Harris Scarfe Ltd (Receivers & Managers Appointed) (in Liq) v Ernst & Young (Reg) - [2005] SASC 255

SUPREME COURT OF SOUTH AUSTRALIA
(Full Court: Application)
HARRIS SCARFE LTD (RECEIVERS & MANAGERS APPOINTED) (IN LIQ) AND ORS v ERNST & YOUNG (REG) AND ORS
Judgment of The Full Court
(The Honourable Justice Perry, The Honourable Justice Debelle and The Honourable Justice Sulan)
12 July 2005
PROCEDURE - SUPREME COURT PROCEDURE - SOUTH AUSTRALIA - PRACTICE UNDER RULES OF COURT - PLEADINGS
The plaintiff company (in liquidation) alleged that as a result of negligent audits by the defendants, a firm of accountants, it had incurred losses by continuing to trade when it would otherwise have ceased trading – the defendants sought leave to appeal against an order of a single judge giving leave to the plaintiffs to file an amended statement of claim – the defendants contended that the proposed pleadings failed to disclose a causal connection between the trading losses and any wrongful conduct on the part of the defendants – consideration of the questions whether the proposed amended statement of claim would disclose a reasonable cause of action, had a tendency to cause prejudice, embarrassment or delay and whether it complied with the rules as to pleadings – held that the statement of claim disclosed an arguable cause of action – application for leave refused.
Supreme Court Rules r 46.18(a), r 46.18(b) and r 46.18(c); Fair Trading Act 1987 (SA) s 56; Supreme Court Act 1935 s 50(1a)(a)(ii), referred to.
Alexander and Ors v Cambridge Credit Corporation Ltd and Anor (1987) 9 NSWLR 310; Sew Hoy & Sons Ltd (In Receivership and In Liquidation) v Coopers & Lybrand (1996) 1 NZLR 392; Adam P Brown Male Fashions Pty Ltd v Philip Morris Inc (1981) 148 CLR 170; Doyle v Olby (Ironmongers) Ltd and Ors [1969] 2 QB 158; Gould and Anor v Vaggelas and Ors (1985) 157 CLR 215; Bateman and Anor v Slatyer and Ors (1987) 71 ALR 553; Galoo Ltd (In Liq) v Bright Grahame Murray [1994] 1 WLR 1360, considered.

HARRIS SCARFE LTD (RECEIVERS & MANAGERS APPOINTED) (IN LIQ) AND ORS v ERNST & YOUNG (REG) AND ORS
[2005] SASC 255
Full Court: Perry, Debelle and Sulan JJ

PERRY J. This is an application by the defendants for leave to appeal to the Full Court from the order of a single judge giving leave to the plaintiffs to file an amended statement of claim.
When the plaintiffs applied for leave to amend the statement of claim, leave to amend was opposed by the first defendant on the ground that the proposed amended pleading would disclose no reasonable cause of action (SCR r 46.18(a)), and by the second and third defendants on the further ground that the amended pleading would have a tendency to cause prejudice, embarrassment or delay (SCR r 46.189(c)), and that it did not comply with the rules of pleading (SCR r 46.18(b)).
Effectively, the argument presented by the defendants before the judge at first instance, was in the nature of a strike-out application. That is how the judge at first instance treated the matter.
Essentially, the defendants contend that the pleading fails to disclose the necessary causal connection between the losses alleged to have been suffered by the plaintiffs and the alleged wrongful conduct of the defendants.
The judge at first instance rejected that contention and held that in his opinion the further amended statement of claim disclosed a reasonable cause of action. He gave leave to file the amended pleading, subject to certain minor adjustments.[1]
[1] Judgment of Bleby J, 30 March 2005 [2005] SASC 114.
As his decision was interlocutory in nature, an appeal from it requires either the leave of the judge at first instance or of the Full Court.[2]
[2] Supreme Court Act 1935 s 50(1a)(a)(ii).
An application for leave was first argued before the judge at first instance, who refused leave.[3]
[3] Judgment of Bleby J 6 May 2005 [2005] SASC 168.
Pursuant to SCR r 94.01(2), the application was renewed by way of appeal to the Full Court.
The court directed that the plaintiffs be heard on the appeal.
Background
The first three plaintiffs, whom I will call collectively “Harris Scarfe”, and the fourth plaintiff, ANZ Banking Group Ltd (“ANZ”), claim damages from the defendants, who are three firms of chartered accountants, with respect to various losses said to have been incurred in consequence of the preparation by the defendants of half-yearly reviews and audits of Harris Scarfe for the period between the year ended 31 July 1996 and 31 July 1999. The reviews and audits were said to have been prepared negligently, in breach of a contractual duty of care and in circumstances amounting to misleading conduct in breach of s 56 of the Fair Trading Act 1987 (SA).
The plaintiffs allege that in the preparation of the various reviews and audits, the defendants failed to detect that senior management of Harris Scarfe had fraudulently manipulated the accounts so as to show substantial operating profits, whereas in reality throughout the relevant period the group had sustained significant losses. Likewise, the net assets of Harris Scarfe were substantially overstated and liabilities understated.
In essence, the case pleaded by Harris Scarfe is that in reliance upon the reviews and audits conducted by the defendants, they continued to trade in the manner in which they had previously traded, which included the implementation of a policy of expansion of the business by acquisition or opening of new stores, whereas if the parlous financial position of Harris Scarfe had been laid bare at the beginning of the period, a controller would have been appointed and there would have been an orderly realisation of Harris Scarfe’s then assets.
A controller was in fact appointed in April 2001, by which time the net asset position of Harris Scarfe had substantially deteriorated. As it was summarised by the judge at first instance:
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 claim of ANZ is predicated upon the assertion that if they had known the true position at the outset of the period in question, they would not have made various loans which were advanced to Harris Scarfe during that period. ANZ alleges that it suffered loss and damage being the shortfall in the recovery of moneys owed to it by Harris Scarfe on the ultimate realisation of the assets of Harris Scarfe.
The application
On the hearing of the application for leave to appeal, the defendants effectively repeated the arguments which they had put unsuccessfully to the judge at first instance. In doing so, they relied heavily upon the decision of the Full Court of the Supreme Court of New South Wales in Alexander and Ors v Cambridge Credit Corporation Ltd and Anor[4] which they contended was indistinguishable from the present case.
[4] (1987) 9 NSWLR 310.
The judge at first instance did not accept that argument, and held that the Cambridge Credit case was distinguishable. He held that a decision of the Court of Appeal of New Zealand in Sew Hoy & Sons Ltd (In Receivership and In Liquidation) v Coopers & Lybrand,[5] which supports the position taken by the plaintiffs, was more in point.
[5] (1996) 1 NZLR 392.
The reluctance of appeal courts to entertain an appeal from decisions relating to practice and procedure has been established by a long line of authority: see, for example, Adam P. Brown Male Fashions Pty Ltd v Philip Morris Inc.[6]
[6] (1981) 148 CLR 170 per Gibbs CJ, Aiken, Wilson and Brennan JJ at 177.
Furthermore, I agree with the observations of Thomas J in Sew Hoy that questions of causation are particularly unsuitable for determination on the basis of pleadings alone:
The inadvisability of seeking to resolve questions of law in advance of the trial when all the facts will be before the Court has been repeatedly stressed. …
Questions of causation are probably particularly unsuitable for consideration on the basis of the pleading alone. As stated by Sir Anthony Mason CJ in March v E & M H Stramare Pty Ltd:[7]
The common law tradition is that what was the cause of a particular occurrence is a question of fact which ‘must be determined by applying common sense to the facts of each particular case’, in the words of Lord Reid: Stapley [v Gypsum Mines Ltd [1953] AC 633 at p 681]
A full grasp of the facts is imperative. Experience has demonstrated time and again that the answer to the question of whether there is a nexus between the breach of the defendant and the loss suffered by the plaintiff and, if so, what it is, then tends to fall into place. Indeed, if the question whether there is a causal connection between the wrong-doing and the damage is to be resolved by the application of common sense, it is difficult to see how that question properly can be approached in advance of the evidence. Common sense thrives on hard facts, not abstractions.
[7] (1991) 171 CLR 506 at 515.
In my view, the very thorough and comprehensive reasons for judgment given by the judge at first instance in support of his order permitting the amended pleading to be filed, are not attended by sufficient doubt to justify the grant of leave to appeal.
Given that I agree entirely with his reasons, no useful purpose would be served by re-visiting the issues and authorities as summarised by him.
I accept that cases such as this, which assert that a negligent audit caused the plaintiff to incur losses by continuing to trade, give rise to difficult questions of causation. Consistently with authority, resolution of such questions will ultimately turn on the application of common sense. That will be a matter for the trial judge to consider in the light of all the relevant circumstances established by the evidence.
The contentions of the defendants came close to the proposition that a course of trading, giving rise to losses, can never be causally attributed to the defendant in a case such as this. I could not agree with a proposition advanced in those terms.
Neither do I accept that it is necessarily the case that the plaintiffs must prove that they entered into every individual transaction forming part of the course of trading, in reliance upon the defendants’ audit certificates.
Reference might usefully be made to other contexts in which the court is obliged to assess damages by reference to losses incurred by reason of a course of trading. An example is cases such as Doyle v Olby (Ironmongers) Ltd and Ors[8] where the plaintiff was fraudulently induced to purchase a business, and carried it on for a period of time after doing so.
[8] [1969] 2 QB 158.
In such cases, as in Doyle v Olby itself, the court may feel it proper to assess damages by reference to cumulative losses progressively incurred over a period of time, without necessarily examining each transaction.
While it might be said that in such cases the necessary causal link is more readily perceived, it is nonetheless necessary for the court to exclude other factors, such as poor business management, when allowance for any such factors might be justified by the evidence.
The approach to the assessment to damages in Doyle v Olby has been expressly approved by the High Court: see Gould and Anor v Vaggelas and Ors.[9] For an example of its application in a case involving damages assessed by reference to trading losses incurred during the carrying on of a business, see Bateman and Anor v Slatyer and Ors.[10]
[9] (1985) 157 CLR 215 per Gibbs CJ at 222-223.
[10] (1987) 71 ALR 553.
In this case, there is a sufficient plea of material facts to sustain the course of action, in that the plaintiffs plead reliance upon the certificates leading to their decision to continue trading.
Whether the losses said to have accumulated at the end of the period of trading may properly be sheeted home to the defendants, is a separate question the answer to which will depend entirely upon the judge’s findings based upon the evidence at trial.
I would refuse leave to appeal.
DEBELLE J. I agree with Perry J that leave to appeal should be refused.
The defendants had opposed the application by the plaintiffs to amend the statement of claim on the ground that the amended statement of claim disclosed no reasonable cause of action and that the amendments have a tendency to cause prejudice, embarrassment or delay in the proceedings. The judge below rejected those contentions and allowed the amendments.
The defendants complain that the plaintiffs have not sufficiently pleaded how the alleged negligence of the auditors caused the losses claimed. In effect, the defendants complain that the plaintiffs have pleaded the issues too simplistically on some kind of post hoc, propter hoc basis. It was contended that the effect of the pleading is to cause the defendant auditors to underwrite trading losses suffered by Harris Scarfe. It was further contended that the judge below had reversed the onus of proof.
Shortly stated, the case for Harris Scarfe Ltd (“Harris Scarfe”) is that, had the defendant auditors reported accurately, a receiver, administrator or liquidator would have been appointed by either the directors of Harris Scarfe, the ANZ Bank, a creditor, a shareholder, the Australian Securities and Investment Commission or some other interested party soon after the auditor’s report for the year ending 31 July 1996 had been received. The receiver, administrator or liquidator, it is alleged, would have
·traded on a conservative basis while 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 those consultants.
It is then asserted that because those steps were not taken the financial position of Harris Scarfe deteriorated further, causing loss to Harris Scarfe. Harris Scarfe then pleads that the measure of that loss is the difference between the net asset deficiency in April 2001 and at the dates when the defendant auditors reported.
I do not accept the submissions of the defendants that a claim of this nature fails to have due regard to the principles in cases such as Alexander v Cambridge Credit Corp Ltd (1987) 9 NSWLR 310 and Galoo Ltd (in liq) v Bright Grahame Murray [1994] 1 WLR 1360. Unlike the facts in those cases, the directors of Harris Scarfe were permitting the company to continue to trade in ignorance of the true position. Harris Scarfe has alleged that its directors relied on the auditors’ reports when making decisions affecting the operations of the company and in consequence suffered loss. The question whether Harris Scarfe is able to establish the causal link between the negligence of the auditors and its losses will depend on the evidence which it will lead: cf. Sew Hoy & Sons Ltd (in receivership & in liquidation) v Coopers & Lybrand [1996] 1 NZLR 392.
There may be serious questions whether the difference in the net asset position represents the true measure of the loss incurred by Harris Scarfe. However, until the evidence is presented, it is not possible to rule on the question whether an assessment of that kind is the correct measure of the loss caused by the negligence of the defendants as opposed to, say, recovery of dividends paid in reliance on the false accounts. The issue cannot be decided in an evidentiary vacuum.
For its part the ANZ Bank asserts that, had it known the true position in 1996, it would have enforced its securities in respect of loans made before the receipt of the auditor’s report for the year ending 31 July 1996 and could have done so without further loss. It adds that it would not have made further loans after that report. The bank claims that the negligence of the auditors caused it to suffer loss by being unable to realise its securities earlier and in being unable to recover the full amount lent on loans made after the negligent report. The bank has identified the losses which they say were caused by the negligence of the defendants. On the face of the matter, there is a clear causal link between the failure of the auditors to properly report and the losses incurred. Again, the question whether those assertions can be established is a matter for determination in the light of the evidence which the bank adduces at the trial.
When stripped to essentials, the effect of the complaints made by the defendants is that the plaintiffs have not provided sufficient particulars of their respective losses. The defendants are in effect questioning whether the plaintiffs are able to prove the alleged losses were caused by any negligence on the part of the defendants. However, they seek to argue the question whether the plaintiffs have in fact proved the causal link between the alleged negligence and their losses in the absence of evidence on those issues.
The question whether further particulars of those losses should be provided is a question for another day. In a complex case of this kind, a useful form of particulars is often the report of an expert as to the loss which has been incurred and how it was incurred. That does not necessarily mean that particulars of some components of the loss cannot be provided before such a report is provided. If no report is to be provided, full particulars might have to be given. For example, it might be appropriate for the ANZ Bank to give particulars of the lending arrangements made after the receipt of the auditors’ reports which the bank says it would not have made if the true financial position of Harris Scarfe had been disclosed. The provision of particulars may answer the defendants’ complaint that they are prejudiced by the pleadings as they stand. I express these views tentatively because the question whether particulars should be ordered was not argued. The point I wish to emphasise is that the defendants’ arguments seem to confuse the question whether there is a reasonable cause of action with the provision of proper particulars.
This is plainly a complex case where issues of causation must be carefully addressed. Harris Scarfe and the ANZ Bank have pleaded that they would have acted differently and have pleaded in general terms the different kinds of decisions which would have been made had the true financial position been known. The defendants might be entitled to particulars of the different kinds of decisions which would have been made. But that, I repeat, is a question which was not argued and may have to be argued. The difference between the issue of causation and the provision of particulars has, I think, been blurred. A causative link between the alleged negligence of the defendants and the losses which the plaintiffs say they have incurred has been pleaded. The question whether the plaintiffs are able to establish the causal link between the alleged negligence and their losses will depend on the evidence which they will lead. In other words, the question whether the plaintiffs are able to demonstrate that the alleged negligence of the defendants caused the claimed losses is a matter for later examination with the benefit of proved facts. It is not for an uninformed decision at this stage.
There is no substance in the assertion that the judge below has reversed the onus of proof.
SULAN J: I would refuse leave to appeal. The relevant factual background is set out in Perry J’s reasons. I shall refer to the first three plaintiffs as Harris Scarfe. The fourth plaintiff is ANZ. I shall refer to the three defendants, the applicants, as the auditors. The main thrust of the auditors’ submissions is that this case is indistinguishable from the circumstances in Alexander & Ors v Cambridge Credit Corporation Limited & Anor[11]. Counsel for the auditors each submit that the pleadings fail to adequately plead that the plaintiffs relied upon the audit report, and that the pleadings do not allege a relevant nexus between the conduct of the auditors and the losses alleged. I do not agree.
[11] (1987) 9 NSWLR 310

It is alleged by Harris Scarfe and ANZ that the half-yearly and annual audits for the 1996 to 1999 financial years were conducted by Ernst & Young in 1996, and Coopers & Lybrand and PricewaterhouseCoopers in the subsequent years. The pleadings particularise the alleged failures of the auditors which it is said amount to negligent conduct on their behalf.
It is alleged that in each year, by reason of breaches of contract, negligence, and misleading conduct of the relevant auditor, that the directors of Harris Scarfe formed certain beliefs and acted upon those beliefs. It is alleged that in each year the directors continued to conduct all aspects of Harris Scarfe’s business in the same manner as previously by reason of the beliefs that the directors had formed. It is alleged that if the directors had known the true position, they would not have continued to conduct the business as they did, and that they would have taken steps to inform ANZ and the Australian Stock Exchange of the true financial position of Harris Scarfe.
The statement of claim alleges that ANZ formed certain beliefs and, by reason of those beliefs, ANZ continued to afford financial accommodation to Harris Scarfe and made further loans. ANZ alleges it would not have continued to advance monies, and would have appointed a receiver.
The position is distinguishable from Cambridge Credit. In that case, the directors were aware that the auditor’s certificate was inaccurate. The directors and the company were not misled. There was no reliance by Cambridge Credit or its directors upon the auditor’s certificate. Cambridge Credit was required to maintain certain ratios under its trust deed. The false audit certificates certified that the business was operating within those ratios. The trustee was misled and relied on the auditor’s certificates, but it was not the trustee which was claiming damages. The trustee had no relevant interest in the case.
As McHugh JA pointed out, the issue of the six-monthly audit certificates did not cause Cambridge Credit’s loss. Although it might be said that if an accurate certificate had been issued in the relevant years, a receiver would have been appointed, the issue of the certificates did not produce the alleged loss. In two of the trading years after inaccurate audit certificates were issued, the company made profits and shareholders’ funds increased.
As to causation, Mahoney JA observed:
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.[12]
[12] Ibid at 335
Harris Scarfe and ANZ do not make their claim simply on the basis that their loss is to be calculated as the difference between the value of the assets if they had been realised in 1996, when compared to their realised value in 2001. Harris Scarfe put their case on the basis that if the directors had known the true position, decisions would have been made about how the business should be conducted having regard to the correct financial position of the companies. ANZ pleads that if it had known the true position, it would have appointed a controller. Each of the plaintiffs relied upon the inaccurate auditor’s certificates and made decisions accordingly.
Harris Scarfe and ANZ plead that losses were incurred as a consequence of the directors and ANZ embarking on a course of conduct whereby business decisions were made and further advances were made in reliance upon the auditor’s certificates. Unlike the situation in Cambridge Credit, their case is to explore conduct in the relevant periods, and to relate that conduct to the breach and the consequential loss.
The question may be whether the plaintiffs can prove their case. Bleby J accurately summarised that the pleadings allege a series of steps and decisions that the plaintiffs took or did not take, based on their reliance on the accounts. Based upon mistaken beliefs the plaintiffs permitted the company to trade in a way which was unprofitable, and in reliance upon the negligently produced certificates, the plaintiffs did not take steps to prevent further trading losses. In the case of ANZ, it continued to provide financial support. In my view, the pleadings do allege a causal connection between the conduct and the losses incurred.