfe Ltd (Receivers & Managers Appointed) (in Liq) v Ernst & Young (No 5) - [2005] SASC 476

SUPREME COURT OF SOUTH AUSTRALIA
(Civil: Application)
HARRIS SCARFE LTD (RECEIVERS & MANAGERS APPOINTED) (IN LIQ) & ORS v ERNST & YOUNG & ORS (No 5)
Reasons for Ruling of The Honourable Justice Bleby
13 December 2005
PROCEDURE - SUPREME COURT PROCEDURE - SOUTH AUSTRALIA - PRACTICE UNDER RULES OF COURT - PLEADINGS
Applications by defendants for plaintiffs to plead further material facts - Operation of Rule 46A - Consideration of the effect of the Statement of Claim - Whether facts relating to loss sufficiently pleaded - Applications dismissed.
Supreme Court Rules 1987 (SA) r 46A, referred to.
Salena Estate Wines Pty Ltd v Devito [2005] SASC 274; Jones v Nuske (2003) 227 LSJS 331; Harris Scarfe Ltd (Receivers and Managers Appointed (In Liquidation) & Ors v Ernst & Young (Reg) & Ors [2005] SASC 113; Sew Hoy & Sons Ltd (In Receivership and in Liquidation) v Coopers & Lybrand [1996] 1 NZLR 392, applied.

HARRIS SCARFE LTD (RECEIVERS & MANAGERS APPOINTED) (IN LIQ) & ORS v ERNST & YOUNG & ORS (No 5)
[2005] SASC 476
BLEBY J:
Background

On 30 March 2005[1] I gave leave to the plaintiffs to file an amended statement of claim against the opposition of the two sets of defendants. The opposition to that application was based on the submission that the proposed statement of claim disclosed no reasonable cause of action. Without going into detail, the defendants alleged that the proposed pleadings did not disclose any necessary causal link between the alleged wrongful conduct of the defendants and the plaintiffs’ alleged losses. I rejected the defendants’ arguments. I subsequently refused leave to appeal.[2] A further application for leave to appeal was made to the Full Court and was dismissed.[3]
[1] Harris Scarfe Limited (Receivers and Managers Appointed) (In Liquidation) & Ors v Ernst & Young (Reg) & Ors [2005] SASC 113.
[2] Harris Scarfe Limited (Receivers and Managers Appointed) (In Liquidation) & Ors v Ernst & Young & Ors (No 2) [2005] SASC 168.
[3] Harris Scarfe Limited (Receivers and Managers Appointed) (In Liquidation) & Ors v Ernst & Young (Reg) & Ors [2005] SASC 255.
The plaintiffs are companies in liquidation, formerly members of the Harris Scarfe Group (“Harris Scarfe”), together with Australian and New Zealand Banking Group Ltd (“ANZ”).
Ernst & Young (“the first defendants”) were auditors of Harris Scarfe for the financial year ending 31 July 1996 and the half yearly review and audit of Harris Scarfe for the financial year ending 31 July 1997. Coopers & Lybrand and their successors in business, PricewaterhouseCoopers (“the second defendants”) conducted the half yearly reviews and audits of Harris Scarfe for the financial years ending 31 July 1998 and 31 July 1999.
By their statement of claim the plaintiffs allege breaches of duty by the defendants in relation to audits and reviews conducted by them between 1996 and 1999, that those breaches caused the directors of the plaintiffs to hold certain mistaken beliefs as to the state of the Harris Scarfe accounts, that those mistaken beliefs in turn caused the directors of Harris Scarfe to continue to trade all aspects of Harris Scarfe’s business as they had previously done in ignorance of the true financial position of the companies and that ANZ, as a result of its mistaken beliefs, continued to afford financial accommodation and made further lending to Harris Scarfe. Harris Scarfe claims loss by reference to the deterioration in the net asset deficiency of the group between the date of an earlier hypothetical receivership, which they allege would have occurred if the true situation had been known, and the date of the actual receivership in April 2001. The plaintiffs claim the amount of the deterioration 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 realised.
The applications
Both sets of defendants now apply for orders that the plaintiffs plead further material facts.
The first defendants seek the pleading of further material facts –
· identifying which transactions or decisions pleaded by the plaintiffs caused a deterioration in the financial position of Harris Scarfe by reference to the policies, decisions and strategies adopted by the plaintiffs in purported reliance on the first defendants’ audit reports; and
· as to the extent of the deterioration in the financial position of Harris Scarfe caused by those transactions or decisions.
The second defendants make an application of similar effect. In addition they seek the pleading of further material facts and circumstances relied on to establish that, by reason of their misconduct in respect of the period ending 31 January 1998 and subsequent accounting periods, the directors in each of the subsequent accounting periods –
·    believed that the audited financial statements were true and correct;
·    believed that Harris Scarfe was in a sound financial position;
·    accepted that the conduct of management in preparing management accounts was reliable;
·    believed that Harris Scarfe was achieving the gross profit levels pleaded;
·    believed that Harris Scarfe was achieving positive store contribution for each store;
·    believed that Harris Scarfe was achieving an operating profit; and
·    believed that Harris Scarfe had certain net asset values pleaded.
They also seek the pleading of further material facts and circumstances relied on to establish that, by reason of the directors’ state of mind induced by the auditors’ alleged wrongful conduct in January 1998, the directors in subsequent accounting periods maintained and adopted certain budgeted gross profit margins. They also seek the pleading of further material facts and circumstances concerning similar matters based on the alleged misconduct, or induced by it, in respect of each of the subsequent audit reports.
Requirements of the Rules
The plaintiffs are required to plead only the material facts relied upon and not evidence or arguments by which they are to be proved.[4] The plaintiffs are required to plead only the material facts relied upon to constitute their causes of action and such further material facts as are necessary to give other parties fair notice of the case which they will have to answer.[5]
[4] Rule 46A.02(b), Supreme Court Rules.
[5] Rule 46A.03, Supreme Court Rules.
An order that further material facts are to be pleaded can only be made where the material facts pleaded do not disclose facts sufficient to give the other parties fair notice of the case which they will have to meet and where the parties seeking them would be “significantly prejudiced” in the conduct of the case by not having them.[6]
[6] Rule 46A.09(1), Supreme Court Rules.
In Salena Estate Wines Pty Ltd v Devito[7] Sulan J, with whom the Chief Justice and Perry J agreed, cited with apparent approval the following passage from a decision of Judge Lunn, a Master of this Court, in Jones v Nuske:[8]
As this action was commenced after 3 June 2000 its pleadings are governed by the new Rule 46A. Much of the old law on pleadings and particulars have been superseded by the provisions of Rule 46A. Rule 46A is to be viewed and interpreted in the light of the mischief which it was designed to overcome. Under the former Rules it was notorious that substantial delays and costs were generated in actions by detailed requests for particulars, and arguments about them, when the resulting amended pleadings contributed little, if anything, to the just and expedient resolution of the action. Rule 46A is intended to limit disputes about proper particularity and pleadings to situations where the lack of particularity would significantly prejudice another party. The old practice also encouraged pleaders to give as little particularity as possible, and hope either the opponents would not request better particulars or the Court would not order them. The new Rules are intended to counteract this.
[7] [2005] SASC 274 at [49].
[8] (2003) 227 LSJS 331 at [6].
It remains only to emphasise that the pleading of further material facts will only be ordered in accordance with Rule 46A.09 where the parties seeking them would be significantly prejudiced, not merely possibly prejudiced, in the conduct of its case by not having the further material facts.
The first defendants’ application
I deal first with the first defendants’ application and at the same time that part of the second defendants’ application of similar effect.
The defendants regard as a “key assumption” in the statement of claim that the decisions taken and transactions entered into by Harris Scarfe in reliance on the incorrect audited accounts caused a fall in the value of the Harris Scarfe Group assets. They argue that they are entitled to have properly pleaded the material facts which underpin this key assumption. This key assumption of the defendants is that the plaintiffs’ claim for damages is a transaction based claim or a claim made up of identifiable losses brought about by Harris Scarfe entering into particular transactions in reliance on the several audit reports. The assumption is that the various transactions and decisions pleaded caused the loss in the sense in which the law understands that term. So understood, the defendants complain that there is a lack of particularity of the losses so caused.
However, that understanding of the plaintiffs’ pleading is misconceived. The misconception is actually acknowledged in another section of the first defendants’ written submission where it is conceded that “the plaintiffs’ case is not based on particular transactions which allegedly caused loss”.[9] As the request for the pleading of further material facts is based on this misunderstanding of the plaintiffs’ pleading, the request is also misconceived.
[9] First defendants’ outline of argument, para.30.
It is not the plaintiffs’ case, as presently pleaded, that the particular decisions made and policies and strategies adopted caused the plaintiffs’ loss. At the risk of over simplifying it, the plaintiffs’ case is that, by reason of the defendants’ negligence, breach of contract and misrepresentations concerning their audit reports, the plaintiffs were misinformed of Harris Scarfe’s true financial position, were told that the companies were making profits and improving their net asset position, whereas in fact the companies were incurring losses and the asset position was deteriorating. It was in that state of knowledge, belief and ignorance of the true facts that the decisions were made and conduct undertaken as pleaded by the plaintiffs, and that the plaintiffs were induced to maintain certain fiscal and trading policies. In the circumstances as then known by the plaintiffs they say that they were reasonable decisions to make and policies to pursue.
The plaintiffs do not rely, in their case on causation, that certain transactions were loss-making transactions. They rely on the fact that continued loss making and asset deterioration then in existence, and which can be demonstrated from a reconstruction of the accounts as they should have been prepared and certified, was concealed from the plaintiffs at the time of each audit report. It is that overall deterioration of which the plaintiffs were then ignorant, and which they say could have been arrested if the true position were known, which constitutes the quantification of the loss as the plaintiffs have now pleaded it. The essence of the plaintiffs’ claim is a failure properly to report previous loss‑making, thereby inducing what was thought to be continued profitable trading. The damages claimed are not losses from particular transactions but losses caused by a pattern or course of trading, particulars of which are given, which the plaintiffs say would not have been embarked on at all if the accounts had been correctly reported.
The plaintiffs’ allegations as to the decisions taken and policies implemented by the plaintiffs are not pleaded as particulars of the plaintiffs’ loss but as particulars of how they continued to trade in the same manner as they had done previously. On their case as pleaded, it is not necessary for the plaintiffs to allege particular losses. Indeed, some of the particular decisions may, in themselves and viewed in isolation, have been profitable. Nor is it necessary to allege that, if they knew the true position, other and different trading decisions would have been made. Their case is that, at each reporting time, if the report were accurate, a controller would have been immediately appointed and the assets disposed of, thereby preventing not only further losses but further trading. In other words, on the plaintiffs’ case none of those decisions would have been taken or policies implemented which were in fact taken and implemented.
That the polices and practices adopted were in fact loss-making and caused overall deterioration in the assets of the plaintiffs, the plaintiffs will no doubt attempt to prove by a reconstruction of the accounts as they should have been prepared. That will go to quantification of the plaintiffs’ alleged losses. Their claim is that the causation, in the legal sense, of those losses was not the pursuit of the practices and policies but the concealment of the fact that these practices and policies were in fact, in the true financial circumstances of the plaintiffs, loss‑making and asset-reducing practices.
The material provisions of the statement of claim[10] do not plead loss caused by pursuing the particular practices and policies adopted, but by reason of the facts pleaded in the earlier relevant paragraphs, including the concealment of the actual losses and asset deterioration at the time of the relevant report.
[10] eg paragraphs 64, 115, 173, 228, 286, 312, 315, 370, 388, 397 and 410.
I repeat the observations I made in Harris Scarfe Limited (Receivers and Managers Appointed) (In liquidation) & Ors v Ernst & Young (Reg) & Ors[11] concerning a dictum of Thomas J in Sew Hoy & Sons Ltd (In Receivership and in Liquidation) v Coopers & Lybrand:[12]
[65]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.’
[66]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.
[11] [2005] SASC 113 at [65] and [66].
[12] [1996] 1 NZLR 392.
The failure to identify loss-making decisions and transactions does not therefore put the defendants at any disadvantage so far as the plaintiffs’ case on causation and damages is concerned. The plaintiffs have pleaded in their statement of claim the trading and fiscal policies they pursued. They have also given particulars of how those policies were implemented in the periods of the defendants’ respective audits. They appear in letters both dated 5 October 2005 to the solicitors for the first and second defendants respectively. Both sides have engaged insolvency and retail trading experts who, I expect, have undertaken extensive analyses of the trading patterns and policies of Harris Scarfe and what they would or should have done assuming certain states of knowledge of the financial circumstances of the companies. Although amended defences in response to the plaintiffs’ amended statement of claim have not yet been filed, there may well be disputes as to whether certain policies and practices pursued by the plaintiffs were commercially sound or otherwise fraught with danger or inherently loss-making even if the accounts were as the directors believed them to be. There may be evidence that external economic influences were bound to ensure that those policies or practices would cause loss. There may be evidence that some of the transactions were of the extraordinary type to which I referred in the extract quoted above. All that will be a matter for the assessment of expert evidence on the topic.
If the defendants succeed in some such arguments at trial the plaintiffs’ claims may fail or may have to be discounted or some appropriate negative allowance made for the occurrence of adverse contingencies. The process of assessment of the plaintiffs’ losses may be one of some complexity, lacking mathematical precision. But it is a process which courts are required to and do confront from time to time. The process will not be assisted, however, by trying to identify particular decisions and policies which in fact caused loss and what loss was in fact caused by the taking of those decisions and the implementation of those policies. In a trading organisation as complex as that of the plaintiffs, that would be an almost impossible task.
I repeat what I said in Harris Scarfe Limited (Receivers and Managers Appointed) (In Liquidation) & Ors v Ernst & Young (Reg) & Ors:[13]
[40]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.
[41]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.
[13] [2005] SASC 113 at [40]-[41].

The first defendants foreshadow an argument at trial that the damages for which they are liable (if any) cannot include what they describe as wrongfully incurred unpayable debt. The argument is that the injured party (the plaintiffs) should receive compensation in a sum which will put the plaintiffs in the same position as they would have been if the wrong had not been committed, in so far as money can do so, but that they cannot recover more than the plaintiffs have lost. They will argue that the plaintiffs cannot recover what are the creditors’ and not the companies losses. Various authorities are cited to support that claim. It is not necessary to comment on those because, as the defendants acknowledge, that is a matter for decision at trial.
However, the defendants complain that the statement of claim does not differentiate between decisions made by the plaintiffs which result in wrongfully incurred unpayable debt and those which do not. This is an added reason why they argue for identifying those decisions and policies which were loss-making.
The short answer to this argument is, once again, that the plaintiffs’ claims for damages as pleaded are not transaction-based claims, so the identification of particular borrowings or increase in creditors as a result of a particular transaction is not relevant. The plaintiffs do not, as I understand their claim, base their claim for damages merely on amounts borrowed and not repaid or on debts otherwise incurred and not paid. The loss they claim is the loss through dissipation of the proceeds of those loans and the dissipation of moneys due to trade and other creditors in loss-making and therefore asset-reducing operations induced by the alleged wrongful conduct of the defendants.
For these reasons, the application by the first defendants and paragraph one of the application by the second defendants must be dismissed.
The second defendants’ further application
The plaintiffs plead that by reason of the defendants’ alleged misconduct, the directors of Harris Scarfe “believed” or “accepted” certain facts which induced them to maintain and adopt particular strategies. The second defendants complain that this does not provide them with fair notice of the facts upon which the beliefs and inducements were founded. I reject that argument.
In each case, the plaintiffs plead delivery of the auditor’s certificate certifying the correctness of the accounts for the appropriate period. The defendants complain that that is the only allegation of fact which is pleaded on which the directors could possibly ground their belief, or which could possibly have induced them to do what they did. They argue that there must have been more, and that they are entitled to know what that was by way of further pleading.
To say that the presentation of the auditor’s certificate is the only other allegation of fact pleaded which could give rise to a conclusion as to the directors’ state of mind and their alleged inducement to pursue certain policies is to ignore other key features of the plaintiffs’ statement of claim. The paragraphs which precede each of the allegations concerning delivery of the auditor’s certificate identify important and fundamental aspects of the accounts of Harris Scarfe which were certified as correct but which are alleged in fact to have been false and misleading. The plaintiffs plead in some detail how the accounts were false and misleading and what, in effect, the directors were not told. Those are pleaded as the facts on which the directors formed their state of mind about the Harris Scarfe financial position and as the foundation for their inducement to take certain action. What weight particular directors gave to that information and those facts and why they were induced to pursue the policies and practices that they did is a matter for evidence at the trial.
If it is the defendants’ contention that the facts alleged are not capable of founding the belief or inducement alleged, then that is tantamount to an application to strike out the pleading for failing to disclose a cause of action. Such application has effectively been dealt with.
One example of the defective pleading relied on by the defendants is a failure to particularise how and where the plaintiffs “maintained and adopted” certain gross profit margins. They complain that the statement of claim does not identify any instance of “adoption”. From a pleading point of view, what is important is that they did maintain or adopt certain profit margins. How they did that is a matter for evidence. There may or may not be any formal board resolutions to that effect. The maintenance and adoption of that particular policy may only be able to be inferred from other direct evidence led. Identification of the proposed defect itself provides the answer to the complaint, namely that the defendants are here seeking particulars of evidence rather than further statements of material fact. No prejudice to the defendants in the preparation of their case has been established by the existing pleading.
The structure of the statement of claim is to plead the facts and circumstances giving rise to the defendants’ contractual, tortious and statutory duties to the plaintiffs and then to plead, in respect of each six month reporting period, the facts and circumstances giving rise to the defendants’ breach of those duties through the provision of false audit certificates, and to plead the consequences of the directors’ reliance on those certificates and the accompanying accounts for the balance of the period to the time when the true position was revealed. It is not alleged that the reliance on one certificate only had effect until production of the next certificate. Thus, the statement of claim alleges a progressive and cumulative reliance on each of the certificates over the period that they were given. While in the period immediately following the first certificate for the year ending 31 July 1996 there is only reliance on the certificate produced for that period, as the pleading progresses, there is progressive reliance on up to nine certificates for related periods until the period ending January 2001. The argument of the second defendants complains of lack of particularisation of reliance on each and on which certificate.
However, that is not a proper subject of particulars. It calls for particulars of evidence which the plaintiffs propose to lead at trial as to what bearing particular certificates and sets of accounts had on a particular director’s state of mind. The defendants have been told what it was that the plaintiffs relied on, why it was false and what state of mind and course of conduct on the part of the plaintiffs that that produced. The rest is a matter for evidence.
It follows that this aspect of the second defendants’ application must also be dismissed.