Esanda Finance Corporation Ltd v Peat Marwick Hungerfords

Citation: (1997) 188 CLR 241

The appellant (Esanda) commenced proceedings against the respondent (PMH) seeking damages for negligence. Esanda was a financier who, in reliance on the audited accounts of a company (Excel), lent money to various companies associated with Excel, accepting a guarantee of repayment from Excel. PMH was a firm of chartered accountants and was Excel's auditor. Esanda pleaded that PMH was negligent in carrying out the audit, and that Esanda suffered loss as a result of relying on the audited accounts. Esanda asserted that it would not have entered into the transactions but for its reliance on the audited accounts.

The statement of claim alleged that PMH owed Esanda a duty of care, as Esanda belonged to a class of persons who might reasonably and foreseeably rely on the audited accounts and audit report. PMH sought to strike out the paragraphs of the statement of claim that alleged negligence, on the basis that the allegations did not disclose any duty of care on the part of PMH. The trial judge refused to strike out the statement of claim and allowed Esanda to add new allegations. PMH appealed to the Full Court which allowed the appeal and ordered the paragraphs alleging negligence be struck out. The Full Court held that PMH's membership of the body which promulgated the accounting standards upon which esanda relied was insufficient to establish a duty of care.

The issues for the High Court were: (i) whether in action for negligence for pure economic loss it is sufficient to plead that it was reasonably foreseeable by an auditor that creditors and financiers of a corporation might rely on the audited accounts of the corporation, along with an unqualified auditor's report upon those accounts, in entering into financial transactions involving that corporation; and (ii) in those circumstances, whether an auditor owes a duty of care to every member of the class comprising creditors and financiers of the corporation.

Held, dismissing the appeal:

Per Brennan CJ:
(i) In actions for negligence occasioning economic loss suffered in consequence of a statement made or advice given by a defendant, foresight or reasonable foreseeability that a member of a class including the plaintiff might rely on the statement or advice and thereby suffer loss has never been held sufficient to support recovery.

(ii) In every case, it is necessary for the plaintiff to allege and prove that the defendant knew or ought reasonably to have known that the information or advice would be communicated to the plaintiff, either individually or as a member of an identified class, that the information or advice would be so communicated for a purpose that would be very likely to lead the plaintiff to enter into a transaction of the kind that the plaintiff does enter into and that it would be very likely that the plaintiff would enter into such a transation in reliance on the information or advice and thereby risk the incurring of economic loss if the statement should be untrue or the advice should be unsound. If any of these elements is missing, the plaintiff fails to establish that the defendant owed the plaintiff a duty to use reasonable care in making the statement or giving the advice.

(iii) As the statement of claim did not plead the necessary elements, the Full Court was correct to order that the relevant paragraphs of the statement of claim be struck out.

Per Dawson J:

(iv) Mere foreseeability of loss by reason of its reliance upon the audited accounts was not sufficient to establish the requisite degree of proximity between the appellant and the respondent.

Per Toohey and Gaudron JJ:

(v) It is necessary to distinguish between reliance as an indicator of proximity and reliance as an element of a cause of action for the negligent provision of information or advice. For the purposes of proximity, reliance clearly involves something over and above the fact that the plaintiff relied on the statement in question as the basis for his or her acting or not acting in a particular way.

(vi) Reliance is to be understood, in the context of the provision of information or advice, as an expectation, which is reasonable in the circumstances, that due care will be exercised in relation to the provision of the information or advice.

(vii) Similarly, the assumption of responsibility should be understood as the assumption of responsibility for providing information or advice in circumstances where it is known, or ought reasonably be known, that it will or may be acted upon for a serious purpose, and loss may be suffered if it proves to be inaccurate.

(viii) A special relationship of proximity marked either by reliance or by the assumption of responsibility does not arise unless the person providing the information or advice has some special expertise or knowledge, or some special means of acquiring information which is not available to the recipient. Further, the relationship does not arise unless it is reasonable for the recipient to act on that information or advice without further inquiry and that it is reasonable for the recipient to act on the information or advice for the purpose for which it is used.

Per McHugh J:
(ix) The mere act of an auditor supplying a signed audit report stating the company's position, knowing that the company would, in turn, pass the statement on to creditors, is not sufficient to establish a duty of care in the circumstances.

(x) There are a number of factors which should be considered in determining whether to extend the liability of an auditor to a person or class of persons whom the auditor knows or ought to know will rely on the audit report, where the auditor has not assumed responsibility to those persons or intended to induce them to rely on the report. These factors include:

• The imposition of an extended duty of care may encourage auditors to be more diligent in the execution of their statutory obligations;
• Extending the liability of an auditor may increase the cost of auditing services which may result in a decrease in the competition for or the provision of such services, and a reduction in the standard of the services;
• The number of trials and the length and complexity of factual and legal issues in negligence actions against auditors and the relative efficiency of parties to absorb losses;
• The fact that creditors and shareholders already have an indirect remedy against the auditor in many cases, in so far as a liquidator or receiver can bring an action on behalf of an audited client;
• The audit client's conduct is the primary reason for the plaintiff's loss, whereas the auditor's role is secondary;
• A plaintiff's ability to establish liability is problematical, even in cases of gross negligence, due to the requirement that the plaintiff prove reliance, when regard is had to the fact that the audit report is itself out of date when it is published;
• The factual issues which arise in auditors’ liability cases make it almost impossible for an auditor to avoid a trial or settlement even when the auditor is not liable to the plaintiff.

Per Gummow J:
(xi) In framing any principle in this area, it is appropriate to have regard to the following considerations:

• A plaintiff, in a case such as this, is attempting to elevate itself beyond the status of other creditors by seeking a solvent defendant from which to recoup the consequences of its poor business judgment in dealing with the company;
• The alleged negligence of the auditor will necessarily be subsidiary to the failures of the company which prepared the accounts the auditor certified;
• The auditing process involves more than the statement of verifiable fact. Instead, it is a complex process involving the formulation of a professional opinion;
• The plaintiff seeks to render the auditor liable as if it had given, but without receipt of reciprocal value for doing so, a guarantee to a range of third parties who finance the operations of the company. This guarantee is unlimited in amount and lacks the protection of various doctrines by which the courts have shown a tenderness to sureties;
• Recipients of that guarantee are in a different league to the recipients of other imposed guarantees, such as consumers in product liability cases.

(xii) As it stood, the statement of claim was deficient in failing to plead a sufficient basis upon which to found the duty of care. The appeal should be dismissed on that limited basis.