Mason & Cox Pty Ltd v KPMG Peat Marwick

MASON & COX PTY LTD v KPMG PEAT MARWICK
[1999] SASC 214

Magistrates Appeal: Civil

PERRY J. In this matter, two appeals from orders of a Master were heard together.
The appellant in both appeals is the proposed defendant to an action (“the substantive action”) contemplated by the respondent. For convenience, I will refer to the appellant as KPMG and to the respondent as Mason & Cox.
Mason & Cox is a company which for many years has conducted a steel foundry at Torrensville. It asserts that KPMG audited its accounts between 1989 and 1995. Mason & Cox’s chief financial officer was one Peter Ladner (“Ladner”). As such he had management and control of its financial matters since about 1989. From 1998 he was joint managing director of the company. In April 1998, Ladner’s employment with the company ceased.
After Ladner’s departure from the company, it was found that during the course of his period as chief financial officer Ladner had systematically diverted funds from Mason & Cox to entities associated with him. Ladner has now been charged with fraud.
By application made on 16 December 1998 in the within proceedings, Mason & Cox sought an order that KPMG “provide discovery by way of pre-action discovery of all files of the defendant with respect to the audit by the defendant and its predecessor firms of the financial statements of Mason & Cox Pty Ltd between 1989 and 1996”. In an affidavit sworn in support of the application, Mr Giles French, the managing director of Mason & Cox, stated inter alia:
“10... I verily believe that an audit of the accounts should have identified the diversion of funds to Ladner’s bank accounts. I am advised by Cowell Clarke, lawyers, that in order to maintain a claim against KPMG it will be necessary to identify the manner in which KPMG failed to exercise reasonable care in the conduct of the audit.”
11.................
12.... ...............
13.The plaintiff is advised that it has a sustainable claim and should initiate proceedings against the defendant.
14.... The plaintiff is further advised that to initiate proceedings without the documents would necessarily involve a statement of claim which would not be properly pleaded and unnecessary costs both to the plaintiff and the defendant would result.
15..............”
The application came on for hearing before a Master. While he was seized of the matter and before ruling on the application, KPMG issued a subpoena directed to Mason & Cox seeking production by them of “all documents containing or recording” the advices referred to in paragraphs 10, 13 and 14 of Mr French’s affidavit, and legal advice referred to in certain other correspondence between the parties. They also sought leave to cross-examine Mr French on his affidavit.
Mason & Cox produced the documents sought in the subpoena, at the same time claiming privilege against their production to KPMG. The Master thereupon placed the documents in a sealed envelope. They remain in the sealed envelope on the court file.
Against the plea of privilege, KPMG argued that Mason & Cox had impliedly waived any claim for legal professional privilege.
On 12 March 1999, the learned Master ruled on the question of privilege. In his fiat dated that day he records “Application dismissed”, which I assume refers to both the application for leave to cross-examine Mr French and the application to have access to the documents containing the legal advice. He further directed that the envelope containing the document recording the legal advice remain sealed.
In the same fiat, remarks which he made are recorded as follows:
“Applying the principles enunciated in the case Goldberg and NG 185 CLR 83, I do not consider that the pltf has imputedly waived the claim for legal professional privilege in respect of the legal advice referred to in paras 13 and 14 of the affidavit of Giles French filed herein on 16 December 1998. This arises out of an application by the deft for leave to cross-examine Mr French in respect of his affidavit. The advice has been produced to the Court in a sealed envelope pursuant to a subpoena issued by the deft.”
Later, by order dated 22 March 1999, the learned master ordered pre-action discovery against KPMG in the following terms:
“1..... That the defendant make an affidavit by its proper officer within fourteen (14) days of this date stating whether any files of the defendant with respect to the audit by the defendant, and its predecessor firms, of the financial statements of Mason & Cox between 1989 and 1996 are, or at any time have been, in the defendant’s possession, custody or power and if not then in its possession, custody or power when it parted with them and what has become of them.
2.That the defendant produce to the plaintiff within seven (7) days from the date of the making of the affidavit, such of the said documents as are in its possession, or custody for inspection and copying.”
In the first of the two notices of appeal before me, KPMG contends that the master erred in upholding Mason & Cox’s claim for privilege, and should have held that it had waived privilege over the legal advice referred to in the subpoena.
In the second notice of appeal, KPMG contends that the learned master erred in ordering pre-action discovery in terms of his order to which I have referred; alternatively, that he erred in not limiting the scope of the documents to be discovered to “.... documents relating to audit planning and executive payroll ...”.
The appeal with respect to the ruling as to privilege may be shortly disposed of.
In Goldberg and Anor v Ng and Ors,[1] Deane, Dawson and Gaudron JJ in their joint judgment stated the principles relating to imputed waiver in the following terms:
“The circumstances in which a waiver of legal professional privilege will be imputed by operation of law cannot be precisely defined in advance. The most that can be done is to identify a number of general propositions. Necessarily, the basis of such an imputed waiver will be some act or omission of the persons entitled to the benefit of the privilege. Ordinarily, that act or omission will involve or relate to a limited actual or purported disclosure of the contents of the privileged material. When some such act or omission of the person entitled to the benefit of the privilege gives rise to a question of imputed waiver, the governing consideration is whether ‘fairness requires that his privilege shall cease whether he intended that result or not’.”[2]
[1] (1996) 185 CLR 83.
[2] Ibid at 95-96, citing Wigmore on Evidence (McNaughton rev 1961), vol 8, par 2327, quoted with approval by Gibbs CJ and by Mason and Brennan JJ in Attorney-General (NT) v Maurice (1986) 161 CLR 475 at 481, 488.
It has not been suggested that legal professional privilege does not attach to the communications in question.
In my opinion, the mere fact that Mason & Cox supports its application for pre-action discovery against KPMG with an affidavit which acknowledges that it has obtained advice that it has “a sustainable claim” against KPMG and should “initiate proceedings against” KPMG, is not a circumstance from which it would be fair to impute a waiver.
The other references in Mr French’s affidavit to advice from Cowell Clarke, that in order to maintain a claim against KPMG “it will be necessary to identify the manner in which” that firm failed to exercise reasonable care in the conduct of the audit, and further, that to initiate proceedings without the documents would “necessarily involve a statement of claim which could not be properly pleaded and unnecessary costs”, take the matter no further.
It will almost invariably be the case that an applicant for pre-action discovery against the person against whom proceedings are contemplated, will have obtained some legal advice, at least of a preliminary kind, to see whether it is worth pursuing the matter. If in the course of making its application it refers to the fact that it has received such advice, I cannot accept the proposition that a necessary consequence is that it is to be regarded as having waived the privilege otherwise attaching to the advice which has been given.
Furthermore, it does not appear to me that with respect to any of the grounds upon which KPMG resists the application for discovery, KPMG’s contentions would be assisted one way or the other by being given an opportunity to see the advice given to Mason & Cox before its application was brought. The Court is entitled to assume that Mr French has accurately summarised the effect of the advice in his affidavit, and that is as far as that aspect of the matter can properly be taken.
The second appeal, with respect to the order for pre-action discovery, gives rise to more difficult questions.
The discretion to make such an order is now to be found in SCR R 60.01 which provides:
“(1).. Orders for discovery against a non party and before action
The Court may make an order for disclosure and production of documents:
(a).... by a party to proceedings seeking such an order against a person who is not a party;
(b) by any person seeking such an order against another person where both are likely to be parties to subsequent proceedings.
(2)... Affidavit in support
Such order may be made:
(a).... before commencement of proceedings, on a summons, with the person against whom the order is sought made a defendant to the summons;
(b)after commencement of proceedings on an application in the action to be served on that person and all other parties to the proceeding;
(3)... With the summons or application shall be filed and served a supporting affidavit, specifying the documents sought and their relevance to the proceedings or proposed proceedings.”
Here, there is no doubt that the threshold question to be addressed pursuant to R 60.01(1)(b), namely, whether or not both parties are “likely to be parties to subsequent proceedings” is satisfied. This is so, notwithstanding the fact that Mr Wilkinson, who appeared for Mason & Cox, intimated during the hearing of the appeal that as yet no decision to sue KPMG had been made. Before he gave that intimation, I had thought from the papers that there were indications that a decision to sue had in fact been taken.
I have already referred to paragraph 13 of Mr French’s affidavit in which he stated:
“The plaintiff is advised that it has a sustainable claim and should initiate proceedings against the defendant.”
From his affidavit, I assumed that, acting on advice, Mason & Cox, while having resolved to sue, did not wish to institute the proceedings before obtaining the pre-action discovery which it sought, so that in any statement of claim it could “... identify the manner in which KPMG failed to exercise reasonable care in the conduct of the audit”.[3]
[3] See paragraph 10 of Mr French’s affidavit.
In his reasons for decision, the master refers to the fact that Mason & Cox “has been advised that it has a cause of action against the defendant”. He goes on to comment:
“It is therefore clear that the plaintiff and the defendant are likely to be parties to action. No proceedings, have yet been issued.
The documents are relevant and they are necessary to identify the manner in which the defendant failed to exercise reasonable care, and to enable the plaintiff to properly plead its cause of action. The planning of the audit and the execution of it are matters which are known only by the defendant and can be identified from the documents sought.”
It is, with respect to the master, in that passage that, in my opinion, he fell into error. He appeared to have regarded the fact that the documents were relevant and that the planning and execution of the audit were matters known only by the defendant, as matters which would justify the making of the order.
In my opinion, more than that has to be demonstrated before an order for pre-action discovery should be made. While no doubt SCR R 60.01 creates a broad discretion, it seems to me that the Court should not lightly make an order obliging a party, who may possibly be sued, to make such a substantial disclosure of documents as that which would be involved if the whole of the audit files of the respondent with respect to the audits conducted between 1989 and 1996 were to be produced.
When the master observes in his reasons, “The plaintiff’s problem is it cannot identify the matter (sic “manner”) in which the duty was breached”, with respect, I think that to be something of an overstatement.
It seems to me that Mason & Cox must be taken to be well aware of the terms upon which KPMG was engaged. Ordinarily, there should be at the least a letter of engagement to perform the audit, or perhaps some more formal document evidencing the terms upon which the audit was to be performed. In a letter dated 15 October 1998 addressed to Mr French, KPMG states:
“The audits were carried out in accordance with Australian Auditing Standards. Our engagement letters are quite clear as to the scope of our audit services and do not, in our opinion, extend to the allegations of theft by the joint managing director.”
It follows that, at the least, there must be letters of engagement in the possession of Mason & Cox.
Furthermore, Mason & Cox must be taken to know what books and records were produced or made available for the purposes of the audit; the terms of the various audit certificates which were issued by KPMG; and the dates upon which they were issued. Furthermore, given that investigations have now brought to light fraudulent misappropriations on the part of Ladner culminating in the institution against him of criminal proceedings, it must be that those investigations have laid bare his modus operandi and more particularly the records which were falsified in order to perpetrate the fraud.
Apart from the legal advice which they have obtained, one would assume that Mason & Cox is in a position to engage expert accountants or auditors who would surely be capable of addressing the matters to which I have referred, and offering an opinion as to whether or not, if KPMG had acted with the care expected of ordinarily competent auditors, given the nature of the records to which they had access and the nature of the fraud which was perpetrated, they should have become aware of the fraud.
Looked at from the point of view of pleading, one would expect Mason & Cox, armed with appropriate legal and accounting advice directed towards those matters, to be able to plead the material facts necessary to support its cause of action. When Mr Wilkinson contended that any statement of claim drawn at this stage would run the risk of being struck out for lack of particularity, I drew attention to the fact that there was a difference between the pleading of material facts and particulars.
If material facts are pleaded which are sufficient to sustain at least one cause of action, the action is not liable to be struck out. On the other hand, if there is a lack of particularity, this would ordinarily be made the subject of an order for the furnishing of further and better particulars, before any question of striking out arises.
Mr Wilkinson suggested that if his client was to bring proceedings at this stage, it would not be able to obtain discovery in the substantive action until the pleadings had been completed. It is true that pursuant SCR R 58.01(1), unless the court otherwise orders, the parties must file and deliver to the other party a list of documents making discovery, within 21 days after the close of pleadings. But pursuant to SCR R 58.04, the court may “on application for discovery made at any stage of the proceedings” order discovery to be made by the filing of a list of documents or affidavits, which may be limited in the manners and the various respects set out in R 58.04(b).
I do not accept, as is suggested in the notes in Lunn Civil Procedure South Australia [4] that “exceptional circumstances must be established for a party to be given discovery” before the close of pleadings. It is commonplace these days, particularly in substantial actions where there is a considerable volume of documents to be discovered, for the discovery to be effected before a responding pleading, such as a defence, is filed. In many cases, most of the documents are already in the possession of the plaintiff. This is frequently the case in the very many actions which have been brought in this Court following the corporate excesses of the 1980s, by liquidators of companies against the former directors. In such cases, the liquidator often has a carefully collated mass of documents extracted from the company records upon which it has obtained advice before the institution of proceedings. I have not hesitated in such cases to order discovery of those documents out of the hands of the plaintiff before the defence is filed.
[4] See R 58.04.01.
In this case, there must be in the hands of the proposed plaintiff, Mason & Cox, a number of documents, including their own records, which would be highly pertinent to the action. Of course, there must also be a very considerable volume of documents to do with the audits in the hands of the defendants. In such a case, it should no longer be the practice of the court, if it ever was, to insist upon completion of the pleadings before full and ample discovery is exchanged between the parties. From the statement of claim, it should be perfectly obvious what the case is about, and the statement of claim alone should be a sufficient basis upon which to identify the bulk of the documents liable to be discovered by both parties.
Of course, after the completion of the pleadings, it may be that particular issues which have been raised at that stage might prompt the need for some supplementary discovery to be made.
Here, it seems to me, with respect to the learned master, that it is not right to say that Mason & Cox is unable sufficiently to identify the manner in which KPMG might be alleged to have breached its duty of care to enable a statement of claim to be drawn up, upon the basis of which Mason & Cox can institute the proceedings.
Mr Wilkinson made much during the course of his argument of the inability of Mason & Cox to be aware at this stage, unless access to the documents in question was to be given, of whatever “audit plan” might have been adopted by KPMG as a preliminary to the making of the audit.
If the audit plan defined the scope of the audit in contractual terms, its terms should have been made known to Mason & Cox before the audit was undertaken. If, on the other hand, there was such a plan but it was not notified to Mason & Cox, while no doubt it would be a discoverable document during the course of the proceedings, it would not have the same significance. The standard expected of KPMG would, in those circumstances, be likely to be defined effectively by reference to the appropriate Australian Auditing Standard, which, after all, KPMG has indicated was the standard pursuant to which the audits were carried out.
Of course, a statement of claim drawn up by Mason & Cox’s advisers at this stage might be the subject of a request for particulars, or attempts to amend it at the initiative of Mason & Cox itself following the making of discovery by KPMG which would follow the institution of the proceedings. But it would hardly lie in the mouth of KPMG in such circumstances to oppose the creation of an opportunity to give further particulars if that was sought by Mason & Cox after discovery had been made, given KPMG’s attitude to the application for such discovery to be made, pre-action.
In any event, it is in the very nature of these actions that it is unlikely that arguments about particularity, or as to the adequacy of discovery, will be put to rest by an order giving pre-action discovery of the kind presently sought. It has become almost routine for pleadings in cases such as this to undergo several editions. Furthermore, I do not think that the making of an order for pre-action discovery is likely to have any significant effect upon the adequacy of the pleading in the first place, given the current standard of pleading.

I have no doubt at all that there will be the usual protracted argument between the parties over the quality and adequacy of the pleading and the adequacy of discovery, irrespective of whether or not the application in question was to be allowed.
To summarise, in my opinion, if Mason & Cox has a cause of action worth pursuing, it ought to be able to be advised accordingly on the material which it has access to at this stage and the instructions which it should be able to give to its advisers as to the circumstances in which the audit was conducted by KPMG. Furthermore, I see no reason why there should be any difficulty in drawing up a statement of claim at this stage.
Bearing that in mind, and the fact, as I have indicated, that pre-action discovery of such a considerable volume of documents should not be ordered lightly and unless there are good grounds shown for such an order to be made, in my opinion, the master erred in failing to dismiss the application.
For these reasons, I would:

(a)Dismiss the appeal against the order upholding Mason & Cox’s claim to privilege; and
(b)Allow the appeal against the order directing pre-action discovery, which I would quash, and as to which I would substitute an order dismissing Mason & Cox’s application.

I will hear the parties as to costs.

JUDGMENT CITATIONS
LISTED IN ORDER OF APPEARANCE IN JUDGMENT

(1996) 185 CLR 83.
Ibid at 95-96, citing Wigmore on Evidence (McNaughton rev 1961), vol 8, par 2327, quoted with approval by Gibbs CJ and by Mason and Brennan JJ in Attorney-General (NT) v Maurice (1986) 161 CLR 475 at 481, 488.
See paragraph 10 of Mr French’s affidavit.
See R 58.04.01.

[1999] SASC 214

2 June 1999