Background

The decision related to a summary judgment motion brought in the context of a class action by the clients of a defunct securities dealer against the dealer's former auditor (see our Exchange post, September 7, 2017, for further detail). It was alleged that the auditor negligently audited an annual registration renewal form required to be filed with the Ontario Securities Commission ("OSC") to confirm regulatory compliance. It was contended that, as a result of this alleged failure, the OSC was deprived of information that would have caused it to intervene in the dealer's operations and thus prevent the class's losses.

Several common issues were certified on consent, including inter alia whether the auditor owed a duty to the class and, if so, whether it breached that duty. The representative plaintiff in turn moved for summary judgment on these questions, amongst others. The motion judge granted summary judgment, holding that the auditor owed the class members a duty of care in its audit and had in turn failed to meet its standard of care.

The Appellate Decision

The Court of Appeal allowed the auditor's appeal, setting aside the judgment below and granting summary judgment in favour of the auditor on the basis that it owed no duty of care to the class.

In arriving at its decision, the Court applied the analytical framework set out in Livent, which had been released after the decision at first instance in Lavender. Under the two-stage Anns/Cooper framework, as refined in Livent, a court must first ask whether the facts establish a prima facie duty of care. This involves establishing two distinct concepts that must be considered separately, namely reasonable foreseeability and proximity. If necessary, the court will then proceed to the second stage where it asks whether residual policy considerations justify denying tort liability.

Epstein J.A., writing for the Court, held that the motion judge erred by conflating the questions of proximity and foreseeability. The Court of Appeal accordingly conducted its own proximity analysis and concluded that proximity was not established with respect to the auditor's client's clients.

The relationship between the auditor and the class did not fall within a previously established category of relationship where proximity had already been found; there was no precedent in which a duty of care had been recognized between an auditor and a company's investor account holders for purposes of auditing the company's compliance with the securities statutory regime. Accordingly, the Court undertook a proximity analysis to determine whether there was a sufficiently "close and direct" relationship to ground a duty of care.

The absence of a personal relationship between the parties, while "not necessarily determinative", is nonetheless an "important factor to consider." Epstein J.A. found that, on a "rigorous examination" of the evidentiary record before the motion judge, a finding of proximity could not be supported for the following reasons:

  1. the auditor's mandate was of limited scope as it undertook only to audit a form that the dealer then provided confidentially to the OSC. The interposition of the OSC (and the dealer itself) between the auditor and the class rendered the relationship between the parties too remote to ground a duty of care;
  2. there was no evidence of class member reliance on the form, which was not intended to inform or otherwise induce the class;
  3. the motion judge based his determination on factual findings that amounted to palpable and overriding errors, such as reliance on a finding that the auditor would have known the names and accounts of the class members when the record revealed that the identities of clients and their accounts in fact changed regularly; and
  4. the applicable statutory scheme did not create a proximate relationship for the purpose of the class members' investment decisions.

In addition, the Court of Appeal reaffirmed that cases of pure economic loss arising from negligence or negligent misrepresentation warrant "significant scrutiny", and the scope of the defendant's undertaking and the plaintiff's reliance on that undertaking are determinative of proximity:

In cases of pure economic loss arising from negligent misrepresentation or performance of a service, two factors are "determinative" of the proximity analysis: (i) the defendant's undertaking; and (ii) the plaintiff's reliance: Livent, at para. 30. Where the defendant undertakes to provide a representation or service in circumstances that invite the plaintiff's reasonable reliance, the defendant becomes obligated to take reasonable care, and the plaintiff has a right to rely on the defendant's undertaking to do so. These "corollary rights and obligations create a relationship of proximity": Livent, at para. 30.

However, the plaintiff's reliance must be within the scope of the defendant's undertaking – that is, the purpose for which the representation was made or the service was undertaken. Anything outside that scope will fall outside the scope of the proximate relationship and the defendant's duty of care; the defendant cannot be liable for a risk of injury against which it did not undertake to protect: Livent, at para. 31. Further, as the majority in Livent observed, at para. 31, "the proximity analysis not only determines the existence of a relationship of proximity, but also delineates the scope of the rights and duties which flow from that relationship" (emphasis in original).

In view of its finding on proximity, the Court of Appeal declined to consider reasonable foreseeability, or residual policy considerations.

Conclusion

As a practical consequence, the Lavender decision will likely discourage negligence claims brought against auditors by parties other than their own clients.

The decision also emphasizes that litigants seeking to establish a duty of care in a claim for pure economic loss must meet a high threshold that requires consideration of not only the scope of the auditor's undertaking, but also the degree of reliance by class members. This aspect of the decision will likely be of comfort to underwriters, securities dealers and other advisers who may become secondary targets of convenience in class actions where an issuer defendant is insolvent.