Law and Ethics Case Study

Deloitte & Touche v. Livent Inc. (Receiver of)

By: Ayman Tawdy
UOT EMBA

Livent produced and staged performances in theatres that it owned in Canada and

the U.S., with its shares listed on Canadian and U.S. stock exchanges. As the business

grew, its directors started to manipulate the company’s financial records by shifting

expenses between periods, programming their accounting software to conceal the

changes, extending or avoiding amortization to inflate profitability, and overstating

revenues by misclassifying loans as asset sales. Deloitte was Livent’s auditor and never

uncovered the fraud. In August 1997, Deloitte identified irregularities in the reporting of

profit from an asset sale. Deloitte had to decide to either resign or submit to

management pressure and agree to management’s questionable accounting

practice. Deloitte bowed to Livent management and finalized Livent’s 1997 audit in

April 1998 issuing a clean audit opinion in spite of Livent management’s deceiving

practices. Moreover, for the purpose of assisting Livent to solicit investment, Deloitte

helped prepare, and approved, a comfort letter/press release issued in September

1997, which misrepresented the basis for the reporting of the profit. New equity investors

later discovered the fraud and further investigation resulted in restated financial reports.

Livent filed for insolvency protection in November 1998. It sold its assets and went into

receivership in 1999. Livent’s receiver manager sued Deloitte later in tort and contract

for issuing clean audit opinion and comfort letter in spite of questionable practices by

senior management indicating fraud that he said Deloitte should have detected.
The trial judge held that Deloitte owed a duty of care to provide accurate information

to Livent’s shareholders. He held that Deloitte failed to meet the standard of care under

this duty, either when it failed to discover the fraud and act on that discovery in August

1997, or when it signed off on Livent’s 1997 financial statements in April 1998. The trial

judge held that the measure of damages was the difference between Livent’s value on

the date on which Deloitte should have resigned and Livent’s value at the time of

insolvency. He reduced this by 25 percent to account for contingencies or trading

losses, which he held were too remote to make Deloitte liable. The trial judge

consequently awarded damages to Livent for breach of its duty of care, and

alternatively for breach of contract, in the amount of $84,750,000. The Court of Appeal

upheld the trial judge’s award and dismissed Deloitte’s appeal and Livent’s

cross‑appeal.

The case was brought in front of the Supreme Court of Canada (SCC) and the panel

was split four to three on the question of whether the auditor was liable in connection to

the negligent audit, and whether they owed duty of care to the creditors and

shareholders affected by this incident.

The SCC allowed the appeal in part, basing their decision on key precedents such as

Anns/Cooper case with its two-stage test to uncover the existence of a duty of care if

there is one, and Hercules v. Ernst &Young, where the SCC had ruled that no duty of

care was owed by the auditor due to policy considerations (indeterminate liability).

In particular, the Supreme Court of Canada upheld the trial judgment that Deloitte was

liable to Livent and its stakeholders for approximately $40 million in damages suffered as

a result of Deloitte’s clean audit opinion on Livent’s 1997 financial statements. The

Supreme Court agreed that there was a duty owed by Deloitte to Livent shareholders
to assist them in overseeing management when conducting the audit and that

Deloitte’s negligence in doing so deprived those shareholders of the ability to discover

the fraud, stop the bleeding and limit the losses earlier. However, the Supreme Court

overturned the trial finding of liability in relation to the 1997 Comfort Letter issued by

Deloitte to assist Livent in attracting investors. In assessing whether there was a duty of

care owed to Livent in relation to the Comfort Letter, the Supreme Court observed that

“Deloitte never undertook, in preparing the Comfort Letter, to assist Livent’s

shareholders in overseeing management; it cannot therefore be held liable for failing to

take reasonable care to assist such oversight. And, given that Livent had no right to rely

on Deloitte’s representations for a purpose other than for which Deloitte undertook to

act, Livent’s reliance was neither reasonable nor reasonably foreseeable.” As such, the

additional approximately $44 million in damages awarded at trial in relation to the

Comfort Letter were set aside.

There are a number of significant implications of this ruling. Auditors should be extremely

careful and diligent in expressing their audit opinions and particularly whenever there is

any conflict with clients over reasonableness or appropriateness of accounting

practices. Not exercising a reasonable level of professional skepticism and overlooking

questionable management practices and red flags will indicate negligence by the

auditors. Auditors who would fail to carry their responsibilities in line with professional

code of ethics with independence from their clients could be exposed to significant

losses and exposure to damages.

Now the question is whether the court ruling in this case is considered ethical and in the

best interest of the community and doing business in Canada. To assess this we might
consider the Modified Moral Standards Approach (Manuel Velasquez – 1992) and see

whether there was a net benefit to society, the decision was fair to all stakeholders, was

it right, and was it consistent with the virtues expected by stakeholders.

In this regard, the ruling affirmed the liability to the shareholders only and not to all

stakeholders who might potentially rely on negligent auditor opinions where no duty of

care was owed by the auditor due to policy considerations (indeterminate liability).

Accordingly, it is not considered completely ethical as it is not considered fair to all

stakeholders.

From a consequentialist standpoint, the morally right decision is one that leads to the

best overall consequence, a decision that is in the best interest of the majority. This is a

relatively flexible system, since it can be applicable to any set of circumstances

because it focuses on the results of an action. However, there is another way to answer

this question, by adopting a view called “hedonism”, which is intrinsic to a broader one

called “utilitarianism”. According to utilitarians, the only thing that is good in itself is

pleasure; therefore, the goal is to maximize it. So, from this standpoint, determining

whether an action is good, depends solely on maximizing utility as well as the well-being

of humans, even if it means sacrificing one for the greater good.

I believe that in this case, the ruling is considered mostly ethical as it maximizes the utility

of the shareholders and creditors relying on auditor opinions reiterating that the auditor

would be liable to a company when it conducts a poor audit overlooking irregularities.

The only issue with the ruling that I find somewhat unethical is that the ruling held that

auditors would not be liable to secondary market purchasers of company shares who

would rely on negligent auditor reports in their investment decisions.

Finally, the ruling would be considered ethical as it satisfies the Hypernorms of honesty,

integrity, fairness, predictability, and responsibility. The decision stresses on the auditor

honesty and integrity in conducting a professional audit with independence and would

be held liable for expressing an opinion accordingly. The decision is fair to the auditors

and the shareholders of the company and consequences for non-compliance are

reasonably predictable.

The balance of power between management and auditors has been disintegrating

over time as there have been an increasing pressure from management to apply

aggressing or questionable accounting practices. This ruling supports the position of the

auditors and restores this balance of power highlighting the ethical, legal, and

professional liability of auditors.

Nonetheless, there exists a dispute in this discussion about whether the rightness or

wrongness of an action should be based on the real consequences of it or the

reasonably foreseeable consequences. This debate was in the heart of the supreme

court decision. The Supreme Court of Canada decision is considered ethical and sets

the legal framework for determining the existence of an audit liability and a reasonably

foreseeable duty of care to shareholders in cases of economic losses due to negligent

auditing.

References
 Livent Inc. v. Deloitte & Touche, 2016 ONCA 11 (CanLII). Retrieved from
https://www.canlii.org/en/on/onca/doc/2016/2016onca11/2016onca11.html?au
tocompleteStr=livent%2520v%2520del&autocompletePos=1

 Judgments of the Supreme Court of Canada. Deloitte & Touche v. Livent Inc.
(Receiver of). Retrieved from https://scc-csc.lexum.com/scc-csc/scc-
csc/en/item/16920/index.do

 The Litigator – Compelling Commentary on Law Affecting Business. Retrieved

from https://www.thelitigator.ca

 Canadian Accountant - Deloitte Liable for Livent Audit. Retrieved from

http://www.canadian-accountant.com/content/business/deloitte-liable-for-
livent-audit

 IPOLITICS – Deloitte Financially Liable for Negligent Livent Audit, top Court Finds.
Retrieved from https://ipolitics.ca/2017/12/20/deloitte-financially-liable-
negligent-livent-audit-top-court-finds/

 Internet Encyclopedia of Philosophy – Act and Rule Utilitarianism