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	England and Wales High Court (Commercial Court) Decisions
You are here: BAILII >> Databases >> England and Wales High Court (Commercial Court) Decisions >> Man Nutzfahrzeuge Aktiengesellschaft & Ors v Freightliner Ltd & Ors [2003] EWHC 2245 (Comm) (07 October 2003) URL: http://www.bailii.org/ew/cases/EWHC/Comm/2003/2245.html Cite as: [2004] PNLR 19, [2003] EWHC 2245 (Comm)

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IN THE HIGH COURT OF JUSTICE
QUEENS BENCH DIVISION
COMMERCIAL COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		7th October 2003

Mr Justice Cooke:

Introduction

1. There are two applications before me on the part of the first Part 20 Defendant, Ernst & Young, a limited liability partnership practising in Canada as Chartered Accountants and the fifth Part 20 Defendants, Ernst & Young, a firm practising as accountants in the United Kingdom. I shall refer to them as EYC & EYUK respectively and to them compositely as EY. EYC applies to set aside service of Part 20 proceedings upon it out of the jurisdiction whilst EYUK applies to strike out the Part 20 Claim made against it under CPR Part 3.4.2 or for Summary Judgment under CPR24.2. Each application has essentially the same foundation, namely that the Part 20 Claim has no reasonable prospect of success and that there is no serious issue to be tried.
2. On 30^th January 2000, Western Star Trucks Holdings Limited (Western Star) a Canadian company entered into a written contract with the First and Second Claimants, (hereinafter Man) for the sale to Man of 100% of the Shares in the fourth Claimant, ERF (Holdings) PLC (an English company) which in turn owns the third Claimant, ERF Limited. I refer to the latter two Companies together as ERF.
3. Man claims damages from Western Star's successor in title, Freightliner Limited, in respect of the sale. The claim is for breaches of warranties given in the sale agreement and for deceit and fraudulent misrepresentations which allegedly induced that sale. Those claims are denied by Freightliner which has brought Part 20 Claims against EYC and EYUK in relation to them. At the relevant time, EYC was the auditor for the Western Star group of companies whilst EYUK was the auditor of the ERF companies.
4. ERF's Company secretary and financial controller was a Mr Ellis. It is common ground between Freightliner and Man that Mr Ellis acted fraudulently in preparing certain of ERF's financial records and that in the course of the due diligence investigations carried out by Man and its accountants, Deloitte & Touche (Deloittes), Mr Ellis made certain fraudulent misrepresentations to them. Following the sale, Mr Ellis continued to be employed by ERF and continued to create fictitious entries in the financial records of ERF, hiding the true financial situation of ERF until some of his misgdoings came to light in August 2001. Further misdoings in relation to VAT surfaced in 2002. It has not been alleged that Mr Ellis was responsible for causing the trading losses themselves but that he took steps to hide them in the accounting documents so that others were unaware of the true situation, with the result that not only was ERF maintained in existence but business decisions were made and further funding was put into ERF in the hope and expectation of profit.
5. In the share purchase agreement warranties were given by Western Star to Man about the accuracy of ERF's financial books and records and in particular the audited accounts for the year ending 30^th June 1999, which was said to be prepared in accordance with the provisions of the Companies Act 1985 and to give a true and fair view of the assets position and the profits earned. By the terms of the agreement Western Star also represented those matters to Man and acknowledged and confirmed that Man was relying upon those representations in connection with its purchase of the ERF shares. Man alleged that in the course of negotiations for the purchase of the shares, Western Star put forward Mr Ellis as its spokesman to explain the contents of ERF's financial statements, both audited and unaudited. ERF's accounts for the years ending 30^th June 1998 and 30^th June 1999, audited by EYUK, were also provided to Man and Deloittes, its investigating accountants, together with other financial documents for which Mr Ellis was largely responsible, covering the period after 30^th June 1999, about which he answered questions. Those financial documents, including the audited 1998 and audited 1999 financial statements, were alleged to be false and fraudulently manufactured by Mr Ellis, which Mr Ellis deliberately concealed from Man, Western Star and EYUK.
6. It is said that the 1998 audited accounts overstated ERF's assets by £20.5M and the 1999 accounts by £35M approximately. The price paid for the shares under the share purchase agreement, which was completed on 8^th March 2000, was £61,922,000.
7. As between Man and Western Star/Freightliner, it is common ground that Mr Ellis fraudulently concealed ERF's true position by false accounting, although the extent of it is in issue. Liability is also very much in issue as is the claim for damages. Man claims to have suffered loss and damage as set out in Annexes 1 and 2 to the amended particulars of claim whilst ERF, which by virtue of article 12.1 and 14.5 of the share purchase agreement was entitled to be indemnified for damages it had suffered, claimed damages as set out in Annex 3.
8. In Annex 1 Man claimed out of pocket losses in respect of injections of cash made by Man into ERF or payments made by Man on ERF's behalf between March 2000 and September 2002 amounting to £190M approximately. In addition future injections of cash or payments to be made were estimated at £38M approximately, recovery of a loan repayment of £24M was sought and recovery also of the purchase price. The total out of pocket loss was therefore given as £314.5M with a credit to be given in respect of the value of ERF when reconstructed.
9. The alternative calculation in Annex 2 set out the difference in value between what Man paid for ERF and ERF's actual worth at the date of completion, 8^th March 2000, consisting of the purchase price of nearly £62M, plus compensation for the net liability position at that date of £66M approximately, together with the cost of restructuring ERF into an economically viable entity, assessed at a further £96M approximately, amounting in total to about £224.5M. In addition under Annex 2 consequential and continuing losses were claimed for the period from 8^th March 2000 until the point when ERF would break even, amounting to a further £121M. Man claim that in reliance upon the representations and the warranties as to the accuracy of the accounts, the additional representations made by Mr Ellis prior to the agreement and Western Star's representation that Mr Ellis was a professional honest and trustworthy senior key employee of ERF, Man was induced to enter into the purchase agreement and to continue Mr Ellis' employment. He was thus in a position to continue further false accounting and in reliance upon all this false information Man and ERF made management decisions about the business of ERF which led to the incurring of the expenses claimed.
10. ERF's claim in Annex 3 amounts to some £294M based on the deterioration of its position from the last financial statements referred to in the agreement (December 1999) until break even.
11. The argument before me proceeded on the basis of a draft amended Part 20 Claim made by Freightliner, as successor to Western Star, against EYC and EYUK in respect of those losses claimed against it by Man. The claims were put into different categories both in paragraphs 7 and 8 of the draft amended Part 20 claim (hereinafter the Part 20 claim) and in the course of argument. The most convenient categorisation appears to be as follows:

i) Western Star's auditing claim against EYUK, by which it is alleged that EYUK owed Western Star a duty of care in relation to the auditing of ERF's 1998 and 1999 accounts. (The EYUK Auditing duty).

ii) Western Star's claim against EYUK in respect of its engagement of EYUK to advise it and provide information to Man in relation to the potential sale of ERF to Man in connection with the due diligence enquiries made by Man and Deloittes.(The EYUK sale duty). It is accepted by EYUK that the allegations made under this head give rise to an arguable duty of care in relation to any advice or information given.

iii) Western Star's auditing claim against EYC in respect of its audit of Western Star's Group accounts, which incorporated the ERF accounts audited by EYUK. (The EYC Auditing Duty). The essence of this claim also is that EYC failed properly to investigate, advise and report to Western Star on the "tip-offs" received by EY in relation to falsification of ERF's accounts.

iv) Western Star's claim against EYC in respect of its engagement of EYC to advise and provide information to Man in relation to the potential sale of ERF to Man in connection with the enquiries made by Man and Deloittes. (The EYC Sale duty). The essence of this claim is that EYC failed properly to investigate, advise and report to Western Star on the "tip-offs" received by EY in relation to falsification of ERF's accounts, in particular by ensuring that EYUK carried out an adequate investigation.

v) Western Star's contribution claims under the Civil Liability (Contribution) Act 1978 against EYUK on the basis of parallel duties owed by EYUK to Man and ERF for the self same damage. It is accepted by EYUK that there would be an arguable case for a duty owed by EYUK to Man in relation to provision of information to Man and Deloittes in the course of their due diligence enquiries, but for the existence of a Hold Harmless letter which EYUK maintains has the effect of negating any liability. It is also accepted that EYUK owed ERF a contractual and tortious duty of care in relation to the auditing of ERF's accounts but it is said by EYUK that there is no recoverable loss.

12. In broad terms, Freightliner claim that EYUK negligently failed to detect the falsification of accounting records by Mr Ellis with the result that the audited accounts did not give a true and fair view of ERF's affairs for the 1998 or 1999 year. It is further alleged that EYUK was informed by an apparently reliable source that information in the accounts department of ERF was being deliberately manipulated at the direction of management and that EYC was informed by another source that EYUK had been told that misrepresentations had been made to ERF's auditors which were known about at a senior level within ERF's management. These "tip-offs" came from independent third parties but may or may not be traceable to the same information emanating from Catherine Wilson who was then working in ERF's accounts department. Her name however was not revealed and the English informant to EYUK had said that she was reluctant and nervous to speak out about this issue herself for personal reasons. The allegation made is that EYC and EYUK failed properly to follow up these "tip-offs" in the context of the audits of ERF and the Western Star group of companies and in the context of the provision of advice and information in relation to the sale of ERF to Man.
13. In paragraphs 52 – 54 of the Part 20 claim, it is alleged that if EYC and EYUK had fulfilled their duties of care and skill as auditors in the context of the proposed sale to Man or had fulfilled their duties in the advice and provision of information in the context of that sale or had fulfilled their duties in relation to the "tip-offs" of false information, the effect would have been as follows:-

i) Western Star would have been informed that the 1998 and 1999 accounts did not give a true and fair view of ERF's business.

ii) Western Star would have been informed that the audited accounts and disclosure schedules provided to Man were materially inaccurate.

iii) Western Star would have been informed that Mr Ellis had acted fraudulently in preparing ERF's accounts.

iv) Alternatively, if EY had not identified the reason for the inaccuracies in the accounts and disclosure schedule, Western Star itself would have investigated the inaccuracies and discovered Mr Ellis' fraud.

v) On discovery of these matters, Mr Ellis' employment would have been terminated or suspended so that he could play no further part in the discussions with Man/Deloittes about the ERF figures and the sale.

vi) Steps would have been taken to ascertain the true position and prevent further losses in the conduct of ERF's business, thus ameliorating the asset position of ERF.

vii) Western Star would not have sold ERF to Man.

viii) Western Star would not have been sued by Man for the damages claimed and would thus not be exposed to any of the losses suffered by Man in relation to the value of the company and the sums expended to put matters right.

The Test to be Applied on the Applications.

14. i) EYUK's applications are made under CPR Parts 3.4(2) and 24.2. On this basis, the Court may strike out a statement of case if it appears that it discloses "no reasonable grounds for bringing the claim" or may give summary judgment if the claimant has "no real prospect of succeeding on the claim" and "there is no other compelling reason why the case or issue should be disposed of at trial". The question which the Court must consider is whether or not there is a real as opposed to a fanciful prospect of success (see Swain v Hillman [2001] 1AER 91 and Three Rivers District Council v Bank of England [2001] 2AER 513).

    ii) EYC's application seeks to have service of proceedings out of the jurisdiction set aside on the basis that there is no serious issue to be tried in relation to each of the claims. The test here is not far removed from that appropriate to EYUK's application under Part 24.

    iii) There are a series of authorities which give guidance and suggest caution in applications of this kind at this stage of the proceedings. Disputed issues of fact, unless the answer is very clear, cannot be resolved on such applications. It is inappropriate to carry out a mini-trial. Equally, it must be borne in mind that disclosure has not taken place and that a party's case as expressed in a claim document may be improved both by disclosure and cross examination of witnesses, particularly where the facts as to what occurred are within the knowledge of parties other than the claimant, either in whole or in part. Furthermore, it is not appropriate to deal in strike out applications or summary hearings with complicated issues (Williams & Humbert v WH Trade Marks [1986] 1AER 129, Morris v Bank of America [2000] 1 AER 954) or with novel issues arising in developing areas of law of which the question of duties owed by auditors and the scope of such duties is one example (see Coulthard v Neville Russell [1998] 1BCLC 143 at page 153i – 155j Equitable Life Assurance Society v Ernst & Young [2003] EWCA Civ.114 at paragraph 40 and Independents Advantage Insurance Company v Michael Cook [2003] EWCACiv.1103 at paragraphs 15-17. The law in the field of auditors' negligence and auditors' duties is in a state of development and transition and there are therefore real difficulties in deciding cases on a summary basis without a full investigation of the detailed facts, unless they fall fairly and squarely within the decided authorities. Particular care is needed in determining a matter against a Claimant before the full facts are known. Electra v KPMG [2001] 1BCLC 589 at pages 614-615.

    iv) In this action, despite two requests for disclosure of EY's working papers, these have not been made available to Freightliner. The evidence before the Court consists of two statements made by Mr Kendrick of EYC, statements by Mrs Sinderson and Ms Sinagola of EYUK and statements by Mr Burke of Western Star and Mr Pointon who provided the "tip-off" information to EYUK. Otherwise, the Court was presented with pleadings and draft pleadings and bundles of correspondence.

    v) Insofar as I refer in this Judgment to issues of fact, I do so solely for the purpose of ascertaining whether or not Freightliner has a real prospect of success on its claims and whether there are serious issues to be tried. My apparent "findings" are therefore not final determinations of fact and are made solely in the context of these applications.

The Basis of EY's Applications

15. EY accepts that, where there are disputed issues of fact, they cannot be resolved on these applications. EY maintains however that the issues of law are clear, despite such disputed factual questions and that on the case advanced by Freightliner and taking its allegations of fact to be correct, there is no basis upon which the claims against EYC and EYUK can succeed. Put shortly, EY's position is as follows:-

i) The audit claims made against EYC and EYUK cannot succeed by reason of the decision of the House of Lords in Caparo Industries PLC v Dickman [1990] 2AC 605 because EYUK's duties as auditors of ERF did not extend to cover any loss caused to shareholders who made investment decisions on the basis of the audited accounts, whether by way of purchase or sale. A fortiori their duties would not extend to cover any losses caused by reason of breach of warranties on a sale by a shareholder. Furthermore, any failure by EYC in relation to the audit of the Western Star Group accounts, by incorporating the EYUK audited ERF accounts was not causative of loss and those group accounts were not relied on by Man nor featured in any way in the main action or Part 20 Claim.

ii) If there is to be any extension of an auditor's duties beyond the statutory purposes referred to in Caparo there must be a clear assumption of responsibility by the auditors to the person concerned in respect of the very transaction in respect of which the duty is said to arise. Forseeability of the possibility of a sale or purchase is not enough or even knowledge of such a sale or purchase. By words or conduct, the auditors would have to accept responsibility for any failure on their part which led to losses in relation to a specific transaction. EY say that there is no sufficient material alleged for extension of the duty of EYUK or EYC beyond the statutory purposes referred to in Caparo.

iii) So far as it is alleged that EYC and EYUK were in breach of duty in the provision of advice to Western Star or information to Man as a result of their engagement by Western Star to carry out these functions in relation to the sale of ERF, it is said that claim against EYUK is unarguable because there is no recoverable loss and is unarguable against EYC because the claim is limited to a failure to ensure that the "tip-off" investigation was conducted properly by EYUK and because there was in practice nothing that EYC could do in that regard.

iv) The losses claimed are irrecoverable because they fall into two categories which cannot be claimed:

a) Neither Western Star/Freightliner nor ERF suffered any loss in relation to the value of the company because that difference in value was not caused by EY but was simply that which EY failed to detect. The difference in value existed whether reported or not.

b) The future trading losses of ERF are irrecoverable on the basis of the decision of the Court of Appeal in Galoo v Bright Grahame Murray [1994] 1WLR 1360.

v) The contribution claims do not run because there is no parallel liability on the part of EY to Man because of the Hold Harmless agreement and there is no parallel liability to ERF because no loss is claimable by ERF in exactly the same way as no loss is claimable by Western Star/Freightliner.

The Factual Premise upon which these Applications proceed

16. For the purpose of these applications, the facts pleaded by Freightliner as verified by the statement of truth in the Part 20 Claim and the evidence submitted by it in the shape of statements from Mr Burke and Mr Pointon are to be taken at face value. Where there is a conflict of evidence between the statements put forward on behalf of EY and Freightliner's case, the position is insufficiently clear for me to form any Judgment on a summary basis. The following assumed facts therefore form the basis upon which my decision falls to be made in relation to the applications before me:-

i) EYC were engaged to audit Western Star's group accounts in accordance with the Canadian Standards of Accounting for the years 1998 and 1999.

ii) EYUK was, by an engagement letter, engaged by ERF to carry out a statutory audit of ERF's accounts for the years ending 30^th June 1998 and 1999, in accordance with the UK Statements of Auditing Standards ("SAS").

iii) Both EYC and EYUK were, before the completion of the ERF's audited accounts for the year ending 30^th June 1999, aware of the projected sale of ERF to Man and of the need for these accounts in the context of that sale since Man's due diligence enquiries were being held up by their absence.

iv) In or about August 1999, both EYC and EYUK were engaged by Western Star to advise it and to provide information to Man in relation to the potential sale of ERF to Man in the context of the due diligence enquiries being made by Man and their accountants, Deloittes. It is accepted by EYUK that it was engaged to do work of this kind and the Hold Harmless letter of 28^th October 1999 (as amended) which EYUK required Man and Deloittes to sign, together with the fees charged for such work, clearly illustrate that significant work was carried out by EYUK in this context. EYC appears to have charged Western Star Can.$190,000 whilst EYUK charged Western Star Can.$264,000 approximately.

v) E-mail exchanges between EYUK and EYC on the one hand and EYC and Western Star on the other indicate that both EYC and EYUK were alive to the potential exposure undertaken by EY to third parties other than ERF in respect of their work and used this as a justification for the fees charged (see e-mails of 24^th September and 14^th October 1999 in particular).

vi) On about 20^th September 1999, a "tip-off" was given to EYUK and on or about 22^nd September a "tip-off" was given to EYC concerning manipulation of accounting information or misrepresentations made to EYUK. The terms of these "tip-offs" and the circumstances surrounding them are the subject of dispute, to which I shall refer later.

vii) On 15^th October 1999, Mr Kendrick of EYC e-mailed Mr Burke of Western Star in terms which Freightliner maintained were such as to put Mr Burke's mind at rest in relation to the "tip-off" information of which he was aware, which he had himself given to EYC.

viii) Following EYUK's clean audit statement for the ERF accounts ending 30^th June 1999, on 4^th November 1999, a copy of those accounts was provided to Man and on a date which is not apparent from the material before me, the 1998 audited accounts had also been supplied.

ix) Both sets of audited accounts contained material inaccuracies which were due to falsification of accounting information by Mr Ellis which EYUK had failed to detect.

x) In failing to detect these discrepancies and giving a clean audit report, EYUK was negligent.

xi) The terms of the share purchase agreement of 30^th January 2000 were known to EYUK and EYC prior to that date and EYUK advised Western Star on the drafting of certain of the warranties in the agreement and assisted with the disclosure to which that agreement referred.

The Issues which arise on these Applications

17. Freightliner point out that although the claims have been subdivided or categorised in the manner to which I have referred, there is no way of isolating one claim from another. They are all interconnected. The "tip-off" information was received both in the context of the audit of ERF and in the context of the work being done by EYC and EYUK for Western Star in relation to the sale of ERF. Whilst therefore duties might arise in relation to the receipt of the "tip-off" information those duties are to be seen in the context of such other duties as fell upon EY in the context of the audit and the sale. EY maintained that the duties of EYUK as auditor of ERF and EYC as auditor of Western Star did not however extend to liability for losses of the kind sustained by Western Star, as set out in the Part 20 claim.

The Scope of the EYUK Auditing Duty

18. The starting point for the submissions on both sides was the decision of the House of Lords in Caparo Industries Plc v Dickman [1990] 2AC 605. The scope of the auditor's duty is, in the ordinary way, determined by the statutory purpose of the audit and does not extend to the provision of information to assist shareholders in the making of decisions as to future investment in the company. It was thus said by EY that EYUK could not owe a duty of care to Western Star to cover any loss caused to Western Star by any audit deficiencies in so far as that loss resulted from a sale by Western Star of its shareholding in ERF. This point was reinforced by the argument that the losses here resulted from the warranties given on the sale and not simply by the decision to sell.
19. As a statement of general principle, this summary of the decision in Caparo is unobjectionable. As pointed out by Freightliner however the Caparo decision gives rise to two different ways in which a shareholder can still succeed in making recovery for loss on a sale or purchase.

i) The House of Lords envisaged the possibility of a case where accounts are audited specifically for the purpose of submission to a potential investor as an exception to the general principle stated (see Lord Oliver at page 650g, 652e – g, Lord Jauncey at page 662b-d and Lord Bridge at page 622a-e and 624c-f when citing with approval Lord Denning in Candler v Crane, Christmas & Co [1951] 2KB 164 and Richmond P in Scott Group Limited v McFarlane [1971] NZLR 553). It is accepted that forseeability of use in such a context is not enough but the question can be stated broadly as being whether or not an auditor such as EYUK can be taken as assuming responsibility on an objective basis for the use of the audited accounts by the vendor in the context of a specific sale, here the sale of ERF shares to Man.

ii) Additionally, one of the statutory purposes of an auditor's report is to give information to shareholders. Whilst the report is not in the absence of a situation such as that outlined in i) above, directed towards an individual shareholder for the purpose of his investment decisions, it is directed towards the shareholders as a collective body for the purpose of enabling them to exercise their powers in general meeting – see Lord Bridge at page 626c – d, Lord Oliver at 630f-g and Lord Jauncey at 662a-d. These passages emphasise the power of the shareholders in general meeting to call the directors to book, to ensure that errors in management are corrected, to remove directors, to question past management and to influence future policy and management. Whilst, as EY point out, the hiring and firing of someone who is not a director may be a matter of "indoor management", Freightliner maintain that the practical effect of Western Star's power to remove the directors in ERF (as its 100% owned subsidiary) would be to achieve the same result. Western Star was thus in a position that it could, if information had been given to it, have secured the removal of Mr Ellis.

20. The decisions in Berg v Adams [1993] BCLC 1045 (see p1063f, 1064e and 1069g), Electra v KPMG [2001] 1BCLC 589 at p. 608C-F and 635h – 636J, ADT v Binder Hamlyn [1996] BCLC 808 at p. 833h-835a and Equitable Life v E & Y [2003] EWCA Civ.1114 at paragraphs 117-123, 128-129 and 133 all refer to these two principles and demonstrate the need for determination of the facts of any particular case before ascertaining how the questions of legal principle are to be applied.
21. Whether or not Western Star's case against EYUK in respect of any negligent audit of ERF on the 1998 or 1999 years falls within the principles set out in Caparo, is a question of fact. Freightliner maintains that EYUK were fully aware that the financial statements were to be relied upon as the basis of a proposed sale of ERF by Western Star to Man and that their audit was critical in this respect and in all the circumstances must be taken to have assumed responsibility for it to Western Star in relation to that sale. EY maintains that unilateral notice of the sale was given and that it was not enough but this is a fact driven issue. In my Judgment, the form of the Part 20 claim and paragraph 15 in particular, is sufficient to give rise to an arguable case as to the existence of such duties which has a real prospect of success.

The Scope of the EYUK Sale Duty

22. It is accepted by EYUK that there is an arguable case to be made against it for a duty owed to Western Star in relation to the pleaded case in paragraph 40 of the Part 20 claim in providing advice to Western Star and information to Man in relation to the sale of the ERF shares but it is said that the nature of the losses alleged is such that they are irrecoverable either because the scope of the duty does not extend to such losses or because the losses in question cannot, as a matter of law or fact, be said to have been caused by any relevant breach. I will revert to this issue of loss later in the judgment.

The Scope of the EYC Auditing Duty

23. It is accepted that EYC owed duties of care in the audit of the Western Star group accounts. It is said by EYC that there is no arguable case of any breach of duty on its part which gave rise to any loss claimed. Freightliner maintain that Western Star relied on EYC for its group audit and for the proper inclusion of EYUK's audited accounts of ERF, as a major trading subsidiary within it. If EYC had properly fulfilled its audit duties, the fabrications would have been detected with all the consequences referred to earlier in this judgment.
24. I was referred in some detail to both English and Canadian auditing standards in the context of the arguments about the "tip-off" information. SAS 110 (the UK's Statements of Auditing Standards) sets out principles relating to the auditor's responsibility to consider fraud and error in an audit of financial statements. The Standards refer to error and fraud, because having identified a matter which could cause a mis-statement in the financial statements, auditors should be concerned to establish the circumstances giving rise to that matter and whether such mis-statement was occasioned by fraud or not. It is in this context that the Standards require auditors to assess the risks that fraud or error may cause the financial statements to contain material mis-statements and to design audit procedures with a reasonable expectation of detecting statements arising from fraud or error. SAS 110.28 states that:

"When conducting an audit where the risk assessment or the audit evidence obtained suggests that there may be fraudulent or dishonest conduct by directors or senior management, the level of professional scepticism and the degree to which evidence independent of the entity is sought is increased. In such circumstances auditors place less emphasis on management representations and documents generated or provided by the entity".

In such circumstances SAS 110.29-31 requires auditors to perform appropriate modified additional procedures if the fraud or error could have a material effect on the financial statements, the extent of such modification or additional procedures depending upon auditors' Judgment as to the circumstances of the fraud as set out in SAS 110.30. It is accepted that such "tip-offs" as occurred here should give rise to a heightened degree of scepticism about management information, but there are issues as to what EYUK was required to do.

25. So far as the Canadian Standards are concerned these bear upon EYC's responsibility in the context of auditing the Group accounts. Section 5135 of the Auditing Standards includes provisions which are broadly similar to those which appear in the English Standards in relation to mis-statement and fraud and the potential involvement of management in the latter. Section 6930 deals with the situation where a primary auditor may wish to rely upon the report and work of a secondary auditor. By sub-section 04, he is entitled to do so, provided he takes reasonable care to assure himself that "such reliance is justified". This requires compliance with sections 6930.10, 6930.17 and 6930.26. Under these provisions there is a need for communication to the secondary auditor of any information which may influence the secondary auditor in forming his opinion and assist in obtaining assurance that the secondary auditor has conducted a proper audit upon which the primary auditor can rely. The primary auditor must review the work of the secondary auditor, if necessary, by reviewing working papers and meeting with that auditor.
26. The claim made against EYC in the context of their auditing duties of Western Star and their failure to adhere to these standards turns entirely on the "tip-off" and the question whether or not EYC fulfilled its duties in relation to that information and whether that failure gave rise to any recoverable loss. Once again, I will revert to these issues, when dealing with the "tip-off" issue and the loss issues as discrete questions.

The Claim for breach of the EYC sale duty

27. Although not formally accepted by EYC, Freightliner in my Judgment has a real prospect of success in contending for the engagement of EYC in the terms set out in paragraph 40 and 42 of the Part 20 claim. This is supported in part by Mr Burke's statement in paragraphs 15 and 23-25 and succeeding paragraphs. Whilst a distinction may be drawn between an engagement to provide information to Man and an engagement to advise Western Star, it is arguable that any engagement to provide information to Man would self-evidently involve advice to Western Star should anything untoward arise out of this process. As already mentioned, both EYC and EYUK charged Western Star for their work in this context, EYC receiving a "success fee" on completion of the sale of Can.$25,000. Mr Kendrick of EYC stated in an e-mail of 18^th October that "he was the senior partner responsible for Western Star's global relationship with Ernst & Young" before stating that he would be in Manchester during the due diligence and could be contacted to discuss any matter urgently.
28. Once again, the issues of breach and recoverable loss are tied in with the receipt of "tip-off" information to which I now turn.

The "tip-off" information.

29. This issue raises a number of disputed questions of fact. Without descending into over much detail there are issues as to:

i) What information Mr Pointon (the English informant) gave to Mrs Sinderson of EYUK – and whether this was of "manipulation of information emanating from the accounts department" in general terms or whether it was "falsification of records relating to second hand vehicles which were subject to buy-back contracts".

ii) Whether, when Mr Burke telephoned Mr Kendrick of EYC to inform him that he had received wind of an anonymous telephone call to EYUK stating that misrepresentations had been made to EYUK, the latter passed this information to Mrs Sinderson at EYUK.

iii) What Mr Kendrick did or did not agree to do in relation to the "tip-off" information. It is Freightliner's pleaded case and Mr Burke's evidence that EYC agreed with Western Star to investigate, advise and report upon this "tip-off".

iv) Exactly what steps were taken by EYC and EYUK in response to these "tip-offs". It appears that EYUK carried out independent third party verification of matters relating to the buy-back issue but not in relation to anything else. As working papers have not been disclosed, Freightliner cannot plead the matter with any greater particularity as to what additional steps EYUK should have taken in addition to the steps which it had already taken on the audit, the one remaining area, it seems being that of the buy-back issue, (about which EYUK already had reservations and about which it knew that Man was concerned).

v) Whether or not EYUK should have pressed Mr Pointon and made greater efforts to obtain access to the ultimate source of his information, Catherine Wilson, who worked in the accounts department at ERF.

vi) Whether Western Star was ever told of the Pointon "tip-off" as such.

vii) Whether the e-mail of 15^th October 1999 was an adequate discharge of the reporting duty owed to Western Star whether on the part of EYC or EYUK. The relevant part of the e-mail read as follows:

"Of course, in the context of the "deep throat" red flag, it is particularly incumbent upon both EY & management to be diligent, full and frank as we go forward through to the completion of both the statutory audit and the due diligence process. Based on our conversations and John Bryant's conversation with Alison (the Managing Director of ERF's conversations with Mrs Sinderson) I don't believe this will or should be an issue."

viii) Whether EYC failed to ensure that EYUK carried out the enquiry properly and took sufficient extra steps to satisfy itself about the information obtained from management.

ix) Whether EYC failed to obtain adequate assurances from EYUK as to what EYUK had done.

30. My attention was drawn to alleged inconsistencies in the evidence of the EY personnel in their statements in the course of argument but it is enough for this purpose to see the extent of the disputed issues of fact in order to determine that Freightliner has realistic prospects of success in relation to breach of this duty, both as against EYC and EYUK. Whilst, as EYC point out, it could not carry out any investigation itself, there are real prospects of establishing that EYC failed properly to monitor and review what EYUK did, particularly in the context of what appears to have been a limited further investigation into "buy-backs" as opposed to any other false information. Both in the context of work relating to sale and work relating to the audit of Western Star which had been completed by this stage but which should arguably have been reviewed if, following proper investigation, information as to falsification of the accounting information relating to its second major subsidiary had been forthcoming, there is, in my judgment no basis upon which EYC can say that there is no prospect of success against them for breach of duty.

The losses claimed.

31. I have already referred to the loss claimed by Man against Freightliner in respect of the sale warranties and in deceit (paragraphs 20 and 22 of the amended particulars of claim). Man allege that in the course of their due diligence enquiries Western Star provided them with the 1998 and 1999 audited accounts of ERF, a budget and further management accounts for the six months period after 30^th June 1999 and also put forward Mr Ellis as their spokesman to answer questions and provide information about the accounting documents supplied. It is pleaded that all these financial documents were false and fraudulently manufactured by Mr Ellis, as he is said to have admitted. In paragraphs 20(A), (B) and (C) Man plead reliance on fraudulent representations in relation to these documents (including the 1998 accounts) and fraudulent inaccuracy in or breach of the warranties given. In paragraph 20(E) breach of article 5.1 of the Share Purchase Agreement is pleaded in running the business of ERF following the accounts date otherwise than in the ordinary course of business. The additional deceit, as alleged, consisted of the provision of the financial documents, representing that they were accurate and discussing them as if they were, thereby dishonestly concealing the true financial condition of ERF. These representations are said to have induced Man to enter into the Share Purchase Agreement where, had it known the truth, it would never have done so.
32. Additionally, had Man been aware of Mr Ellis' true character, contrary to Western Star's alleged representation that he was an honest, professional and competent employee who could be trusted, it would not have permitted him to remain in employment as ERF's financial controller following the purchase, whereas it did so, thus enabling him to continue fabrication of accounting documents. In reliance upon the financial information provided to them, both before and after the purchase, Man and ERF decided what obligations ERF should take on, what costs it should incur and what finance should be put into ERF by Man. The loss claimed is thus all loss and damage claimed by Man from the purchase of ERF and from ERF continuing to employ Mr Ellis in the shape of Annexes 1, 2 and 3 to the amended particulars of claim. These set forth Man's "out of pocket" losses in respect of Man's cash injections into ERF and the purchase price itself (Annex 1), the difference in value of ERF as warranted and as it actually was as at the date of completion, plus the cost of restructuring and the continuing losses until ERF's break even point (Annex 2) whilst ERF claims a sum amounting to its deterioration in asset value since 31^st December 1999 until the break even point as set out in Annex 3.
33. It is the losses claimed by Man from Freightliner that Freightliner seeks to recoup from EYC and EYUK, as set out in Section (G) of the Part 20 claim. It is said that if EY had not acted in breach of duty, Western Star would have known ERF's true financial position, would have discovered Mr Ellis' fraud and would not have entered into the sale contract with Man. Mr Ellis would no longer have been able to make representations on Western Star's behalf nor would he have been in a position to continue to conceal financial information and continue his fraud between the 31^st December 1999 and 8^th March 2000, nor following completion. It is therefore said that the exposure to Man's claims flows directly from the alleged breaches of duty by EYC and EYUK.
34. Freightliner therefore put in issue the question of causation of loss by reference to Mr Ellis' position and his potential removal from it. Although, as EY point out, there is no suggestion that Mr Ellis was guilty of any defalcation himself so that his actions were not the immediate cause of trading losses, his fabrication of accounts and lies in relation thereto had the effect, as alleged, of concealing these losses leading directly to what Man would say were reasonable business decisions as a direct consequence. It was those decisions which led to the injection of funds and incurring of losses after the date of completion. This raises a significant issue of fact in the context of arguments about causation, particularly by reference to Annex 1 of Man's claim for damages, part of Annex 2 and Annex 3.
35. The losses set out in Annex 1 are, it is said, losses that would have fallen on Western Star in the absence of a sale because, in reliance on the falsified audited accounts, Western Star would have taken the same type of action as Man did following the sale, in reliance on those accounts. This management activity in reliance on the accounts raises no issues of causation of loss questionable under principles enunciated in Galoo and falls within the principles of recoverability in Caparo.
36. In addition, so far as concerns the first part of Annex 2 of Man's claim for damages, namely the difference in the value of the company at the date of completion, it is argued that the continued employment of Mr Ellis had impact upon that, following the fabrication of the 1998 and 1999 audited accounts. If EYUK had discovered the fabricated elements of either the 1998 or the 1999 accounts, then Mr Ellis' activities would have been stopped at an earlier date and the flow of losses stemmed so that the value of the company would not have been so diminished at 30^th June 1999, 31^st December 1999, 30^th January 2000 or 8th March 2000. Not only could these fall within Caparo, as loss based on management decisions in the light of the falsified audited accounts, but the loss could be said to fall within the principles of recoverability set out in Sasea v KMPG [2000] 1 AER 676.
37. EY argued that any claim for the difference in value could not be caused by any breach by EY because the fact of over valuation would be a loss which fell upon Western Star in any event. If the fraud had been detected in the 30^th June 1999 accounts, the value of the company would have been diminished in any event but would merely have been detected. It would then have fallen upon Western Star. The effect of the sale was merely to move that loss to Man and then for it to revert to Western Star under the terms of the indemnities. For the reasons already given however this ignores the possibility of discovery of fraud in the 1998 accounts, the continuing activities of Mr Ellis thereafter, the diminution in value after the 1998 audit and the further diminution in value between 1^st July 1999 and 8^th March 2000.
38. EY also argued that any continuing losses were irrecoverable as a matter of law as a result of the decision of the Court of Appeal in Galoo v Bright Grahame Murray [1994] 1WLR 1360. On the basis of this decision, EY argue that any trading losses which occur after the completion of an audit which fails to uncover deficiencies in the financial affairs of the company are irrecoverable from the auditors because the negligent failure to report does not cause the future loss but merely provides the occasion for the company to continue to trade and incur those losses as a result of its trading activities. It is not enough to say that if the deficiency had been discovered the company would have ceased to trade. EY rely upon passages in Glidewell LJ's Judgment at page 1369 – 1375B. Attention was directed by Freightliner to a passage cited by Lord Justice Glidewell from Alexander v Cambridge Credit Corporation Limited (1987) 9NSWLR 310 where Mahoney JA said at page 333-335:-

"In the present, the company's loss resulted from the defendants' breach in the sense that the course of events vis-à-vis the company would have gone in a different direction had it not been for that breach. But that, I think, is not, or is not necessarily, sufficient. Thus, the breach allowed the company to continue in business. If its net worth had fallen because, for example, the main buildings it owned had been destroyed by an earthquake, I do not think that that loss would have been causally related to the breach which let the company continue in business ……

It may sometimes be argued that a breach exposes the plaintiff to particular dangers and that if what happens subsequent to the breach is loss from a danger of that kind, the loss may be seen as a result of the breach ……… But, again, I do not think that this argument is open to this company………. There are some dangers loss from which will raise causal considerations and some will not. But the company's case has been conducted on the basis that there is not to be - and there has in fact not been – a detailed examination of what particular things caused the fall in net value of the company between 1971 and 1974 and the nature for this purpose of them. In the end, the company's case has been that the loss it claims was caused by the breach because, and because alone, the breach allowed the company to continue in existence. Some of the incidents flowing from its existence during 1971-1974 may be the results of the breach; some, for example, those flowing from earthquakes or the like will not be. But the basis of the plaintiff's claim has been such that no inquiry is to be or has been pursued, for this purpose, into what in fact happened, why and the relationship of what happened to the breach. I do not think that this is enough to establish a causal relationship."

39. In this action, Freightliner say that, unlike in Galoo, there is a plea of loss caused as a result of the failure by the auditors in detecting Mr Ellis' fraud in exactly the same way as if they had failed to detect defalcations which continued after they had given a clean certificate of audit (the Sasea case). This was the very thing that they were to guard against in the course of their audit. In my Judgment, this raises an arguable issue which is not capable of being determined on a summary basis but requires investigation of the facts in order to determine whether it is well founded before applying any principles of causation. In this context I note that the description of causation as a matter of common sense in Galoo has been referred to in the New Zealand case of Sew Hoy v Coopers & Lybrand [1996] 1NZLR 392 (at page 399) as amounting to no more than saying that causation is a jury question of fact with the result that it must be rare that a Court would be able to strike out an allegation that a particular loss was caused by a particular breach, (per MacKay J). In this New Zealand Court of Appeal decision, that Judge went on to state that he did not think that Galoo could be regarded as deciding, as a matter of law, that a decision by a Company trading at a loss to continue trading could never, without something more be a cause of further loss. Thomas J thought that questions of causation were particularly unsuitable for consideration on the basis of pleadings alone because they raised questions of fact and common sense thrived on hard facts not abstractions. On the pleadings in the action before me, the causation argument does not simply follow the same line as Galoo and issues of fact arise which require determination before deciding whether the Galoo principle applies or whether this is a case more akin to Sasea. As put in a later New Zealand decision, Price Waterhouse v Kwan [2000] NZLR 39, issues arise as to whether the acts or omissions said to constitute negligence have a real influence on the occurrence of the loss and make more than a de mininis or trivial contribution to its occurrence (paragraph 28).
40. I was addressed also on the questions of whether or not an issue of this kind is more appropriately framed in terms of the scope of duty rather than causation of loss. I was referred to the lecture to the Chancery Bar Association given by Lord Hoffman on 15^th June 1999 entitled "Common Sense and Causing Loss" in this connection. If the matter is to be viewed in this light, this raises issues of the kind discussed earlier in this Judgment in the context of Caparo and is once again incapable of determination summarily.

The Contribution claims.

41. The claims raised under the Civil Liability (Contributions) Act 1978 arise in respect of the potential liability of EYUK to Man and the potential liability of EYUK to ERF. No contribution claim is made in respect of any parallel liability of EYC.

Man's Claim against EYUK

42. No such claim has actually been pursued. Man have sued Freightliner alone. Freightliner contend that such a claim by Man against the auditors would however be sustainable for much the same reasons as it maintains that it has a claim as vendor in respect of the known sale for which the audited accounts were to be produced. Man's pleaded reliance upon the accounts, according to Freightliner, speaks for itself. Whilst EYUK does not accept this it does accept that as a result of the provision of information direct to Man and Deloittes in response to their due diligence enquiries, it is arguable that a duty could be owed but, it is said, the existence of the Hold Harmless letters negatives the possibility of liability on this basis.
43. I was addressed by both parties on the proper construction of the letter dated 28^th October 1999 from EYUK addressed to Man and Deloittes and signed by them in acknowledgement of its terms. The letter was subsequently amended and falls to be read in the context of other correspondence, including perhaps a letter of 19^th October 1999 from EYUK to Western Star. Because I have come to the conclusion that the construction of this letter is not straightforward and therefore does not provide a comprehensive answer to any claim against EYUK, I will not condescend to detail in reviewing the arguments put forward by the parties. In essence, however, paragraphs 1 to 5 of the letter deal with ERF's request to EYUK to allow Man and Deloittes access both to their working papers relating to the audit of ERF for the years ending 30^th June 1998 and 30^th June 1999 (the audit papers) and to the taxation computations and correspondence with the Inland Revenue in respect of those computations, (the taxation papers), so that Man could consider the position in the context of their projected purchase of ERF. The letter also refers to authorisation being given by ERF to EYUK to give explanations in relation to the audit papers and the taxation papers which were together referred to as "the working papers". These early paragraphs of the letter refer to the fact that the 1999 accounts had not yet been completed and the limitations to which the audit papers and taxation papers were subject in the context of any reliance for the purpose of a sale and purchase.
44. The critical paragraph of the Hold Harmless letter is paragraph 6, a copy of which is annexed to this Judgment. It will be seen that access was granted to Deloittes to the working papers (as defined) and the statement was made that EYUK were prepared to give explanations in relation thereto "or other information or representations relating to or arising from our work". The question which arises, put shortly, is whether or not the expression "or other information relating to or arising from our work" which is part of the definition of "information" does or does not include the audited accounts for 1998 and 1999. Those audited accounts, once provided to Western Star, were in Western Star's province so far as distribution was concerned. The permission of EYUK was not required for access to them. The 1998 accounts had been audited long since and the 1999 accounts were not the subject of clean audit until 4^th November 1999. The issue to be determined is whether or not the expression "Information" to which paragraphs 6(1) – (6) refer and for which liability is essentially excluded includes the audited accounts which were not, as such, the subject of the letter. It seems to me that, in a matter of this kind, context may be all important and factual issues therefore may fall to be determined in construing the document.

ERF's claim against EYUK

45. The argument put forward by EYUK as to the absence of any possible liability to ERF was that the loss claimed was irrecoverable for the same reasons put forward when saying that EYUK would not be liable to Western Star. Thus, it was said that the loss in value could not be advanced because it would have been suffered in any event by ERF and the future loss was irrecoverable on the basis of Galoo. Both these points cannot be conclusively determined at this stage for the reasons given above and, in the case of any liability of EYUK to ERF, it is worth noting that it would have been ERF which, as claimed, would have dismissed Mr Ellis had the information been made available to it as it alleges it should.

Conclusion

46. In my Judgment the issues of duty and causation which arise on the cases put forward by the parties are fact sensitive and inappropriate for determination on a summary basis. Whilst it can be said that there are principles of law enshrined in Caparo and Galoo, it is also right to point out that the areas of law with which the decisions deal are areas which are not only developing but also not free from difficulty. Whether EYUK assumed a responsibility for the audit to Western Star and/or Man in the context of the sale, what obligations EYC and EYUK undertook in the context of the work relating to Man's due diligence enquiries and whether there was a breach of them and what obligations and breaches arose in relation to the "tip-off" information all raise issues of fact which cannot be resolved now and to which the principles of law can only be applied when the facts are found. The causation issues which are raised are equally questions which should only be answered once a full factual determination has been made. There are real issues to be tried and Freightliner has real prospects of success on each of its claims.
47. In my Judgment, therefore, both the applications made by EYUK and EYC must fail. The claim against EYUK should not be struck out nor determined summarily on a Part 24 basis and service of the proceedings on EYC should not be set aside. Permission is given for the amendment of the Part 20 claim in the form put before the Court, (including the additional amendment made in the course of argument), subject to the usual provision that Freightliner should pay the costs of and occasioned by the amendments.
48. Subject to hearing any argument on the point, it seems to me that costs must follow the event and, unless there are any unusual features of these applications to which the parties wish to draw my attention, that Freightliner should be entitled to the costs of resisting the applications on the standard basis but I make no order before hearing whether the parties wish to address me on the subject.