Livent Inc. v. Deloitte & Touche, 2016 ONCA 11

By Strathy C.J.O, Blair and Lauwers JJ.A.
Ontario Court of Appeal
Jan 09, 2016


Heard:  March 23-26, 2015

On appeal from the judgment of Justice Arthur M. Gans of the Superior Court of Justice, dated April 4, 2014, with reasons reported at 2014 ONSC 2176, 11 C.B.R. (6th) 12.

R.A. Blair J.A.:

A.      LIVENT
(1)                Livent’s Accounting Software is Modified
(2)                Kickbacks
(3)                Expense Rolls
(4)                Amortization
(5)                Revenue Transactions
(1)                The Ex Turpi Causa Defence
(2)                Corporate Identification Doctrine
(a)          Corporate Attribution Rules
(b)          Genesis and Development of the Corporate Identification Doctrine
(i)       Lennard’s Carrying
(ii)     Canadian Dredge
(iii)     Application of Canadian Dredge
(3)                Use of the Corporate Identification Doctrine to Apply the Ex Turpi Causa Defence
(4)                Conclusion on Attribution and Ex Turpi Causa
(1)                Purposes of an Audit of a Publicly-Traded Company
(2)                Articulating the Standard of Care
(3)                The Standard of Care Framework: 1996-1998
(a)           Statutory and Regulatory Framework
(b)          The CICA Handbook
(i)    The Objective of an Audit
(ii)     Knowledge of the Client
(iii)     Management’s Good Faith and Professional Skepticism
(iv)     The Detection of Material Misstatements
(c)          The Deloitte Manuals
(d)          Resignation by an Auditor
(4)                Conclusion on Standard of Care
(1)                Pre-1996 Audits
(2)                1996 Audit
(a)           1996 Audit – The PPC
(b)          1996 Audit – Musicians’ Pension Surplus Receivables
(c)          1996 Audit – Revenue Transactions
(3)                1997 Engagements
(a)           Q2/Q3 1997 and the Put – Part One
(b)          1997 Audit and the Put – Part Two
(i)    The Put – Part Two
(4)                Conclusion on Breach of Standard of Care
(1)                Backdrop
(2)                Factual or “But for” Causation
(3)                Remoteness/Proximate Cause
(a)           Normal Business Losses and Deepening Insolvency
(b)          Contingencies
(4)                Conclusion on Causation
I.        DAMAGES
(1)                Measure and Quantum of Damages
(2)                Contributory Negligence
(1)                Contingencies
(2)                Damages and the 1996 Audit
(a)           Discovery of Fraud not a Precondition of Liability
(b)          Necessary Intermediate Audit Steps
(c)          Livent’s Access to the Capital Markets
(3)                Conclusion on the Cross-Appeal


[1]          Garth Drabinsky and Myron Gottlieb were flamboyant entertainment impresarios who, in the 1990s, created and developed a live entertainment empire known as Live Entertainment Corporation of Canada Inc., or Livent. The developer of high-profile stage productions such as The Phantom of the Opera, Show Boat, Kiss of the Spider Woman, Music of the Night, and Sunset Boulevard, Livent had every appearance of a healthy, dynamic, and successful business enterprise.

[2]          Financially, however, it was not. The Livent house of cards came tumbling down in 1998 when new management discovered that Drabinsky and Gottlieb had been fraudulently manipulating the company’s financial books and records over a number of years in order to inflate the earnings and profitability of the operation so they could attract over U.S.$200 million and $77.5 million through the capital markets.[1]

[3]          Livent filed for insolvency protection in Canada and the United States and was placed in receivership. Its assets were subsequently sold for a realization value of approximately U.S.$144 million. Drabinsky and Gottlieb were ultimately convicted of fraud and forgery and sent to jail.

[4]          Deloitte & Touche (“Deloitte”) was the auditor for Livent and its predecessor from 1989 through to 1998, when the fraud was discovered. It issued clean audited financial statements throughout this period. In this action, Livent – through a Special Receiver appointed in the insolvency proceedings for various purposes, including bringing this claim – sues Deloitte for damages in contract and negligence arising out of Deloitte’s failure to follow generally accepted auditing standards (“GAAS”) and thereby discover material misstatements in Livent’s books, records and financial reporting attributable to the Drabinsky and Gottlieb fraud. 

[5]          After a 68-day trial, Gans J. found that Deloitte was not negligent in respect of the pre-1996 audits. Nor was Deloitte liable in respect of the 1996 audit: while it was negligent, its negligence caused no damage to Livent. Deloitte was, however, liable for damages arising from negligence in August/September 1997 and the spring of 1998. He awarded Livent damages in the amount of $84,750,000 plus interest, totalling $118,035,770.

[6]          Deloitte appeals that judgment, alleging the trial judge made multiple legal errors. It argues that it should not be responsible for fraud committed by Livent. It seeks to attribute wrongs committed by Livent officers and employees to the corporation and to rely on the defence of ex turpi causa, sometimes referred to as the defence of illegality. Deloitte also argues that its negligence was not the factual or proximate cause of damages to Livent. While Livent became insolvent, it was in a money-losing business. And, since Livent is insolvent, it is Livent’s creditors that are hurt, not the company itself.

[7]          Livent rejects these arguments. In its cross-appeal, it submits that the trial judge erred in failing to hold Deloitte liable for negligence in respect of the 1996 audit and also in reducing the award of damages by 25 per cent to account for what he called “contingencies”.

[8]          For the reasons that follow, I would dismiss the appeal and the cross-appeal.



[9]          Drabinsky and Gottlieb’s goal was to create a vertically-integrated live entertainment empire that would generate and present high-profile musical and theatrical productions in the entertainment centres of the world. A vertically-integrated live entertainment company is one that assumes all the risks of and responsibilities for – and reaps all of the rewards, if any, from – the entire development, production and performance of the theatrical works. In Livent’s case, this included the ownership and refurbishing of some of the theatres in which the works were performed. It was a costly, capital-intensive, high-risk/high-reward, and, as it turned out, cash-burning undertaking with a constant and voracious appetite for new funding. In the end, this turned out to be Livent’s undoing.

[10]       In 1989, Drabinsky and Gottlieb left the Cineplex organization after a very public but failed take-over bid attempt.  In leaving, however, they purchased and took with them all of the assets and certain of the liabilities of Cineplex’s live entertainment division. The assets included the Pantages Theatre in Toronto and the rights to the production of Phantom.

[11]       The assets were acquired in the name of their partnership, the MyGar Partnership, which first retained Deloitte to audit its financial statements for the year ended December 31, 1989. The audit retainer continued until MyGar was rolled into Livent in 1993.  Thereafter, Deloitte was retained annually as Livent’s auditor until the events leading up to this lawsuit occurred in 1998.

[12]       MyGar was initially successful, at least on the surface. It had a small number of shows and theatres. Phantom and the Joseph and the Amazing Technicolor Dreamcoat tour were popular. In May 1993, MyGar made a public offering and emerged as the public company, Livent. Two years later, Livent applied for registration with the U.S. Securities and Exchange Commission in order to list its shares on the NASDAQ stock exchange. Deloitte prepared financial statements and comfort letters with respect to all of these initiatives.

[13]       By the end of 1995, Livent had six shows in various stages of presentation, including Show Boat, Phantom, Kiss, Music of the Night, and Sunset Boulevard. It also had five other shows under production, including Ragtime, and was spending significant amounts acquiring and renovating the Lyric and Apollo Theatres in New York and the Oriental Theatre in Chicago. By all accounts, Livent and its colourful principals, Drabinsky and Gottlieb, were the toast of the live entertainment milieu.

[14]       But the demand for new funding was constant, and in 1996 – described by the trial judge as “a watershed year” – the web began to unravel. Phantom in Toronto was nearing the end of its run. Sunset Boulevard was an artistic misfire and a financial flop. Livent was required to take an $18.5 million write-off on the show. The financial results for Kiss showed that critical acclaim did not necessarily translate into financial success, and Music of the Night was not meeting expectations. Show Boat, although spectacular, was losing money simply because it was such a costly production. In 1996 alone, Livent went to the markets to raise in excess of $96 million through debenture offerings and public and private placements of its common stock.

[15]       All the while – as far back as the early MyGar days – Drabinsky and Gottlieb (and a legion of employees who were complicit with them) had been misleading Deloitte, investors, and the public, through a progressively complex and massive fraudulent scheme.

[16]       I pause to describe this scheme before continuing with the chronology.


[17]       As Deloitte emphasizes, the trial judge found that Livent “was rife with fraud”: para. 28.  While Drabinsky and Gottlieb were at the centre of the exercise, many other officers and employees of Livent were knowing and willing participants. These included the Chief Operating Officer, the Chief Financial Officer, the Senior Vice-President of Finance, Livent’s General Counsel, the Director and Executive Vice-President, the Senior Vice-President North American Touring, members of the accounting staff and some members of Livent’s Audit Committee. Maria Messina, who until May 1996 was the lead Engagement Partner at Deloitte on the Livent file, was one of them. She left Deloitte and joined Livent at that time, first as Vice-President Finance and later as Chief Financial Officer.

[18]       There were various aspects of the fraud. The following summary is taken largely from the reasons of the trial judge.

(1)          Livent’s Accounting Software is Modified

[19]       Livent’s Manager of Information Services altered Livent’s accounting software in various ways to facilitate the fraud. For example, the software was modified to (i) allow entries to the general ledger to be reversed or unposted and then posted to a different account or to a different accounting period, and (ii) permit staff to change the date on selected invoices. As the trial judge noted, it was “undisputed that the purpose of these modifications was to conceal Livent’s accounting manipulations and to ensure that no trail existed which could be uncovered by Deloitte during the course of the audit”: para. 29.

(2)          Kickbacks

[20]       Between 1991 and 1993, Drabinsky and Gottlieb received approximately $7.5 million in direct or indirect kickbacks from certain Livent service providers through a system that saw the service providers present false or inflated invoices to Livent and then, after receipt of payment from Livent, forward an amount to Drabinsky and Gottlieb or one of their companies.  The kickbacks were part of a plan to enable Drabinsky and Gottlieb to receive money from MyGar in excess of the limits on their “draws” under a loan agreement with RBC.

[21]       The kickbacks were not disclosed to Deloitte. Many of the false or inflated invoices related to theatre engineering investigation work for intended productions and a construction development project involving the lands associated with the Pantages Theatre in Toronto. To make matters worse, a significant percentage of these inflated amounts were capitalized as assets on the MyGar and Livent books, thus falsifying the financial strength of the companies and creating – as the trial judge observed – “a significant distortion to the balance sheet of each from the early days of the operation and well before the date of the IPO”: para. 34.

(3)          Expense Rolls

[22]       Using the modified software referred to above, financial staff, at the behest of Drabinsky and Gottlieb, manipulated expense entries either by backing them out of particular accounting periods, from quarter to quarter or into another year-end, or by moving them into and charging them against other activities or productions. 

[23]       These expense roll manipulations enabled the participants to colour the rosiness of Livent’s financial picture to their advantage, as needed.

(4)          Amortization

[24]       In terms of dollar value, the largest aspect of the fraudulent scheme by far involved the manipulation of millions of dollars of pre-production costs (“PPC”) through their improper transfer from specific shows to fixed assets, or from show to show and, in particular, from one show to another that had not yet opened.

[25]       The PPC included all costs incurred to mount a production prior to its opening – for example, the costs associated with set design and construction, costume design and fabrication, pre-opening advertising, and salaries and related amounts paid to the cast, crew and musicians during rehearsals.

[26]       The improper transfer of the PPC permitted the manipulators either to amortize the PPC over an extended period of time or to avoid amortization in any particular period, depending on the need to show positive results. The overall effect was that Livent’s income was significantly overstated. In the trial judge’s words, this technique was “the watchword of the operation from about 1994 on to early 1998”, when the bubble burst: para. 41.

(5)         Revenue Transactions

[27]       With the need to show that their plans for integrated growth were flourishing and as the demand for more funding intensified, Drabinsky and Gottlieb turned to a series of one-off revenue transactions in an effort to enhance the bottom line. These transactions involved the supposed sale of various assets to third parties, including Livent’s interests in the production rights of its shows, the sponsorship or naming rights associated with its theatres or the productions, and certain lands and density rights associated with the redevelopment and expansion of the Pantages Theatre in Toronto (the “Revenue Transactions”). 

[28]       A common feature of the Revenue Transactions was that the income they generated was to be received over a period of time. There was a continuing tension between Livent and Deloitte, therefore, about when and in what amounts these income streams could be counted as income for the purposes of financial accounting. Many of the Revenue Transactions also had another theme in common: they were not true sales of assets, but were more in the nature of loans or financing agreements.

[29]       There were four Revenue Transactions in fiscal year 1996 and five in fiscal year 1997. As a result of them, Livent recorded approximately $40 million in income in those two years.

[30]       The most critical of the Revenue Transactions was an agreement entered into in May 1997 between Livent and Dundee Realty Corp. (“Dundee”) involving the transfer of Livent’s air rights over the Pantages Theatre and some associated lands for the purpose of building a new condominium-hotel tower and a new theatre. The consideration for the transfer was $7.4 million, but the agreement contained a “put” in favour of Dundee that enabled it to escape from the transaction for a number of reasons, including if construction had not commenced by December 1999. I shall refer to this agreement and its put – which proved to be central to the unravelling of the Livent enterprise – as the “Pantages Air Rights Agreement” and the “Put”.

[31]       Gottlieb insisted on including the revenue from this transaction in Livent’s second quarter (“Q2”) results for the 1997 year – something he needed to enhance the bottom line for purposes of a large public offering that was scheduled for the fall in the United States. This led to considerable controversy with Deloitte and a series of events which caused the trial judge to dub the Pantages Air Rights Agreement and the “infamous” Put as the “Achilles heel” of Deloitte’s defence in the action: para. 174.

[32]       I will return in more detail to this Agreement and the Put later. I note here, however, that although Deloitte was aware of the Revenue Transactions and spent some time examining them, it (like everyone else) was misled by the Livent players as to the true nature of the transactions.


[33]       There were other earlier instances of information being withheld from Deloitte – instances of which Deloitte became aware.

[34]       For example, an October 1990 memorandum revealed that Drabinsky and Gottlieb had withheld relevant financial information. The memorandum dated October 24, 1990 from a Deloitte Manager, Ron Cutway, to two Deloitte partners, Aaron Glassman and Leonard Barkin, reported that RBC had concerns about MyGar. Cutway reported that the bank was concerned that Drabinsky and Gottlieb had failed to report that MyGar was in default of its agreement with the bank. RBC had also complained that it “was not fully satisfied with their dealings with MyGar” and that Drabinsky and Gottlieb were “not proving to be as ‘above board’ with the bank as they should be” regarding cash flows and other financial information. Cutway concluded:

Overall I feel we should conclude that the relationship between the client and the bank is not good and that we should be particularly careful regarding the client’s verbal representations concerning his relationship with the bank and possibly concerning other matters as well. [Emphasis added.]

[35]       A naming agreement entered into between The North York Performing Arts Centre Corporation and Livent in December 1991 carried with it a $7.5 million liability that was not disclosed to Deloitte during the 1991 audit. Deloitte learned about this agreement (and therefore about its non-disclosure) in or around November 1993, however.

[36]       The seeds for distrust had been sown, but Deloitte continued to show no concern. It would reap the produce of those seeds later on.


[37]       The fraud was ultimately discovered after a new management team was put in place by new equity investors in June 1998.

[38]       On April 13, 1998, Livent announced that Lynx Ventures LP, an investment vehicle of Michael Ovitz, had agreed to invest U.S.$20 million in Livent in return for 12 per cent of Livent’s equity. It was also announced that Roy Furman, through Furman Selz Inc., would invest U.S.$2 million in Livent in exchange for 1.2 per cent of Livent’s equity.

[39]        The deal closed in June 1998 and new management subsequently took control. The new team included Robert Webster, a former KPMG partner who assumed responsibility for the financial aspects of the organization as Livent’s new Executive Vice-President.

[40]       On August 6, 1998, in response to an inquiry from Webster about budget overages, Messina and Tony Fiorino, Livent’s Theatre Controller, revealed to Webster that there had been a number of improper cost transfers to fixed asset accounts as well as between shows.

[41]       Later that day, Grant Malcolm, Livent’s Senior Production Controller, and Diane Winkfein, Livent’s Senior Corporate Controller, along with Messina and Fiorino, met with Webster. They disclosed additional accounting irregularities to him.

[42]       A press release was immediately issued disclosing the fraud and the suspension of Drabinsky and Gottlieb. Trading of Livent shares on the TSX and NASDAQ was suspended.

[43]       Deloitte withdrew its original audit opinions on Livent’s financial statements for the years 1996 and 1997.

[44]       KPMG was appointed to conduct an independent investigation and PricewaterhouseCoopers was retained as an independent accounting advisor for Livent’s Audit Committee. Deloitte conducted a re-audit.

[45]       On November 18, 1998, Livent issued restated financial statements for the fiscal years ended 1996 and 1997, and the first quarter of 1998. The restatements identified over $98 million in accounting irregularities.


[46]       The following day, November 19, 1998, Livent filed for insolvency protection in the United States and in Canada. Its assets were sold in the insolvency proceedings to SFX Entertainment Inc. for approximately U.S.$144 million. Drabinsky and Gottlieb were dismissed for cause.

[47]       In September 1999, Livent was placed in receivership and Ernst & Young was appointed Receiver and Manager. Two years later, in November 2001, Roman Doroniuk was appointed the Special Receiver and Manager of Livent for various purposes, including a potential action against Deloitte. This action was commenced on February 28, 2002.

[48]       Livent’s collapse generated a number of U.S. class actions brought by certain investors against Deloitte and other defendants under U.S. securities laws. These actions were settled. As part of the settlement, the U.S. judge supervising the class actions issued orders containing bar provisions and releases. The effect of those bar provisions and releases is an issue on this appeal.

[49]       To complete the saga up to the point of this proceeding, Drabinsky and Gottlieb were convicted of two counts of fraud and one count of forgery in Ontario’s Superior Court of Justice. Their convictions were upheld on appeal, although the sentences imposed were reduced to five years’ imprisonment for Drabinsky and four years’ imprisonment for Gottlieb.

[50]       Further, Deloitte partners were the subject of proceedings before the Discipline Committee of the Institute of Chartered Accountants of Ontario. Three partners were disciplined for their actions relating to the audit of Livent’s 1997 financial statements. The decision of the Discipline Committee was upheld by this Court as well.


[51]       I note that while Livent sued Deloitte in contract and tort, the main thrust of the argument at trial related to the negligence claim and Livent conceded that the damages would be the same in contract as in tort. For that reason, the trial judge’s reasons focus on the tort analysis. However, he concluded that the contract claim succeeded for the same reasons as the tort claim. On the appeal and cross-appeal, argument focussed on the tort claim as well.

[52]       For the purposes of these reasons, the issues to be addressed are the following:

(a) Were the losses sustained Livent’s losses or, instead, the losses of its creditors and other stakeholders?

(b) Is Livent’s claim defeated by the doctrines of corporate identification (an aspect of corporate “attribution”) or ex turpi causa, or by the effect of the U.S. bar orders?

(c)  Did the trial judge extend the duty of care beyond the duty owed to Livent?

(d)  What are the purposes of an audit of a publicly-traded company and what is the standard of care to be applied in determining whether Deloitte was negligent?

(e)   Did Deloitte breach the standard of care?

(f)  If Deloitte did breach the standard of care, were Livent’s losses caused by Deloitte’s negligence? This involves a consideration of (i) the application of the “but for” test, and (ii) issues of remoteness and proximity, including the notions of normal business losses and “deepening insolvency”, and what the trial judge referred to as “contingencies”;

(g) If Livent’s losses were caused by Deloitte’s negligence, what are those damages and should they be limited or minimized by operation of the doctrine of contributory negligence?

(h)  Did the trial judge err in failing to hold Deloitte liable for its breaches of the standard of care in relation to the 1996 audit (the cross-appeal)?



[53]       The standard of review on an appeal of this nature is not controversial.

[54]       The standard of review on pure questions of law is correctness, while that applicable to findings of fact, and questions of mixed fact and law that lie more towards the factual end of the spectrum, is palpable and overriding error: Housen v. Nikolaisen, 2002 SCC 33, [2002] 2 S.C.R. 235, at paras. 8, 10, 36. This latter deferential standard is equally applicable to inferences of fact, which a trial judge arrives at by sifting through the relevant facts, deciding their weight, and drawing factual conclusions: Housen, at paras. 22, 25. As the Supreme Court of Canada explained in H.L. v. Canada (A.G.), 2005 SCC 25, [2005] 1 SCR 401, at para. 74,it is not open to appellate courts to interfere with reasonable inferences drawn by the trial judge:

Not infrequently, different inferences may reasonably be drawn from facts found by the trial judge to have been directly proven. Appellate scrutiny determines whether inferences drawn by the judge are “reasonably supported by the evidence”. If they are, the reviewing court cannot reweigh the evidence by substituting, for the reasonable inference preferred by the trial judge, an equally — or even more — persuasive inference of its own. This fundamental rule is, once again, entirely consistent with both the majority and the minority reasons in Housen. [Emphasis in original.]

[55]       All of these considerations underlie my approach to the analysis of the appeal and the cross-appeal.


[56]       A recurring theme in Deloitte’s submissions is that Livent is not claiming for its own losses, but rather is advancing a proxy claim, indirectly, for losses sustained by its creditors and investors that will be recoverable in Livent’s insolvency proceedings.  For example, in its factum, Deloitte argues that:

  • the duty of care to an auditor’s client does not extend “to assuming economic responsibility for losses experienced by those standing behind it”;
  • the authorities “do not support imposing economic responsibility on auditors for losses beyond those actually suffered by the corporation”;
  • it is a mistake to assume that an auditor’s duty to its client “exists to the extent of all possible losses, however indeterminate, without regard to who exactly is experiencing those losses”;
  • “Livent itself lost nothing because of its frauds”;
  • the trial judge incorrectly assumed that “investor losses are recoverable so long as the company lends its name to an action to recover investor losses on behalf of the investors”; and
  • “[t]he trial judge … failed to apply these principles and granted an award of damages to Livent representing losses experienced not by it, but by its creditors.”

[57]       I reject Deloitte’s submission that the losses were not Livent’s losses. It impermissibly conflates damages sustained by the corporation with the distribution of those damages, once recovered, to creditors and other stakeholders, as part of the assets of the corporation, in the course of the proceeding under theCompanies’ Creditors Arrangement Act, R.S.C. 1985, c. C-36 (“CCAA”). The two legal constructs are quite different, with different rationales and purposes. To conflate them is to disregard the long-recognized principle of corporate law that a corporation is a legal entity separate and apart from its shareholders and stakeholders, and that the corporation alone has the right to sue for wrongs done to it: Hercules Managements Ltd. v. Ernst & Young, [1997] 2 S.C.R. 165, at para. 59.

[58]       In this respect, the debate on the appeal surrounding the impact of the Supreme Court of Canada’s decision in Hercules, and related authorities, is of little assistance. In Hercules, the Court affirmed that, generally speaking, auditors do not owe a duty of care to investors as individuals and that a claim for auditor’s negligence causing harm to the corporation rests with the corporation; it must be pursued either by the corporation or by way of a derivative action on behalf of the corporation.

[59]       Here, Deloitte relies on Hercules for the converse proposition: if the corporation must sue for damages caused to it by an auditor’s negligence, and third-party stakeholders may not assert such a claim, it follows that the corporation may not be used as “a passive receptacle of a cause of action against the auditor to pursue claims ‘for the benefit of’ anyone but itself.” As I have said, however, Livent is not suing here to recover losses sustained by anyone else.

[60]       The trial judge was clear that he was assessing damages sustained by the corporation.  At para. 365, he stated:

[I]t is clear and beyond doubt that Livent cannot advance a claim on behalf of stakeholders, such as shareholders and noteholders. The claim for breach of contract and for negligence is that of the corporation and no such cause of action rests with the shareholders or creditors. The fact that some stakeholders might benefit from any recovery in this action does not, in my view, alter this conclusion.

[61]       And the trial judge summarized Livent’s theory of damages as follows, at para. 291:

The plaintiff’s theory of damages can best be expressed in the following sentence: the measure of damage equals the change or increase in the losses sustained by Livent between the time of Deloitte’s breach and the time of Livent’s eventual CCAA filing, if not its insolvency. [Emphasis added.]

[62]       The damages experts – Ian Ratner for Livent and Stephen Cole for Deloitte – formulated that theory into the following equation:

Loss (L) = Actual Liquidation Deficit (ALD) – Estimated Liquidation Deficit (ELD)



[63]       In this formula, the Actual Liquidation Deficit or ALD is not in dispute. It represents the losses sustained by Livent after taking into account the amounts recovered on the sale of its assets to SFX Entertainment Inc. in August 1999, and is fixed at $418,830,000. The quantum of the Estimated Liquidation Deficit or ELD is contested, but is established by determining what the estimated loss on the sale of the assets would have been at the “Measurement Date” – namely, the date when (a) Deloitte breached its standard of care, (b) the fraud would have been discovered but for the breach, (c) if the fraud had been uncovered, Livent would have been unable to access the capital markets, and (d) this would, in turn, have led to a formal insolvency.

[64]       I will return to the formula later. For present purposes, it is important to note that both experts agreed that the formula generates a number that capturesLivent’s economic loss. In his examination-in-chief on behalf of Deloitte, Cole stated:

The new Ratner theory, as I said earlier, is the sum [referenced in an exhibit], and I should say at the outset that I believe that that is a quantification of Livent’s economic loss. I don’t believe it is a correct calculation, but it is focused on Livent the corporation.


His new theory will bring the court to the same place as what I have been advancing. They are very similar but for our different methods of computing fair market value.  Both methods address the corporation’s loss and both methods recognize the penultimate importance of fair market value. [Emphasis added.]

[65]       I do not suggest that, in making this statement, Cole was conceding that, as a matter of law, Deloitte was responsible for Livent’s loss. What he was recognizing – as I see it – is that whatever loss the formula produced was a loss sustained by Livent and not by anyone “standing behind” it, such as a creditor, investor, or shareholder. I agree and have no difficulty in concluding that the losses in question are Livent’s losses.


[66]       At trial, Deloitte took the position that Livent’s losses were not recoverable because they were caused by its own illegal acts. This submission was advanced on two separate, but somewhat overlapping bases. First, Deloitte argued that Livent’s claim is defeated by operation of the defence of illegality, also known as ex turpi causa. Secondly, it relied on the doctrine of corporate identification (sometimes referred to as the doctrine of “attribution”). As the trial judge noted, these submissions “achieved more than some prominence” during oral argument: para. 245.

[67]       The trial judge rejected both defences. He concluded that, for legal and policy reasons, neither the corporate identification nor the ex turpi causa doctrine should apply. It was not necessary to attribute the frauds to Livent in order to prevent the wrongdoers from profiting from their frauds or to protect the integrity of the legal system. None of the damages to be paid by Deloitte would directly or indirectly benefit a participant in the frauds. Attributing the frauds to Livent would not serve the public policy objectives of either doctrine.

[68]       Deloitte submits the trial judge erred in arriving at these conclusions. It argues that the trial judge failed to recognize that the frauds perpetrated by Livent’s principals, Drabinsky and Gottlieb, and many senior managers and other employees, permeated the corporate structure such that Livent was itself identified with the impugned conduct. The frauds were not committed against Livent; they were committed by Livent. In addition, Deloitte was a victim of the frauds and the ex turpi causa doctrine should be applied to prevent Livent from profiting from its own criminal acts.

[69]       The analysis of these issues requires an examination of both the ex turpi causa doctrine and the corporate identification doctrine. When and why does a party’s conduct bar recovery under the ex turpi causa doctrine?  When and why is a corporation identified with the conduct of its “directing mind” in circumstances such as these? And does either doctrine afford Deloitte a defence to Livent’s claim? In answering these questions, I will review the case law in some detail, given the significance of these issues not only at trial, but also on appeal.

[70]       As I will explain, I agree with the trial judge that neither doctrine assists Deloitte.

(1)       The Ex Turpi Causa Defence

[71]       The phrase ex turpi causa non oritur actio means “from a dishonourable cause an action does not arise”. The statement of Lord Mansfield in Holman v. Johnson (1775), 98 E.R. 1120, at p. 1121, has often been cited as authoritative:

No Court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act. If, from the plaintiff's own stating or otherwise, the cause of action appears to arise ex turpi causa, or the transgression of a positive law of this country, there the Court says he has no right to be assisted. It is upon that ground the Court goes; not for the sake of the defendant, but because they will not lend their aid to such a plaintiff.

[72]       The leading Canadian cases on ex turpi causa are the decisions of the Supreme Court of Canada in Hall v. Hebert, [1993] 2 S.C.R. 159, and British Columbia v. Zastowny, 2008 SCC 4, [2008] 1 S.C.R. 27.

[73]       In Hall, the plaintiff was injured when, in a drunken state, he lost control of his friend’s car and suffered serious head injuries. He sued his friend, the owner of the car, with whom he had been drinking, for giving him permission to drive the vehicle while drunk. The defendant raised the ex turpi causa defence.

[74]       The appeal concerned, amongst other things, the role of ex turpi causa in tort cases. The majority decision, written by McLachlin J., held that courts can bar recovery in tort on the basis of the plaintiff’s illegal or immoral conduct, but only to preserve the integrity of the legal system. That concern does not exist where the plaintiff’s claim is merely for compensation for personal injuries sustained due to the defendant’s negligence. She emphasized, at pp. 179-80, that the use of the ex turpi causa defence is limited:

[T]here is a need in the law of tort for a principle which permits judges to deny recovery to a plaintiff on the ground that to do so would undermine the integrity of the justice system. The power is a limited one. Its use is justified where allowing the plaintiff's claim would introduce inconsistency into the fabric of the law, either by permitting the plaintiff to profit from an illegal or wrongful act, or to evade a penalty prescribed by criminal law. Its use is not justified where the plaintiff's claim is merely for compensation for personal injuries sustained as a consequence of the negligence of the defendant.

[75]       The majority of the Court declined to apply the defence in the circumstances of that case.

[76]       In Zastowny, the Supreme Court affirmed Hall, describing the ex turpi causa doctrine as a matter of judicial policy designed to preserve the integrity of the justice system by preventing inconsistency in the law.

[77]       The case involved a prisoner who was sexually assaulted by a prison official while he was in jail. The prisoner sued and was awarded general and aggravated damages, the cost of future counselling, and compensation for past and future wage loss. At issue was whether he was barred from receiving compensation for wages lost due to incarceration.

[78]       Quoting from Hall, Rothstein J. described the issue, at para. 20, as “under what circumstances should the immoral or criminal conduct of a plaintiff bar the plaintiff from recovering damages to which he or she would otherwise be entitled[?]” He summarized the applicable principles and approach derived from Hall, which I in turn summarize as follows:

  • Because the application of the ex turpi causa doctrine invalidates otherwise valid and enforceable actions in tort, its application must be based on a firm doctrinal foundation, must be made subject to clear limits and should occur “in very limited circumstances.”
  • The only justification for its application is to preserve the integrity of the legal system. This concern is only in issue where a damages award in a civil suit would allow a person to profit from illegal or wrongful conduct or would permit evasion or rebate of a penalty prescribed by the criminal law. This would create inconsistency in the law by punishing conduct through the criminal law, on the one hand, and by rewarding it on the other.
  • The ex turpi causa doctrine generally does not preclude an award of damages in tort because such awards tend to compensate the plaintiff rather than amount to “profit”.
  • The ex turpi causa doctrine is a defence in a tort action. The plaintiff's illegal conduct does not give rise to a judicial discretion to negate or refuse to consider the duty of care which goes to the relationship between a plaintiff and a defendant. It is independent of that relationship. The defendant may have caused harm by acting wrongly or negligently, but the “responsibility for this wrong is suspended only because concern for the integrity of the legal system trumps the concern that the defendant be responsible.”
  • Treating the ex turpi causa doctrine as a defence places the onus on the defendant to prove the illegal or immoral conduct that precludes the plaintiff's action. And as a defence, it allows for segregation between claims for personal injury and claims that would constitute profit from illegal or immoral conduct, or the evasion of, or a rebate of, a penalty provided by the criminal law.

[79]       The Supreme Court concluded that permitting the plaintiff to recover the wages he lost while in prison would introduce an inconsistency in the fabric of the law, which would compromise the integrity of the justice system. In effect, the plaintiff would be indemnified for the consequences of committing illegal acts for which he had been found criminally responsible.

[80]       The application of the ex turpi causa doctrine has therefore been strictly limited in Canada. It will apply only where allowing a plaintiff’s claim would introduce inconsistency into the fabric of the law – by “giving with one hand what it takes away with the other”: per McLachlin J. in Hall, at p. 178, quoted with approval by Rothstein J. in Zastowny, at para. 22.

[81]       I now turn to the corporate identification doctrine, since the issue is whether the frauds of Drabinsky and Gottlieb can be attributed to Livent for the purposes of invoking the ex turpi causa defence.

(2)          Corporate Identification Doctrine

(a)       Corporate Attribution Rules

[82]       By way of introduction, it is helpful to understand how the corporate identification doctrine meshes with other rules of corporate attribution.

[83]       As the Privy Council noted in Meridian Global Funds Management Asia Ltd. v. Securities Commission, [1995] 2 A.C. 500, at p. 506, a variety of rules are used to determine which acts should be attributed to a corporation. A corporation’s “primary” rules of attribution are typically found in its corporate constitution. For instance, the articles of association may specify that a majority vote of shareholders shall be a decision of the company. There are also primary rules of attribution found in business law and general rules of attribution – such as agency law – that apply equally to natural persons.

[84]       As the Privy Council explained at p. 507, “[t]he company’s primary rules of attribution together with the general principles of agency, vicarious liability and so forth are usually sufficient to enable one to determine its rights and obligations.” It is only in exceptional cases – for instance, where a rule of law precludes attribution on the basis of the general principles of agency or vicarious liability – that these principles are not sufficient. For example, a rule may be stated in language primarily applicable to a natural person or require some state of mind. It is in these special circumstances that the doctrine of corporate identification comes into play.

(b)       Genesis and Development of the Corporate Identification Doctrine

[85]       The corporate identification doctrine has its origins in two distinct and unrelated fields, criminal law and maritime law. In criminal law, the doctrine arose from the need to resolve the issue of whether, and in what circumstances, a corporation could be subject to criminal liability for a mens rea offence (an offence requiring a guilty mind). In shipping law, it arose from the need to determine whether a ship-owning corporation could take advantage of a defence, or limit its liability by statute, when the events giving rise to the claim occurred without the “actual fault or privity” of the owner of the ship. These concepts, a guilty mind and fault or privity, are not readily applicable to a corporation, which is a legal fiction.

[86]       I now turn to the two leading cases on corporate identification.

(i)           Lennard’s Carrying

[87]       The seminal case on corporate identification is the House of Lord’s decision in Lennard’s Carrying Co., Ltd. v. Asiatic Petroleum Co., Ltd., [1915] A.C. 705.  Under s. 502 of the Merchant Shipping Act, 1894 (U.K.), 57 & 58 Vict., c. 60, a ship owner had no liability for loss or damage to goods caused by a fire on board the ship where the damage occurred “without his actual fault or privity”. The issue could be resolved easily enough where the owner was a person, but how could acorporation be actually at fault for, or privy to, the cause of the damage?

[88]       Cargo owners sued the ship owner in question after the ship caught fire as a result of defective boilers and the cargo was destroyed. The ship was owned by one limited company and managed by another. The managing director of the latter company, John M. Lennard, was registered as the ship’s manager and took part in its active management on behalf of the ship’s owner. He knew, or at least ought to have known, that the ship’s boilers were defective.

[89]       The House of Lords concluded that the ship’s owner could not avoid liability based on s. 502. In what has become a famous passage, Viscount Haldane described the nature of a corporation and its directing mind, at p. 713:

My Lords, a corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation. That person may be under the direction of the shareholders in general meeting; that person may be the board of directors itself, or it may be, and in some companies it is so, that that person has an authority co-ordinate with the board of directors given to him under the articles of association, and is appointed by the general meeting of the company, and can only be removed by the general meeting of the company.

[90]       Viscount Haldane went on to find, at pp. 713-14, that in the case of a corporation, the requisite fault or privity was not based on the corporation’s vicarious liability for the acts of its employees, but rather was the fault of “somebody for whom the company is liable because his action is the very action of the company itself.” Since Lennard was the “directing mind” of the ship-owning company, his fault or privity in relation to the cause of the fire was the company’s fault or privity and it could not escape liability.

[91]       While the House of Lords explained its decision as a matter of statutory interpretation, the decision has been read as establishing a “general principle of corporate liability”: R. v. Canadian Dredge & Dock Co., [1985] 1 S.C.R. 662, at p. 678. It is not evident, however, that Lennard’s Carrying was intended to state principles of general application.

[92]       In Meridian Global Funds, the Privy Council recognized, at p. 506, that “there has been some misunderstanding of the true principle upon which that case was decided.” It emphasized, at p. 507, that the decision in Lennard’s Carrying was a matter of statutory interpretation and that fashioning a special rule of attribution is context-specific:

[T]here will be many cases in which … the court considers that the law was intended to apply to companies and that … insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy. [Emphasis in original.]

[93]       Despite this caution, Lennard’s Carrying has been followed and referred to in a long line of cases, including the leading Canadian case on corporate identification, Canadian Dredge.

(ii)         Canadian Dredge

[94]       Canadian Dredge involved an appeal by four corporations convicted of fraud and conspiracy under the Criminal Code, R.S.C. 1970, c. 34, as a result of bid rigging. They contended that they were not liable because their managers, who were responsible for the bidding, were acting in fraud of the corporations, were acting for their own benefit, or were acting contrary to instructions. Some of the appellants also challenged the existence of any theory of corporate criminal liability for mens rea offences.

[95]       The Court stated the specific question to be resolved, at p. 669:

Is the criminal liability of a corporation, when it is based on the misconduct of a directing mind of the corporation, affected because the person who is the directing mind is at the same time acting, in whole or in part, in fraud of the corporation, or wholly or partly for his own benefit or contrary to instructions that he not engage in any illegal activities in the course of his duties?

[96]       In answering this question, Estey J. traced the history of the identification theory, including the decision in Lennard’s Carrying, and explored its development in various jurisdictions. He described the theory in the following way, at pp. 682-83:

[The identification theory] produces the element of mens rea in the corporate entity, otherwise absent from the legal entity but present in the natural person, the directing mind. This establishes the “identity” between the directing mind and the corporation which results in the corporation being found guilty for the act of the natural person, the employee…. In order to trigger its operation and through it corporate criminal liability for the actions of the employee (who must generally be liable himself), the actor-employee who physically committed the offence must be the “ego”, the “centre” of the corporate personality, the “vital organ” of the body corporate, the “alter ego” of the employer corporation or its “directing mind”.

It is the wrongful action of the ‘primary’ representative which by attribution to the corporation creates ‘primary’ rather than ‘vicarious’ liability, according to the identification theory.

[97]       The difficult question for the Court to answer was the “appropriate outer limit of the attribution of criminal conduct of a directing mind when he undertakes activities in fraud of the corporation or for his own benefit”: p. 701. Estey J. ultimately drew the following boundaries, at pp. 713-14:

Where the criminal act is totally in fraud of the corporate employer and where the act is intended to and does result in benefit exclusively to the employee-manager, the employee-directing mind, from the outset of the design and execution of the criminal plan, ceases to be a directing mind of the corporation and consequently his acts could not be attributed to the corporation under the identification doctrine…[T]he identification doctrine only operates where the Crown demonstrates that the action taken by the directing mind (a) was within the field of operation assigned to him; (b) was not totally in fraud of the corporation; and (c) was by design or result partly for the benefit of the company.

[98]       In this case, Deloitte submits that this test is satisfied and so the wrongful acts of Livent’s directing minds should be attributed to Livent.

(iii)       Application of Canadian Dredge 

[99]       Canadian Dredge has been applied in a number of different contexts. In particular, Deloitte points to the fact that it has been applied in the non-statutory, civil context. Deloitte also points to the fact that the corporate identification doctrine has been used as a shield as well as a sword. In other words, rather than using the corporate identification doctrine to impose liability on a corporation, as was the case in Canadian Dredge, it has been used to shield a defendant from liability to a corporation. Deloitte relies on two cases in support of these submissions. 

[100]    First, Deloitte relies on this Court’s decision in Standard Investments Ltd. v. Canadian Imperial Bank of Commerce (1986), 52 O.R. (2d) 473, leave to appeal refused, [1986] S.C.C.A. No. 29, as an example of a case in which the Canadian Dredge test has been applied in the non-statutory, civil context.

[101]    In that case, two bank customers sued the bank for breach of fiduciary duty based on the conduct of the bank’s president and chairman. After consideringLennard’s Carrying and Canadian Dredge, Goodman J.A. stated, at p. 493:

In my view the identification doctrine is equally applicable in a civil action where the plaintiff seeks to establish liability on the part of a defendant corporation on the basis of an alleged breach of fiduciary duty (without reliance on the principle of respondeat superior). It is my further view that in such a case the onus on the plaintiff can be no higher than that placed on the Crown in a case of alleged corporate criminal responsibility.

[102]    It was found that the knowledge, intentions and acts of the president and chairman were those of the corporation for the purpose of determining whether the corporation had committed a breach of its fiduciary duty to its customer.

[103]    I do not find Standard Investments of particular assistance, beyond its demonstration that Canadian Dredge can apply in the civil context to attribute knowledge or state of mind to a corporate defendant. It also demonstrates that attribution is not the end of the analysis, but rather a step in determining the legal consequences of the knowledge or state of mind. However, it does not deal with a situation where, as here, a defendant attempts to avoid liability by attributing the acts of corporate individuals to a plaintiff.

[104]    Deloitte also places significant reliance on the Supreme Court of Canada’s decision in 373409 Alberta Ltd. (Receiver of) v. Bank of Montreal, 2002 SCC 81,[2002] 4 S.C.R. 312, for the proposition that corporate identification may be used as a shield.

[105]    The case involved two private corporations. Douglas Lakusta was the sole shareholder, director and officer of 373409 Alberta Ltd. and Legacy Holdings Ltd. He received a cheque payable to 373409, but altered the cheque by adding Legacy as a payee. He deposited it into Legacy’s account without endorsing it. The bank credited Legacy’s account with the amount, which Lakusta subsequently withdrew.

[106]    After 373409 went into liquidation, its Receiver and Manager brought an action in conversion against the bank for having accepted 373409’s unendorsed cheque for deposit into Legacy’s account. A lending institution’s liability in conversion depends on finding that (1) payment on the cheque was made to someone other than the rightful holder of the cheque, and (2) such payment was not authorized by the rightful holder. In that case, the sole question was whether the bank was authorized by 373409 to deal with the cheque as it did.

[107]    The Supreme Court concluded that 373409, through Lakusta, authorized the bank to deposit the proceeds of the cheque into Legacy’s account. In effect, Lakusta, qua shareholder and director, authorized Lakusta, qua officer, to deposit 373409’s funds into Legacy’s account.

[108]    While Major J. noted, at para. 22, that Lakusta’s actions may have been wrongful vis-à-vis 373409’s creditors, his actions were not in fraud of the corporation itself:

In Canadian Dredge & Dock Co. v. The Queen, [1985] 1 S.C.R. 662, it was held at p. 713, that where a criminal act “is totally in fraud of the corporate employer and where the act is intended to and does result in benefit exclusively to the employee-manager”, that act cannot be attributed to the corporation. In this appeal, Lakusta’s diversion of money from 373409 to Legacy may very well have been wrongful vis-à-vis the corporation's creditors. However, Lakusta’s action was not in fraud of the corporation itself. Since Lakusta directed the funds into Legacy’s account with the full authorization of 373409’s sole shareholder and director, being himself, that action was not fraud in respect of 373409.

[109]    Because 373409, through Lakusta, authorized the bank to deposit the cheque’s proceeds into Legacy’s account, the bank was not liable in conversion.

[110]    The trial judge in this case commented on this decision. He noted that it did not involve an action by an “affected” company against a third party for a breach of duty or contract. He stated that “[p]roperly understood, 373409 Alberta Ltd. did not involve [the] corporate identification doctrine at all”: fn. 167. Rather, the case depended on the “primary rules” of attribution in corporate law, where the actions of the sole shareholder and director are attributed to the corporation. Canadian Dredge was only used to explain why the wrongfulness of Lakusta’s actions with respect to the creditors did not prevent his actions from being attributed to the corporation for the purpose of determining whether the bank was authorized to deal with the cheque.

[111]    I agree that the Supreme Court’s decision in 373409 Alberta was more concerned with conventional rules of attribution than with the corporate identification theory. The Supreme Court found that Lakusta was the sole officer of 373409 and its only agent. He was acting within the scope of the authority granted to him by 373409 and his action in instructing the bank to deposit the cheque’s proceeds into Legacy’s account was attributable to the corporation on agency principles. I therefore find the case of little assistance.

(3)         Use of the Corporate Identification Doctrine to Apply the Ex Turpi Causa Defence 

[112]    Two things are apparent from the foregoing cases on the ex turpi causa defence and the corporate identification doctrine.

[113]    First, under Canadian law, the ex turpi causa defence does not give the court discretion to withhold a civil remedy for damages merely because the plaintiff has engaged in misconduct. The overriding concern is whether permitting recovery would give rise to inconsistency in the law and thereby damage the integrity of the legal system.

[114]    Secondly, the corporate identification doctrine, which has been applied in both the civil and the criminal context, both as a sword and as a shield, is not a free-standing legal rule. It is a mechanism to facilitate the application of rules of law, either statutory or common law, to a corporation where the primary rules of attribution are not available. I agree with the proposition, expressed by the Privy Council in Meridian Global Funds, that the application of the mechanism must be tailored to the terms of the particular substantive rule it serves.

[115]    In this case, the question is whether the corporate identification doctrine can be used to attribute the frauds of Drabinsky and Gottlieb to Livent, allowing Deloitte to rely on the ex turpi causa defence. I now turn to case law dealing with that very issue – the use of the corporate identification doctrine to apply the ex turpi causa defence.

[116]    The parties point to three cases in which the issue was the use of the corporate identification doctrine to attribute wrongdoing to a corporation for the purposes of applying the ex turpi causa defence.

[117]    First, Deloitte relies on Hart Building Supplies Ltd. v. Deloitte and Touche, 2004 BCSC 55, 41 C.C.L.T. (3d) 240, a decision the trial judge in this case described as being “almost on all fours”: para. 255. Deloitte says the trial judge erred in not following Hart Building, “the only case on point in the Canadian jurisprudence” and which is “squarely against” Livent’s position.

[118]    Hart Building sued its auditor, Deloitte, for failing to detect that Calvin Larson – the corporation’s president, general manager, director and minority shareholder – had fraudulently overstated its inventory. Deloitte argued that Larson’s actions were the actions of Hart Building and that the corporation was not entitled to profit from its own fraud.

[119]    After setting out the criteria established in Canadian Dredge for the application of the corporate identification doctrine, the trial judge in Hart Buildingcommented that Canadian courts have applied the doctrine where it was established either that the directing mind intended to benefit the corporation as well as himself or herself, or that the corporation did, in fact, obtain some benefit, even if the ultimate consequences for the corporation were disastrous.

[120]    She found that Larson was the directing mind of Hart Building and he had acted within his authority in dealing with the inventory and with Deloitte. Larson’s intention was to allow Hart Building to survive until economic conditions had improved and this was to the benefit of the corporation.

[121]    She rejected the submission that the corporate identification doctrine should not be applied because doing so would deny compensation to Hart Building, a victim of Deloitte’s negligence. Deloitte was a victim of Larson’s deception and to allow recovery would permit Hart Building to benefit from its own fraud. She concluded, at paras. 63-64:

Larson was Hart's directing mind and its alter ego. Hart may not benefit from its own fraud. Hart, in the person of Larson, deliberately misrepresented the true state of its financial affairs to Deloitte, in contravention of the agreement it entered into with Deloitte by virtue of the representation letters Larson, acting on behalf of Hart, signed. Hart knew that the audited financial statements were incorrect, because Hart provided false information with the knowledge and intention that the auditors would rely on that false information in preparation of the statements. Hart did not rely on the audited statements because Hart's directing mind knew those statements were incorrect.

The identification doctrine applies in these circumstances and Hart's action must be dismissed.

[122]    The trial judge in the case before this Court declined to follow Hart Building. He referred to an article by Professor Darcy L. MacPherson that questioned the application of the doctrine to actions against third parties and raised policy arguments against its use to shield an auditor from liability for negligence in the preparation of the statutorily-mandated audit: see Darcy L. MacPherson, “Emaciating the Statutory Audit – A Comment on Hart Building Supplies Ltd. v. Deloitte & Touche” (2005) 41 Can. Bus. L.J. 471.

[123]    The trial judge concluded that “the corporate identification doctrine was not intended to and does not apply to an action commenced by an aggrieved company against a third party for negligence or breach of contract”: para. 261. He concluded, as well, that on a proper analysis, the issue was not whether the fraud of the principals should be attributed to the corporation for all purposes, but rather whether it should be attributed to the corporation for the purposes of applying the ex turpi causa doctrine.

[124]    I think the trial judge was right in declining to follow Hart Building, which is not binding in any event. The trial judge in Hart Building applied the ex turpi causadoctrine without actually identifying it, and without considering the issue identified by the Supreme Court in Hall and Zastowny – namely, whether the application of the doctrine was necessary to preserve the integrity of the justice system.

[125]    However, to the extent that the trial judge in this case was suggesting that the corporate identification doctrine could never be used to attribute thoughts or actions to a corporation for the purposes of allowing a third party to rely on a defence such as ex turpi causa, I should not be taken as agreeing with that general proposition. The application of an attribution rule is contextual and will depend on the circumstances of the case.

[126]    The second case referred to by the parties was the House of Lords’ decision in Stone & Rolls Ltd. (in liquidation) v. Moore Stephens (a firm), [2009] UKHL 39, [2009] 1 A.C. 1391, one of the Court’s last decisions before being replaced by the Supreme Court of the United Kingdom. In Deloitte’s submission, the trial judge erred in relying on Lord Mance’s dissenting opinion. Livent, on the other hand, submits that the case is distinguishable, as it involved a one-person company, although it also submits that Lord Mance’s dissenting opinion is persuasive.

[127]    Stone and Rolls Ltd. (“S & R”) was beneficially owned, controlled and managed by Zvonko Stojevic. He used the company to engage in frauds on a number of banks, including a Czech bank. Substantial sums were fraudulently extracted from the banks, channelled through S & R and paid to Stojevic and other fraudsters. The Czech bank successfully sued Stojevic and S & R, obtaining judgment for more than U.S.$94 million. S & R was unable to pay the damages and went into liquidation.

[128]    The company’s liquidators sued the company’s auditor, Moore Stephens, in contract and negligence for failure to detect the fraud. It was acknowledged that if the claim against the auditor succeeded, the major beneficiary would be the Czech bank, which had no direct claim against the audit firm. The firm denied negligence and brought an application to have the claim struck on the basis of ex turpi causa.

[129]    The trial judge held that the actions and state of mind of Stojevic could be attributed to S & R, but since detection of fraud was the “very thing” the auditor was engaged to undertake, the firm was not entitled to rely on that fraud to support an ex turpi causa defence.

[130]    Moore Stephens appealed to the Court of Appeal. The Court concluded that S & R was to be attributed with responsibility for the fraudulent activities of Stojevic, since S & R was a “villain”, not a “victim”. Because S & R relied on the illegal conduct to found its claim against its auditor, ex turpi causa was a defence to the claim.

[131]    In a split decision, the House of Lords dismissed the appeal.

[132]    The majority, in three separate sets of reasons, agreed in the result that the auditor could invoke the ex turpi causa defence. 

[133]    Lord Phillips, who delivered the lead opinion, observed at para. 86, that “all whose interests formed the subject of any duty of care owed by Moore Stephens to S & R, namely the company’s sole will and mind and beneficial owner Mr. Stojevic, were party to the illegal conduct that forms the basis of the company’s claim.” However, Lord Phillips was not persuaded that ex turpi causa “would necessarily defeat S & R’s claim if S & R were a company with independent shareholders that had been ‘high-jacked’ by Mr Stojevic”: para. 63.

[134]    In dissent, Lord Scott concluded Stojevic’s actions should not be attributed to S & R for the purposes of an action by S & R against its auditor. He was not satisfied that the ex turpi causa doctrine was engaged because, as the company was insolvent, Stojevic would not benefit from his misconduct.

[135]    Lord Mance, who was also in dissent, agreed, at para. 275, that the ex turpi causa doctrine should not apply:

[T]his appeal should be allowed on the ground that Moore Stephens’s duty was to the company, that it is not sufficient for Moore Stephens to argue that every relevant emanation of the company consisted of Mr. Stojevic as its directing mind and sole shareholder, if Moore Stephens failed in breach of duty to the company to detect the continuing scheme of fraud being pursued by Mr. Stojevic and to detect that the company was (in fact, due to such scheme of fraud) insolvent or potentially so. In that context, Moore Stephens cannot attribute to the company itself, for the purpose of invoking against it the maxim ex turpi causa, the knowledge of and involvement in the fraud of Mr. Stojevic which (it is for present purposes to be assumed) they ought to have detected and reported to regulators or other proper authorities in the company's interests. What would have happened upon such detection and report is simply a matter of causation.

[136]    He expressed concern that the view espoused by the majority “will weaken the value of an audit and diminish auditors’ exposure in relation to precisely those companies most vulnerable to management fraud”: para. 276. As discussed below, I share his concern about weakening the integrity of the audit system.

[137]    Given its multiple sets of reasons, it has been said that “it is notoriously difficult to extract a ratio from the judgments” in Stone & RollsMadoff Securities International Ltd. v. Raven & Ors, [2013] EWHC 3147 (Comm.), at para. 315. Indeed, in Jetivia SA v. Bilta (U.K.) Ltd. (in liquidation), 2015 UKSC 23, [2015] 2 W.L.R. 1168, a subsequent decision of the U.K. Supreme Court, Lords Toulson and Hodge concluded, at para. 154, that “Stone & Rolls should be regarded as a case which has no majority ratio decidendi. It stands as authority for the point which it decided, namely that on the facts of that case no claim lay against the auditors, but nothing more.” With some qualifications, Lords Neuberger, Clarke, and Carnwath were of the view that Stone & Rolls should, borrowing the words of Lord Denning M.R. in In re King, [1963] Ch. 459 (C.A.), at p. 483, be put “on one side in a pile and marked ‘not to be looked at again’”: Bilta, at para. 30. Lord Mance himself observed that the correctness in law of the outcome in Stone & Rolls might “one day fall for reconsideration”: para. 50.

[138]    In view of these qualifications, I find Stone & Rolls to be of limited assistance. I also agree that the case is distinguishable in that it involved a one-person company.

[139]    Thirdly, it remains to consider the judgment of the U.K. Supreme Court in Bilta, referred to above. That decision, affirming the judgment of the Court of Appeal, was released after the argument of the appeal in this case. This Court invited and received additional submissions on the decision.

[140]    Bilta (U.K.) Ltd. was an English company. Its directors, Muhammad Nazir and Chetan Chopra, who was the sole shareholder, used the company to perpetrate a Value-Added Tax or VAT fraud. It was alleged that Jetivia SA, a Swiss company, and its managing director, Urs Brunschweiler, had knowingly assisted the Bilta directors in their breach of fiduciary duty. This resulted in Bilta owing the tax authorities more than £38 million and becoming insolvent. Bilta’s liquidators then commenced proceedings against Jetivia, Brunschweiler, Nazir and Chopra for conspiracy to defraud, breach of fiduciary duty, dishonest assistance, and fraudulent trading.

[141]    Jetivia and Brunschweiler applied for their claims to be struck out or summarily dismissed on the grounds that they were precluded by ex turpi causa. The argument was that Bilta could not sue them because the wrongful acts of Bilta’s directors should be attributed to the company.

[142]    The High Court dismissed the application for summary dismissal, and Jetivia and Brunschweiler appealed. The Court of Appeal dismissed the appeal and the Supreme Court unanimously dismissed a further appeal. 

[143]    The Supreme Court’s judgment by the seven-member Court consisted of four separate sets of reasons. There was considerable disagreement on the scope of the ex turpi causa defence, but some unanimity on the doctrine of attribution. Lord Neuberger, summarizing his views and those of five of his colleagues, stated the following proposition on attribution, at para. 7:

Where a company has been the victim of wrongdoing by its directors, or of which its directors had notice, then the wrongdoing, or knowledge, of the directors cannot be attributed to the company as a defence to a claim brought against the directors by the company's liquidator, in the name of the company and/or on behalf of its creditors, for the loss suffered by the company as a result of the wrongdoing, even where the directors were the only directors and shareholders of the company, and even though the wrongdoing or knowledge of the directors may be attributed to the company in many other types of proceedings.

[144]    This proposition is not difficult to accept. Directors cannot tag a corporation with their own misdeeds to set up a defence to a suit by the company’s liquidators.

[145]    The Court did, however, disagree about the approach to the ex turpi causa defence, having what Lord Neuberger described, at para. 13, as a “spectrum of views.” His own view was that the case was not a proper one for the resolution of the issue.

[146]    In view of the well-established Canadian jurisprudence on the ex turpi causa doctrine, I derive little assistance from Bilta on this point.

[147]    In conclusion, I find Hart Building, Stone & Rolls and Bilta of little assistance in determining whether the trial judge erred in refusing to allow Deloitte to rely on the ex turpi causa defence through the mechanism of the corporate identification doctrine.

[148]    I now turn to an analysis of the trial judge’s application of the corporate identification and ex turpi causa doctrines on the facts of this case and my conclusions in that regard.

(4)          Conclusion on Attribution and Ex Turpi Causa

[149]    In my view, the trial judge did not err in concluding that Deloitte could not rely on the corporate identification doctrine or the ex turpi causa doctrine to excuse itself from liability.

[150]    The trial judge properly identified the question to be answered. He recognized that the question was “not whether Gottlieb and Drabinsky’s fraud should be attributed to the corporation for all purposes”: para. 263 (emphasis in original). Rather, the question was “whether their fraud should be attributed to Livent for purposes of applying the ex turpi causa doctrine”: para. 263 (emphasis in original). He recognized that he was obliged to determine whether declining to apply the doctrine would undermine the justice system.

[151]    The trial judge was not persuaded that attributing Drabinsky and Gottlieb’s frauds to Livent would serve the purposes of the ex turpi causa doctrine on the facts of this case. He stated, at para. 270:

In the case at bar, the plaintiff corporation had innocent shareholders and directors who were not party to the fraudulent schemes of Gottlieb and Drabinsky. Hence, if Livent were to recover damages from Deloitte, none of that money would provide any benefit, direct or indirect, to anyone who participated in the fraud. No wrongdoer would therefore be allowed to profit from his wrong or to evade a criminal sanction, and therefore the integrity of the legal system would not be called into question. In these circumstances, therefore, I am not persuaded that the purpose of the ex turpi causa doctrine would be served by attributing the fraud to the company.

[152]    He also noted that attributing the frauds to the company in the circumstances of the case would deprive the innocent participants of a remedy for auditor’s negligence in a situation where the services of an auditor are most important – where there is fraud by high-level management. 

[153]    The trial judge quoted with approval, at para. 272, Lord Mance’s observation, made at para. 241 of Stone & Rolls in dissent, that the “very thing” an auditor undertakes is to exercise reasonable care in relation to the possibility of financial impropriety. Lord Mance said: 

Leaving aside situations in which the directing mind(s) is or are the sole beneficial shareholder(s), it is obvious ... that an auditor cannot, by reference to the maxim ex turpi causadefeat a claim for breach of duty in failing to detect managerial fraud at the company's highest level by attributing to the company the very fraud which the auditor should have detected. It would lame the very concept of an audit – a check on management for the benefit of shareholders – if the higher the level of managerial fraud, the lower the auditor's responsibility. When Lord Bridge noted in Caparo Industries plc v Dickman [1990] 2 AC 605, 626E that shareholders' remedy in the case of negligent failure by an auditor to discover and expose misappropriation of funds by a director consisted in a claim against the auditors in the name of the company, he cannot conceivably have had in mind that it would make all the difference to the availability of such a claim whether the director was or was not the company's directing mind. The fact that a "very thing" that an auditor undertakes is the exercise of reasonable care in relation to the possibility of financial impropriety at the highest level makes it impossible for the auditor to treat the company itself as personally involved in such fraud, or to invoke the maxim ex turpi causa in such a case. [Emphasis added.]

[154]    The policy underlying the ex turpi causa doctrine is, as I have discussed, to maintain the integrity of the justice system by preventing a wrongdoer from profiting from his or her wrongdoing or evading a criminal sanction. As noted above, there may be cases where the doctrine could be applied as a defence in a civil action brought by a corporate plaintiff and cases where the wrongdoing of the directing mind(s) of a plaintiff corporation could be attributed to the corporation for the purposes of invoking the ex turpi causa doctrine.

[155]    However, I reject Deloitte’s submission that the trial judge erred in failing to apply the corporate identification doctrine, despite finding that the test fromCanadian Dredge had been met, and further erred in finding that Livent’s cause of action was not barred by the ex turpi causa defence.

[156]    In my view, even if the Canadian Dredge test were to be applied in the context of this case such that the fraudsters’ acts are attributed to Livent, there is no basis for invoking the ex turpi causa defence through attribution because invoking the defence is not required to maintain the integrity of the justice system in these circumstances. The actual fraudsters will not profit from their wrongdoing and have not evaded criminal sanction. Nor will Livent profit from the wrongdoing. As I will explain, Livent in fact suffered a loss.

[157]    In addition, I am not persuaded that the three-step Canadian Dredge test – which was developed in a much different context than the one here – is necessarily the complete answer where a defendant seeks to attribute illegal or wrongful acts to a corporate plaintiff for the purposes of invoking the ex turpi causadefence in a civil action, as Deloitte seeks to do here. As I have explained, the application of the corporate identification doctrine must be tailored to the terms of the particular substantive rule it serves.

[158]    In my view, even if the Canadian Dredge factors are satisfied, there are at least two additional factors that are relevant to the inquiry. The first is whether applying attribution for the purposes of ex turpi causa is consistent with the contract or relationship between the plaintiff and the defendant, including contractual or other duties owed by the defendant to the plaintiff. The second is whether doing so is necessary to preserve the integrity of the justice system – an overriding consideration in the ex turpi causa context.    

[159]    In the circumstances of this case, the contractual relationship between Deloitte and Livent was shaped by the statutory, regulatory and professional standards governing Deloitte as an auditor of a public company, which I detail below.

[160]    In addition, I note that under the engagement letters, which formed part of the contract between Deloitte and Livent, Deloitte undertook to evaluate the fairness of the presentation of the financial statements in conformity with generally accepted accounting principles (“GAAP”) and to conduct its audits in accordance with GAAS. It is true that, under those same letters, Livent acknowledged that it was responsible for designing effective internal controls, properly recording transactions in the accounting records, making appropriate accounting estimates, safeguarding assets and ensuring the overall accuracy of the financial statements. Nonetheless, in accordance with GAAS, Deloitte was under an obligation to have proper auditing procedures in place to reduce the risk of not detecting material misstatements to an appropriately low level. To borrow the words of Lord Mance, one of the “very things” Deloitte was retained to do was to exercise reasonable care in relation to detecting fraud. This is underscored by the fact that Deloitte knew at all material times that the financial statements it prepared were being used to solicit investment in Livent.

[161]    With respect to the second inquiry – whether attribution is necessary to preserve the integrity of the justice system – as found by the trial judge, no wrongdoer would profit and no criminal sanction would be evaded if Livent were awarded damages. In short, it is unnecessary to apply the ex turpi causa doctrine to preserve the integrity of the justice system. Indeed, it could be said in these circumstances that the opposite would be true. I find perceptive Lord Mance’s view in Stone & Rolls, referred to above, that “[i]t would lame the very concept of an audit” if the auditor could, “by reference to the maxim ex turpi causa, defeat a claim for breach of duty in failing to detect managerial fraud at the company’s highest level by attributing to the company the very fraud which the auditor should have detected”: para. 241.

[162]    Furthermore, applying the ex turpi causa doctrine in these circumstances would risk undermining the value of the public audit process, and thereby the integrity of the justice system as well. I agree with the trial judge’s observation, at para. 271, that applying the ex turpi causa doctrine on these facts would have a perverse effect: 

Indeed, to attribute the fraud to the company in these circumstances would have the perverse effect of depriving the innocent participants in the enterprise of a remedy for the negligence of its auditor in precisely those cases where the services of an auditor are most critical – namely, the detection of wrongdoing by high-level management. That proposition is, in my opinion, part of the underlying rationale of the leading auditors' negligence cases in Canada and the U.K. … [T]he leading decisions in both jurisdictions contemplate a corporation bringing an action against its auditor for failure to detect wrongdoing by directors.

[163]    In the end result, there is no reason to interfere with the trial judge’s conclusion that Deloitte cannot rely on the corporate identification doctrine for the purposes of invoking the ex turpi causa defence to escape liability for its negligence.


[164]    Nor am I persuaded that the U.S. bar orders preclude Livent from advancing its claim.

[165]    As I have explained, Deloitte takes the position that this action is really brought on behalf of Livent’s stakeholders. It submits that the Receiver’s claims should be dismissed because the stakeholders have already received compensation through settlements of investor class actions in the United States. Building on this argument, it also submits claims that Livent’s action is barred by releases and bar orders made by a U.S. court in approving the settlements of the class actions brought on behalf of Livent’s shareholders and noteholders.

[166]      The settlements were embodied in orders of the United States District Court for the Southern District of New York. The terms of the orders were similar.  These terms:

  • approved the settlements as fair and reasonable and in the best interests of the class;
  • discharged Deloitte and barred all future claims against it in, arising out of, or relating to, the actions;
  • released Deloitte of all claims belonging to the representative plaintiffs and members of the classes;
  • released Deloitte of all claims by others arising out of the claims settled by the classes; and
  • barred the classes or anyone claiming on their behalf from pursuing the settled claims, directly or indirectly, in any other forum.

[167]    The trial judge rejected Deloitte’s position on this issue. He gave two reasons.

[168]    First, the U.S. class action litigation was entirely different from this proceeding. The plaintiffs and causes of action were different. The class actions were brought under U.S. securities legislation permitting investors to recover their personal financial losses from Deloitte as a result of misrepresentations in Livent’s financial statements. The claims in this action were brought by Livent, as distinct from its stakeholders, and the cause of action was for negligence in the performance of the auditor’s duties, not negligent misrepresentation.

[169]      Secondly, Deloitte’s submission was contrary to Livent’s plan of reorganization, which courts in Canada and the U.S. approved and to which Deloitte is deemed to have consented. The plan confirmed that Livent’s assets included its claim against Deloitte.

[170]      I agree with the trial judge’s conclusion and his reasons.

[171]      Nothing in the court orders approving the settlements expressly or impliedly includes Livent’s claims in this action within the scope of the settled claims. Livent was a defendant in the class actions. The settlements contained no release or bar of Livent’s claims against Deloitte. As a matter of interpretation, the orders do not address Livent’s claims. Deloitte does not argue otherwise.

[172]     Deloitte is therefore driven to argue that this is really an action brought on behalf of Livent’s stakeholders, who have already been compensated in the class actions. I have previously rejected that submission.

[173]    I therefore reject this ground of appeal.


[174]    The trial judge found that the duty of care question could “be answered in the affirmative without too much difficulty”: para. 49. He noted that in the wake of the Supreme Court’s decision in Hercules, “there can be little doubt that auditors owe a duty of care to the company for the benefit of the corporate collective, the shareholders”: para. 50.

[175]    Deloitte, however, argues that, in effect, the trial judge extended an auditor’s duty of care to its client to include economic responsibility for losses experienced by those standing behind it. In doing so, it raises the “spectre of indeterminate liability” – an issue that has been the subject of discussion in a number of cases: see e.g. Ultramares Corp. v. Touche, 174 N.E. 441 (N.Y.C.A. 1932), per Cardozo C.J., at p. 444; Caparo Industries plc v. Dickman, [1990] 1 All E.R. 568 (H.L.), at pp. 576-77; Haig v. Bamford, [1977] 1 S.C.R. 466, at p. 484; and Hercules, at paras. 31-41.

[176]    I reject Deloitte’s argument on this point.

[177]    There can be no real dispute that Deloitte owed a duty of care to its client, Livent, to conduct the audit in accordance with the applicable standard of care. 

[178]    While issues of remoteness remain to be addressed below, for duty of care purposes, once it is accepted that the cause of action being asserted belongs to Livent and is not being advanced for the benefit of third-party stakeholders, policy concerns about imposing an “indeterminate liability” on auditors  – much touted by Deloitte in its argument – fall away. 

[179]    I now turn the issue of the standard of care.


[180]    The trial judge considered the standard of care for the relevant period at some length. In assessing the standard of care, he considered the evolution of case law dealing with auditor’s negligence. He also heard days of expert evidence. D. Paul Regan testified as an expert on behalf of Livent, while Ken Froese and David Yule gave expert evidence on behalf of Deloitte. Amongst other things, they made reference to the Handbook of the Canadian Institute of Chartered Accountants (the “CICA Handbook”), the Institute of Chartered Accountants of Ontario Member’s Handbook (the “ICAO Member’s Handbook”) and its Council Interpretations, and Deloitte’s audit manuals for the relevant period (the “Deloitte Manuals”).

[181]    Recognizing that an auditor has a duty to exercise, at a minimum, the skill and care which a reasonably competent and cautious auditor would exercise in the same circumstances, the trial judge grappled with the more difficult task of determining the requisite standard of skill and care to be exercised in this particular case.

[182]    Deloitte does not appear to challenge the trial judge’s analysis on standard of care other than on the question of the duty of an auditor to resign. Nevertheless, in this section I will review the standard of care analysis in some detail, since it informs the subsequent discussion on negligence, causation and damages.

[183]    Before turning to the standard of care analysis, it is important to understand the purposes of an audit in the context of a publicly-traded company.

(1)          Purposes of an Audit of a Publicly-Traded Company

[184]    Courts, including the trial judge in this case, have recognized that audits fulfil two key objectives: (i) to ensure that the financial information presented by management provides a fair and accurate picture of the financial affairs of the corporation and of any changes in the financial position of the corporation; and (ii) to provide shareholders with information for the purpose of overseeing the management and affairs of the corporation (including the ability to measure the level of honesty with which management performs its duties).  In this regard, Lord Oliver made the following observation in Caparo Industries, at p. 583:  

It is the auditor’s function to ensure, so far as possible, that the financial information as to the company’s affairs prepared by the directors accurately reflects the company’s position in order, first, to protect the company itself from the consequences of undetected errors or, possibly, wrongdoing … and, second, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company’s affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided.

[185]    The Supreme Court of Canada adopted this statement of the objectives of an audit in the Canadian context in Hercules, at paras. 48-49. The same purposes are amply reflected elsewhere in the case law, and they remain central to the auditing function in the corporate context: see e.g. In re London and General Bank(No. 2), [1895] 2 Ch. 673 (Eng. C.A.), at pp. 682-83; Fomento (Sterling Area) Ltd. v. Selsdon Fountain Pen Co. Ltd., [1958] 1 All E.R. 11 (H.L.), at p. 23; Pacific Acceptance Corp. v. Forsyth (1970), 92 W.N. (N.S.W.) 29 (S.C.), at p. 53; Roman Corp. Ltd. v. Peat Marwick Thorne (1993), 11 O.R. (3d) 248 (Gen. Div.), at p. 260; and Capital Community Credit Union Ltd. v. BDO Dunwoody (2000), 4 B.L.R. (3d) 1 (Ont. S.C.), at paras. 223-27, aff’d (2002), 151 O.A.C. 32. See also William A. Macdonald, Report of the Commission to Study the Public’s Expectations of Audits (Toronto: Canadian Institute of Chartered Accountants, 1988), at pp. 1-2.

[186]    In the case of publicly-traded corporations, however, an audit has a third important and broader objective involving the responsibilities of securities regulators and the interests of the investing public. It is not only the corporation and its existing shareholders who need and rely on the auditors’ reports. Securities regulators and members of the investing public also rely on them for disclosure of a fair and accurate picture of the financial position of the corporation. The auditors’ standard of care in such circumstances must reflect this reality as well.

[187]    This role of an audit of a publicly-traded company is reinforced by s. 1.1 of the Securities Act, R.S.O. 1990, c. S.5, which provides that one of the Act’s purposes is to foster fair and efficient capital markets by protecting investors from unfair, improper or fraudulent practices, and to maintain public confidence in those markets. An auditor must be alive to the impact of its reports in this context.

[188]    It follows that the auditor of a publicly-traded company acquires an added layer of responsibilities that is not necessarily present where the audit is performed in relation to a private corporation or private individuals.

(2)          Articulating the Standard of Care

[189]    The general standard of care applicable to an auditor’s work was described near the turn of the 19th century in In re Kingston Cotton Mill Co. (No. 2), [1896] 2 Ch. 279 (Eng. C.A.), at p. 288:

It is the duty of an auditor to bring to bear on the work he has to perform that skill, care, and caution which a reasonably competent, careful, and cautious auditor would use. What is reasonable skill, care, and caution must depend on the particular circumstances of each case.

[190]    This formulation has stood the test of time and been adopted in cases too numerous to list. The secret of its longevity lies in its contextual adaptability. While the general formulation of the standard of care remains the same, the “particular circumstances” of a case encompass not just the factual setting in which the audit is conducted, but also the statutory and regulatory framework and the professional requirements prevailing at the time. Facts vary and the governing statutory, regulatory and professional requirements evolve over time, but they all contribute to the setting in which the standard is to be applied in any particular case. Where, as here, the audit is of a publicly-traded corporation – and thus there is an added public-interest dimension to the auditor’s responsibilities – the setting calls, in addition to everything else, for close adherence to the dictates of all applicable securities regimes accompanied by a careful attentiveness to the need for accurate financial disclosure to securities regulators and the public.

[191]    I will review what the standard of care was at the relevant time. For the purposes of this appeal, the relevant period is 1996 to 1998.

(3)          The Standard of Care Framework: 1996-1998

(a)          Statutory and Regulatory Framework

[192]    Livent appointed Deloitte as its auditor to fulfill its obligations under the Securities Act. At the material time, s. 21.10(4) of the Securities Act required Livent to appoint an auditor to prepare and submit annual audited financial statements prepared in accordance with GAAP, as well as other regulatory filings, to the Ontario Securities Commission.

[193]    As a reporting issuer, Livent was required to file comparative financial statements prepared in accordance with GAAP after its financial year-end: Securities Act, s. 78. Along with the comparative financials, it was required to file an auditor’s report prepared “in accordance with the regulations” and the auditor was required to make “such examinations” necessary to prepare the report: ss. 78(2) and (3).

[194]    The regulations under the Securities Act directed an auditor conducting an audit required by that Act to prepare its report in accordance with GAAS: R.R.O. 1990, Reg. 1015, ss. 1(3), 2(2).

[195]    A public corporation, such as Livent, listed on the NASDAQ stock market in the United States was subject to similar legislative requirements.

[196]    At the relevant time, National Policy Statements (“NPS”) – which were issued by the Canadian Securities Administrators and adopted by the Ontario Securities Commission – applied to the Livent audits as well. Amongst other things, the NPS made clear that an auditor’s report containing one or more reservations (i.e. a qualified opinion, an adverse opinion, or a denial of opinion) would generally not satisfy the requirements of the securities legislation: NPS No. 50, Part 5 (Reservations in an Auditor’s Report Filed by an Investment Fund).

[197]    In addition, Livent was subject to requirements under Ontario’s Business Corporations Act, R.S.O. 1990, c. B.16 (“OBCA”). It was obliged to appoint an auditor for the purposes of reporting on the financial health of the company: OBCA, s. 149. As Livent’s auditor, Deloitte was required (i) annually to examine and verify the fairness and accuracy of its financial statements as prepared by management in accordance with GAAP, and (ii) to prepare an auditor’s report in accordance with GAAS: OBCA, ss. 153(1), 155; and R.R.O. 1990, Reg. 62, ss. 40-41. Deloitte also had an obligation to inform Livent’s directors if it was notified or became aware of an error or misstatement in a financial statement that was, in its opinion, material: OBCA, s. 153(3).

(b)      The CICA Handbook

[198]    Deloitte’s role as Livent’s auditor was also subject to the professional standards applicable to auditors as set out in the CICA Handbook and the ICAO Handbook at the time.

[199]    The Supreme Court of Canada has said that rules set by a self-governing professional body are “of guiding importance in determining the nature of the duties flowing from a particular professional relationship”: Hodgkinson v. Simms, [1994] 3 SCR 377, at p. 425. Further, “[t]hese rules must be taken as expressing the collective views of the profession as to the appropriate standards to which the profession should adhere”: MacDonald Estate v. Martin, [1990] 3 S.C.R. 1235, at p. 1244.  

[200]    In the auditing context, this Court has held that the CICA Handbook “is of great assistance” to courts in determining the requisite standard and “a persuasive guide to the applicable standard of care”: Bloor Italian Gifts Ltd. v. Dixon (2000), 48 O.R. (3d) 760, at paras. 27, 31; and Sherman v. Orenstein & Partners (2006), 11 B.L.R. (4th) 233, at para. 33.

[201]    The trial judge reviewed the relevant provisions in the CICA Handbook in considerable detail, focusing on those sections dealing with “Audit of Financial Statements” (s. 5000), “Knowledge of the Entity’s Business” (s. 5140) and “Auditor’s Responsibility to Detect and Communicate Misstatements” (s. 5135).

[202]    Given their significance, I will review the standards from the CICA Handbook in effect at the relevant time in some detail.

(i)           The Objective of an Audit

[203]    At the time, the CICA Handbook provided that the objective of an audit of financial statements was to express an opinion as to whether the statements presented fairly, in all material respects, the financial position, results of operations, and changes in financial position in accordance with GAAP: s. 5000.01. Deloitte certainly accepted this purpose, as it was explicitly stated in Deloitte’s engagement letters to Livent.

(ii)          Knowledge of the Client

[204]    The CICA Handbook stressed the importance of continuously obtaining and applying knowledge of the client’s business. The trial judge summarized the salient points stipulated in s. 5140 of the CICA Handbook, entitled “Knowledge of the Entity’s Business”, at para. 92:

(i) Auditors must obtain and apply knowledge of the client’s business continuously and cumulatively.  The knowledge obtained from the moment of the decision to accept the engagement, together with knowledge amassed over the course of the subsequent audit periods, must be updated to ensure that it reflects the current circumstances of the client.

(ii) Knowledge obtained when planning an audit for the current period must be refined and supplemented as the audit progresses.

(iii) As a corollary, the planning and execution of an audit must reflect the auditor’s knowledge of the client.

(iv) Knowledge of the client’s business affects multiple components of the audit, including determining materiality levels, assessing the inherent risk associated with the audit, understanding and obtaining sufficient information in respect of the client’s internal controls, identifying the nature and sources of available audit evidence, designing audit procedures, and understanding the substance of transactions.

(v) Assessing whether sufficient appropriate audit evidence has been obtained, including evidence related to significant management representations.

[205]    As the trial judge noted, at para. 93, “an auditor is required to assess the information accumulated during the course [of] the audit to determine whether or not decisions made during the planning stage remain appropriate.” Amongst other things, the CICA Handbook instructed auditors, in making this assessment, to identify and consider the business environment of the client, the characteristics of ownership and management, and the operating characteristics of the client.

(iii)       Management’s Good Faith and Professional Skepticism

[206]    The CICA Handbook dealt with the concept of management’s good faith and the related concept of professional skepticism, which are particularly significant in this case given the trial judge’s finding that one of Deloitte’s shortcomings was its failure to exercise sufficient professional skepticism.

[207]    The Handbook recognized at s. 5000.05 that “the assumption of management’s good faith [was] a fundamental auditing postulate”, which meant that “in the absence of evidence to the contrary, the auditor [could] accept accounting records and documentation as genuine and representations as complete and truthful” (emphasis added). At the same time, “[t]he assumption of management’s good faith [was] not a source of audit evidence nor a substitute for the requirement to obtain sufficient appropriate audit evidence to afford a reasonable basis to support the content of the auditor’s report.”

[208]    Sections 5000.06 and 5135.05 dealt with the need to approach the audit with an attitude of professional skepticism. I set them out in their entirety, given their significance in this case:

Section 5000.06

An attitude of professional scepticism means the auditor assesses the validity of evidence obtained and is alert to evidence which contradicts the assumption of management’s good faith. For example, the auditor is alert to evidence which may indicate accounting records and documentation have been altered or representations are false. It does not mean the auditor is obsessively sceptical or suspicious. Without an attitude of professional scepticism, the auditor may not be alert to circumstances which should lead him or her to be suspicious and he or she may then draw inappropriate conclusions from evidence gathered.

Section 5135.05

An attitude of professional scepticism is inherent in applying due care in accordance with the general standard … Such an attitude is necessary for proper consideration of factors which increase the risk of material misstatements and evaluation of evidence obtained. The auditor recognizes that conditions observed and evidence obtained, including information from previous audits, need to be evaluated with an attitude of professional scepticism to assess the risk of material misstatement. In particular, an attitude of professional scepticism means the auditor is alert to:

(a) factors which increase the risk of material misstatement …

(b) circumstances which make him or her suspect the financial statement are materially misstated;

(c) conditions observed or evidence obtained which contradicts the assumption of management’s good faith. The auditor needs to be aware of factors which increase the possibility of management misrepresentation. For example, management can direct subordinates to record transactions or conceal information in a manner that can materially misstate financial statements. [Emphasis added.]

[209]    These provisions echoed the sentiments expressed long ago in In re Kingston Cotton Mill Co. (No. 2) to the effect that an auditor “is a watch-dog, but not a bloodhound”, and is entitled to rely on the representations made by “tried servants of the company in whom confidence is placed by the company” and to assume they are honest, provided the auditor takes reasonable care, but that “[i]f there is anything calculated to excite suspicion”, the auditor “should probe it to the bottom”: pp. 288-89.

[210]    Lord Denning expressed similar views regarding the need for professional skepticism in Fomento, at p. 23:

An auditor is not to be confined to the mechanics of checking vouchers and making arithmetical computations. He is not to be written off as a professional “adder-upper and subtractor”. His vital task is to take care to see that errors are not made, be they errors of computation, or errors of omission or commission, or downright untruths. To perform this task properly, he must come to it with an inquiring mind—not suspicious of dishonestly, I agree—but suspecting that someone may have made a mistake somewhere and that a check must be made to ensure that there has been none. [Emphasis added.]

(iv)        The Detection of Material Misstatements

[211]    The CICA Handbook affirmed that the auditor was responsible for detecting material misstatements in financial statements or other financial information. It defined misstatements as either “errors” (i.e., unintentional misstatements) or “fraud and other irregularities” (i.e., intentional misstatements): ss. 5135.01-5135.02.

[212]    The CICA Handbook recognized – as did the trial judge – that fraud may be very difficult to detect. However, given the difficulty in detecting fraud, the Handbook stressed the need to have proper auditing procedures in place to reduce the risk of not detecting material misstatements to an appropriately low level, and, in particular, the need to adapt the auditing plan where circumstances made the auditor suspect the financial statements were materially misstated: ss. 5135.07-5135.17. 

[213]    For instance, in circumstances involving “higher risk assessment” – as Deloitte recognized the Livent environment to be – the CICA Handbook imposed an obligation to perform heightened audit procedures providing more reliable evidence: s. 5135.07. This included recognizing the need for more extensive supervision and the use of personnel with more experience and training: s. 5135.08. The CICA Handbook also stipulated that where there was a reason to suspect the financial statements were materially misstated, the auditor was required to perform procedures to confirm or dispel that suspicion: s. 5135.14.

[214]    These provisions were consistent with the common law, which affirmed that until a suspicion is dispelled – until the auditor has “probe[d] it to the bottom” – the auditor cannot make an unqualified auditor’s report. Even where the auditor may be following or attempting to follow GAAS, it may not be excused from liability where the auditor “has an opportunity to acquire or is exposed to knowledge or information which might affect [its] opinion but [it] fails to recognize and act on that information”: Revelstoke Credit Union v. Miller, [1984] 2 W.W.R. 297 (B.C.S.C.), at p. 303.

[215]    Subsequent authorities considering the same applicable standards have confirmed that where the auditor uncovers “significant weaknesses” during the course of the audit, it has a duty to inform the directors of the client company: BDO Dunwoody, at paras. 231-32. See also Pineridge Capital Group Inc. v. Dunwoody & Co., 1999 CanLII 5925 (B.C.S.C.), at paras. 26-27; and Sydney Cooperative Society Ltd. v. Coopers & Lybrand, 2003 NSSC 35, 213 N.S.R. (2d) 115, at paras. 148-49. 

(c)      The Deloitte Manuals

[216]    As noted earlier in these reasons, Deloitte had its own manuals on how to conduct an audit in accordance with GAAS – the “Deloitte Manuals” – which set a standard of care Deloitte must be presumed to accept as reasonable: see Dairy Containers Ltd. v. NZI Bank Ltd., [1995] 2 N.Z.L.R. 30 (H.C.), at p. 54.

[217]    Amongst other things, the Deloitte Manuals dealt with the detection of fraud and error. Interestingly, it appears Deloitte set a higher standard for itself than that of assuming management’s good faith. Article 1.37 of the particular Manual in effect for the years subsequent to 1995 neither assumed that management was dishonest nor assumed unquestioned honesty.  It stated:

We neither assume that management is dishonest nor assume unquestioned honesty. Rather, we exercise professional skepticism and recognize that conditions observed and evidential matter obtained, including information from prior audit engagements, need to be objectively evaluated to determine whether the financial statements are presented fairly in all material respects.

[218]    Article 17 of the same Manual is significant as well. It dealt with circumstances where control tests indicated “the possible existence of fraud or error” (emphasis added).  Article 17.75 stated:

If the results of our tests of controls indicate the possible existence of fraud or error, we should consider the potential effect on the financial statements. If we believe the indicated fraud or error or risk thereof could have a material effect on the financial statements, we should perform appropriate modified or additional procedures.

[219]    Subsequent provisions in the same Article fleshed out how to approach the “appropriate modified or additional procedures.” In particular, Article 17.77 did not allow Deloitte auditors to assume that an instance of fraud or error was an isolated occurrence. Article 17.78 noted the auditor’s responsibility to “confirm or dispel a suspicion of fraud or error”, and to discuss the matter with management if the suspicion could not be dispelled.  

(d)       Resignation by an Auditor

[220]    It is important to note one final issue related to the standard of care before turning to breaches of the standard of care. As noted above, Deloitte takes issue with the trial judge’s finding that it ought to have resigned in August/September 1997 or April 1998 at the latest.

[221]    Where an auditor suspects fraud or error and management does not assist the auditor in dispelling the suspicion, the auditor is left with three options:

  • to issue an unqualified audit report and risk breaching the standard of care owed to the client, the applicable legislation, and possibly the contract with the client;
  • to issue a reservation of opinion, which will generally not satisfy the client’s need for an unqualified audit report under the legislation; or  
  • to resign.

[222]    If the auditor chooses the second option and the client elects to discharge the auditor, then the incoming auditor must request that the outgoing auditor explain the reasons for the replacement, thus putting the new auditor on notice of the former’s suspicions: OBCA, s. 151(4).

[223]    In addition to requirements under the OBCA, Part 4 of NPS No. 31 (Change of Auditor of a Reporting Issuer), which was in effect at the relevant time, imposed reporting obligations on reporting issuers where an auditor resigned or was discharged. The reporting issuer was required to prepare and deliver a “Reporting Package” to its shareholders, the securities administrators, and the incoming and outgoing auditor: NPS No. 31, ss. 4(1)-4(3). Where the change of auditor followed a reportable event – defined as a disagreement, unresolved issue or consultation – the reporting issuer was required to describe the information contained in the Reporting Package, including the outgoing auditor’s reasons for its resignation or discharge, in a press release: NPS No. 31, ss. 3.3, 4.4.

[224]    At the relevant time, the resignation of auditors was addressed in the ICAO Member’s Handbook. According to Council Interpretation 201.1 in the ICAO Member’s Handbook, issued June 1993, an auditor could and, as a matter of professional judgment, should resign in certain circumstances, including where there was a loss of trust in the client. Paragraphs 10, 12, and 15 of Council Interpretation 201.1 provided:

The auditor should never lightly resign an appointment before reporting and should not resign at all before reporting if there is reason to suspect that the auditor’s resignation is required by reason of any impropriety or concealment, upon which it is the auditor’s duty to report. Subject to that general statement, however, there may be exceptional circumstances in a particular case that would justify the auditor’s resignation. This will be a matter of individual judgment in each case.

As a general rule, the proper course for an appointed auditor to follow is the completion of the auditor’s statutory duties: having been appointed by the shareholders the auditor should report, as required in the legislation. The auditor should cease to act on behalf of a client only after a successor has been properly appointed and the auditor has been relieved or disqualified.

An auditor should not voluntarily cease to act on behalf of a client after commencement of an audit engagement except for good and sufficient reason. Reasons may include:

(a) loss of trust in the client;

(b) the fact that the auditor is placed in a situation of conflict of interest or in circumstances where the auditor’s objectivity could reasonably be questioned; or

(c) inducement by the client to perform illegal, unjust or fraudulent acts. [Emphasis added.]

[225]    As discussed below, this document was introduced into evidence and expert evidence was led on the resignation issue.

(4)         Conclusion on Standard of Care

[226]    The foregoing discussion underlies the analysis of whether Deloitte breached the standard of care, to which I now turn.


[227]    The trial judge conducted his analysis of, and made his findings on, whether Deloitte had performed the Livent audits in accordance with GAAS and whether, if it had done so, the fraud or other irregularities would have been detected, over four general time periods: (i) the pre-1996 audits; (ii) the 1996 audit; (iii) the Q2 and third quarter (“Q3”) 1997 engagement; and (iv) the 1997 audit. He found that Deloitte had fallen below the applicable standard of care in relation to both the Q2 and Q3 1997 engagement and the 1997 audit, and that it was therefore negligent, by having (at least):

  • improperly dealt with such audit items as the PPC and certain of the Revenue Transactions, including the Pantages Air Rights Agreement and its accompanying Put;
  • failed to put a proper audit plan and the necessary auditing procedures in place to detect possible misstatements or irregularities, when it knew that Livent was a “high risk” client whose principals pushed the envelope (and, in fact, characterized the 1996 audit as such);
  • become too close to the client and lost its required level of “professional skepticism”;
  • succumbed to the demands of Gottlieb to change the audit team to one more open to Livent’s approach and, having done so, failed to put a team in place that had sufficient knowledge of the Livent audit history and the aggressive characteristics of its two flamboyant principals and that was, in the trial judge’s words, at para. 210, simply “not up to the task”;
  • failed to respond with the appropriate professional skepticism following Gottlieb’s incurably deceitful presentation to the Livent audit committee;
  • failed to resign in such circumstances; and
  • allowed its name be associated with the announced “settlement” of auditing differences in September 1997, when it knew that the press release announcing the resolution was misleading.

[228]    Deloitte does not appear to challenge the negligence findings set out above, with one exception: it submits that the trial judge erred in finding that it was obliged to resign as auditor in August/September 1997.

[229]    In my view, the record amply supports the trial judge’s findings that Deloitte was negligent in its conduct of the 1997 audit and the Q2 and Q3 1997 engagement. Indeed, the evidence to that effect is overwhelming. The trial judge’s findings on negligence and the consequences of the negligence are lengthy and complex.  I review them in the following passages, as they are key to my analysis on causation and damages, as well as to the issues on the cross-appeal, set out below.

(1)       Pre-1996 Audits

[230]    The trial judge found that Deloitte met the requisite standard of care in the preparation of Livent’s annual audits up to and including the 1995 audit year. This was at least partly because both parties’ experts agreed that they could not conclude any higher than that Deloitte “may have”, not “should have”, discovered the fraud in the pre-1996 timeframe, and partly because the level of professional skepticism expected to be applied to the audit was lower in Canada during this period than in the U.S. (Livent’s expert was an American.) 

[231]    The trial judge was not persuaded that Deloitte had fallen below the accepted standards for the pre-1996 audits, despite Livent’s arguments about the improper amortization of the PPC in that period, the need to take into account what was known to be Drabinsky and Gottlieb’s aggressive approach to accounting matters and their general reputation as enfants terribles, and the level of staff experience applied to the audits.

(2)         1996 Audit

[232]    The trial judge found that Deloitte failed to meet its standard of care and to complete the 1996 audit in accordance with GAAS in the way in which it dealt with two areas of the audit: (i) the PPC; and (ii) the Musicians’ Pension Surplus Receivables in relation to two of Livent’s productions, the Kiss tour in New York andShow Boat in New York. In addition, although he ultimately found that Deloitte did not fall below the required standard in dealing with the 1996 Revenue Transactions prior to mid-July 1997, he nonetheless concluded that the criticisms related to the treatment of those transactions were not without merit.[2]

[233]    In the end, however, the trial judge concluded that these breaches did not cause Livent any compensable damages. That said, the seeds for the troubles to come were germinating during this period.

[234]    Livent contests the trial judge’s conclusion on the cross-appeal, which I address in detail below.

[235]    As I have noted, the trial judge found that 1996 was something of a watershed year for Livent and, as a consequence, Deloitte. Financially speaking, Livent was ever in need of new money to finance its productions, which involved significant upfront costs, and real estate investments in Chicago, New York, Vancouver and Toronto. The trial judge described Livent’s financial position in 1996, at para. 134:

Livent was always casting a covetous eye to the capital markets, seeking to raise money either by way of debenture offerings or through public or private placements of its common stock. In 1996 alone, it raised in excess of $96 million, with an increase in liabilities, net of production trade accounts, of almost $70 million from 1995. Revenues from productions were not keeping pace with the demands of the operation and it became apparent that Livent was going to have to look away from its core business to fund its debt burden, at the very least. Indeed, in 1996 Livent took an $18.5 million write-off in respect of the Sunset Boulevard production, which was by no means insignificant. [Footnote omitted.]

[236]    It was also significant during this period – at least from Deloitte’s perspective – that it had to re-staff its Livent audit team after Messina left Deloitte to join Livent. In her place, Deloitte appointed John Cressatti as the new Engagement Partner. While there was some carryover from the old team, including senior manager Christopher Craib, Cressatti had no experience dealing with Livent and was a relatively new audit partner.  

[237]    Deloitte recognized that the audit risk at this time was “greater than normal” – a Deloitte euphemism for “high risk”. The trial judge noted, at para. 136, that in preparing the 1996 audit plan in which the overall assessment of the engagement risk was so defined, the Livent audit team was confronted with the following realities:

  • Livent faced internal and external business and industry risks.
  • It had entered into a number of material and unique revenue-generating transactions, which created reporting issues.
  • It was publicly-traded in both Canada and the U.S. and attracted a high level of scrutiny and public observation.
  • Livent management was sensitive to reported net earnings levels, and was aggressive in arriving at its bottom line.
  • The valuation of the PPC was subject to management estimation and financial projections. In addition, resultant amortization and/or write-offs of the PPC were known to have a significant impact on net earnings.

[238]    And while not specifically identified as an engagement risk for 1996, previous audit planning memos underscored that Drabinsky and Gottlieb were very demanding and expected timely, high-quality service at relatively low cost. The trial judge described the pressures on the Livent audit team, at para. 137:

It was previously understood that the pressures on the audit partners were and would be significant. Deloitte recognized that its tax group in particular might be able to provide additional services to Livent, although there was a strained relationship in that area, which had to be safeguarded in some fashion. Whether this inherent conflict between the Firm's professional obligations, on the one hand, and its attempts to earn additional fees and satisfy the demands of its client, on the other, drove the audit agenda was never directly addressed in evidence, but sometimes appeared to be the elephant in the room. [Footnote omitted.]

[239]    It was also recognized in planning the 1996 audit that the level of professional skepticism had to be increased on all fronts. It was anticipated in the audit planning memo that there would be more than normal Engagement Partner involvement, if not the utilization of two audit partners, to ensure compliance with the audit plan. At the same time, however, the planning materiality level for 1996 was set at $1,670,000, an increase of roughly 30 per cent from the previous year. The trial judge was puzzled by that change since it meant that “less drilling down would be undertaken by the audit staff even though there were some new and looming issues, as the planning memo suggested”: para. 139.

[240]    With that backdrop in mind, I turn to the trial judge’s analysis with respect to the three areas referred to above – namely the PPC, the Musicians’ Pension Surplus Receivables, and the 1996 Revenue Transactions.

(a)         1996 Audit – The PPC

[241]    The trial judge observed that the “PPC should have been front and center in the Deloitte collective mindset when it came to the completion of the 1996 audit”: para. 143.  He concluded that “Deloitte’s approach to the 1996 PPC audit cannot be said to have been in accordance with GAAS by any measure”: para. 152. Indeed, it did not even comply with Deloitte’s own undertaking in its audit plan for the year to “[o]btain operating projections for each production” and to “compare projected results with historical results where data available”: paras. 146-48. Deloitte was aware that the Livent productions had performed poorly in 1996, and that “after amortization of PPC, the Livent shows lost, in the aggregate, $22.9 million, while they were projected to earn a net income of $20.6 million, a variance or swing of 218%”: para. 148. Nonetheless, except for isolated instances, Deloitte failed: (i) to obtain and review the 1996 budgets; (ii) to do more than accept management’s estimates as to potential revenue for any one show (which led it into the realm of “audit by conversation”); (iii) to test the accuracy of those estimates against recently experienced results (which were available and which would have cast doubt on the accuracy of the estimates); or, (iv) to test the reasonableness of Livent’s forecasting by looking at past forecasts against actual results. In the end, when Deloitte did its after-the-fact corrective audit, an $11 million charge was taken against 1996 net income in respect of the PPC not sufficiently amortized in the year, in addition to a $3.1 million adjustment for the PPC improperly recorded or moved from account to account between various productions.

[242]    There was ample evidence to support the trial judge’s findings with respect to Deloitte’s failure to comply with GAAS in relation to the 1996 audit of the PPC.

(b)       1996 Audit – Musicians’ Pension Surplus Receivables

[243]    Under New York law, Livent was required to use musicians represented by a local union for its performances in New York, and to remit a percentage of box office revenues to the union on account of the musicians’ pension entitlements. Livent told Deloitte, however, that the union was entitled to receive less under its collective agreement than what Livent had remitted and so Livent was entitled to record the difference as a credit and a receivable. Livent did not disclose that the union disputed this interpretation. 

[244]    The trial judge concluded that it was acceptable for Deloitte to have accepted Livent’s representation for the 1995 audit, but not for the 1996 audit.  Instead of decreasing, which one would have expected had Livent’s representation been accurate, the receivable remained the same for one show (the Kiss tour in New York) and increased for the other (Show Boat New York).  Deloitte ignored this evidence, which the trial judge found “was a red flag and should have been recognized as such, especially considering that the audit risk for the 1996 audit was set as ‘high’”: para. 162. Deloitte’s expert acknowledged in cross-examination at trial that this aspect of the audit did not conform to GAAS.

(c)       1996 Audit – Revenue Transactions

[245]     I described the Revenue Transactions in general terms above. As explained, they were designed to enhance the veneer of Livent’s profitability in order to attract much-needed cash funding and involved the “sale” to third parties of various Livent assets. A common feature of these transactions was that the income they generated was to be received over a period of time and so there was a continuing tension about when and in what amounts these income streams could be counted for the purposes of financial accounting. Many of the transactions also had another theme in common: they were not true sales of assets, but were more in the nature of loans or financing agreements.

[246]    There were four of these Revenue Transactions in fiscal year 1996 and five in fiscal year 1997. As a result of them, Livent recorded approximately $40 million in income in those two years.

[247]    Deloitte’s treatment of the Revenue Transactions in the 1996 audit was subject to some criticism. Nevertheless, the trial judge was not prepared to find that, even if Deloitte had taken appropriate measures, the fraud or other irregularities in relation to these transactions would have been discovered, given the deceit that permeated the Livent organization at the time. He concluded that Deloitte could not be faulted for its treatment of the Revenue Transactions prior to mid-July 1997.

[248]    The criticisms of the 1996 audit treatment of the Revenue Transactions are significant, however, because they signal a flaw that would ultimately prove to be Deloitte’s undoing: Deloitte was becoming too accommodating to its client – something driven by the threat of losing its high-profile and high-flying client – and in the process had lost its professional objectivity and its required attitude of professional skepticism. As I will explain, Deloitte yielded to Livent pressures and lent its name to the Q2 1997 financial statements that did not comply with Canadian GAAP and provided a clean audit opinion for the 1997 audit year that did not comply with GAAS. Had Deloitte not done so, the trial judge found that the fraud would have been uncovered in August/September 1997 or, at the very latest, in April 1998.

[249]    Deloitte’s audit planning memorandum for the 1996 audit acknowledged that Livent had entered into multiple “material and unique revenue-generating transactions” in 1995 and 1996, which motivated management to select reporting methods that were “less favourable than potential alternatives” – whatever that meant, as the trial judge observed: para. 163.

[250]    It is not necessary to review the 1996 Revenue Transactions here. The trial judge ultimately concluded, although “not without some misgivings,” that Livent was not liable for its performance of the 1996 audit with respect to the Revenue Transactions, even though criticisms of Deloitte’s treatment of them had merit: para. 170. Suffice it to say that a considerable amount of Deloitte partner and staff time and resources were devoted to the debate over the amount of revenue from these transactions to be included in revenue for the 1996 audit year. After much back-and-forth between Deloitte (including representatives of Deloitte U.S.) and Gottlieb and other senior Livent financial personnel, Deloitte finally accepted over $30 million in revenue from these transactions as income for 1996 from a Canadian GAAP perspective.  In contrast, Deloitte U.S. accepted only $16 million for U.S. GAAP purposes.

[251]    In assessing the Revenue Transactions, the trial judge relied heavily on what was known at trial as the “Wardell Chronology”. This was a memorandum prepared by Bob Wardell, an Advisory Partner on the Livent file, in July 1997 in preparation for a meeting between Martin Calpin, Deloitte’s National Risk Management Partner, and Gottlieb who, the memorandum suggests, was continually threatening to drop Deloitte as Livent’s auditor. Deloitte’s concern about losing Livent as a client is evidenced by the following comments from the Wardell Chronology as summarized by the trial judge, at para. 168:

Gottlieb was not pleased that Deloitte was questioning Livent management on the agreements and felt that Deloitte U.S. was dragging its feet in agreeing with the inclusions of the same amounts [i.e. the approximate $30 million accepted by Wardell from a Canadian GAAP perspective] for U.S. GAAP purposes. He threatened to pull the account if Deloitte did not accept Livent's accounting treatment of the transactions.

At the end of March [1997], Wardell met with two other senior partners of Deloitte, Bruce Richmond and Paul Cobb. The latter was responsible for the Dundee Bancorp audit. Wardell "was concerned not only with the impact these events were having with respect to our relationships with Livent, an important public client, but also the possible fallout to Dundee Bancorp given Myron's relationship with Ned Goodman and his position as Chairman of Dundee's audit committee".[3]

The U.S. Partners were unmoved by the arguments. In June [1997], Rod Barr, a senior Canadian partner in the National Office and a specialist on SEC matters, was asked by his American counterparts to weigh in on the argument. He reviewed the transactions but remained adamant that the Canadian position was flawed and "would NOT withstand the scrutiny of a professional skeptical challenge". In this prophetic memo, he raised four areas of concern [to the U.S. partners], which ultimately formed the basis of the plaintiff's criticism of Deloitte in respect of the transactions:

(a) Was Deloitte certain that there were no side deals "or other relationships among the counterparties" that would alter the nature of the agreements?

(b) Why were the agreements silent on refundability?

(c) What analysis had been undertaken to ensure that the counterparties had the ability to meet their commitments under the agreements?

(d) What audit procedures were actually undertaken to check on the legitimacy of the agreements, since the U.S. partners were under the impression that much of the work comprised an audit by conversation, only?

Wardell was not persuaded that the complaints and warnings articulated by Barr were warranted. While he was more inclined to accept that the deals reached were obtained because of the "level of sophistication, business acumen and negotiating skills of Messrs. Drabinsky [and] Gottlieb", a position which he believed was lost on his U.S. partners, he was in large measure, relying on the "written and verbal representations from Livent's senior in-house counsel and all senior executives", including his former partner Messina, that there were no undisclosed agreements or amendments. He went on to observe: "If we were not prepared to accept such representations, it seems to me we should resign as auditors as we effectively would be questioning the fundamental integrity of our client". [Underlining in original; emphasis added in italics; footnotes omitted.]

[252]    The trial judge concluded his review of the Wardell Chronology by noting, at para. 169, how Deloitte gave in to Gottlieb’s forceful, if not bullying, tactics:

As previously suggested, the Wardell Chronology was prepared as an aide mémoire for Martin Calpin in preparation for a meeting that was scheduled to take place with Gottlieb in late July, during which Gottlieb wanted to discuss "relationship and client services issues". Gottlieb clearly believed that the best defence was a good offence and, as I assess the evidence, bullied the Deloitte partners to bend to his positions, with the added leverage of his connection to Dundee Bancorp and its CEO, Ned Goodman, which he threw in for good measure. [Emphasis added.]

[253]     In other words, Deloitte’s thinking about the substantive issues was, at least to some degree, influenced by strong pressure from Gottlieb. 

(3)          1997 Engagements

[254]    In 1997, the seeds of trouble took root.  Unfortunately, Deloitte continued to mistake the weeds for flowers when a little digging in the exercise of its professional skepticism obligation and the application of its accumulated audit knowledge would have revealed the underlying rot.

[255]    The 1997 year has two components for purposes of the analysis: (i) the Q2 and Q3 engagement; and (ii) the 1997 audit.

[256]    Because of their central role in what occurred in relation to the 1997 year – recall the trial judge referred to them, at para. 174, as “the Achilles heel of Deloitte’s defence” – I now return in more detail to the Pantages Air Rights Agreement and the controversial Put, and the circumstances surrounding them.

(a)         Q2/Q3 1997 and the Put – Part One 

[257]    As explained above, the Pantages Air Rights Agreement purported to transfer Livent’s air rights above the Pantages Theatre and adjoining lands to Dundee for a price of $7.4 million. The parties initially entered into a letter agreement dated May 22, 1997. Attached to the letter agreement was a term sheet, which included the Put in favour of Dundee enabling Dundee to withdraw from the arrangement in certain circumstances. The parties subsequently entered into a more formal “Master Agreement”, which was said to be effective as of June 30, 1997, although the transaction did not close until August 15, 1997.

[258]    The controversy over the Put first flared up in August 1997.

[259]    Deloitte had a number of concerns about the Pantages Air Rights Agreement, including that the Put effectively allowed Dundee to exit the Agreement without paying the balance of $4.9 million on the transfer price. On August 1st, Wardell and Peter Chant, who were Advisory Partners on the Livent file, met with Gottlieb, Messina and Gord Eckstein, Livent’s Senior Vice-President of Finance. Wardell and Chant advised them that it would not be appropriate to recognize the gain from the transfer of the air rights in Q2 1997 – something that Livent was intent on accomplishing in order to shore up its Q2 financial statements for the purposes of a planned debenture offering in fall 1997.

[260]    On August 6th, Messina informed Wardell that Gottlieb was pushing to have $6 million included in Q2 and to have no public disclosure of its inclusion. That same day, Wardell called Gottlieb to express concern that Gottlieb would even consider that course of action. He warned Gottlieb that if Livent were to include a material gain on the air rights transaction in Q2, Deloitte would not be able to provide the comfort letters needed for the debenture offering in the fall.

[261]    Gottlieb ignored Wardell’s warning. Instead, he went to the Livent Audit Committee and tabled draft consolidated financial statements for Q2 and the six months ending June 30, 1997, which included a $6 million gain on the sale of the air rights. Deceitfully, he did not inform the Audit Committee about Deloitte’s concerns, and the Audit Committee approved the financial statements. No one from Deloitte was present at the meeting.

[262]    When Wardell and Chant learned what had happened shortly thereafter, they were understandably upset. Gottlieb was advised that Deloitte was going to exercise its statutory right as an auditor to insist that an Audit Committee meeting be convened. Deloitte sent Gottlieb a letter on August 25th formally advising that, in its view, the Q2 results as reported were materially misstated. 

[263]    Gottlieb responded, before the Audit Committee met, by purporting to eliminate at least some of Deloitte’s concerns by having Livent’s lawyer delete any reference to the Put in the Master Agreement. Livent’s solicitors and Dundee provided misleading information that the Put had been removed and that there was a firm deal for the sale of the air rights as at June 30, 1997. In spite of these assurances, Deloitte remained concerned. 

[264]    As it turned out, Deloitte’s concerns were justified. Assurances from Livent’s external counsel and from Dundee aside, and unbeknownst to Deloitte, Livent and Dundee had entered into a covert side agreement on August 15th that contained the Put that Deloitte had been advised was “intentionally deleted” from the Master Agreement.  

[265]    There were intense discussions over this period of time, but in the end Deloitte’s opposition was overcome.

[266]    The Audit Committee met on August 26th, 27th and 29th. Deloitte presented its concerns and advised that it would resign if Livent did not reverse the revenues. Deloitte argued that the sale revenues could not be reported in Q2, even though the Put had been removed from the Master Agreement as of August 15th, for three reasons: (i) no tangible consideration had passed prior to June 30th; (ii) the transaction had not closed as of that date; and (iii) the appropriate GAAP guidelines would not permit revenue recognition.

[267]    To buttress its position in the debate, Livent sought second opinions from KPMG and from an accounting professor from the Ivey Business School. Both supported Livent’s position that the transaction was, arguably, properly reportable in Q2. As the trial judge observed, “[t]he matter appeared to come down to whether or not Deloitte would resign as auditors or whether or not some accommodation could or should be negotiated”: para. 187. With the two opinions in hand that supported their position, Gottlieb and Eckstein were content to let Deloitte resign should it decide to do so. However, others within the Livent camp were concerned that Deloitte’s resignation might negatively affect other sponsorship deals and the debenture offering planned for the fall.

[268]    Ultimately, a compromise was reached. It involved Livent’s issuing of the following press release on September 2nd:

Livent Inc. announced today that in contemplation of a possible issuance of U.S. $100 million debt securities in the United States, it has adjusted its accounting treatment for non-theater real estate transactions in order to be consistent with U.S. GAAP. This adjustment, which has no effect on prior years’ income, will result in the recognition of income before income taxes of $4.8 million ($0.17 per share) in the third quarter of 1997 rather than in the second quarter, as previously announced. The adjustment is in connection with the sale by the Company of air rights to a real estate developer pursuant to a binding contractual arrangement in place prior to the end of the second quarter.

[269]    The effect of moving the $4.8 million from Q2 1997 to Q3 was that $1.2 million was still left in Q2 when, on the evidence pertaining to Canadian GAAP, it ought not to have been. As well, the press release did not tell the whole story, and left the reader with the mistaken view that the decision to revise the financials was driven by a technical U.S. GAAP issue, rather than by Deloitte’s concerns about the appropriateness of recognizing the revenue at all. The trial judge was also troubled by Deloitte countenancing a press release suggesting there was a binding deal at the end of Q2 when – even on Livent’s version – there had been a material amendment in August by, minimally, dropping the Put.

[270]    Even after the compromise, however, Gottlieb remained unhappy.  He pressured Deloitte to change the audit team. Deloitte yielded to this pressure.  Instead of treating Gottlieb’s request as a “red flag” warranting a review of the entire relationship from Deloitte’s perspective, rather than from the client’s perspective, Deloitte changed the composition of the team almost entirely. That left the audit role to be conducted by a new set of senior partners and a support and field staff that had little or no history of the file or the client relationship. 

[271]    The trial judge commented that he was “not sure the Livent-Dundee and Goodman-Gottlieb relationships were not forming part of the backdrop against which this decision was made”: para. 195.

[272]    In the end, the trial judge took Deloitte to task at para. 196 for being too accommodating to Livent:

Whatever might have been Deloitte’s motivation to continue as auditor, I have concluded that it was too accommodating at this point and put itself in a most curious if not fatal position by changing the audit team, virtually from top to bottom.

[273]    In addition, the trial judge found that “Deloitte should have remained firm in its resolve to sever its relationship with Livent at the end of August 1997 at the earliest, but no later than the end of Q3, or September 30th, at the latest”: para. 201. In his view, the “red flags were certainly aflutter by that time”: para. 201.  However, while Deloitte, “even with the change of audit teams, was clearly aware that Livent’s management was more than merely pushing the envelope from a GAAP perspective, it seemed to turn a blind eye to the warning signs”: para. 201.

[274]    In reaching those conclusions, he made a number of key findings:

  • there was a complete breakdown in the Deloitte/Livent relationship when Gottlieb placed the Q2 statements before the Audit Committee in early August 1997 without advising the Committee of Deloitte’s concerns, an inexcusable action that could not – once discovered – simply be negotiated away: para. 202;
  • with this knowledge, and with or without knowledge of the other Revenue Transactions, Deloitte’s “collective professional skepticism should have been elevated at this point when they had reason to question the integrity of Gottlieb”: para. 204;
  • someone at Deloitte should have questioned Dundee’s president and Deloitte’s external counsel about why the Put was apparently “intentionally deleted”: para. 204;
  • the situation deteriorated even further when Deloitte agreed to the September 2nd press release when it knew or ought to have known that it was misleading: para. 205; and
  • to make matters worse, Gottlieb subsequently sought to include the present value of a new Revenue Transaction involving AT&T in the Q3 results: para. 206.

[275]    The trial judge also found that Deloitte fell below the standard of care in accepting the revenue from the Pantages Air Rights Agreement for inclusion in the Q3 results and in a manner that was inconsistent with the September 2nd press release. He accepted the evidence of Livent’s expert “that it was not open for Livent to recognize a gain on the sale of Air Rights in Q3 1997 when it had issued a press release that stated unequivocally that it was backing out the gain to accord with U.S. GAAP – and then did not adhere to the restrictions described by U.S. GAAP”: para. 198. In fact, Douglas Barrington, Deloitte’s Vice-Chairman at the time in question, accepted this conclusion in cross-examination, acknowledging that “[i]f you adopted U.S. GAAP and it didn’t qualify, then it shouldn’t be in Q3”: para. 198.

[276]    As I have noted, Deloitte does not seriously challenge the trial judge’s negligence findings save one. It takes issue with the finding that it had an obligation to sever its relationship with Livent during this time period and that, by failing to do so, it was negligent. It contends that the evidence did not support the finding that it ought to have resigned in August/September 1997, and that an auditor’s decision to resign is a matter of professional judgment and is owed deference by the courts.

[277]    I reject these submissions. In my view, there is no reason to interfere with the trial judge’s finding that Deloitte ought to have resigned in August/September 1997.

[278]    One of Deloitte’s own partners, Wardell, had raised resignation as a possibility in July 1997 and it was very much on the table at the August 1997 meetings.

[279]    Contrary to Deloitte’s submission, there was ample evidence to support the trial judge’s finding that Deloitte ought to have resigned. As discussed above, Council Interpretation 201.1 in the ICAO Member’s Handbook, which was in effect at the relevant time, stated that a “loss of trust in the client” provided “good and sufficient reason” for resignation. Deloitte’s expert, Ken Froese, testified that an auditor’s resignation was governed by the Council Interpretations. He agreed that resignation could be appropriate in a situation where “you have a loss of trust in the client sufficient that you don’t have confidence in their integrity or what they’re telling you”, although his opinion was that in the circumstances involving Gottlieb’s presentation to the Audit Committee without revealing Deloitte’s concerns, “it could go either way”.

[280]    The trial judge found, however, that there was, or should have been, a complete breakdown of the relationship between Deloitte and Livent in August/September 1997. In support of that conclusion, the trial judge pointed to the “red flags” alerting Deloitte to the fact “Livent’s management was more than merely pushing the envelope from a GAAP perspective”: para. 201. And, as noted above, the trial judge also pointed to Gottlieb’s conduct in purposefully placing the Q2 statements before the Audit Committee when he knew they contained information “which Deloitte presaged amounted to material misstatements” (an act the trial judge described as “inexcusable” and “not simply one which could be negotiated away): para. 202. These findings, which support his conclusion that Deloitte ought to have resigned, were open to the trial judge.

[281]    Nor do I think the finding should be overturned on the basis of deference to the exercise of an auditor’s professional judgment. Professional judgment must be exercised reasonably in the circumstances; it is not a panacea for laundering professional negligence. Here, the trial judge found, as he was entitled to do on the record, that Deloitte simply turned a blind eye to the warning signs. It is clear from reading his reasons as a whole that he did not accept that Deloitte had exercised its professional judgment reasonably in the circumstances.  I agree with that conclusion.

[282]    In summary, there is no reason to interfere with the trial judge’s findings with respect to Deloitte’s treatment of the Pantages Air Rights Agreement and the Put for Q2 and Q3 1997 or his conclusions about Deloitte’s failure to meet the requisite standard of care in relation to them, including its duty to resign. 

(b)       1997 Audit and the Put – Part Two

[283]    In the trial judge’s view, “[t]he 1997 audit was beset with problems right from the get-go”: para. 210. He held that Deloitte failed to comply with GAAS and with its legal professional obligations in four general areas.

[284]    First, the new team, put in place at Gottlieb’s insistence, “was not up to the task”: para. 210. It had little or no history with the client or senior management. It was still reeling from the previous Q2 and Q3 1997 engagement, which had been thrust on it quickly. It had to deal with five new Revenue Transactions put together by Drabinsky and Gottlieb. Finally, it had to cope with a last-minute requirement, just before audit sign-off, that the capitalized PPC for the year be reduced by $27.5 million in order to accommodate the demands of Ovitz and Furman as a condition of their share purchases.

[285]    Secondly, the 1997 audit plan was inadequate and displayed little independent thought. It lacked any cautionary instructions to assist the new team, which was “charged with the responsibility of auditing a ‘greater than normal’ risk audit client that had more than a modest history of aggressive, if not questionable, accounting practices”: para. 211.

[286]    Thirdly, issues relating to the treatment of the PPC for 1997 and the treatment of the five new “unusual” Revenue Transactions should have compelled Deloitte to withhold a clean audit. The trial judge was particularly nonplussed over how Deloitte could have been prepared to sign off on the “final” PPC numbers put forward by management just prior to the Audit Committee meeting on April 9, 1998, yet do a complete U-turn and agree to sign off on PPC numbers that were written down by an additional $27.5 million, simply because that was a condition of the Ovitz and Furman share transaction.

[287]    Finally, Deloitte fell below the standard of care in its treatment of the uncovered Put. Having learned that the Put, which it had been told had been “intentionally deleted”, was alive and well and in full force, Deloitte was obliged to conduct a full and thorough investigation of the entire Livent file. As the trial judge found, “[o]n April 3, Deloitte knew that management, at its highest level, was involved in a fraud, and therefore the assumption of management’s good faith was, by definition, contradicted”: para. 233. In such circumstances, as the CICA Handbook and the Deloitte Manual indicated at the time, the auditor was required to adapt the audit plan, to perform heightened audit procedures, and to bring an attitude of professional skepticism to the process. Deloitte did not do any of this in relation to the revelation of the continuing Put.

[288]    The trial judge concluded that, the Put issue aside, Deloitte was obliged to withhold a clean audit opinion for the 1997 audit year, given the other issues noted above.

[289]    Since it was the Put that garnered most of the trial judge’s attention, however, I return in more detail to the second part of the Put controversy.

(i)    The Put – Part Two

[290]    On or about April 2, 1998 (before the final 1997 audit sign-off), Dundee’s President, Michael Cooper, told Bob Savaria, the Deloitte Engagement Partner on the Dundee audit, that Dundee took the position that the Put was still operative. Savaria delivered this news to the Deloitte partners on the Livent audit, who then convened a meeting. The meeting included various Deloitte partners on the Livent file and the Dundee file, as well as legal counsel.

[291]    Chant attended the meeting. He was one of Deloitte’s senior Advisory Partners on the Livent file at the time and he was upset. He made a number of forceful points to his partners before leaving the meeting in an angry huff. First, he emphasized that Gottlieb had misled them on three separate occasions. Secondly, he argued that if this were Deloitte U.S., they would have already terminated their relationship with Livent. Thirdly, he warned that Deloitte should terminate its relationship with Livent.  Finally, in his view the Put had not been “intentionally deleted”, but rather had been removed from the Master Agreement and inserted into a separate confidential agreement to deceive Deloitte back in August 1997.

[292]    After Chant left the meeting, the remaining partners decided to formulate a plan to investigate the matter further, which included speaking to Drabinsky and Gottlieb.

[293]    Barrington and Tony Power, Deloitte’s new Lead Client Services Partner on the team, met with Drabinsky, who expressed ignorance of the whole matter. Gottlieb, who then joined the meeting, provided the following explanation, quoted by the trial judge, at para. 219:

Myron agreed that there was a side agreement but it was only temporary, a bridging situation. He said that when he talked to Cooper about removing the put, Cooper agreed that they didn’t need it but that he couldn’t make the decision on his own, that it would have to go to his CEO for clearance. Therefore he suggested the temporary side agreement to protect himself.

Myron said that Cooper came back to him later and said that he had received clearance and said “the agreement doesn’t exist; it was never there; so tear it up”. So Marvin [sic] tore it up "it was as simple as that, I swear to God". We will now get documentation of this position from both sides.

[294]    Surprisingly, given what had already transpired, Barrington and Power were satisfied with Gottlieb’s facile explanation. Barrington subsequently prepared a memo setting out the terms on which Deloitte would continue working with Livent. It included a list of steps to be taken for Deloitte to accept that the Put had been eliminated. In particular, Deloitte wanted: (1) a copy of the secret Put agreement signed on August 15, 1997; (2) confirmation in writing that the Put agreement was cancelled in Q3; (3) an opinion from Livent’s legal counsel that the document was an effective cancellation of the Put in Q3; and (4) full disclosure of those facts to the Audit Committee in Deloitte’s presence.

[295]    Deloitte subsequently took the position that it had been provided with a satisfactory explanation regarding the Put based on the following events:

  • Gottlieb told Barrington and Power that he had ripped up his copy of the Put, at some unspecified time and date, when Cooper told him it was no longer needed.
  • Ned Goodman, Dundee Bancorp’s CEO, wrote Gottlieb a letter dated April 4th that said that the Put agreement had been cancelled sometime in August, a fact which he had not communicated to Cooper because of the “pace of business and travel”.
  • On April 7th, counsel for Livent drafted an agreement that effectively said that if the Put had been alive, it was now “officially” dead.

[296]    But that was not the end of the Put.

[297]    According to Gottlieb, the Put remained alive and well. As noted by the trial judge, Gottlieb wrote to Cooper on April 7th – the same date as the agreement purporting to eliminate the Put – confirming that the Put agreement “is binding and effective and remains so in favour of Dundee Realty Corporation as if it has never been cancelled”: para. 227. Indeed, the Put was subsequently memorialized in yet another agreement dated May 27, 1998 with modest changes from the August 15, 1997 version. In a cover letter from Gottlieb to Goodman enclosing the agreement, Gottlieb asked that the agreement be kept in a sealed envelope in a safe or safety deposit box.

[298]    As noted above, the trial judge concluded that “[o]n April 3, Deloitte knew that management, at its highest level, was involved in a fraud, and therefore the assumption of management’s good faith was, by definition, contradicted”: para. 233. He described Deloitte’s plan to deal with the elimination of the Put as “well short of reasonable, both in terms of its design and its execution” and Deloitte’s investigation – which the trial judge said at best “appeared to have been an audit by conversation” – as “[falling] well short of generally accepted auditing standards and its legal standard of care”: paras. 231, 234.

[299]    The trial judge’s conclusions were well-supported by the record.

(4)         Conclusion on Breach of Standard of Care

[300]    From the history of the relationship, Deloitte knew that Drabinsky and Gottlieb were aggressive entrepreneurs who pushed the envelope in terms of accounting and financial measures. As early as the Cutway memo in 1990 and the non-disclosure respecting the naming agreement (known by the 1993 audit), at least some within Deloitte had concerns about Drabinsky and Gottlieb “not proving to be as ‘above board’ … as they should be”. 

[301]    Additional red flags emerged during the following years.  These red flags should have heightened Deloitte’s awareness of the need to apply an objective attitude of professional skepticism, but apparently did not.  By August/September 1997, the red flags were fully “aflutter” and included:

  • the fact that the audit environment for the 1996 audit had been classified as “high risk”;
  • the 218 per cent variance in the 1996 audit between Livent’s $22.9 million loss after amortization of the PPC and the projected net income of $20.6 million;
  • the frequent resort to unusual Revenue Transactions and the insistent inclusion of questionable revenues from those transactions in income;
  • the inconsistency in the Musicians’ Pension Surplus Receivables from the 1995 audit to the 1996 audit;
  • Gottlieb’s known deceit in failing to disclose Deloitte’s reservations about including the gain from the Pantages Air Rights Agreement in Q2 1997 to the Audit Committee in August 1997;
  • Gottlieb’s insistence that Deloitte change the composition of the audit team in order to make it more compatible with Livent’s accounting strategies; and finally,
  • Gottlieb’s constant resort to the severance-of-the-relationship trump card.

[302]    By April 1998, in the course of conducting the 1997 audit, there was yet another red flag – the revelation that the Put continued to exist and that management had clearly lied to Deloitte in that regard.

[303]    All of these factors supported the trial judge’s finding that Deloitte had failed to meet its professional standard of care as of August/September 1997 or, at the latest, April 1998, and that Deloitte was therefore negligent.

[304]    I turn now to what follows from these findings of negligence.


(1)         Backdrop

[305]    The trial judge’s causation analysis must be understood against the backdrop of Livent’s theory of liability and damages, which the trial judge accepted. 

[306]    In Livent’s submission, had Deloitte conducted its audits and financial statement engagements in accordance with the requisite standard of care, Deloitte would have discovered the fraud and other material misstatements earlier. In the alternative, had Deloitte resigned, as it should have done in August/September 1997, the fraud would have been discovered by its successor, or at least Deloitte’s reasons for resignation – loss of trust in Livent’s management – would have had to be disclosed to regulators and the public. As a result, Deloitte would not have been able to give clean audit opinions or otherwise endorse interim unaudited financial statements with “comfort letters” from the point of the discovery onwards. Without the clean audit opinions and comfort letters, Livent would no longer have been able to access the capital markets to satisfy its insatiable appetite for cash, and no further losses would have been incurred because Livent would have become insolvent at that point.  Livent’s measure of damages therefore equals the change or increase in the losses it sustained – i.e., the difference in its net asset/liability position – between the time of Deloitte’s breach and the time of Livent’s eventual CCAA filing (L = ALD – ELD).

[307]    As outlined above, the trial judge found that Deloitte had not fallen below the requisite standard of care in relation to the 1995 or earlier audits. He concluded that Deloitte had failed to meet the standard of care with respect to: (i) certain aspects of the 1996 audit; (ii) the work performed regarding the interim unaudited six-month Q2 and Q3 1997 financial statements; and (iii) the 1997 audit. He found, however, that even if Deloitte had fulfilled its duty of care with respect to the 1996 audit year, it would not have resulted in Livent being denied access to the capital markets at that time, thereby triggering the “but for” test for causation for that period.[4] With respect to 1997, however, he found that the “but for” test was met: if Deloitte had fulfilled its duty with respect to the Q2 and Q3 1997 engagement and the 1997 audit, Livent would no longer have been able to access the markets.

[308]    In support of his conclusion on causation with respect to 1997, the trial judge found that:

  • Deloitte knew at all material times that Drabinsky and Gottlieb were using the financial statements certified by it, and the comfort letters provided, to assist them in convincing third parties to invest money in or extend credit to Livent (indeed, Deloitte admitted that Drabinsky and Gottlieb used the false and misleading financial results of Livent they had caused to be promulgated to induce stakeholders to invest in or extend credit to Livent);
  • the use of fraudulently misstated financial statements to induce people to invest in a company was an entirely predictable (i.e., reasonably foreseeable) outcome;
  • while the fraudsters may not have been directly stealing money from the company, they nonetheless caused Livent to improperly incur greater liabilities than it would otherwise have incurred;
  • Deloitte should have resigned from the audit at the end of August 1997 or, at the latest, September 30, 1997; or, at the very least,
  • Deloitte should not have given a clean comfort letter respecting the fall 1997 debenture offering or a clean audit opinion respecting the 1997 financial statements;
  • had either of these events occurred, Livent’s access to the capital markets to fill its voracious need for cash through debt or equity financing, would have been foreclosed; and, as a result,
  • Livent would have been required to shut down its business and seek insolvency protection before it incurred the subsequent increase in liabilities arising from its continued financing ventures (liabilities which, reasonably foreseeably, could not be offset by Livent revenues, given the cash-burn nature of the Livent operations at the time).

[309]    Deloitte raises a number of issues on causation and damages. It challenges the trial judge’s findings on, and analysis of, factual causation. It also raises a number of issues related to remoteness or proximate cause and damages. In particular, it contends that: 

  • the trial judge failed to apply the “but for” test properly, as he did not expressly consider what would have occurred if Deloitte had complied with the standard of care;
  • the damages claimed are too remote to be attributed to Deloitte’s conduct because they flow not from Deloitte’s negligence, but rather from “the vicissitudes in Livent’s business to which Livent was always exposed and which Deloitte had no part in causing”;
  • Canadian courts ought not to give effect to the notion of “deepening insolvency” adopted in some U.S. jurisdictions;
  • Deloitte’s liability ought to have been reduced to nil as a result of the “contingencies” the trial judge applied; and
  • Livent’s contributory negligence should bar it from recovering (or, at least, recovering everything).

[310]    As I will explain, I reject each of these submissions.

(2)         Factual or “But for” Causation

[311]    As the Supreme Court of Canada has recently confirmed in Clements v. Clements, 2012 SCC 32, [2012] 2 S.C.R. 181, the test for showing causation is the “but for” test – a factual inquiry to be applied in a robust and common sense fashion. The test requires the court to be satisfied, on a balance of probabilities, that “but for” the defendant’s negligence the injury would not have occurred (i.e., the defendant’s negligence was necessary to bring about the injury): see paras. 8-10,per McLachlin C.J.  The Court made the following observation, at para. 10: 

A common sense inference of “but for” causation from proof of negligence usually flows without difficulty.  Evidence connecting the breach of duty to the injury suffered may permit the judge, depending on the circumstances, to infer that the defendant’s negligence probably caused the loss.

[312]    It is not necessary that the defendant’s negligence be the sole cause of the injury, as explained by Major J. in Athey v. Leonati, [1996] 3 S.C.R. 458, at para. 17:

As long as a defendant is part of the cause of an injury, the defendant is liable, even though his act alone was not enough to create the injury.  There is no basis for a reduction of liability because of the existence of other preconditions: defendants remain liable for all injuries caused or contributed to by their negligence. [Emphasis in original.]

[313]    Deloitte takes issue with the trial judge’s “but for” analysis as it relates to the trial judge’s finding that, had it resigned in August/September 1997, the fraud would have been discovered. In particular, the trial judge found that disclosure of the reasons for resigning “might very well have sounded the death knell to the proposed debenture offering”, signalling the end of Livent’s access to the capital markets: para. 188.

[314]    Deloitte submits that the trial judge’s comment that Deloitte’s resignation “might very well” have prevented the proposed debenture offering from proceeding does not constitute a finding that the offering would not have occurred.

[315]    Deloitte also submits that the resignation would not have led to the discovery of the fraud or have prevented the fall 1997 debenture offering from proceeding because all it would have revealed – had it been disclosed to the regulators and a subsequent auditor – was that there had been a simple accounting dispute over whether revenue associated with the Pantages Air Rights Agreement could be recognized in Livent’s Q2 financial statements.

[316]    Furthermore, Deloitte contends that, even if it had resigned, a replacement auditor would have been found and would have given the fall 1997 comfort letter and the clean 1997 audit opinion, thus enabling Livent to continue beyond Q3 1997.

[317]    In my view, none of these arguments has merit.

[318]    I do not accept that the trial judge made no finding as to what would have happened had Deloitte resigned in the August/September period. I read his comment that disclosure to the regulator or successor auditor “might very well have sounded the death knell” as a finding on a balance of probabilities that disclosure would have ended Livent’s access to the capital markets.

[319]    Nor am I persuaded by the argument that disclosure of the reasons for resignation would have been as benign as Deloitte submits.  While it may be accurate to say that the resignation would not have been as a result of the fraud – given how things stood at the time – it is not accurate to say that the reason for the resignation, if fully disclosed, would have been simply an accounting dispute over the inclusion of a revenue item in the financial statements.  The disclosed reason would have had to have been a loss of trust in the client based on the lack of integrity of at least Gottlieb, one of the two driving forces of the company.  The impact of that type of disclosure would inevitably have had more impact on regulators, the successor auditor, and potential investors than a mere “accounting dispute” over revenue inclusion. 

[320]    These conclusions undermine the submission that a replacement auditor would likely have emerged and continued to depict the same laundered image of Livent’s operations. Disclosure to the regulators, the public and the subsequent auditor that the reasons for resignation included genuine questions about the integrity of Livent would have set red flags even more aflutter and would have required a very close, more careful and objective investigation into Livent’s financial statements – one that involved the requisite application of “an attitude of professional skepticism”. 

[321]    I am not persuaded that the trial judge erred in his finding, at para. 241, that Deloitte’s resignation in August/September 1997 would have precipitated Livent’s demise:

I have first concluded that Deloitte should have pulled the plug on its relationship with Livent at the end of August or, at the very latest, September 1997. In my view, had matters come to a head on either of those two dates, then Deloitte would have been obliged to make “full and frank” disclosure not only to the Audit Committee but to the regulators, the results of which would have put Livent in the position it found itself in 11 months hence.

[322]    I agree with the trial judge that it is more likely than not that a careful and objective investigation into Livent’s financial statements, pursued with “an attitude of professional skepticism”, would have revealed the fraud, with the same consequences that followed when the fraud was actually discovered a year later.

[323]    I now turn to the issue of remoteness or proximate cause.

(3)          Remoteness/Proximate Cause

[324]    As explained in Mustapha v. Culligan of Canada Ltd., 2008 SCC 27, [2008] 2 S.C.R. 27, at para. 12, the remoteness inquiry asks whether “the harm [is] too unrelated to the wrongful conduct to hold the defendant fairly liable”. The test for determining whether the harm is too remote is reasonable foreseeability:Mustapha, at paras. 12-13.

[325]    The trial judge dealt with remoteness at paras. 308-26 of his reasons. There, he addressed two English cases – Galoo Ltd. (in liq.) v. Bright Grahame Murray (a firm), [1995] 1 All E.R. 16 (C.A.), and Sasea Finance Ltd. (in liquidation) v. KPMG (formerly KPMG Peat Marwick McLintock (a firm)), [2000] 1 All E.R. 676 (C.A.) – which I will discuss below. Relying on those cases, as well as the evidence before him, he found that most, but not all, of Livent’s losses were attributable to the improper increase in liabilities caused by Deloitte’s negligence. At para. 318, he stated:

On the one hand, Livent’s losses after the Measurement Date are largely attributable to the very fraud which Deloitte should have detected. The fraudsters may not have been directly stealing from the company, but they did directly cause the company to improperly incur greater liabilities than it would otherwise have incurred. The use of fraudulently misstated financial statements to induce people to invest in a company is entirely predictable. Livent’s losses – to the extent they are attributable to this improper increase in liabilities – cannot be said to be too remote. [Emphasis added.]

[326]    The trial judge recognized, however, that not all of Livent’s losses ought to be visited on Deloitte. He found that “Deloitte ought not to be liable for the losses attributable to Livent’s legitimate but unsuccessful ventures”: para. 319. Accordingly, he reduced the net economic loss number of $113 million as at August 31, 1997 (which I will discuss below) by 25 per cent to reflect that Deloitte’s breaches of the standard of care were not the proximate cause of all of the losses sustained by Livent.

[327]    In reaching that number, he relied on expert evidence regarding “contingencies”, which related to the “vagaries” of the business Livent was in.

[328]    Deloitte submits that the trial judge made a number of errors in his analysis of remoteness and damages. I will address each of the alleged errors in turn. 

(a)         Normal Business Losses and Deepening Insolvency

[329]     In arguing that it should not bear the losses sustained by Livent, Deloitte raises two, and in some ways overlapping, themes. Deloitte argues, first, that the trial judge erred in applying a doctrine known as “deepening insolvency” that has received mixed application in various U.S. jurisdictions, but that has not, as yet, been applied in Canadian jurisprudence. Secondly, it submits that any alleged negligence on its part did not cause Livent’s loss; rather, any losses sustained by Livent from continuing in business were caused by the money-losing nature of its business, which Deloitte had no part in causing.  

[330]    At the heart of each submission is the argument that an auditor’s negligence permitting a corporation to continue operating a money-losing business may create the opportunity for losses to continue or accumulate, but is not the proximate cause of those losses, which continue to be attributable to the decisions of management.

[331]    For this proposition, Deloitte relies on several American authorities that criticize the notion of “deepening insolvency”: see e.g. In re CitX Corp., 448 F. 3d 672 (3d Cir. 2006); and In re Parmalat Securities Litigation, 501 F. Supp. 2d 560 (Dist. Ct. N.Y. 2007). “Deepening insolvency” has been defined in American writings and jurisprudence as “the artificial prolongation of a corporation’s existence past the point of insolvency”, or “an injury to [a debtor’s] corporate property from the fraudulent expansion of corporate debt and prolongation of corporate life”: John Tully, “Plumbing the Depths of Corporate Litigation: Reforming the Deepening Insolvency Theory” (2013) U. Ill. L. Rev. 2087, at p. 2089; and In re CitX Corp., at p. 677, citing Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., 267 F. 3d 340 (3d Cir. 2001).

[332]    Deloitte also relies on the English Court of Appeal’s decision in Galoo, which deals with a somewhat similar fact situation to the one in this case.

[333]    In my view, the U.S. and English cases relied on by Deloitte do not undermine the conclusion that its negligence was the proximate cause of those losses attributable to the improper increase in net liabilities.

[334]    The theory of deepening insolvency was an important issue at trial. As noted by the trial judge, “[a] significant amount of time was devoted by both sides… to the concept of ‘deepening insolvency’”: para. 344. At the end of the day, however, the trial judge was not persuaded that the notion of deepening insolvency “assist[ed] the defendant in reducing the damages”: para. 352.

[335]    Deloitte submits, however, that the trial judge did, in effect, apply the concept of deepening insolvency and erred in doing so. I do not agree and, in my view, the concept of deepening insolvency provides little, if any, assistance in this case.

[336]    American authorities supporting the doctrine (either as a cause of action or a theory of damages) have done so on the basis that third-party negligence permitting management to prolong the life of a corporation past insolvency and accumulate additional debt beyond its ability to pay may constitute recoverable harm to the corporation: see e.g. Bloor v. Dansker (In re Investors Funding Corp. of New York Securities Litigation), 523 F. Supp. 533 (Dist. Ct. N.Y. 1980);Schacht v. Brown, 711 F. 2d 1343 (7th Cir. 1983); Thabault v. Chait, 541 F. 3d 512 (3d Cir. 2008); and Lafferty.

[337]    American authorities criticizing and declining to apply the doctrine have done so on the basis that an insolvent corporation is not necessarily harmed by, but may even benefit from, entering into additional debt transactions and that a company’s insolvency is deepened not by the debt or investment itself, but rather by management’s misuse of the opportunity created by them: see e.g. In re CitX Corp.; and Parmalat.

[338]    I do not think it necessary, or useful, in this case to determine whether “deepening insolvency” is to be recognized as a cause of action or a theory of damages in Canada. It is a label that describes many of the same considerations that underlie the debate about whether the damages that Livent claims are available under traditional tort and contract principles.  In my view, they are, and in this respect I agree with the statement of the Court of Appeals for the Third Circuit in Thabault, at p. 523, that “traditional damages, stemming from actual harm of a defendant’s negligence, do not become invalid merely because they have the effect of increasing a corporation’s insolvency.”

[339]    To qualify as “actual harm of a defendant’s negligence,” the injury sustained must have been a reasonably foreseeable risk or consequence of the breach, however. This brings me to the debate surrounding Galoo and subsequent related authorities from the U.K.

[340]    Galoo Ltd. and its parent company sued their auditor alleging that it had negligently failed to discover their continued insolvency. The Galoo companies argued that, had they known they were insolvent, they would have ceased trading and would not have incurred further liabilities or trading losses.  Two kinds of harm were alleged: (i) the acceptance of increased debt; and (ii) continued trading losses.  The Court of Appeal concluded on the facts as pleaded – Galoo was a pleadings case – that the statement of claim disclosed no reasonable cause of action.

[341]    Galoo is somewhat analogous to the present case factually and in terms of the arguments raised against the auditor. Perhaps signalling why Deloitte arguesGaloo is “on all fours” with this case, Glidewell L.J. summarized the plaintiffs’ submissions on the trading losses head of damages as follows, at p. 24:

(a) If they had not acted in breach of their duty in contract or tort, [the auditor] would have detected the fraud during their audit of the 1985 accounts. (b) In that case, [the Galoo companies] would have been put into liquidation in mid-1986 and thus ceased to trade at that date. (c) If the companies had ceased to trade, they would neither have incurred any further trading losses nor paid the dividend in 1988. (d) Therefore the trading losses and the loss caused by the dividend payment were caused by the breach of duty by [the auditor].

[342]    Deloitte submits that, unless this Court determines that Galoo should not be followed in Ontario, the appeal should be allowed. I would not incorporate Galoointo the law of Ontario. But there are a number of reasons why Galoo does not assist Deloitte, in any event.

[343]    First, the circumstances of the losses in Galoo are distinguishable. With respect to the first head of damages, the Galoo companies claimed that they had suffered a loss merely because they had continued to accept loans. The Court recognized that the acceptance of new debt could not, in and of itself, amount to a loss causing damages. It was balance sheet neutral in the sense that, on acceptance of the loan, the company had both the money to use and the obligation to repay it. As for the trading losses, the Galoo companies alleged that the opportunity to incur trading losses from their continued operations resulted in compensable damages. The Court rejected this claim because the auditor’s negligence did no more than create the occasion (i.e., the continued operations of the business) for the harm to occur, but did not cause the harm itself – “in the sense in which the word ‘cause’ is used in law”: p. 30. It relied on an Australian decision, Alexander v. Cambridge Credit Corp. Ltd. (1987), 9 NSWLR 310, which held that, as a matter of common sense, allowing a company to continue in existence did not, without more, cause losses occasioned by the ordinary risks associated with carrying on business. 

[344]    Here, however, that “more” is present and was pleaded. Livent has alleged that Deloitte’s negligence resulted in the issuance of clean comfort letters and audit opinions, which Livent then relied upon to access the capital markets and improperly incur increased liabilities. Deloitte’s breaches did not merely create the opportunity for Livent to continue in existence, but rather assisted it in improperly taking on further liabilities that it could not repay, due to the cash-burn nature of its business. As I will explain in more detail below, Livent has drawn the causal nexus – missing in Galoo – between Deloitte’s breach and Livent’s loss.

[345]    Secondly, Galoo is also distinguishable on the basis of its legal analysis, which differs from the prevailing law in Canada. The Galoo Court rejected the application of the “but for” test and instead applied what can best be described as a “common sense” application of an “effective” or “dominant” cause test: pp. 28-30.  In Canadian law, the negligent act need only be “a” cause of the reasonably foreseeable injury; it need not be an “effective” or “dominant” cause: see Athey v. Leonati.

[346]     Finally, Galoo is not binding on this Court and, in any event, does not even appear to reflect the law in the United Kingdom at this point.

[347]    For example, in Sasea, a subsequent case from the English Court of Appeal, the losses resulted from certain defalcations by a principal of the company that should have been detected by the auditors, but were not. The Court declined to give effect to the argument that the auditor’s negligence only created the opportunity for the company’s losses, but did not cause them.

[348]    The Court in Temseel Holdings Ltd. v. Beaumonts, [2002] EWHC 2642 (Comm.), also declined to follow Galoo. The Temseel Court rejected a motion to dismiss a negligence claim against an auditor. It was alleged that the auditor had failed to detect that the directors had overestimated the profit margins of certain transactions, leading the company to continue to engage in those transactions on the same basis, which resulted in losses to the company. Galoo was distinguished, at para. 52, on the basis that “[t]he complaint made by the company [was] not simply that it was allowed to continue trading, but rather that in reliance upon the figures which had been supplied to it and represented to be correct it continued to trade in a particular manner” (emphasis added).  Livent did so in the present case as well.

[349]    The most recent commentary from the United Kingdom touching on this subject is contained in the U.K. Supreme Court’s decision in Bilta, referred to above in the context of the doctrines of attribution and ex turpi causa, with which it was primarily concerned. In discussing the issue of loss or damage in their joint reasons, Lords Toulson and Hodge relied on remarks by Lord Mance in Stone & Rolls to the effect that “to cause a deficit to a company making it insolvent is to cause it loss”: Bilta, at para. 176. (Lord Mance was on the Bilta Court and gave separate reasons, but did not comment on this point). Lords Toulson and Hodge rejected the defendant’s submission that Bilta had suffered no loss “since it began life with negligible assets and never acquired any lawful assets, so it had none to lose”: Bilta, at para. 176.  They concluded, at para. 178:

A company’s profit and loss account and its balance sheet may be positive or negative.  When the directors caused Bilta to incur VAT liabilities, and simultaneously caused it to misapply money which should have been paid to HMRC, leaving the company with large liabilities and no means of paying them, the directors caused it to suffer a recognisable form of loss. [Emphasis added.]

[350]    Although Bilta is not an auditor’s negligence case, the damage/loss issue is comparable to this case.

[351]    In the end, I do not accept Deloitte’s broad proposition that an auditor’s negligence permitting a company to continue to stay in business when, had the negligence not occurred, the business would have ceased operations, merely creates the opportunity for the business to accumulate further losses, but cannot be the proximate cause of those losses. As this case demonstrates, there are circumstances where the auditor’s knowledge and the factual matrix can establish the necessary causal nexus between the auditor’s breach and the client’s losses.

[352]    As discussed above, a public company, such as Livent, is required by statute to have audited financial statements to access the capital markets in Canada and the U.S. Moreover, in the course of a public offering, an issuer, such as Livent, will provide comfort letters in conjunction with its offering memoranda. The comfort letters, prepared by the issuer’s auditor, relate to the issuer’s latest unaudited interim financial statements. Presumably, without such comfort letters, the markets are less likely to respond positively to the offering. 

[353]    As recognized by the trial judge, Drabinsky and Gottlieb were more than a little aggressive in ensuring that Livent’s financial statements reflected its performance in the rosiest of all lights. The trial judge also found that “Deloitte knew at all material times that Gottlieb and Drabinsky were using the financial statements to assist them in convincing third parties to invest money in or extend credit to Livent”: para. 280.

[354]    Given this knowledge, it was a reasonably foreseeable risk that Livent would incur increased liabilities as a result of its continuing resort to capital market offerings through the use of financial statements founded on fraud or other material misstatements that Deloitte, in the reasonable exercise of its duties, ought to have discovered.

[355]    In addition, Deloitte had knowledge regarding the cash-burn nature of Livent’s business and the record of losses being accumulated in the various productions – knowledge derived through Deloitte’s audit history and its ongoing relationship with Livent’s principals. Consequently, it was also reasonably foreseeable and predictable that there would not be offsetting profits or assets to balance against the increased liabilities. 

[356]    In these circumstances, the losses related to what the trial judge described, at para. 318, as the “improper increase in liabilities” did not flow from “the vicissitudes of Livent’s business … which Deloitte had no part in causing”, as Deloitte has suggested.  They flowed reasonably from Deloitte’s failure to do its job properly, which would have stopped the bleeding.

[357]    Before concluding on the issues of factual causation and proximate cause, I turn to Deloitte’s final argument relating to the trial judge’s remoteness/proximate cause analysis – that concerning contingencies.

(b)          Contingencies

[358]      Deloitte submits that the trial judge’s erroneous approach to causation reflects itself in his recognition of a 25 per cent discount for what he called contingencies. On its cross-appeal, Livent also takes issue with the contingencies analysis.

[359]    As explained above, the trial judge took into account evidence of contingencies in his remoteness analysis. While he used the term contingencies, I do not think he was referring to that term in the traditional sense in which it is used in tort law (where “contingencies” generally refers to future events or considerations that may affect the quantum of damages awarded). Rather, the trial judge was using the term to refer to the evidence he had heard relating to the “vagaries” or the money-losing nature of Livent’s business. In the end, nothing much turns on the terminology used by the trial judge to describe what he was dealing with here.

[360]    The focus of the parties’ differences on the contingencies point is not the 25 per cent reduction figure chosen by the trial judge. Instead, both parties argue that the trial judge erred in applying any contingencies factor.

[361]    Livent submits that there should be a zero per cent reduction for contingencies because, on the basis of Athey v. Leonati and the “but for” test, Deloitte’s negligence does not have to be the sole cause of Livent’s losses, but only “a” cause, and further that, once it is foreseeable Deloitte’s breach would result in an increase in net liabilities to Livent, the full extent of the losses need not be foreseen for purposes of the remoteness analysis.

[362]    Deloitte submits, on the other hand, that there should be a 100 per cent reduction – i.e., no damages – because the losses all flowed from the inherent vicissitudes of Livent’s risky business and were not attributable to Deloitte’s breach of its standard of care. In the jargon of the litigation, these kinds of losses were loosely referred to as “trading losses” (after the reference to such losses in that fashion in Galoo).

[363]    I reject these arguments. In my view, there is no reason to interfere with the trial judge’s conclusion that there should be a 25 per cent reduction to reflect the fact that Deloitte’s negligence was not the proximate cause of all the increase in Livent’s net liabilities during the period between Deloitte’s breach and the CCAA proceeding (referred to by the trial judge as the “delta” period).

[364]    In arriving at this conclusion, the trial judge recognized an inherent difficulty with the “contingencies” analysis.  At para. 319, he stated:

[T]he basic measure of damages in this case – the increase in liquidation deficit that would not have occurred but for Deloitte’s negligence – does not permit me to readily ascertain how much of the damage ought to be seen as a result of the normal vagaries of Livent’s business, and therefore too remote to be recoverable.

[365]    He turned to the evidence of Stephen Cole for some assistance in this regard. In particular, he relied on Cole’s evidence regarding the vagaries of the industry, which he summarized, at para. 320:

Cole opined that Livent engaged in a very risky business, which was fraught with perils right from the start of the enterprise.  He suggested that the following factors contributed to Livent’s total economic loss: (a) the inherent risks of the Broadway theater and musical productions industry; (b) the pursuit of a high-risk integrated operating strategy (i.e. all aspects of the production and distribution of a show were carried out by Livent); (c) the financial failure of several large-scale productions, which were not backstopped by successful productions; (d) the investment in and construction of multiple theaters, which was lost when the theatres were liquidated; and (e) the carrying and financing charges associated with the aforesaid activities. [Footnote omitted.]

[366]    The trial judge admitted he wrestled with the issue of determining the remoteness question through a contingencies analysis. He observed further that the application of a contingencies analysis “[did] not admit of precise calculation” and was not “an all or nothing proposition because the concepts are more than a little ‘soft’ and difficult if not impossible to pin down”: para. 325.

[367]    Despite those challenges, he ultimately concluded, at paras. 324-26, that there should be a 25 per cent reduction to reflect the fact – as he put it – that “it would not be fair and reasonable to visit the entire delta at Deloitte’s door” and that “the consequence of certain of the ‘trading losses’ should not be borne by Deloitte”:

I have struggled through this area, with some misgivings.  It is my assessment of the evidence, heard throughout the course of the entire trial, including the evidence of Cole, that the raw number should be reduced by 25%.  In my opinion, the percentage chosen reflects the change in the environment in which Livent was functioning after year-end 1995, and would account for the “trading losses” that would be generated from the unprofitable but legitimate theatre business.

[368]    By “the change in the environment in which Livent was functioning after year-end 1995”, I take the trial judge to be referring to the cumulative effect of the increased financial stress on Livent arising from, amongst other things: (a) the exponentially increasing expenditures associated with at least 11 different shows in various stages of presentation and production, and with the cost of acquiring and renovating at least three theatres in the United States; (b) the downturn beginning in the “watershed” year of 1996 resulting from Phantom in Toronto nearing the end of its run, and the financial failure of such shows as Sunset Boulevard, Kiss,and Show Boat; (c) the escalating demand for funding accompanying these developments; and (d) the increasing pressure from Drabinsky and Gottlieb and their juggling to keep all of these balls in the air. 

[369]    The trial judge explained it in this fashion, at para. 323:

As best as I have been able to distill the welter of material thrown my way, there was a change in Livent’s game plan from about the middle of 1995 to the day of reckoning in August 1998.  Unfortunately for Livent, this change in game plan was coupled with a change in its operating fortunes during this period, driven by internal and external forces.  While the general business strategy remained essentially the same throughout, namely the establishment of a vertically-integrated theatre and production company, the growth in expenditures in both productions and theatre construction was exponential, and not incremental.  That increase might have been manageable except for the fact that Livent suffered significant losses from several of its own productions, which, had things rolled out as anticipated, it might have self-financed some or a larger portion of the enterprise, without relying on the capital markets or its creditors as a primary source of funds.

[370]    Thus, the trial judge distinguished between losses generated from Livent’s unprofitable, but legitimate theatre business, operating within the changed environment, and those losses attributable to Deloitte’s negligence.

[371]    In grappling with the remoteness question, the trial judge found some assistance in comparing GalooSasea, and this case on a spectrum of factual situations involving auditor’s negligence. I think this comparison is helpful as well. At one end of the spectrum, Sasea involved losses that were directly caused by the very fraud that the auditor negligently failed to detect – namely, the embezzlement of funds from the company. In that case, the auditor was liable. At the other end of the spectrum, Galoo was a case where the only nexus between the auditor’s negligence and the resulting loss was that the breach allowed the company to stay in business. The claim was struck. This case is somewhere between those two cases on the spectrum, however. Here, as the trial judge found, at para. 318:

On the one hand, Livent’s losses after the Measurement Date are largely attributable to the very fraud which Deloitte should have detected.  The fraudsters may not have been directly stealing from the company, but they did directly cause the company to improperly incur greater liabilities than it would otherwise have incurred. The use of fraudulently misstated financial statements to induce people to invest in a company is entirely predictable. Livent’s losses – to the extent they are attributable to this improper increase in liabilities – cannot be said to be too remote. [Emphasis added.]

[372]    As noted earlier in these reasons, the trial judge summarized Livent’s theory of damages at para. 291: “[T]he measure of damage equals the change or increase in the losses sustained by Livent [during the delta period]” (emphasis added). However, while the Measurement Date is the triggering moment for the measurement of damages, it does not follow that Deloitte is responsible for any and all losses sustained by Livent during the delta period. What Livent is entitled to recover is “the increase in liquidation deficit that would not have occurred but for Deloitte’s negligence”, but not those losses that, to paraphrase Mustapha, are too remote to hold Deloitte fairly liable. In short, Deloitte is only responsible for those losses that are reasonably foreseeable as a result of its negligence.

[373]    As I have explained, it was a reasonably foreseeable risk that Livent would incur increased liabilities as a result of its continuing resort to the capital markets through the use of financial statements founded on fraud or other material misstatements that Deloitte ought to have discovered. In addition, Deloitte had knowledge of the record of losses being accumulated in the various productions and the cash-burn nature of Livent’s business, and consequently could have reasonably foreseen that there would not be offsetting profits or assets to balance against the increased liabilities. 

[374]    In the result, Livent suffered enhanced losses, which were reasonably foreseeable, as a function of Deloitte’s negligence permitting Livent to resort again to the capital markets and to acquire investment liabilities which inevitably would not be offset by assets because of the cash-burn nature of its business.

[375]    On the other hand, the losses resulting from the vicissitudes of Livent’s money-losing business during the delta period are simply unrelated to Deloitte’s negligent acts. As the trial judge recognized, Deloitte should not be responsible for losses generated by the unprofitable, but legitimate theatre business operating within the changed environment from 1996 onwards.

[376]    Finally, on the cross-appeal, Livent submits that to apply a contingencies factor to reduce the quantum of damages “amounts to a back door application of the doctrine of contributory negligence”.

[377]    The trial judge rejected that argument. I agree with the trial judge. As explained above, “contingencies” in this context refers to the “vagaries” of Livent’s inherently unprofitable business. “Contributory negligence” refers to the apportionment of liability and damages arising from the negligent acts, according to the degree of fault of the plaintiff in relation to those acts. The two concepts are different.  I will deal with the issue of contributory negligence below.

(4)          Conclusion on Causation

[378]    To conclude, Deloitte’s negligence caused Livent to continue to operate in circumstances in which it was reasonably foreseeable both that the company would continue to accumulate increased liabilities through its access to the capital markets, but also – perhaps even more significantly – that it would have no means of paying down those liabilities because of the cash-burn nature of Livent’s money-losing business.

[379]    Deloitte’s negligence did not merely create the opportunity for Livent to stay in business (Galoo).  It created the opportunity for Livent to stay in business andfor the fraudsters to continue to take Livent to the capital markets, thus enhancing the losses that would otherwise have been incurred had Livent remained in business during the delta period. The enhanced liabilities resulted from Deloitte’s negligence (Sasea, Temseel, and Bilta), would not have been incurred “but for” that negligence (Clements and Athey v. Leonati), were a foreseeable risk of Livent’s continuing in business, and the harm incurred was therefore not “too unrelated to the wrongful conduct to hold [Deloitte] fairly liable” (Mustapha).

[380]    In reaching this conclusion, I recognize the need for the law not to overreach by exposing auditors of public companies to unreasonable obligations.  In my view, however, where the proper factual and legal connection between the breach and the losses exists – i.e., where it is reasonably foreseeable that the losses will be sustained and where, “but for” the negligence, the company would not have incurred them – the auditor’s breach can be the cause of those losses and give rise to compensable damages.

[381]    I now turn to issues relating to the quantum of damages.


(1)         Measure and Quantum of Damages

[382]    The parties agree that it does not matter whether this case is viewed as a breach of contract case or a tort case. They do not dispute the trial judge’s conflation of the measure of damages in tort and in contract in the circumstances. Subject to the limiting factors discussed below, Livent is to be put in the same position it would have been in had the tort or breach of contract never been committed.

[383]    Nor do the parties quarrel with the use of the formula “Loss (L) = Actual Liquidation Deficit (ALD) – Estimated Liquidation Deficit (ELD)”, determined as of the Measurement Date, as defined earlier in these reasons, for the purpose of calculating Livent’s economic loss. 

[384]    As noted earlier, the ALD is not in dispute and is fixed at $418,830,000.  It represents the losses sustained by Livent after taking into account the amounts received on the sale of its assets. Much evidence was led about the calculation of the ELD, however. The experts differed. There was no agreement on what the appropriate Measurement Date was. The experts prepared their calculations based on Measurement Dates of March 1997 and March 1998 and, ultimately, at the trial judge’s request, Cole (Deloitte’s expert) prepared a calculation based on a Measurement Date of August 31, 1997.

[385]    In addition, central to the differences between the experts on the ELD valuation was their approach to establishing the value of Livent’s assets as at the Measurement Date. Ratner, for Livent, compared the actual amount realized from the sale of Livent’s assets against the adjusted book value of those same assets. Cole, on the other hand, estimated the fair market value of Livent’s assets as at the Measurement Dates to arrive at what he thought the assets would have netted had they been disposed of at those moments in time. The practical impact of the different approaches was that the higher the value placed on the assets at a given Measurement Date, the lower the ELD, and therefore the higher the damages.

[386]    The trial judge found that neither of the experts’ approaches was “unassailable” and, accordingly, that their respective numbers “could [not] be accepted without modification”: para. 303. Acknowledging that “but for choosing a mid-point between the two” (Livent’s suggestion), he was “at a loss to settle upon a principled approach for preferring one set of numbers over another”, he in effect split the difference: para. 303. He found that the “raw numbers” for a Measurement Date of March 1997 (about the time the 1996 audit was completed) and March 1998 (within days of the discovery of the Put) were, respectively, $155 million and $53.9 million, based on the mid-point between the Ratner and Cole calculations for those dates.

[387]    Deloitte argues that it was not open to the trial judge to take an unprincipled approach to fixing the quantum of damages by simply choosing the mid-point between the experts’ numbers. 

[388]    I do not accept this argument. As the trial judge observed, “[t]he assessment of damages is as often as not a mug’s game” (para. 274) and trial judges are obliged to do the best they can on the evidence, short of failing to analyze the evidence at all or simply guessing: see e.g. Murano v. Bank of Montreal (1995), 20 B.L.R. (2d) 61 (Ont. Gen. Div.), at pp. 120-23, rev’d in part on other grounds (1998), 41 O.R. (3d) 222 (C.A.).

[389]    I do not think that the decision of this Court in Danecker v. Danecker, 2014 ONCA 239, assists Deloitte in this respect. There, the trial judge had simply averaged the numbers of the experts without conducting any analysis of the evidence. That is not the case here, where the trial judge engaged in a lengthy consideration and analysis of both experts’ evidence and their respective approaches. Having reviewed all of the evidence, including that of Cole and Ratner, he concluded that neither approach could be accepted without modification.  It does not follow that he was thus required to assess the damages at zero.  I see no palpable and overriding error in the circumstances.

[390]    The next step for the trial judge was to settle on a Measurement Date.  Ultimately, he landed on August 31, 1997 because of his views outlined above as to Deloitte’s breaches in the August/September period of that year. Recognizing that both experts’ ELDs had decreased between March 1997 and March 1998 as one moved closer to the ALD, the trial judge then turned to Cole’s re-worked estimate of the economic loss as of August 31, 1997 (approximately $100 million). He compared that number with Cole’s estimate as at March 1997 ($136 million), and applied the ratio between those two estimates (73.5 per cent) to the “raw number” of $155 million that he had arrived at in the fashion explained above. This gave the trial judge a net economic loss number for August 31, 1997 of $113 million, which is the figure he reduced by 25 per cent on account of contingencies. I see no error in this approach.

[391]    I turn now to the issue of contributory negligence.

(2)       Contributory Negligence

[392]    The trial judge observed that “the purpose of an audited statement, namely to [ensure] that the interests of shareholders are safeguarded by giving them the means to supervise management, would be undermined if an auditor’s responsibility were reduced in proportion to the egregiousness of the misconduct which it failed to detect”: para. 340. I agree with that statement in the context of this case: the application of the doctrine of contributory negligence in the circumstances here would, in my view, amount to a back-door application of the doctrine of corporate identification, which I rejected earlier.

[393]       Deloitte’s argument is that s. 3 of the Negligence Act, R.S.O. 1990, c. N.1, governs and that the trial judge had no option but to give effect to this provision.  Section 3 states:

In any action for damages that is founded upon the fault or negligence of the defendant if fault or negligence is found on the part of the plaintiff that contributed to the damages, the court shall apportion the damages in proportion to the degree of fault or negligence found against the parties respectively. [Emphasis added.]

[394]    It is clear from this provision, however, that the fault or negligence contributing to the damages must be “fault or negligence … on the part of the plaintiff”.  Here, I have concluded – as did the trial judge – that the fraudulent acts of Drabinsky and Gottlieb are not to be attributed to Livent for the purposes of the ex turpi causa defence. I agree with Livent’s counsel that to apply that same conduct to Livent for the purpose of assessing contributory negligence in this case “is just the attribution/illegality argument under another name” and that, in the absence of attribution, “[t]he requirements of the Negligence Act are not met”.

[395]    Deloitte argues nonetheless that the “innocent” representatives of Livent were at least equally negligent in failing to take steps that would have led to the discovery of the fraud. It submits that the trial judge erred in his assertion that “[he] did not hear any evidence to suggest that the innocent members of the Board or the Company’s shareholders knew or ought to have known, or were warned, that something was amiss at any time relevant to the audits in question”: para. 341.  

[396]    In this respect, Deloitte relies principally on information that had been provided to the then-Chair of Livent’s Audit Committee regarding the inclusion of revenue from the Pantages Air Rights Agreement in August 1997, the recognition of what was known as the AT&T transaction in Q3 1997, and Deloitte’s discovery of the side agreement containing the Put in April 1998. It does not follow that conveying this information to the Chair of the Audit Committee – whom the trial judge found was “basically the last honest man standing” (para. 101) – constituted a warning, or even knowledge, that something was amiss during the period relevant to the audits in question. The trial judge was alive to and reviewed all of the pertinent evidence in assessing whether any “innocent” director or shareholder “failed to take steps to minimize, if not avert, the harm done, whose want of care could be attributed to the Company”: para. 337. He concluded that there was not. I see no basis for interfering with that finding.

[397]    Deloitte argued that it was unfair for it to be wholly responsible for the damages sustained by Livent when it was Livent’s own principals that perpetrated the fraud and Deloitte had relied on information obtained from other third parties such as Dundee and Livent’s solicitors. The reality is that Deloitte did not need to stand alone at trial. It could have taken third-party proceedings for contribution against the fraudsters, Dundee and the solicitors, but it chose for its own undisclosed reasons not to do so. Although this point is not dispositive – as the trial judge recognized – it works against Deloitte’s “unfairness” argument.

[398]    I would not interfere with the trial judge’s decision not to apply the doctrine of contributory negligence in the circumstances.


[399]    On the cross-appeal, Livent raises two issues:

(1)      Having found that Deloitte breached the standard of care in its audit of the 1996 financial statements and having quantified the damages at $155 million, did the trial judge err in not awarding Livent the damages that resulted from this breach?

(2)      Regardless of whether damages are awarded from August 1997 or an earlier date, did the trial judge err in applying a 25 per cent reduction to Livent’s damages to account for contingencies?

[400]    I begin with the observation that what Livent endeavours to persuade this Court to do on the cross-appeal is, for the most part, to revisit and reweigh the trial judge’s findings of fact, the inferences he drew from those facts, and the conclusions of mixed fact and law to which he came based on those findings and inferences. I would decline to do so. In its arguments relating to the cross-appeal, Livent has not shown any palpable and overriding error with respect to the trial judge’s factual findings, the inferences he drew from those findings, or the conclusions reached as a result of those findings and inferences. 

(1)         Contingencies

[401]    I have dealt with the contingencies issue above and for the reasons already expressed there, this ground of appeal cannot succeed. Accordingly, this portion of the reasons will deal only with the first question. 

(2)          Damages and the 1996 Audit

[402]    As noted above, the trial judge found that Deloitte failed to meet the standard of care by not completing the 1996 audit in accordance with GAAS in its treatment of: (i) the PPC; and (ii) the Musicians’ Pension Surplus Receivables in relation to the Kiss tour of New York and Show Boat in New York. However, he was “not persuaded that [Deloitte’s] negligence had caused any compensable harm as of the signing of the opinion in 1997” for the 1996 financial statements: para. 173.  He reached that conclusion based on his finding that a confrontation with management over the PPC and the Musicians’ Pension Surplus Receivables – even if those misstatements had been discovered as they should have been – would not “have revealed instances of fraud or other irregularities sufficient to close Livent down”: para. 171.

[403]    Livent contests the trial judge’s decision on this issue. Not surprisingly, it accepts his findings that Deloitte breached the standard of care in relation to the 1996 audit. However, it submits that the trial judge erred in finding that no compensable damages flowed from those breaches. Why? Because, says Livent in broad-brush terms, if the trial judge had assessed the impact of Deloitte’s deficient conduct relating to the 1996 audit with sufficient rigour, he would have concluded that a competent auditor, acting in accordance with the standard of care, should have exercised heightened professional skepticism, probed deeper, made other auditing adjustments, and discovered fraud or material misstatements of such a magnitude that no clean audit opinion could have been issued.

[404]    Had that occurred, Livent’s “house of cards” would have tumbled down by March 1997, about the time the 1996 audit was completed. Indeed, Livent speculates that had the audit been performed in a competent fashion following detection of the breaches with respect to the PPC and the Musicians’ Pension Surplus Receivables, the effect would have been dramatic:  instead of recording a net profit of approximately $11 million for 1996, Livent could well have taken a net loss of over $20 million. Livent submits that this would have been the result had proper adjustments been made for the misstatements regarding the PPC and the Musicians’ Pension Surplus Receivables (said to be approximately $15 million) and other misstatements conceded by Deloitte (amounting to an additional $3 million), together with what Livent claims should have been assessed for misstatements relating to the Revenue Transactions (roughly another $20 million).

[405]    For these reasons, Livent accepts the trial judge’s finding that the amount of $155 million is a fair estimation of the economic loss it claims to have sustained as of March 1997, but submits that he erred in not awarding that full amount in damages.

[406]    In advancing this broad submission, Livent alleges that the trial judge committed three errors.  In its view, he erred:

(a)     in finding that the discovery of fraud was a necessary precondition to a damages award;

(b)     in failing to analyze the impact of the necessary intermediate audit steps Deloitte was obliged to undertake on discovery of material misstatements; and

(c)     in failing to assess the probable impact of properly revised financial statements on Livent’s access to capital markets.

[407]    Although there is some overlap in the analysis of these alleged errors, I will deal with each in turn.

(a)      Discovery of Fraud not a Precondition of Liability

[408]    Livent submits that the trial judge considered only one of the three routes to liability advanced by it at trial in relation to the 1996 audit year: the failure to detect fraud. Livent claims it advanced two other routes to liability as well, which the trial judge ignored – namely, the failure to comply with auditing standards and the failure to probe to the bottom when suspicions ought to have been aroused.

[409]    I do not accept this submission.

[410]    I agree with Livent that, as a general principle, auditors may be exposed to liability in the absence of fraud. There is no need for a plaintiff to prove that the auditor ought to have discovered fraud as a threshold for establishing liability and damages: see e.g. BDO Dunwoody. However, the trial judge did not impose fraud as a precondition for liability in this case.

[411]    While he did place some emphasis on discovery of the fraud, it is apparent from the trial judge’s thorough review of Deloitte’s conduct in relation to the 1996 audit – summarized earlier in these reasons – that he was alive to the potential impact of other “irregularities” (i.e., other intentional misstatements apart from fraud: CICA Handbook, ss. 5135.01-5135.02). Indeed, in encapsulating his reasoning for not finding compensable damages in this context, the trial judge said, at para. 171:

While I have concluded that Deloitte did not conduct an audit in accordance with GAAS in respect of the PPC and Musicians' Pension Surplus Receivable accounts, I am not satisfied that a confrontation with management over these accounts as deductions from revenue would similarly have revealed instances of fraud or other irregularities sufficient to close Livent down. [Emphasis added.]

[412]    Amongst the “other irregularities” reviewed by the trial judge were the material misstatements in the PPC amortization numbers and the quantums of the alleged Musicians’ Pension Surplus Receivables.

[413]    Finally, it is worth noting that, in his conclusion on the 1996 audit, the trial judge linked his analysis regarding compensable damages to the broader causation analysis set out later in his reasons. In this latter section, he dealt with both the “but for” test and issues of remoteness and proximity. In dealing with the “but for” test, he made it clear that “the actionable breaches that must be taken into account in the causation analysis include every breach of the standard of care”: para. 286 (emphasis added). In dealing with remoteness/proximate cause, he addressed Deloitte’s position “that any audit failures on its part did not cause loss to Livent”: para. 310 (emphasis added).

[414]    For these reasons, I am not persuaded that the trial judge made a finding of fraud a precondition to a finding of damages, as Livent asserts.

(b)       Necessary Intermediate Audit Steps

[415]    Livent submits that the trial judge failed to ask himself what a competent auditor would have been required to do next if, during the course of the audit, the auditor had discovered misstatements of the magnitude he found Deloitte ought to have uncovered during the 1996 audit (i.e., the approximate $15 million referred to above).  What a competent auditor would have been required to do, according to Livent, is captured in the following five auditing steps Livent says are found in the CICA Handbook then in effect:

(1)       to determine whether the misstatements that it detected were made intentionally or unintentionally;

(2)       if intentional misstatements were uncovered or potentially present, to probe to the bottom with heightened professional skepticism to either dispel or confirm suspicion of fraud;

(3)       to reconsider the audit plan when faced with material misstatements to determine whether audit procedures ought to be expanded in order to gain comfort that other material misstatements had not gone undetected;

(4)       to step back to consider whether all of the misstatements detected suggested a pattern which would mandate a re-examination of the entire audit through a lens of higher professional scrutiny; and

(5)       to quantify the known and likely misstatements in order to be able to conclude whether the statements were materially misstated.

[416]    I shall refer to these five steps as the proposed “intermediate audit steps”.

[417]    Livent’s basis for proposing the intermediate audit steps is founded on an approach to the “but for” test advocated in the academic writings of Professors Philip Osborne and David Robertson: see Philip H. Osborne, The Law of Torts, 4th ed. (Toronto: Irwin Law, 2011); and David W. Robertson, “The Common Sense of Cause in Fact” (1997) 75 Tex. L. Rev. 1765.  That approach recognizes that “[t]he application of the but for test rarely calls for close or precise analysis” and that “[m]ost frequently, courts merely identify the test and draw a conclusion”: Osborne, at p. 53. However, to enhance clarity and certainty in the “but for” analysis, the authors suggest that the application of the test involves a number of distinct steps. In a passage adopted by the trial judge at para. 286 of his reasons, Professor Osborne – whose work draws on that of Professor Robertson – says, at p. 53:

[T]he application of the but for test involves a number of discrete steps. First, the harm that is alleged to have been caused by the defendant must be identified.  Second, the specific act or acts of negligence by the defendant must be isolated. Third, the trier of fact must mentally adjust the facts so that the defendant’s conduct satisfies the standard of care of the reasonable person, being sure to leave all other facts the same. Fourth, it must be asked if the plaintiff’s harm would have occurred if the defendants had been acting with reasonable care. [Footnote omitted.]

[418]    The intermediate audit steps proposed by Livent arise out of the third of these “discrete steps.” In substance, the third Osborne step requires the trier of fact to step back, isolate the specific acts of negligence, and “mentally adjust the facts so that the defendant’s conduct satisfies the standard of care of the reasonable person”. This backward-looking exercise is described by Professor Robertson as “using the imagination to create a counterfactual hypothesis” or “counterfactual inquiry”, thereby “asking what would have happened under a factual scenario that never actually existed”: Robertson, at p. 1770, fn. 21 (emphasis in original).

[419]    The parties have not provided this Court with any jurisprudence directly adopting what I will call the “mental adjustment” or “counterfactual inquiry” approach articulated by Professors Osborne and Robertson as an aspect of the application of the “but for” test. However, the trial judge and the parties seem to have accepted it as a working theory, and as part of the conceptual “but for” framework. I am prepared to accept its application for the purposes of this case.

[420]    In substance, Livent’s argument is that the trial judge’s failure to engage in the mental adjustment/counterfactual inquiry exercise caused him to miss the link between Deloitte’s breaches of the standard of care for the 1996 audit and Livent’s damages. I disagree.

[421]    What the mental adjustment/counterfactual inquiry exercise contemplates, in my view, is that the trial judge – to the best of his or her ability – will carefully assess the evidence to determine what would likely have occurred had the defendant complied with the standard of care. Recall Professor Osborne’s acknowledgement that “[t]he application of the but for test rarely calls for close or precise analysis.” In the context of this case, the question to be answered was what would likely have occurred if Deloitte had discovered the material misstatements pertaining to the 1996 audit that the trial judge found ought to have been discovered (i.e., the misstatements regarding the PPC and the Musicians’ Pension Surplus Receivables)?

[422]    In my view, the trial judge specifically addressed this question and, based on his findings, answered it. Although Livent does not agree with those findings, or the conclusions drawn from them, the trial judge in effect applied the mental adjustment/counterfactual inquiry analysis and, in doing so, demonstrated that he was alive to the principal issues raised by Livent’s proposed intermediate audit steps.

[423]    Livent dismisses the trial judge’s findings on the basis that he “made a rolled-up hypothetical assumption to arrive at a ‘but for’ world where Deloitte presumably provides a clean opinion because Gottlieb would ‘have yielded to the suggested write-offs rather than pull the plug on the enterprise’”: para. 173. It seeks to characterize the factual findings underlying the trial judge’s conclusion as “conclusory assumptions”. Specifically, it articulates three “conclusory assumptions”:

(1) Drabinsky and Gottlieb would have “yielded to the suggested write-offs” with respect to the material misstatements regarding the PPC and the Musicians’ Pension Surplus Receivables “rather than pull the plug on the enterprise”: para. 173;

(2) “a confrontation with management over these accounts as deductions” would not “have revealed instances of fraud or other irregularities sufficient to close Livent down”: para. 171; and

(3) the 1998 write-offs “speak volumes in terms of the pragmatism of Drabinsky and Gottlieb”: para. 173.

[424]    However, the factual findings made by the trial judge, and the inferences and conclusions based on them, are not “conclusory assumptions”. What Livent’s submission overlooks is that the mental adjustment/counterfactual inquiry exercise called for in these circumstances is by nature an exercise in developing a “hypothetical assumption” (“rolled-up” or not), and the trial judge explicitly addressed his mind to what Deloitte would have done next, had it discovered the material misstatements. While the trial judge may not have articulated his analysis in a way that specifically addressed the five intermediate audit steps now proposed by Livent, he arrived at the end point by finding that the 1996 financial statements were “materially misstated”, but that their discovery would not have resulted in Deloitte’s failing to give a clean audit opinion for 1996.

[425]    In this respect, he made the following specific findings, at para. 173:

[W]hen an auditor uncovers items or misstatements that, individually or collectively, would exceed materiality, rather than simply withholding a clean opinion, the issues are first discussed with management to see if some middle reporting ground can be achieved.  In the instant case, and even though it was often “Gottlieb’s way or the highway”, I have no reason to conclude that, when push came to shove, Gottlieb as the pragmatist would not have yielded to the suggested write-offs rather than pull the plug on the enterprise.  His hubris and the conceit of Drabinsky, and their collective view that their frauds would not be discovered, would have driven that agenda. [Emphasis added.]

[426]    Experts for both Livent and Deloitte agreed that upon discovery of a material misstatement in the financial statements, an auditor will inform the client of the error and push the client to correct it. For example, Livent’s expert, Paul Regan, testified that, upon discovery of a material error, the auditor informs the client and the client either records the corrected entry or “[i]f the client fails to record those entries, given the materiality of these known errors on the financial statements, you qualify your opinion and you don’t give a clean opinion on those financial statements.”

[427]    In addition to the foregoing evidence, the trial judge found that the detection of the PPC overstatement from 1996, had it occurred, would not itself have brought to light the more serious issue of the “amortization rolls”: para. 172.  He also compared the 1996 audit with the later circumstances leading to the Ovitz and Furman acquisitions in 1998 where Drabinsky and Gottlieb were prepared to take massive write-offs before the deal was done – which, the trial judge said, “[spoke] volumes in terms of the pragmatism of Drabinsky and Gottlieb”: para. 173. This comparison, too, reinforced his view that, even with the detection of the 1996 misstatements, a confrontation with management would not have led to the discovery of “fraud or other irregularities sufficient to close Livent down”: para. 171.

[428]    While Livent quarrels with the trial judge’s resort to the comparison with the Ovitz and Furman transactions, I see no error in his looking at what actually happened at that time for some assistance in considering what would have happened in 1997. He was dealing with the same Livent actors pursuing their same goals in the Livent universe.

[429]    Although not specifically referred to by the trial judge in this context, his finding that Livent would, in the end, have yielded to Deloitte’s demands (had they been made, as they should have been) is consistent with what happened in other instances where concessions were made as well. In 1996, for example, when Deloitte pushed for a write-down for the PPC in relation to Sunset Boulevard, Livent agreed and, after discussions, assented to an $18.5 million charge against income. Subsequently, in 1997, after the great debate over the inclusion of revenue from the air rights transaction, Livent ultimately agreed to include most of it in Q3 and not Q2.

[430]    All the findings of the trial judge on this issue were grounded in the evidence.  I see no error in the “hypothetical assumption” about the “‘but for’ world” which the trial judge accepted, and no basis for overturning his finding as to what would likely have occurred had Deloitte complied with the standard of care and detected the material misstatements regarding the PPC and the Musicians’ Pension Surplus Receivables during the 1996 audit.

(c)      Livent’s Access to the Capital Markets

[431]    The 1996 financial statements incorporated the material misstatements identified by the trial judge and, in Livent’s view, other material misstatements as well. Livent’s final submission on the cross-appeal is that, in the revised audit scenario, the trial judge failed to consider how the 1996 financial statements, had they been properly prepared, would have affected the covenants in Livent’s secured loans and its access to the capital markets generally.

[432]    Livent had acquired two new secured lenders as at December 1996 – CIBC and the trustee of a $72.5 million debenture – to whom it owed approximately $96.8 million by the end of March 1997. Livent argues that, even at a conservatively estimated re-visited loss of approximately $3.4 million for 1996 – the loss that would have resulted had the proper adjustments been made for the misstatements regarding only the PPC and the Musicians’ Pension Surplus Receivables – it would have been in breach of its loan covenants. This would have made it difficult for Livent to borrow more money, something that was a constant need, particularly in view of the accelerating cash-burn nature of its business at that time.

[433]    There are at least two difficulties with this submission. It is raised for the first time on appeal and Livent led no evidence at trial to the effect that any breach of its loan covenants would have had an impact on its ability to borrow more money or on its access to the debt or equity markets.

[434]     In any event, the trial judge found that – in the absence of a discovery of the fraud – the reporting of significant losses had not prevented Livent from accessing the capital markets. His findings are supported by the evidence.

[435]    For instance, apart from the Ovitz-Furman transactions referred to above – that generated U.S.$22 million in private placements in the face of a $44 million loss position – James Pattison and Conrad Black (two Livent directors) were prepared to advance a further U.S.$12.2 million, following an additional PPC write-down of $23.6 million in Q1 1998. It was open to the trial judge to consider what would have happened in respect of the 1996 audit, with these facts in mind.  He did so, at para. 284:

[E]ven if Deloitte had uncovered inadvertent errors in the years prior to year-end 1996, I am persuaded that Livent would likely still have been able to access the capital markets for share underwritings and debt placement. This proposition is underscored by the events of the spring of 1998, when Ovitz and Furman insisted on a massive PPC write down, throwing Livent into a huge loss position. Regardless of this swing in fortunes, it was still able to complete the underwriting.  Indeed, the situation repeated itself in the months following the Ovitz-Furman closing and after a further write down of PPC and a further anticipated Q2 loss.  Messrs. Black and Pattison seemingly beat a path to Drabinsky’s door to dump additional millions into Livent’s lap. The fraud to that point had not been uncovered and access to the capital markets had not been denied, accordingly. Regardless of the newly recorded losses, Drabinsky’s star was still shining brightly on the horizon.

[436]    It stands to reason that, if Livent could attract investment in the spring 1998 after already recording a $44 million loss, it could have done so after recording a $3.4 million – or perhaps even higher – loss for year-end 1996.  The trial judge’s observation, at footnote 2, that “the [cachet] associated with Drabinsky was clearly the allure that attracted the investors” is supported by the record, including the testimony of Livent’s witness, Robert Webster, who characterized Drabinsky as “the creative heart and soul of the company”, the person with whom the company was identified in the public market, and the person whose “skill set was integral” to the decisions of investors. Drabinsky’s star was shining in March 1997 when the 1996 audit was being completed as well.

[437]    The probable impact of revised financial statements on Livent’s access to the capital markets was precisely the issue that troubled the trial judge and that he sought to resolve in respect of the 1996 audit. He addressed it directly, as well as in the context of his causation analysis and the mental adjustment/counterfactual inquiry exercise already described above.  I would not interfere with his conclusions on this issue.

(3)          Conclusion on the Cross-Appeal

[438]    In the end, Livent seeks to have this Court substitute different findings of fact for those arrived at by the trial judge in respect of his conclusion that no compensable damages flowed from the breaches of the standard of care that he identified in relation to the 1996 audit year. In my view, his findings, and the inferences and conclusions he drew from them, were well-founded on the evidence. I would dismiss the cross-appeal.


[439]    For all the foregoing reasons, the appeal and the cross-appeal are dismissed.

[440]    Counsel advised that the parties have resolved the issue of costs.

Released: January 8, 2016  

“R.A. Blair J.A.”

“I agree G.R. Strathy C.J.O.”

“I agree P. Lauwers J.A.”


[1] Dollar figures are in Canadian currency, unless otherwise specified.

[2] I note that the trial judge concluded, at para. 170, that “as of middle of July, [Deloitte] could not be faulted for the work it did in respect of the Revenue Transactions and the conclusions it reached.” However, at para. 140, he had stated that “Deloitte failed to meet its standard of care in the way it dealt with PPC, the Musicians’ Pension Surplus Receivable and the Revenue Transactions.” Reading his reasons as a whole, I am satisfied that the trial judge did not find a breach with respect to Deloitte’s audit of the Revenue Transactions as of mid-July 1997.

[3]  I note, as an aside, that it was a Dundee company that was involved in the Pantages Air Rights Agreement and the Put, discussed in more detail below.

[4] As noted earlier in these reasons, Livent argues on the cross-appeal that the trial judge erred in failing to find liability in relation to the 1996 audit. I will address this argument below.