DEVELOPMENTS IN THE LAW RELATING TO NEGLIGENT MISSTATEMENTS: ANY RECOURSE FOR INVESTORS AND CREDITORS?

Citation(1992) 4 SAcLJ 333
Publication Date01 December 1992
AuthorANGELINA LIM — CHAN HUI LIAN ERIN GOH — LOW SOEN YIN
Date01 December 1992
Introduction

Traditionally, the courts have been reluctant to award damages for pure economic loss which is not a consequence of physical damage to the plaintiff’s person or property. The main exception is when the loss is caused by a negligent misstatement. However, given that statements may be widely disseminated and their effects are more far-ranging than that of physical acts, the courts have been very cautious in imposing liability on the maker for fear of exposing him to “liability in an indeterminate amount for an indeterminate time to an indeterminate class.”1

Recovery for economic loss resulting from negligent misstatements was first allowed in the landmark case of Hedley Byrne & Co Ltd v. Heller & Partners Ltd.2 Since then, much litigation has ensued on the scope of the new liability. Most of the cases have turned on the question of the circumstances which would give rise to a duty of care. In order to keep liability within reasonable bounds, the courts have generally required the existence of a “special relationship” between the maker and recipient of the statement. This special relationship is said to exist if: (a) the maker of the statement possesses (or professes to possess) special skill or information), (b) the maker knows or ought to have known that the recipient would rely on the statement, and (c) it was reasonable for the recipient to rely.

Recent cases have indicated a major shift in judicial policy, brought about by the fear of placing an unduly heavy burden on the professions. Whereas earlier cases3 had allowed recovery on the basis of Lord Wilberforce’s test of foreseeability and policy consideration laid down in Anns v Merton LBC4, this test has been decisively rejected by the House of Lords in Caparo Industries plc v. Dickman and others.5 The single general principle approach previously used to determine the existence and scope of a duty of care in every situation has been discarded in favour of a more cautious and restrictive case-by-case approach, using the concepts of foreseeability, proximity and fairness.

Given the somewhat narrow ambit of the Caparo decision, and the varied commercial situations to which professionals lend their advice, the new approach has been criticised as giving rise to uncertainty and inconsistency in the law. Many of the recent cases concerned the issues of whether and to whom an accountant or auditor owes a duty of care when he is preparing or auditing a set of acounts. It is pertinent to note that accountants today do more than traditional book-keeping and preparation of accounts. They also give advice as consultants on a wide range of activities from tax planning, corporate structuring, information systems planning to takeovers and mergers. In doing so, their exposure to the risk of liability for negligent misstatements is far greater than ever before, and raises interesting questions concerning their liability for professional negligence.

The aim of this article is to examine the cases decided in the aftermath of Caparo, and to try and extract some principles which may help in identifying the situations in which members of the accounting profession (accountants and auditors) and other financial advisors may be held to owe a duty not to make inaccurate and misleading statements which may cause economic loss to a recipient who relies on them.

Caparo and other cases

In Caparo Industries plc v Dickman, The House of Lords had the opportunity to review the caselaw relating to the duty of auditors for statements made in a company’s annual audited reports. Caparo Industries plc (Caparo), who were shareholders of Fidelity plc, purchased additional shares in the company and subsequently took over the company in reliance on the company’s audited reports. After the takeover, Caparo brought an action against, inter alia, the auditors of Fidelity plc, alleging that the auditors owed them a duty of care, either as potential bidders or as existing shareholders. It was argued that the auditors had breached this duty of care in preparing accounts that were inaccurate and misleading as the stocks were overvalued and after sales credits had been underprovided for, thus reflecting a profit when it should have shown a loss.

At the trial of a preliminary issue as to whether the auditors owed a duty of care to Caparo, Sir Neil Lawson held that no such duty of care existed to individual shareholders, although a duty may be owed to the shareholders as a class. On appeal, the Court of Appeal by a majority (O’Connor LJ dissenting), allowed the appeal in part on the ground that the auditors owed a duty to the respondents as existing shareholders because there was sufficient proximity between an existing shareholder and the auditors who were considered to have voluntarily assumed a direct responsibility for the accuracy of audited accounts. However, it was decided that no duty of care was owed to Caparo as potential investors.

The auditors appealed from this decision to the House of Lords which unanimously allowed the appeal and held that no duty of care was owed by the auditors to Caparo, whether as an individual shareholder or as a potential investor. The law lords emphasised the importance of the need for proximity of relationship between the parties in addition to the requirement of foreseeability. Proximity was to be determined by the circumstances in and the purposes for which the statements were made.

Since the statements in question had been contained in the company’s audited accounts, it was decided that the statements had been made for the purpose of fulfilling the statutory requirements of the Companies Act 1985. The purpose behind the statutory requirement for audited accounts, their lordships reasoned, was to provide existing shareholders of the company with reliable information to enable them to exercise their class rights at the company’s general meeting. As such, the auditors owed no duty of care to the takeover bidder because the accounts had not been prepared specifically for the purpose of giving financial advice in relation to a takeover bid. Nor was there a duty of care owed to Caparo in their capacity as an existing shareholder because the audited accounts had not been prepared for the purpose of assisting existing shareholders in deciding whether or not to acquire additional shares.

Immediately after this judgement, there was a great deal of speculation as to how the decision of the House of Lords would be interpreted and applied in subsequent cases6. It did not take long for the courts to be faced with another case on negligent misstatement within the context of another takeover scenario. Applying Caparo, the Court of Appeal in James McNaughton Paper Group Ltd v Hicks Anderson & Co7 applied the concepts of foreseeability, proximity and reasonableness and held that a firm of chartered accountants who had prepared a set of draft accounts for a corporate group did not owe a duty of care to a takeover bidder who had relied on the accounts. This was so in spite of the fact that the accountants had met with the potential investor during negotiations for the takeover and had made an oral representation concerning the financial status of the company in question. The court placed a great deal of emphasis on the fact that the accounts presented to the potential investor had been merely draft accounts and thus it was not foreseeable that the bidder would rely on them in the same way as one would rely on final accounts.

As for the accountants’ oral representation to the effect that the company was breaking even or doing marginally worse, it was decided that this was merely a general statement. According to Neill LJ, this general statement did not affect the specific figures in the draft accounts and the accountants could not have foreseen that the takeover bidder would rely on it without further inquiry or advice. The Court of Appeal did not seriously consider the question of proximity because the takeover bidder had failed to satisfy the court that it was foreseeable that they would rely on the draft accounts and the oral representation.

In a matter of months, the Court of Appeal had further opportunity to consider the same issue in Morgan Crucible Co plc v Hill Samuel & Co Ltd8, which arose out of similar facts. Here, the takeover bidder sought to amend his statement of claim (in view of the decision in Caparo) to allege that there was the necessary proximity for the defendants (including the company’s directors, a firm of financial advisors and a firm of auditors) to owe him a duty of care in relation to financial statements made after the bid was announced. It was agreed by all parties to the action that no duty of care could have arisen before the bidder was identified. The court then decided that the moment the initial bid was made, there was an arguable case for liability of the directors...

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