Citation(2008) 20 SAcLJ 171
Date01 December 2008
Published date01 December 2008

In the context of annual statutory audits required of companies, this article explores the duty of care of statutory auditors, the standard of care expected of statutory auditors, causation, and the contributory negligence, if any, of the company’s own directors and officers in failing to detect or prevent cases of fraud. This article considers these questions in light of two recent decisions of the Singapore Court of Appeal, and highlights key conclusions as well as unresolved issues that will be of interest not only to legal scholars and practitioners, but also to members of the accounting profession and company directors.

I. Introduction

1 The requirement to conduct annual statutory audits is an inescapable fact in the life of a modern corporation. In the normal course of business, a company will engage auditors to perform a yearly audit to ensure, inter alia, that its accounts represent a true and fair view of the company’s finances. Companies are also required to file the results of the audit conducted as part of their statutory reporting requirements under the Companies Act (“CA”).1

2 The performance of the annual statutory audit is sometimes perceived as routine or even mundane by companies. A firm’s top management would be expected to have its attention and energies focused on profit-maximisation or business development, and may be tempted to view the audit requirement as a bothersome or even unnecessary interruption to the firm’s otherwise constant ebb and flow of transactions and earnings.

3 However, the occasion may arise when an annual statutory audit fails to reveal omissions or errors in a company’s finances, or worse, a fraud that has been committed on a company. In terms of liability for the loss suffered due to a fraud committed by an employee or director of the company, difficult questions arise in relation to: (a) the duty of care of statutory auditors; (b) the standard of care expected of statutory auditors, (c) causation; and (d) the contributory negligence, if any, of the company’s own directors and officers in failing to detect or prevent the occurrence of fraud.

4 These are critical questions that will be of interest not only to legal scholars and practitioners, but also to members of the accounting profession and company directors.

5 As such, it is particularly noteworthy that these issues were the subject of two recent decisions of the Singapore Court of Appeal,2 in PlanAssure PAC v Gaelic Inns Pte Ltd,3 and JSI Shipping (S) Pte Ltd v Teofoongwonglcloong.4 The Court of Appeal also considered the legal significance of professional guidelines and industry regulations, namely, the Singapore Standards on Auditing (“SSA”) published by the Institute of Certified Public Accountants of Singapore (“ICPAS”).

6 The above decisions of the Court of Appeal in Gaelic Inns and JSI Shipping addressed and clarified many of the uncertainties facing both auditors and company directors, and the legal import and significance of these decisions will be the subject of this article.

II. Background and context of recent Court of Appeal decisions in Gaelic Inns and JSI Shipping
A. PlanAssure PAC v Gaelic Inns Pte Ltd
(1) The conduct of the statutory audits

7 GIPL is a company incorporated in Singapore that is an owner and operator of certain well-known pubs in Singapore. The company engaged a firm of certified public accountants to audit its accounts for the financial years (“FYs”) of 2001, 2002 and 2003. The audits had to comply, inter alia, with the terms of s 207 of the CA, and express an opinion as to whether GIPL’s financial statements gave a true and fair view of its profit and loss.5

8 The yearly audits for FYs 2001 and 2002 were completed without incident. Thereafter, GIPL retained the auditors’ services to conduct the yearly audit for FY 2003.6

(2) Fraud by the company’s employee

9 The dispute in Gaelic Inns essentially arose out of acts of fraud committed by one D, who was the group finance manager of GIPL. As GIPL was not able to fully recover misappropriated amounts from either D or from its insurers, a key question was whether and to what extent its auditors should be liable for the company’s losses.

10 From 2001 to 2004, D devised and carried out a scheme whereby she delayed banking in cash on the day of sales into GIPL’s bank account, and instead used the cash for her personal benefit. To make up for the resulting shortfall, D would bank in an equivalent amount of cash subsequently collected from later sales. For a period of time, D managed to avoid detection because she would subsequently bank in the same amount of money that she had taken out, using a method of misappropriation described by accountants as “teeming and lading”.7

11 D’s misappropriation of funds was eventually detected in May 2004. D was subsequently charged with and convicted on three counts of criminal breach of trust under s 408 of the Penal Code8. Six other similar charges were taken into consideration. According to the police investigations, D had misappropriated a total sum of S$1,006,115.12. However, GIPL was only able to recover the sum of S$8,929 from D, and an additional sum of S$ 100,000 from its insurers.9

(3) The High Court proceedings

12 In July 2005, a year after D’s misappropriation was discovered, GIPL commenced a suit against its auditors, seeking damages of close to S$1m for negligence in respect of the audits performed by the appellant between 2002 and 2004. GIPL essentially pleaded that the auditors had failed to detect D’s cash misappropriations during the audit of the accounts for FYs 2001, 2002 and 2003, thereby emboldening and enabling D to continue with her misappropriation.10

13 The first instance hearing in the High Court resulted in a finding that the auditors had failed to discharge their duty of care and were liable for the entire amount of losses in FY 2004, in the amount of $775,266.02. However, the High Court dismissed GIPL’s claim for losses in FYs 2001 and 2002 because of the GIPL’s inability to show that there were losses suffered during this period, and held that GIPL was precluded from recovery in relation to the 2003 losses because of its own contributory negligence.11 The auditors subsequently appealed against the decision of the High Court.

B. JSI Shipping(S) Pte Ltd v Teofoongwonglcloong
(1) The conduct of the statutory audit

14 The dispute in the JSI Shipping case arose out of acts of fraud committed by one R, who was a director of a Singapore company, JSPL. JSPL was a provider of international logistics and door-to-door freight-forwarding services to its mainly US-based customers.12 The ultimate holding company of JSPL was a US company, JSISC.13

15 The auditors were certified public accountants which conducted three statutory audits of JSPL accounts in respect of financial years (“FYs”) 1999, 2000 and 2001.14 The results of all three audits were unqualified.15

16 At the material time, the two directors of JSPL were R, who was based in Singapore as Asia Director to head JSPL, and one C, who resided in California and headed JSISC.16 As Asia Director, R had overall control and responsibility of JSPL’s day-to-day operations in Singapore and reported to C on all operational and business issues.17

(2) Fraud by the company’s director

17 R was eventually discovered to have misused funds belonging to JSPL.18 C confronted R, who resigned and confessed to the misappropriations.19

18 JSPL then engaged another firm of auditors, NLAD, to conduct a special audit to ascertain the full extent of R’s malfeasance.20 The special audit concluded that R had misappropriated company funds amounting to $1.808m during the relevant period. A second special audit also revealed that there was an overpayment of salary for R amounting to $18,000 during the stated period, and that R had received non-approved sums of money for allowances and other benefits amounting to about $174,000.21

(3) The High Court proceedings

19 At first instance, JSPL claimed that all its losses were caused by the auditors’ breaches of its contractual obligations and duty of care in relation to the three audits carried out for FYs 1999, 2000 and 2001.22 While the High Court accepted that an auditor had to use reasonable skill, care and caution, it held that what amounted to reasonable care

depended on the circumstances of each case.23 The judge found that the auditors had conducted the three audits in question without breach of duty or negligence.24 JSPL subsequently appealed against this decision.

III. The duty of care of auditors in conducting an annual statutory audit
A. The effect of disclaimers of limiting clauses contained in the auditors’ letter of engagement

20 The legal effect of disclaimers and limitations contained in the auditors’ standard letter of engagement was considered by the Court of Appeal in Gaelic Inns.

21 In Gaelic Inns, the Court of Appeal considered the effect of the auditors’ letter of engagement which contained a disclaimer that the company should not rely on the audit to disclose irregularities or fraud. However, the Court of Appeal held that such disclaimers or limitation clauses merely restated the degree of skill and care that was required of an auditor under the accepted professional accounting standards.25 While a plain reading of the purported disclaimer appeared to exempt the auditors from liability in the event that fraud was not detected during an audit, it was not open to the auditors to seek to exclude or limit its liability in relation to GIPL for negligence or any other breaches of duty in this manner.26 The court also stated that the role of a statutory auditor is not a perfunctory one, but is rather that of a reasonably competent auditor exercising the requisite skill and responsibility coupled with a healthy and reasonable dose of professional scepticism.

22 It is thus significant that the duty of care owed by auditors to their...

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