Chapter 5 Case Flashcards

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1
Q

Caparo Industries v Dickman

A

Purpose and Duty of Auditors & 3 fold test

Caparo Industries relied upon an audited financial report to make decision for their takeover bid of another company. The report was proved to have given a false image of the company’s profits and Caparo made a loss. Caparo brought a claim against the auditors, stating that the auditors owe a duty of care to shareholders.

The HL held that no duty was owed either to existing shareholders or potential shareholders as for a duty to arise, 3 factors had to exist.

1) A sufficient degree of proximity in the relationship between the parties;
2) The knowledge that the report would be communicated to the shareholder or investor in connection with a particular transaction in the contemplation of the parties;
3) The shareholders or investors would place reliance on the report when deciding whether to enter into relevant transactions.

An auditor of a public company routinely prepares accounts, in contrast to the preparation of a report for a specific purpose for an identified party, owed no duty to the public at large.

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2
Q

Re Kingston Cotton Mill Co. (No. 2)

A

Purpose and Duty of Auditors

J, one of the managers, provided auditors with fabricated certificates for stocks-in-trade. The balance sheet with the false inventory values showed sufficient distributable profits which would not be present if they were stated at its true value. The reports were signed by the auditor and dividends were distributed. The auditors would have noticed something amiss if they had compared the different books and calculated the cost of sales and would have called for an explanation.

The Court held that it is not part of the duty of auditors to take stock. They were justified in relying on certificates provided by managers, persons of acknowledged competence and high reputation, and were not bound to check his certificates in the absence of anything to raise suspicion and they were also not liable to any dividends wrongfully paid. Auditors are not bound to be suspicious where there are no circumstances to arouse it. He is only bound to exercise a reasonable amount of care and skill.

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3
Q

Re Thomas Gerrard & Son Ltd

A

Purpose and Duty of Auditors

The auditors were put on inquiry for negligently failed to investigate a case of alterations of invoices made by the company. The company paid dividends based on falsely positive reports and incurred additional taxes. The auditors argued that they were not given sufficient time.

The Court held that if the directors do not allow auditors time to do their work properly, auditors should refuse to make a report or make an appropriately qualified report. The auditors were order to repay dividends and cost of recovering taxes and any tax not recoverable.

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4
Q

Leeds Estate Building and Investment Co v Shepherd

A

Purpose and Duty of Auditors

Auditors must check and verify company’s account.

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5
Q

Formento (Sterling Area) Ltd v Selsdon Fountain Pen Co Ltd

A

Purpose and Duty of Auditors

Selsdon obtained licence to manufacture, use and sell ball-pointed pens and accessories protected by patents from Formento in exchange for royalties. Auditors were appointed by Formento to check on the royalties paid by Selsdon. The auditors found that royalties of refills type “A” had been paid but upon inquiry of type “B” and “C”, Selsdon said that they weren’t covered by patents. The auditors pressed for specimens or specifications but obtained no more information.

The Court held that the auditors were entitled to ask for the information and Selsdon committed a breach of that clause in refusing it.

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6
Q

Barings Plc v Coopers & Lybrand

A

Criminal Sanctions apply where information or explanation is misleading, false or deceptive in a material particular. Auditors owe a duty of care to parent company of a subsidiary.

Barings Futures (Singapore) together with other companies were subsidiaries of BLS. The group later collapsed as a result of fraudulent trading by BFS’s general manager.The group brought an action against BFS’s auditors. They contended that the auditors owed them a duty of care for failure to detect the fraud during audits.

The Court held that although the immediate loss was due to a failure of internal group controls, the audits failed to detect the fraud. Had they been brought to their attention, other companies in the group would not have remitted further funds to BFS.

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7
Q

Salad Oil Swindle

A

Criminal Sanctions apply where information or explanation is misleading, false or deceptive in a material particular

An Oil company discovered that it could obtain loans based on the inventory level of its salad oil. An inspector was hired to inspect the oil. The company added water into the oil to inflate the levels. The oil was also moved from one tank to another when the inspector was brought away to have a drink.

The owner was convicted of fraud and sent to seven years in prison.

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8
Q

Re London and General Bank Ltd

A

Criminal Sanctions apply where information or explanation is misleading, false or deceptive in a material particular

The auditor of London and General Bank Ltd presented a confidential report to the directors informing them of the insufficiency of securities on which the capital of the company was invested. In his report to the shareholders, however, merely stated that the value of the assets was dependent on realisation and consequently, the shareholders approved a proposed dividends out of capital and not of income.

The Court held that the auditor had been guilty of misfeasance and was liable to repay the dividends paid.

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9
Q

Morgan Crucible Co Plc v Hill Samuel Bank Plc

A

Criminal Sanctions apply where information or explanation is misleading, false or deceptive in a material particularA company was a target for a take-over bid. Its financial statements and forecasts were available for inspection and were seen by the other party. The bid was accepted and the new owner claimed that the accounting policies were negligently prepared and wholly misleading.

The Court held that the company intended the bidder to rely on the pre-bid statements and forecast and where they did so, there was a relationship of sufficient proximity to give rise to a duty of care by the auditors.

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10
Q

Sasea Finance Ltd v KPMG

A

Sasea Finance Ltd went into voluntary liquidation. Investigations revealed that the companies within the group had been vehicles of fraud. SFL brought an action against KPMG alleging that they had been negligent and in breach of contract in their preparation of the accounts. SFL contended that if KPMG had exercised reasonable skill and care, SFL would have avoided losses attributable to the frauds.

The Court held that KPMG were under a duty to warn the directors or a third party within a reasonable period of any fraud or irregularity that was likely to result in material loss. Each transaction discussed in the case had either been fraudulent or irregular.

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11
Q

Customs and Excise Commissioners v Barclays Bank Plc

A

Barclays was notified by Custom and Excise to freeze an account on orders of the Court. Barclays replied that they did but the account holder subsequently withdrew all the balance. Custom and Excise held that Barclays owed a duty of care to it. Barclays argued that they did not owe a duty of care unless it had voluntarily undertaken the assumption of responsibility. Customs argued that the correct approach was the Caparo threefold test.

The HL held that in the absence of any single touchstone of liability and the court was faced with a novel situation, apply threefold test. However, they held that the Customs could expect a bank to respect the order but it could not rely on them doing so. It had to rely on the court to ensure that the bank did not flout the order, thus a relationship of proximity could not be established. It would not be fair, just and reasonable to hold that B owed a duty of care to Customs.

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12
Q

Moore Stephens v Stone & Rolls Ltd

A

Stone was the sole directing mind of Rolls Ltd. The company was found to commit fraud and consequently went into liquidation. The liquidator of Rolls Ltd brought a claim against the auditors, contending that they were negligent in their audit. The auditors argued using the maxim ex turpi causa non oritur actio.

The HL divided 3-2 in favor of the auditors’ defence. Rolls Ltd was neither the target nor the victim of the dishonesty, it was itself the fraudster and thus the ex turpi causa defence could be applied.

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13
Q

Al Saudi Banque v Clark Pixley

A

Auditors do not owe a duty of care to existing or future creditors who extend credit on the strength of the audited accounts.The company secured loans from a bank based on audited accounts. The company was subsequently wound up with a very large deficiency in its accounts. The banks claimed that the auditors were negligent.

The Court held that the auditors did not owe a duty of care to banks as the auditors did not make their reports to the banks themselves or to the company with the intention or in the knowledge that it would be supplied to the banks. There is thus a lack of proximity. Even if proximity was established, it was not just and reasonable to impose a duty of care on auditors to banks.

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14
Q

Berg Sons & Co Ltd v Mervyn Hampton Adams

A

Berg Sons & Co Ltd was involved in fraudulent activities. The liquidators brought a claim against the auditors for being negligent and in breach of contract in the preparation and certification of audited accounts.

The Court held that the auditors were negligent and in breach however, the company had not been misled and did not rely on the certificate. The auditors’ failure had no relevance to the eventual insolvency. At the time of the certification, the company was not insolvent and they were right to value it as a going concern. The fraudulent transactions were also too remote from the certification of the accounts for any duty of care to arise.

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15
Q

James MacNaughten Paper Group Ltd v Hicks Anderson & Co

A

When considering the liability of an auditor in negligence, the fact and nature of any communications direct between the auditor and the potential investor must be allowed for.

Lord Neil set out six headings to establish liability:

1) The purpose for which the statement was made
2) The purpose for which the statement was communicated
3) The relationship between the advisor, advisee and any relevant third party
4) The size of any class to which the advisee belongs
5) The state of knowledge of the advisor
6) Reliance by the advisee

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