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Cite as: [2005] CSIH 39, [2005] ScotCS CSIH_39

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Royal Bank Of Scotland Plc v. Bannerman Johnstone Maclay [2005] ScotCS CSIH_39 (26 May 2005)

SECOND DIVISION, INNER HOUSE, COURT OF SESSION

Lord Justice Clerk

Lord Osborne

Lady Cosgrove

 

 

 

 

[2005CSIH39]

A2237/00

OPINION OF THE LORD JUSTICE CLERK

in

RECLAIMING MOTION

in the cause

ROYAL BANK OF SCOTLAND plc

Pursuers and Respondents;

against

BANNERMAN JOHNSTONE MACLAY, Chartered Accountants; and A G BANNERMAN, G J JOHNSTONE, D J MACLAY, R B McKERRAL, M G MacBETH and M G McCUSKER, the whole partners thereof as such partners and as individuals

Defenders and Reclaimers:

_______

Act: Currie, QC, D E L Johnston; Brodies

Alt: Dean of Faculty (C M Campbell, QC), Paterson; Brechin Tindall Oatts

26 May 2005

I Introduction

[1]      This is an action of reparation arising from the insolvencies of APC Limited (APC) and its subsidiary APC Civils Limited (APC Civils). The pursuers were the bankers of both companies. The defenders were the auditors of APC.

[2]     
The pursuers claim damages for losses allegedly sustained by them in consequence of negligence on the part of the defenders in the auditing of APC and of fraud on the part of Michael McMahon (McMahon) who, they allege, was one of the defenders' employees and was acting in the course of his employment with them at the material time.

[3]     
The Lord Ordinary heard a debate on the defenders' plea to relevancy. He dismissed the fraud case. Quoad ultra he allowed proof before answer. The defenders have reclaimed against the allowance of proof before answer. The pursuers have cross-appealed against the dismissal of the fraud case.

[4]     
In the reclaiming motion and in the cross-appeal some lesser issues have fallen away. There are now four main issues, namely (1) whether the pursuers have relevantly averred the existence of a duty of care on the part of the defenders; (2) the significance, if any, of the defenders' failure to issue a disclaimer of liability in respect of the audited accounts; (3) whether the pursuers have pled a relevant claim for damages for losses sustained through their lending to APC Civils, and (4) whether the pursuers have pled a relevant case of vicarious liability on the part of the defenders for the fraudulence of McMahon. Counsel have in all essentials renewed the submissions that they made to the Lord Ordinary. The Lord Ordinary has set them out at length (cf Royal Bank of Scotland Ltd v Bannerman Johnstone Maclay, 2003 SC 125, at paras [11]-[42]; [59]-[71]) and I need not rehearse them.

II The pursuers' relationship with APC and APC Civils

[5]     
The pursuers aver that APC was formed after a management buyout of Adam Bruce Plant Hire Limited (Adam Bruce), which had become insolvent. APC assumed liability for about £1,900,000 owed by Adam Bruce to the pursuers. APC began to trade as plant hirers in December 1994 or in January 1995. The pursuers give both dates. APC Civils began to trade in September 1997. Its business was to carry out some of APC's contracts for motorway work.

[6]     
The pursuers aver that they were the principal bankers to APC and APC Civils and provided both companies with overdraft facilities. They gave APC a term loan of £1,500,000 and a small firm's loan of £100,000.

[7]     
On 24 September 1998 the pursuers appointed joint receivers to APC. On 28 September 1998 they appointed joint receivers to APC Civils. At the dates of the receiverships the overdrafts of APC and APC Civils were £8,255,146 and £3,530,820 respectively.

[8]     
The pursuers aver that they appointed the receivers because they discovered that the accounts of APC included material inaccuracies and, as a result, greatly overstated the value of APC's fixed assets and of its profitability. The overstatements were the result of a fraudulent scheme.

[9]     
The pursuers aver that on completion of the buyout, they obtained an option to subscribe for 30%, later increased to 55%, of the share capital of APC. In 1996 they exercised that option and thereafter injected further equity into APC, all of which is now worthless. The pursuers specify the details of these transactions.

III Analysis of the pursuers' case

  1. Duty of care
[10]     
The pursuers aver that the defenders had a close relationship with APC and an intimate understanding of its relationship with the pursuers. After the management buyout, the defenders, and in particular their partner Mr McKerral, prepared the business plan for APC on the basis of which the pursuers originally provided finance to APC. During 1995 the defenders were involved in preparing financial projections for APC for the three years ending on 30 November 1997 and a "Review of August 1995 Management Accounts" dated 7 November 1995.

[11]     
It was a condition of the overdraft facilities given to both companies, and set out in the relative facility letters, that the pursuers should be provided with annual audited financial statements as soon as they were available, and in any event within 180 days after the end of each company's financial year, and with management accounts shortly after the end of each month. The facility letters began to be issued by the pursuers before the first audit.

[12]     
On or about 26 September 1995 Paul Canning, an employee of the pursuers, attended a meeting at the offices of the defenders with one of the defenders' partners and a representative of APC for the purposes of reviewing APC's management accounts for July 1995.

[13]     
McMahon was seconded to APC as its financial controller from about December 1995 to March 1996 and APC was invoiced by the defenders for the provision of accountancy services. McMahon was responsible for the provision of financial information and forecasts. He was responsible for preparing the daily financial reports and monthly management accounts that were supplied to the pursuers as a condition of their lending. He also produced year-end figures for APC, which the defenders audited. During this period the final documentation for the audit to 30 November 1995 was being completed. The accounts for that period were signed on 16 April 1996.

[14]     
From the outset the defenders knew of the pursuers' involvement with APC and of their option to subscribe for a significant shareholding in the company. Through their audit of the accounts of APC, the defenders knew that the pursuers were APC's principal bankers, were shareholders in APC from October 1996 and were substantial creditors of APC. They knew that the business of APC was heavily reliant on its overdrafts with the pursuers. They knew that the shareholders of APC, including the pursuers, relied on the audited accounts in order to obtain assurances that the company's financial statements were free of material mis-statements caused by fraud or other irregularity or error. They knew that APC was a business making heavy demands for cash in order to fund the plant and machinery hired out by it. They knew or ought to have known that in these circumstances the critical consideration for those such as the pursuers who funded APC, by loan or by injection of equity, was its profitability. By reason of Statement of Auditing Standards 130, the defenders saw and were aware of the terms of the facility letters granted by the pursuers to APC, and accordingly knew that the provision of audited and management accounts to the pursuers was a condition of their funding APC to enable it to continue to trade.

[15]     
The pursuers therefore believe and aver that the defenders knew that the pursuers would rely on the audited accounts as a check on the reliability of the monthly management accounts provided to them by APC. The pursuers relied on the audited accounts for this purpose and in deciding whether to maintain, increase or withdraw their lending to and support of APC. The defenders knew that the statements and accounts audited by them constituted the main independent check on APC's own monthly management accounts and the main means of assessing the profitability of APC. They knew of the importance, especially in relation to a highly-geared business such as APC, of scrutinising closely the ability of the company to trade as a going concern. The defenders had a close relationship with APC and an intimate understanding of its relationship with the pursuers.

[16]     
The defenders audited the accounts of APC for the audit periods to 30 November 1995 and to 31 March 1997 and for those accounts signed unqualified audit reports dated 16 April 1996 and 15 January 1998 respectively. At the date of the receivership they were in the course of finalising the accounts of APC for the period to 31 March 1998 and had already prepared accounts to 31 March 1999 in draft.

[17]     
The pursuers aver that they made the overdraft facilities and the term loan available to APC and to APC Civils and injected the equity funds into APC in reliance upon the audited accounts and audit reports prepared by the defenders.

[18]     
The pursuers aver that it was the defenders' duty to the pursuers to take reasonable care in acting as the auditors of APC and that it was their duty to exercise the reasonable skill and care that would be exercised by any auditor of ordinary competence. It was also the defenders' duty in auditing the accounts of APC to have regard to any liabilities of APC Civils that might have a material impact on the accounts of APC itself and to satisfy themselves, either from audited accounts of APC Civils or from other adequate evidence, as to the existence and extent of any such material liabilities. In all these circumstances it was reasonable for the pursuers to rely on the defenders to exercise reasonable skill and care in auditing APC's accounts. Separatim, in all the circumstances the defenders in any event assumed responsibility towards the pursuers for exercising reasonable skill and care in auditing APC's accounts.

[19]     
The pursuers specify numerous reasons why the defenders failed to exercise reasonable skill and care in the auditing of the accounts. These relate to the interpretation of, and the conclusions to be drawn from, the vouchers; the implications of the change by APC in its accounting system in January 1997, and the conclusions to be drawn from various areas of deficiency in the draft accounts to 31 March 1998 (Cond 7).

(2) Disclaimer

[20]     
The parties agree that the defenders did not add to the audited or the draft accounts any disclaimer of liability on their part to the pursuers.

(3) Losses from lending to APC Civils

[21]     
The losses on which the pursuers found include the losses sustained in their lending to APC Civils. They aver that APC Civils was a wholly-owned subsidiary of APC and shared the same management (Cond 5). Their lending to APC Civils relied upon their assessment of the financial position of APC and the trustworthiness of its management. That assessment included, in particular, reliance on the accounts of APC. The accounts of APC reflected the liabilities of APC Civils. In these circumstances it was reasonable for the pursuers to rely on the accounts of APC in deciding whether to maintain, increase or withdraw lending to APC Civils.

[22]     
Although the defenders did not complete audited accounts for APC Civils, the pursuers seek reparation for losses sustained in their lending to APC Civils on the basis that they relied heavily on the audited accounts of APC in all their decisions to support APC and APC Civils, and in particular on the fact that the audited accounts disclosed that APC was trading profitably (Cond. 9). The pursuers also refer to there having been reciprocal cross-guarantees between the two companies in relation to their indebtedness to the pursuers (Cond 9). These guarantees are incorporated in certain of the facility letters to which counsel have referred.

(4) Vicarious liability of the defenders for the alleged fraudulence of McMahon

[23]     
The pursuers aver that McMahon and certain executives of APC engaged in a fraudulent scheme by which McMahon made journal entries in APC's books which capitalised, as additions to plant, certain direct costs and expenditure allegedly incurred on spares and repairs and associated labour, mostly in relation to steel buckets. They aver that in March 1996 McMahon, together with Elizabeth Clow, the Chief Executive of APC, and two other executives, David Jarvie and Scott Brown, went to the Hilton Hotel in Glasgow. McMahon had obtained blank invoices from Dalton Demolition UK Limited (Dalton), a company of scrap merchants for whom he had previously carried out work. At the Hilton Hotel he used a colour photocopier to make copies of the invoices. With Elizabeth Clow and David Jarvie, he filled in the invoices to refer to the purchase by APC from Dalton of steel to be used for the production of buckets. They also destroyed existing petty cash receipts and replaced them with new ones referring to the Dalton invoices.

[24]     
The pursuers aver that the sums vouched by these invoices were then capitalised as balance sheet items. The result was that the level of APC's petty cash spending was concealed, and some of that spending was removed from the profit and loss account and transferred to the balance sheet in the form of alleged purchases or production of buckets, spares and repairs. The total of £527,457 resulting from these journal entries and manipulations of the invoices and petty cash receipts was then treated as a single year-end capitalisation. These averments imply that in this way revenue expenditure properly charged to profit and loss account was reduced, while the balance sheet value of the assets was correspondingly increased by the inclusion of non-existent assets described in the invoices. The pursuers aver that this was done shortly before the defenders finalised their audit of APC's accounts to 30 November 1995 and that it was done in order to conceal the level of APC's petty cash spending and its overall lack of profitability and thereby to induce the pursuers to continue and to extend their financial support for APC.

[25]     
The pursuers aver that the defenders are responsible for the acts of McMahon within the scope of his authority as an employee of theirs and in particular for his actings as financial controller of APC during the period of his secondment; and that the fraudulent acts alleged against McMahon were carried out by him in the course and within the scope of his employment by the defenders (Cond 8).

IV The Lord Ordinary's conclusions

(1) Duty of care

[26]     
The parties agree that the existence of the duty of care imputed to the defenders is to be determined in a case of this kind on the threefold test set out in Caparo Industries plc v Dickman ([1990] 2 AC 605), namely whether the loss was foreseeable; whether there existed a relationship of proximity between the parties; and whether it is fair, just and reasonable that the law should impose the duty of care of a given scope on the one party for the benefit of the other.

[27]      The Lord Ordinary considered it to be reasonably clear from Caparo Industries plc v Dickman (supra) that for a relationship of proximity to exist the adviser must, at the time at which the advice is given, be aware of (1) the identity of the person to whom the advice or information is to be communicated, (2) the purpose for which the person is to be provided with the advice or information, and (3) the likelihood that the person to whom the advice or information is communicated will rely on it for the known purpose (para [45]).

[28]     
Before the Lord Ordinary counsel for the defenders submitted that a relationship of proximity between the defenders and the pursuers could be held to exist only if there were averments that the defenders intended that the pursuer should rely on the audited accounts for the purpose of making their lending and investment decisions, or averments from which that could be inferred. The element of intention was an additional requirement (para [46]) that was not pled by the pursuers.

[29]     
After a survey of the authorities, the Lord Ordinary concluded that this submission was not well-founded. He considered that there was no compelling authority to the effect that such an intention was essential. On the contrary, there was a consistent line of authority that the relationship of proximity could be found in the defenders' providing the information in the knowledge that it would be passed to the pursuers for a specific purpose and was likely to be relied on by the pursuers for that purpose.

[30]     
The Lord Ordinary referred to the pursuers' averments about the degree to which the defenders were involved in the financial affairs of APC beyond their formal role as auditors and their awareness of the pursuers' role as APC's principal bankers and as the source of their working capital. He considered that these averments were relevant in a general way to the question of proximity, but that the critical averments were those relating to the defenders' knowledge of the use to which the pursuers could be expected to put the accounts. In his view, the pursuers' averments relevantly supported the inference that the defenders were aware of the terms of the facility letters and of the pursuers' entitlement to see management accounts and annual audited accounts. That in turn, in his view, relevantly supported the inference that the defenders were aware that the purpose for which the audited accounts would be communicated to the pursuers was that directly, or indirectly as a check on the reliability of the management accounts, they would be likely to be relied on in the making of decisions as to whether, and if so at what level, the pursuers would continue to lend to APC. Those averments, in his opinion, relevantly supported the existence of a relationship of proximity giving rise to a duty owed by the defenders to the pursuers to take reasonable care to save them from suffering loss through their reliance on the accounts when they were making lending decisions (para [55]).

[31]     
The Lord Ordinary considered that the position might be rather different in relation to that part of the case that was founded on reliance on the draft accounts to 31 March 1998; but since it was averred that the defenders, when providing the draft accounts to APC, were aware that the pursuers were seeking reassurance that the audited accounts to 31 March 1998 would not differ materially from the management accounts provided in April 1998, the question whether the defenders knew that the draft accounts would be passed to the pursuers and relied on by them for the purpose of lending decisions was a matter that ought, in his view, to be determined after proof before answer (para [56]).

[32]     
On the separate question whether the defenders owed a similar duty to the pursuers in relation to the pursuers' option to take shares in APC, the Lord Ordinary considered that it would be difficult to make a decision on the relevancy of those averments at that stage. It might be argued that lending and injecting equity capital were simply two ways in which the pursuers were supporting APC and that it would be unrealistic to distinguish the pursuers' use of the accounts for one of those purposes from their use of them for the other. He considered that the decision on that point was best reserved until after proof before answer (para [57]).

(2) Disclaimer

[33]     
The Lord Ordinary rejected the defenders' submission that a disclaimer could be relevant only if it had already been determined that there was a duty of care. He considered that there was clear authority for the role which the absence of a disclaimer might play in determining whether there had been an assumption of responsibility such as to create the necessary relationship of proximity. Since the defenders had not disclaimed responsibility to the pursuers in respect of the relevant accounts, the existence of a duty of care did not depend on there being averments of a positive intention on the defenders' part that the pursuers should rely on the accounts. It depended on whether the pursuers had made adequate averments that the defenders knew that the accounts were to be passed to the pursuers for use by them as guidance in the making of decisions about the level of financial support that they would provide to APC (para [54]).

(3) Losses sustained through lending to APC Civils

[34]     
Counsel for the defenders submitted that the pursuers could not claim damages for losses sustained through lending to APC Civils because they did not aver that the defenders had prepared accounts for APC Civils or had misstated the financial position of APC Civils. APC Civils was a separate corporate entity with which the pursuers had separate lending agreements. A loss sustained through lending to APC Civils could not fall within the scope of any duty that the defenders might owe to the pursuers in relation to the accounts of APC.

[35]     
The Lord Ordinary concluded that the pursuers had averred sufficient to enable them to argue that it was reasonably foreseeable by the defenders that the pursuers would rely on the audited accounts of APC in making lending decisions in relation to APC Civils and that, if they were negligent in their auditing of the accounts of APC, the pursuers were likely to suffer loss on their lending to APC Civils. He regarded it as questionable whether the pursuers could, on their averments, show that reliance on the audited accounts of APC for the purpose of making decisions with regard to the level of their lending to APC Civils, was included in the purpose for which, to the defenders' knowledge, the audited accounts of APC were made available to the pursuers. He considered that in the absence of averments that the defenders knew that the pursuers required, and were being provided with, the audited accounts of APC at least in part for the purpose of enabling them to make decisions on the level of their lending to APC Civils, it might be argued that reliance on the APC accounts for that purpose was outwith the scope of the defenders' duty of care. He considered, however, that it would be inappropriate to make a decision on that issue at that stage. There was undoubtedly a close relationship between APC and APC Civils of which the defenders must have been aware. The existence of the cross-guarantees created a situation in which, in a question with the pursuers, it might be said that it was artificial to distinguish between lending to one and lending to the other. The question whether any loss suffered by the pursuers in lending to APC Civils in reliance of the audited accounts of APC fell within the scope of the defenders' duty of care was therefore a matter that ought to be reserved for decision after evidence had been heard (para [62]).

(4) Vicarious liability

[36]     
On the question of vicarious liability, the defenders' position was and remains that, from the pleadings, the court should conclude that at the material time McMahon was an employee pro hac vice of APC; and that in any event the pursuers had failed to plead a relevant case that his fraud, if committed, was committed in the course and within the scope of his employment with the defenders.

[37]     
The Lord Ordinary held that the defenders' argument that McMahon was employed pro hac vice by APC could succeed only if, taking the pursuers' averments pro veritate, the court could hold that to be the only tenable conclusion. He concluded that, in the absence of averments to the effect that the description of McMahon as "financial controller" of APC was a mere empty title, or an inappropriately grandiose description of his job, that job title must be taken at face value. It implied a position of responsibility for the financial affairs of the company that was subordinate only to the Board. The pursuers' averments were consistent with that view and were difficult to reconcile with the retention of direction and control of his activities by the defenders. The directors could scarcely delegate control of the company's financial affairs to one who was not subject to their direction and control of the tasks that he undertook on the company's behalf and of the manner in which he performed them. McMahon's responsibility for the preparation of the company's annual figures for audit by the defenders also seemed to be inconsistent with McMahon's remaining subject to the direction and control of the defenders. He considered it to be implicit in the pursuers' averments that while the defenders made McMahon's services available to APC at a price, it was APC who entrusted him with the duties of financial controller and to whom he was answerable for what he did in that capacity. He considered that this inference was supported by the fact that the alleged fraud pointed to McMahon's being under the direction and control of the Board of APC.

[38]     
Overall, the picture of the financial controller and the chief executive of APC conspiring together to present a false picture of its financial standing was more consistent with the view that McMahon was under the direction and control of the company rather than of the defenders. That was the natural inference from the pursuers' averments. Their pleadings on the point were irrelevant (at para [75]).

[39]     
The question whether McMahon's alleged fraud was committed in the course and within the scope of his employment with the defenders therefore did not arise. If it had arisen, the Lord Ordinary would have concluded that what McMahon did was not sufficiently closely connected with what he was employed to do for it to be fair and just to hold the defenders liable. On the contrary, on these averments McMahon was acting in concert with the chief executive and other employees of APC in carrying through a fraudulent scheme conceived for the benefit of APC; the scheme was only incidentally facilitated by his participation, being in essence a fraudulent manipulation of the accounts carried out within the management of the company, and its connection with the work that he was employed by the defenders to do was remote rather than close. If therefore he was in the employment of the defenders, it would be unfair and unjust to hold them vicariously liable for the loss allegedly suffered as a result (para [77]).

V Conclusions

  1. The reclaiming motion

Duty of care

[40]     
To succeed in having this action dismissed on relevancy, so far as it is based on the duty of care, the defenders must satisfy the court that, even if the pursuers were to prove their record on all material points, the action would nonetheless be bound to fail.

[41]     
The defenders' basic contention throughout has been that since the pursuers have sued the defenders in their capacity as statutory auditors, the general principle applies on which auditors are not, by the mere fact of their having certain obligations under Part VII of the Companies Act 1985, liable to third parties for claims of this kind (Caparo Industries plc v Dickman ([1992] 2 AC 605); and that for liability to arise it is essential that the defenders should have taken it upon themselves to act for or advise the pursuers in respect of the specific matter out of which the loss arose. This could be looked at in two ways. It could be said that the purpose of the defenders' actings must be to induce, advise or benefit the pursuers in relation to the particular transactions that resulted in the loss; or it could be said that the pursuers must be entitled to proceed on the basis that the defenders had assumed responsibility towards them for their financial affairs in relation to the matter concerned. The pursuers have failed to aver facts and circumstances from which it could be inferred that the defenders prepared the accounts with the purpose or with the intention that they should be relied on by the pursuers. The same element of intention was necessary if the court took the "assumption of responsibility" approach (cf Henderson v Merrett Syndicates Ltd, [1995] 2 AC 145).

[42]      It is not disputed that if the defenders merely acted as auditors under Part VII, they would not on that account owe a duty of care to prospective lenders or investors in the preparation of the accounts (Caparo Industries plc v Dickman, supra). While it is true that the pursuers refer to the duties of the defenders qua auditors, a fair reading of the pursuers' averments shows that they allege that the facts and circumstances took the defenders beyond the confines of that role in such a way as to incur liability towards the pursuers.

[43]     
As a result of Caparo Industries plc v Dickman (supra) it is settled that auditors may incur liability to certain third party claimants for negligence in the preparation of accounts (i) where the loss for which the claim is made was foreseeable by the auditors when they were preparing the accounts; (ii) where there exists between the auditors and the claimant a sufficient relationship of proximity, and (iii) where it would be fair, just and reasonable in the circumstances that liability should be imposed.

[44]     
Foreseeability is not in issue in this case. The two critical issues are proximity and the fair, just and reasonable test. Both of these issues, in my view, are in this case sensitive to the facts and circumstances (cf Electra v KPMG Peat Marwick, [1999] Lloyd's LR 670, Auld LJ at p 684; cp Wickstead v Browne, (1992) 30 NSWLR 1). I fail to see how this court could find against the pursuers on either question on the pleadings.

[45]     
According to Caparo Industries plc v Dickman (supra), the relationship of proximity is established where the defender knows (1) the identity of the person to whom his advice or information is to be communicated; (2) the purpose for which that person is to be provided with the advice or information, and (3) the fact that that person is likely to rely upon the advice or information for the known purpose (Caparo Industries plc v Dickman, supra, Lord Bridge of Harwich at pp 620H-621B; Lord Oliver of Aylmerton at p 638C-D; cf Lord Ordinary at paras [45]-[46]).

[46]     
On this principle, auditors may incur liability to third parties such as shareholders, creditors and prospective investors if they undertake work that exceeds the specific functions of auditors under Part VII; for example, by assisting in a due diligence operation being carried out on behalf of a prospective investor (Electra v KPMG Peat Marwick, supra, Clarke LJ at p 700), by making express representations to a prospective bidder as to the financial state of the company (ADT Ltd v BDO Binder Hamlyn, [1996] BCC 808), by preparing accounts for submission to a prospective investor (Caparo Industries plc v Dickman, supra, Lord Oliver of Aylmerton at p 650; Galoo Ltd v Bright Grahame Murray, [1994] 1 WLR 1360, Glidewell LJ at p 1381; Haig v Bamford, Hagan, Wicken and Gibson, [1976] 3 WWR 331, refd to in Scott Group Ltd v McFarlane, [1978] 1 NZLR 553) or by making representations for inclusion in bid defence documents (Morgan Crucible Co PLC v Hill Samuel & Co Ltd, [1991] Ch 295). Whether auditors have exceeded their statutory functions in any of these or similar ways is, in my view, pre-eminently a question of fact.

[47]      Before the Lord Ordinary, counsel for the defenders submitted unsuccessfully that the three aspects of knowledge on the part of the defenders described in Caparo Industries plc v Dickman (supra, Lord Oliver of Aylmerton at p 638C-D) did not constitute a sufficient basis for a relationship of proximity between them and the pursuers. There had to be an extra ingredient, namely that the defenders "intended" that the pursuers should rely on the audited accounts for the known purpose (cf Lord Ordinary, at para [64]).

[48]     
The Lord Ordinary examined those cases in which intention was referred to in the formulation of the requirements of the duty of care (eg Galoo Ltd v Bright Grahame Murray, [1994] 1 WLR 1360, Glidewell LJ at pp 1381E-1382C; 1385H; Evans LJ at p 1388E; Esanda Finance Corporation Ltd v Peat Marwick Hungerfords, [2000] Lloyd's LR 684; Caparo Industries plc v Dickman, supra). Having examined the statements on the point in their context, he concluded that while an intention on the part of a provider of information or advice that the recipient of it should act upon it supported the existence of the necessary relationship of proximity, such an intention was not a sine qua non. He found support for that view in the decision of Millett J, as he then was, in Al Saudi Banque v Clark Pixley ([1990] 1 Ch 313, at p 332B-D), a decision that was referred to with approval by the House of Lords in Caparo Industries plc v Dickman (supra), and in the decision of Sir Brian Neill in BCCI (Overseas) Ltd v Price Waterhouse (No 2) ([1998] BCC 617, at p 635F).

[49]      I agree with the view of the Lord Ordinary. I accept that in a case of this kind the mere knowledge of an auditor that the company will probably supply the audited accounts to a third party creditor is not enough in itself to impose a duty of care; but, with one possible exception which I shall discuss, namely R Lowe Lippman Figdor & Franck v AGC (Advances) Ltd ([1992] 2 VR 671), none of the case law to which we have been referred suggests that, for the relationship of proximity to exist, the provider of information or advice must have a positive intention that the third party recipient will rely on it, and nothing short of that. On the contrary, with that possible exception, the cases support the view that to create the relationship of proximity, it may be sufficient in some circumstances that the provider of the information or advice knows that it will be passed to the third party recipient for a specific purpose and that the recipient is likely to rely on it for that purpose (eg Hedley Byrne & Co Ltd v Heller and Partners Ltd, [1964] AC 465, Lord Morris of Borth-y-Gest at pp 502-503; Lord Hodson at p 514; Caparo Industries plc v Dickman, supra, Lord Bridge of Harwich at p 621; Lord Jauncey at p 662C-D; ADT Ltd v BDO Binder Hamlyn, supra, May J at pp 828H-829B). I agree with the Lord Ordinary in his interpretation of the cases on this point (paras [47]-[50]).

[50]      No doubt an express intention on the part of the provider of the information or advice that the third party will rely upon it will more strongly support the existence of proximity. In some cases it may be essential; but I cannot see why the desiderative element implicit in that intention should be essential in every case. If it were, it would follow, I think, that where the provider of information or advice expressly intended that it should not be relied on by any third party recipient, he would not incur liability. That is not the law. Such an intention could not prevail against the actual or presumed knowledge of the provider that the information or advice was likely to be relied on by the third party (Caparo Industries v Dickman, supra, Lord Oliver of Aylmerton at pp 638-639; BCCI (Overseas) Ltd v Price Waterhouse (No 2), supra, Sir Brian Neill at p 635).

[51]     
In their submissions on the reclaiming motion counsel for the defenders modified their previous position. They said that they did not challenge the formulation of the proximity test in Caparo Industries plc v Dickman (supra); but they submitted that on a true interpretation of that decision, the key concept in liability was that of the positive "purpose" with which the defenders gave the information or advice, namely the purpose that the recipient should rely on it. On this point, counsel for the defenders relied on the statements of Lord Roskill and Lord Oliver of Aylmerton on the matter of purpose in Caparo (supra, at pp 629 and 638). In my opinion, this submission reads more into Caparo than is there. Purpose is certainly an important consideration; but those statements are, I think, more concerned with the purpose of the recipient than with that of the giver of the information.

[52]     
Counsel for the defenders referred us, in the context of the defenders' purpose, to R Lowe Lippman Figdor & Franck v AGC (Advances) Ltd (supra). In that case the Supreme Court of Victoria stressed the importance of the intention of the maker of the statement to induce the third party to act upon it; but without, I think, suggesting that that intention was an indispensable requirement for liability (cf Brooking J at p 679). In that case the court considered, but did not expressly follow, Caparo Industries plc v Dickman (supra) and Al Saudi Banque v Clark Pixley (supra). R Lowe Lippman Figdor & Frank v AGC (Advances) Ltd is distinguishable on its facts, and has to be seen in the light of the less categorical statements on the point by the High Court of Australia in Esanda Finance Corporation Ltd v Peat Marwick Hungerfords, (supra, Dawson J at p 691; McHugh J at p 701). But if, as counsel for the defenders have suggested, the case does establish that that intention is in all cases essential, it is at variance, in my view, with Caparo Industries plc v Dickman.

[53]     
If I am right in thinking that the element of positive intention, or on the defenders' revised formulation purpose, is not a sine qua non of the existence of a duty of care, I am in no doubt that the pursuers are entitled to enquiry on the averments that they have made.

[54]     
On the pursuers' averments, the defenders were more than statutory auditors of APC. They had a key role in the establishment, and in the survival strategy, of both APC and APC Civils. APC was founded in debt. The defenders were directly involved in APC's obtaining its set-up finance. Thereafter they were directly involved in keeping APC and APC Civils afloat. The survival of both companies depended on the pursuers' continued support, which depended on there being satisfactory management accounts verified in due course by audited accounts. During 1995 the defenders prepared financial projections for APC for the three years ending on 30 November 1997. In September 1995, one of their partners and a representative of APC had a meeting at the defenders' offices with an official of the pursuers to review APC's management accounts for July 1995. The defenders later prepared the review of the August 1995 management accounts. They knew that the prompt provision of annual audited financial statements, monthly management accounts and daily financial reports was a condition of the pursuers' lending to APC under the facility letters, which the pursuers began to issue before the first of the audits.

[55]     
The daily and monthly financial reports and year-end figures submitted to the pursuers in the period from about December 1995 to March 1996 were the responsibility of an employee of the defenders who was on secondment to APC and that during that period the defenders invoiced APC for the provision of accounting services. That would link the defenders even more closely with the survival strategy to which I have referred.

[56]     
These averments must be read along with the pursuers' averments as to the defenders' knowledge of the significance of this information to the pursuers' continued financial support of APC by way of overdrafts and, it is reasonable to infer, by way of equity investment.

[57]     
In Al Saudi Banque v Clark Pixley (supra), it was found that the defendant auditors had neither supplied the plaintiff banks with their audit reports nor sent them to the company with the intention or in the knowledge that the company would supply them to the plaintiffs. For that reason there was held to have been no relationship between the defendants and the banks. In this case, it is possible that the pursuers could establish after proof that such a relationship existed between the parties as a result of the defenders' direct involvement in the affairs of APC and their professional support of it. On these averments, therefore, it is possible that the pursuers could establish the necessary proximity.

[58]     
In any event, even on the defenders' own approach to the case, I would not rule out the possibility that after enquiry the pursuers could prove that the defenders had the purpose to which I have referred.

[59]     
Moreover, I can see no reason why, on this aspect of liability, we should exclude from enquiry the pursuers' case so far as it is based on accounts that were in draft. Whether the fact of their being in draft makes any material difference in this case is a matter to be decided after the facts have been fully ascertained (cf Galoo Ltd v Bright Grahame Murray, supra, Evans LJ at pp 1387H-1388B; Electra v KPMG Peat Marwick, supra, Auld LJ at p 696).

[60]     
Furthermore, it may be significant to the fair, just and reasonable test that the duty of care imputed to the defenders is alleged to have been owed to a single and identified third party in respect of an exposure of a known and defined amount (cf Caparo Industries plc v Dickman, supra, Lord Oliver of Aylmerton at pp 632-633; 635-636; Al Saudi Banque v Clark Pixley, supra, Millett J at pp 330; 337-338).

[61]     
I conclude therefore that we would be wrong to decide on the pleadings that the pursuers' case is bound to fail. In my view, the pursuers are entitled to proof before answer. Since your Lordship and your Ladyship are of the same view, I think that it is neither necessary nor desirable that we should discuss the extensive case law on the matter in any greater detail, nor that we should draw hard and fast conclusions on the application of it to this case. That is more appropriately done when the facts have been fully ascertained (Miller v SSEB, 1958 SC (HL) 20, Viscount Simonds at pp 31-32; Lord Keith of Avonholm at p 33).

[62]     
The Lord Ordinary considered the question of duty of care without reference to the averments relating to McMahon because he had decided that the case based on the defenders' vicarious liability for McMahon's alleged fraudulence was irrelevant. For reasons that I will give, I disagree with the Lord Ordinary on this point. If I am right, it may be that if the pursuers prove that McMahon committed the fraud alleged and did so as an employee of the defenders and in the course of his employment with them, that could have some bearing on the question of the duty of care.

Failure to disclaim

[63]     
Before the Lord Ordinary counsel for the defenders submitted that the absence of any disclaimer on the part of the defenders of liability to the pursuers could not be taken to indicate that the defenders had assumed responsibility to them in relation to the accounts. The existence of a disclaimer implied the antecedent existence of a duty. Accordingly, the absence of a disclaimer could not be relevant to the question whether a duty of care existed. The Lord Ordinary rejected that submission for reasons to which I have referred (para [53]). I agree with his reasons. While a disclaimer may validly elide a liability for breach of a duty of care that is found or agreed to exist, the absence of a disclaimer may, in my view, be a relevant circumstance pointing to an assumption of responsibility in respect of the information or advice tendered. That, I think, is consistent with the statement of Lord Reid in Hedley Byrne & Co Ltd v Heller & Partners Ltd ([1964] AC 465, at p 486) which the Lord Ordinary quotes (para [53]).

[64]      Counsel for the defenders referred us to section 310 of the 1985 Act, which provides, in effect, that a disclaimer made by an auditor is void. The Lord Ordinary was not referred to this section. In my view, it is irrelevant to this case. It applies to claims against the auditors by the company (Burgoine v Waltham Forest LBC, [1997] BCC 347). There is nothing in that provision to prevent an auditor from disclaiming liability to third parties, and I see no reason why a disclaimer that would be void in a question with the company should not be valid in a question with a third party, nor why a failure to disclaim against a third party should not in appropriate circumstances be a factor pointing to an assumption of responsibility or to the creation of a relationship of proximity.

Losses from lending to APC Civils

[65]     
In my opinion, the Lord Ordinary was right in deciding that the question of liability for the losses sustained by the pursuers in consequence of their lending to APC Civils was a matter for proof before answer. Although the pursuers did not rely on any audited accounts of APC Civils, they have averred that APC Civils was a wholly-owned subsidiary of APC; that the two companies shared the same management; that the audited accounts of APC reflected the liabilities of APC Civils; and that each company guaranteed the overdraft of the other. On their averments they would be entitled, in my opinion, to prove that the defenders knew all of this. It cannot be said that, on any view, the defenders' liability could not extend to such losses.

(2) The cross-appeal

[66]     
In my opinion, the Lord Ordinary erred in dismissing the action so far as it is based on fraud. He went too far in concluding from the pleadings that McMahon's job title as financial controller of APC implied a position of responsibility that was subordinate only to the Board and therefore that McMahon was in the pro hac vice employment of APC. In my opinion, he ought not to have reached such a definite conclusion without enquiry. It may be that an important, though not necessarily conclusive, source of evidence on the question will be the contract that regulated McMahon's secondment from the defenders to APC (cf Mersey Docks & Harbour Board v Coggins & Griffith (Liverpool) Ltd, [1947] AC 1, Lord Simonds at p 20; Lord Uthwatt at p 22). The contract is not referred to in the pleadings and has not been produced. Furthermore, without enquiry one cannot conclude with certainty that McMahon's responsibilities as financial controller of APC were necessarily incompatible with his remaining under the general direction and control of the defenders and within their general employment.

[67]      A heavy burden of proof lies on the general employer who pleads that the employee was transferred to the pro hac vice employment of another (Mersey Docks & Harbour Board v Coggins & Griffith, supra). That question is, in my opinion, sensitive to the facts and circumstances of the case (cf Marshall v William Sharp & Sons Ltd, 1991 SLT 114, LJC Ross at p 121A). There may be cases in which the pleadings are so clear on the point that a definite conclusion can be drawn at the stage of debate; but if there are such cases, this is not one of them. In my opinion, this question can be properly determined only after enquiry.

[68] I am further of the view that the Lord Ordinary erred in holding that even if McMahon remained in the employment of the defenders, the pursuers' pleadings were irrelevant in failing to disclose that his wrongdoing was so closely connected with his employment with the defenders that it was fair and just to hold them vicariously liable for it. In my view, the Lord Ordinary was not entitled to draw such a vital conclusion from the pleadings. If we assume that McMahon remained at all material times in the employment of the defenders, the issue, in my view, is whether he acted outwith the scope of his employment or acted wrongfully within the scope of it. That too is a judgment that is critically dependent on enquiry. On the pursuers' averments it is open to them to prove that McMahon committed the fraud alleged in the course of book-keeping and financial record-keeping and that these functions were exactly the sort of functions that lay within his province as financial controller of APC. If so, it is open to them to show that his actings were not remote from the duties of his employment, as the Lord Ordinary held, but were directly connected with them (cf Lister v Hesley Hall, [2000] 2 WLR 1311). I conclude therefore that the pursuers are entitled to proof before answer on both aspects of the fraud case. Moreover since, for the reasons that I have given, the fraud case may have a bearing on the duty of care issue, the allowance of proof before answer on the former gives added point to the allowance of proof before answer on the latter.

VI Interlocutor

[69]     
I propose that we should refuse the reclaiming motion; allow the cross-appeal; recall the Lord Ordinary's interlocutor, and remit the case to the Outer House for proof before answer on the whole record.

SECOND DIVISION, INNER HOUSE, COURT OF SESSION

Lord Justice Clerk

Lord Osborne

Lady Cosgrove

 

[2005CSIH39]

A2237/00

OPINION OF LORD OSBORNE

in

RECLAIMING MOTION

in the cause

ROYAL BANK OF SCOTLAND plc

Pursuers and Respondents;

against

BANNERMAN JOHNSTONE MACLAY, Chartered Accountants; and A G BANNERMAN, G J JOHNSTONE, D J MACLAY, R B McKERRAL, M G MacBETH and M G McCUSKER, the whole partners thereof as such partners and as individuals

Defenders and Reclaimers:

_______

 

Act: Currie, QC, D E L Johnston; Brodies

Alt: Dean of Faculty (C M Campbell, QC), Paterson; Brechin Tindall Oatts

26 May 2005

[70]     
I have had the opportunity of reading the opinion of your Lordship in the Chair. I am in complete agreement with it and have nothing useful to add.

SECOND DIVISION, INNER HOUSE, COURT OF SESSION

Lord Justice Clerk

Lord Osborne

Lady Cosgrove

 

 

 

 

 

 

 

[2005CSIH39]

A2237/00

OPINION OF LADY COSGROVE

in

RECLAIMING MOTION

in the cause

ROYAL BANK OF SCOTLAND plc

Pursuers and Respondents;

against

BANNERMAN JOHNSTONE MACLAY, Chartered Accountants; and A G BANNERMAN, G J JOHNSTONE, D J MACLAY, R B McKERRAL, M G MacBETH and M G McCUSKER, the whole partners thereof as such partners and as individuals

Defenders and Reclaimers:

_______

 

 

Act: Currie, QC, D E L Johnston; Brodies

Alt: Dean of Faculty (C M Campbell, QC), Paterson; Brechin Tindall Oatts

26 May 2005

[71]     
I have had the opportunity of reading the Opinion of your Lordship in the chair. I find myself in complete agreement with its reasoning and conclusions. In particular, I agree that it would not be safe to decide the issues that arise in this case without hearing evidence. In a case such as this when all the facts are not known, when they and the legal principles turning on them are complex and the law, as here, is in a state of development, it can only be in a rare and exceptional case that the action can be disposed of on relevancy. In my view, this is not such a case. It is not possible to deal with the important and difficult questions of law that arise without a fuller knowledge of all the facts and circumstances. In that situation, the less said at this stage about the arguments for and against relevancy, the better (Wilkie v. Scottish Aviation Limited, 1956 SC 198, Lord Justice Clerk (Thomson) at p. 201; Miller v. South of Scotland Electricity Board, 1958 S.C. (H.L.) 20, Viscount Simonds at p. 31). I agree with your Lordship that it is neither necessary nor desirable that we should draw any firm conclusions on the application of the extensive case law to this case. I also agree that we should refuse the reclaiming motion, allow the cross appeal and pronounce an interlocutor in the terms proposed by your Lordship.


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