Proving losses - the Ikumene case

In the case of Ikumene Singapore v Leong Chee Leng, the plaintiffs, who were the audited company and its majority shareholder, lost because no duty of care was owed by the auditor to the plaintiff shareholder as regards the statutory audit.

Another reason for the plaintiffs' loss was that they could not prove that their loss was caused by the auditor's negligence. Normally, in the case of negligent misstatement cases eg wrong advice given to a client by a professional, the plaintiff must prove that the wrong information or advice caused his loss. This is shown as follows - if the defendant had provided correct information, the plaintiff would have taken action A, but since wrong information was given, the plaintiff took action B, which turned out to be worse than action A.

In the Ikumene case, the plaintiffs were not able to show how if the auditor was not negligent,and provided them with correct information, they would have avoided losses to the company which were trading losses.

Gaelic Inns, JSI Shipping 2 - contributory negligence

The concept of contributory negligence is used by defendants to reduce the amount of damages payable to the plaintiff on the grounds that the plaintiff failed to take reasonable care of his own welfare.

In a traffic accident case, examples of contributory negligence might include

• a plaintiff pedestrian who recklessly runs across a road, and
  
• a car passenger who fails to wear his seat belt.

In the 2 cases headlined above, the court found that the plaintiff companies were themselves contributorily negligent in failing to take steps to stop the fraud complained off. In the JSI Shipping case, the court found that the overseas director did not even read the audit reports that he was complaining about. He also did not take prompt action to terminate Riggs' (the dishonest director)employment and to report the matter to the authorities. Although the auditors used s 391 of the Companies Act, the court found contributory negligence concepts were also relevant.

The concept of contributory negligence echoes concepts of "reasonable diligence" expected from all company directors under s.157 of the Companies Act

JSI Shipping case

In the case of
JSI Shipping (S) Pte Ltd v Teofoongwonglcloong (a firm)
[2007] 4 SLR 460; [2007] SGCA 40,

Riggs, one of the plaintiff company's directors, who was the only one based in Singapore, had drawn excessive remuneration and made other unjustified claims which resulted in a loss of over $1.8m to the company. Unfortunately, Riggs fled the country and no monies were recovered from him.

The defendants were auditors of the plaintiff company over the relevent period of 3 financial years when they issued unqualified audit reports relating to the ccompany's financial statement.

The court found that the auditors were negligent in not verifying the amounts that Riggs was entitled to. They failed to seek alternative evidence when Riggs told that that he had no written employment contract. Furthermore, the court found that the fact that the defendants had asked the other director who was based overseas asked to sign off on the directors' report and draft accounts did not absolve the auditors from liability as they had not made it clear to the overseas director the importance of him verifying their correctness of what he had signed.

On the facts, the court therefore found that the auditors were liable for the loss.

The Gaelic Inns and JSI Shipping cases

As mentioned in a previous posting, the 2 cases of

1. PlanAssure PAC v Gaelic Inn Pte Ltd and
   
2. JSI Shipping (S) Pte Ltd v Teofoongwonglcloong
   

are Court of of Appeal cases involving the liability of auditors. In both cases, the auditors failed to spot fraud committed by the officers of the respective plaintiff companies and were therefore found liable to some extent for the losses caused by the fraud.

It is of course impossible for auditors to stop the first act of fraud and it is normally impossible to blame them except in exceptional cases. For example, if the auditors were hired to suggest improvements in a company's internal control systems but failed to point out serious weaknesses, thus allowing fraud to occur.

The normal way in which auditors are to be blamed for fraud losses is that if the fraud was discovered earlier by the auditors, then either later fraudulent acts would have been stopped or that it might have been possible to recover more of the stolen monies before the criminals had disposed of it. Notice here that the plaintiffs are using arguments as to what might have happened and not on certainties. This is well accepted by the court. Few things in life can be predicted with 100% certainty. The courts adopt a realistic approach by working with probabilities of events happening where appropriate.

Auditors - duty of care

As is well known, in order to sue for professional negligence, it is necessary for the plaintiff to show that 3 things -

• a duty is owed by the defendant professional to the plaintiff;
• the defendant breached his duty of care; and
  
• damage or harm is caused to the plaintiff.

This post will examine the concept of duty of care being owed by auditors and accountants. A duty of care by a defendant to the plaintiff is owed when it is forseeable that harm may be caused to the plaintiff by the defendant's carelessness (what is sometimes called "the neighbour principle"). In plain English, this means that one can predict that if the professional is careless, the plaintiff might in some cases suffer harm. This area of law is complicated due to the courts also considering public policy and fairness, but that is a discussion for another day. In addition, suing for negligent words whether they are written or oral is also more complicated than suing for negligent actions.

What this post aims to do is to mention the leading case of Caparo Industries v Dickman [1990] 2 AC 605, a decision of the House of Lords, England's highest court. This case has been accepted by the Singapore courts. The court held in this case that auditors owe no duty of care to company shareholders in respect of the statutory audit. This means that any lawsuit brought by shareholders of a company against an auditor who is alleged to have performed a negligent audit of the company or given a negligently incorrect audit report is sure to fail. This only applies where the audit is the statutory audit required by the statutes relating to companies (the relevant statute in Singapore would be the Companies Act).

In the above case, the plaintiff was a shareholder who claimed that it had relied on the audit report relating to an investee company which it received, and based on this, proceeded to take over control of the company. The court dismissed the case on a preliminary issue without even deciding whether or not the auditors were careless, since the plaintiff had failed to establish duty of care, its lawsuit stood no chance of succeeding.

It should be noted that a shareholder could sue an auditor where the auditor is specially hired, eg for a due diligence audit - often used where the shareholder is planning to buy over the company. The shareholder could sue in contract law or in tort law.