The Ontario Divisional Court’s recent decision in Whitehouse et al. v. BDO Canada LLP provides guidance on when a certification motion can be dismissed in the context of a pleading that fails to disclose a cause of action. The Divisional Court upheld a previous ruling in determining that a financial auditor, in performing audit engagements for a portfolio management firm, owed no duty of care to the firm’s unitholders in funds.
The Divisional Court’s decision has some direct implications for financial auditors and defendants to class actions. Specifically, it reinforces that:
- where the plaintiff has not specifically pled material facts showing a precise undertaking/representation to assist unitholders, allegations of negligence brought against auditors by third-party investors will likely not succeed and a corresponding class proceeding will likely not be certified; and
- an action will not be certified as a class proceeding if the cause of action in negligence is based on a duty owed to an overly broad, unknown, and indeterminate group of class members.
The plaintiffs were individual unitholders in mutual fund trusts (the Funds) issued by Crystal Wealth Management System Ltd (the Company), a portfolio management firm. In accordance with the Securities Act (Ontario) (OSA), the Company was required to prepare annual audited financial statements to send to every unitholder and file with the Ontario Securities Commission (OSC). The Company retained BDO Canada LLP (the Auditor) to audit the Funds.
From 2007 to 2015, the Auditor provided clean audit opinions. In April 2017, the OSC issued a temporary order prohibiting trading in the Funds and trading in securities held by the Funds. In April 2017, the OSC also appointed Grant Thornton LLP as receiver (the Receiver) over all the assets of the Company. The Receiver subsequently found that the Funds’ net asset values, as disclosed by the Company, were false or manipulated and that, as a consequence, the net asset values of certain Funds had been materially overstated. Since April 2017, the unitholders have been unable to redeem their investments in the mutual funds.
In June 2017, the plaintiffs commenced an action under the Ontario Class Proceedings Act, 1992 against the Auditor, alleging negligence in preparation of the audit reports for the Company. The claim sought a declaration that the Auditor had a duty of care to the class members, which it breached by negligently performing its professional services. The “class members” included every person who invested in any of the Funds of the Company from April 12, 2007 to April 7, 2017 and who retained investments in any of the Funds on April 7, 2017.
On June 15, 2018, the plaintiffs brought a motion at the Ontario Superior Court of Justice to certify the action as a class proceeding. The motion judge refused to certify the class proceeding against the Auditor, stating that the pleading failed to disclose a cause of action.
For negligent performance of a service to be a cause of action, there must have been a duty of care, which in turn requires (inter alia) sufficient proximity and reasonable foreseeability. However, any duty that is owed can be negated by public policy concerns.
After reviewing existing settled law on the duty of care owed to unitholders (including Hercules Managements Ltd v Ernst & Young, Deloitte & Touche v Livent Inc. (Receiver of) and Lavender v Miller Bernstein LLP each as discussed below), the motion judge held that for cases arising from the negligent performance of a service:
- there must be a specific undertaking from the defendants to the plaintiffs; and
- the plaintiffs’ reliance must be sourced within that undertaking.
However, any duty that appears to be owed on that basis might nevertheless be negated on the ground, for example, that it would impose indeterminate liability on the defendants.
The motion judge held that the plaintiffs failed to plead any facts indicating a “direct relationship, undertaking or representation” between the Auditor and the class members. Without a pleaded basis for sufficient proximity, the motion judge held it was plain and obvious that the Auditor, in performing statutory audits, did not owe the plaintiffs a duty of care with respect to their investment decisions. There was no undertaking for the class members to rely on.
The motion judge further considered whether a duty of care arose from the Auditor’s role in ensuring the Company’s compliance with Ontario securities law. The motion judge ultimately concluded that the relationship between the Auditor, the OSC and the unitholders was too remote to ground a duty of care. The motion judge noted that there was no undertaking by the Auditor to assist the proposed class members in their investment decisions or safeguard them from the Company’s non-compliance with the OSA.
The plaintiffs appealed the motion judge’s decision to the Divisional Court.
Divisional Court Decision
On appeal, the Divisional Court upheld the motion judge’s ruling that the plaintiffs had not properly pleaded a cause of action in negligence. Specifically, the Divisional Court held that (i) there was no duty of care that the Auditor owed to the class members, and (ii) the class member definition, as pleaded, was overly broad and indeterminate.
Relationship between auditor and investors
The Divisional Court noted that the judicial and appellate authority considered by the motion judge confirmed that pleaded facts must suggest a precise undertaking of responsibility that gives rise to a relationship owed to the class members. Two cases were particularly influential in the ruling:
- Hercules Managements Ltd v Ernst & Young involved a similar fact pattern in which investors claimed for loss against a company’s auditor. The Supreme Court of Canada ultimately reasoned that the auditor’s mere knowledge of the investors is insufficient for a claim in negligence. The Court also acknowledged that many investors could conceivably review and rely on an audit report even after an auditor ceases to act for the company. Therefore, the Court cautioned that a finding of a category of duty of care would create a risk of indeterminate liability, which might be contrary to public policy.
- Lavender v Miller Bernstein LLP involved a company that retained an auditor to audit reports to file with the OSC. The Ontario Court of Appeal confirmed that absent making representations to the members of the class, or an undertaking to assist the investors in particular investment decisions, there was no direct relationship between the Auditor and the investors.
On appeal, the plaintiffs argued that the motion judge failed to accept, as pleaded, that: (i) the audit reports were delivered directly to the unitholders, (ii) the Auditor knew and intended that the unit-holders would rely on the reports for investment decisions, and (iii) the unitholders did rely on the audit reports in making their investment decisions. The Divisional Court affirmed the motion judge’s conclusion that simply providing audit reports to the OSC did not give rise to a level of undertaking to assist unitholders with investment decisions. Similarly, the Court held that the Auditor’s mere knowledge that the unitholders might rely on the reports did not establish an undertaking either. Ultimately, the Court held that in failing to plead specific facts in which intent could be inferred, a conclusion could not be drawn that the Auditors intended for the unitholders to rely on the reports for their investment decisions.
Class member definition
The Divisional Court held that the class definition, which included every person who invested in any Funds from April 12, 2007 to April 2017 and retained those investments on April 7 ,2017, was overly broad and indeterminate.
Specifically, the Divisional Court reasoned that the class definition implied that there would be members who relied on the Auditor’s reports but acquired units after the Auditor ceased to be the Auditor. The Court observed that, if the plaintiffs’ argument were to be accepted, a cause of action in negligence could be founded on a duty an auditor owed to an unknowable group of prospective investors. The Court concluded that this would lead to the risk of indeterminate liability, against which the Supreme Court of Canada had cautioned in Hercules.