The Ontario Court of Appeal granted an appeal and dismissed a class action against an auditor. In doing so, the Court applied the updated test recently established by the Supreme Court to determine whether a duty of care arises between a negligent party and the party claiming damages.
The Court also determined that a claim based on negligent words or reports must be determined in accordance with the test for “negligent misrepresentation”. Previous courts had ruled that “negligent misrepresentation” and “negligent misstatement” (also sometimes called “negligent simpliciter”) were two separate torts with different tests. Having two separate test allowed some plaintiffs to succeed under the broader “negligent misstatement” test where they would fail under the test for the “negligent misrepresentation”
Facts of Lavender
Buckingham Securities (“Buckingham”), now defunct, was securities dealer. In 2001, the Ontario Securities Commission suspended Buckingham’s registration and Buckingham was placed into receivership because it breached regulatory requirements by failing to segregate investor assets and maintain a minimum level of free capital. Buckingham’s investment clients lost millions.
Barry Lavender commenced a class action in 2005 against Buckingham on behalf of all investment account holders against Miller Berstein LLP (“MB”). MB was Buckingham’s auditor between 1998 and 2001. The central allegation was that MB negligently audited annual registration renewal documents filed with the OSC. Those forms confirmed compliance with the regulations that the OSC later determined had been breached by Buckingham. The investors, however, would never have seen the MB reports.
The class brought a summary judgment motion on five common issues before Belobaba J., who granted judgment on the common issues, save for damages, which were to be left for individual damages trials. MB appealed. The Court of Appeal set aside the summary judgment decision and instead dismissed the action against MB.
The Lower Court Decision
The five common issues addressed at the motion (and their disposition) were as follows:
(a) Was Buckingham required to segregate the cash and securities of the class member investors from its own cash and securities? (Yes, but not in dispute)
(b) Did Buckingham fail to do so? (Yes, but not in dispute)
(c) Did the defendant owe a duty of care to class members when it audited and filed the Form 9s? (In dispute, and the lower court ruled in favour of the class)
(d) Did the defendant breach this duty of care? (In dispute, and the lower court ruled in favour of the class)
(e) Was this breach of duty a cause of damages to the class members? If so, can such damages be determined on a class-wide basis? How should the damages be calculated? (This was determined to be an issue individual to each class member and could not be decided in the motion)
The motions judge, Belobaba J., determined that the case was not a negligent misrepresentation case, despite the fact that the negligence allegedly arose from MB’s audit reports which represented to the OSC that MB was in compliance with the applicable regulations.
This is not a negligent misrepresentation case. The plaintiff is not saying that the class members relied on or even saw the Form 9s – they did not. The plaintiff’s claim is in negligence simpliciter – that the defendant owed and breached a duty of care causing foreseeable losses for which it should now be found liable. (Lavender, 2017 ONSC 3958 [“Lavender ONSC”] at para 12)
Belobaba J. reviewed a number of cases, including Yorkshire Trust Co v. Empire Acceptance Corp.,1985 CanLII 334 (BC SC) and Lipson v. Cassels Brock, 2013 ONCA 165 (CanLII). These cases held that it was possible to pursue a negligence simpliciter claim for negligence misstatements and that such negligence simpliciter claims followed a different test than the standard test for negligent misrepresentation set out in Queen v. Cognos Inc.,  1 SCR 87. In a negligence simpliciter case reliance is not a necessary element as long as the plaintiffs shows that the misrepresentation was required to create the opportunity that led to the plaintiff’s loss.
The claim in simple negligence is distinct from [the plaintiff’s] claim in negligent misrepresentation, which required proof of reliance on the opinion by individual class members in deciding to participate in the program. Framed in this way, the cause of action in simple negligence does not require a showing of reliance on the Cassels Brock opinion by individual class members. The allegation is that class members suffered damage because they participated in the program, which, but for Cassels Brock’s negligent opinion, would not have been marketed by the promoters and thus not available to class members. (Lavender, ONSC at para 14 citing Lipson at para 96 to 98)
Although the SCC had determined in Queen v. Cognos that reasonable reliance was a necessary element of a negligent misrepresentation claim, some courts had conceptualized reasonable reliance as essentially an element of proving causation. For instance, in Collette v. Great Pacific Management Co., 2004 BCCA 110 (CanLII) at para 34:
The reason for insistence on reliance is to establish causation. If causation can be established otherwise, then reliance is not required.
The logic that the issue of reliance is merely a matter of causation was explicitly accepted in Metzler Investment GMBH v. Gildan Activewear Inc., 2009 CanLII 74223 (ON SC). Although neither Collette nor Metzler are cited by Belobaba J.,. his reasoning is similar:
Here as well, the plaintiff’s negligence claim is based on the allegation that class members sustained losses which, but for the defendant’s false audit of the Form 9s, would not have been sustained. If the defendant had filed accurate Form 9s documenting the regulatory breaches (or had not filed at all) the OSC, on the evidence, would in all likelihood have intervened before all the assets and monies were lost. In short, I am satisfied that on these facts and in principle that the negligence claim is appropriate. (Lavender, ONSC at para 15)
Since the claim in question was a claim for pure economic loss, Belobaba J. determined it was necessary to apply the Anns/Cooper test to determine whether a duty of care arose in the circumstances:
The more pressing issue is whether on the facts herein the plaintiff can establish a duty of care. This is a case about an auditor’s misstatement that was filed with the OSC, was never seen by the class members, and arguably caused pure economic loss to the auditor’s client’s clients. This is obviously not a conventional negligence case. Nor is it sufficient for the plaintiff to say that the case fits within the “negligence performance of a service” category in which courts have recognized duties of care in certain third-party-benefit situations. The underlying facts in the cases that have been grouped by academic commentators under the “negligent performance of a service” category are varied and the applicable law has not yet been uniformly articulated or accepted.
In any event, as the Supreme Court noted in Martel, the categories of recovery in tort for pure economic loss, such as the ‘negligence performance of a service’ category, are “merely analytical tools” that may provide structure to the varied factual situations that can arise. If the case (such as the case here) does not fall within a relationship that has been previously recognized as giving rise to a duty of care, the two-stage Anns-Cooper analysis must be undertaken.
The first stage of the Anns-Cooper analysis asks whether the facts disclose a sufficient level of foreseeability and proximity to establish a prima facie duty of care. The second stage of the analysis asks whether there are residual policy considerations that would justify denying liability in tort even though a prima facie duty of care has been established. The onus at the first stage is on the plaintiff; at the second stage, on the defendant. (Lavender ONSC at paras 16-18)
In the lower court’s application of the test, the Anns/Cooper test was reduced to a determination of whether there was a relationship of sufficient closeness such that, as a matter of “simple justice”, the auditors ought to have been mindful of the class’ interests:
The first stage of the analysis, reasonable foreseeability and proximity (or neighborhood), requires the court to “evaluate the closeness of the relationship between the plaintiff and the defendant and to determine whether it is just and fair having regard to that relationship to impose a duty of care in law upon the defendant.” As the Supreme Court noted in Hercules Management, the question of proximity, in essence, is “whether, as a matter of simple justice, the defendant may be said to have had an obligation to be mindful of the plaintiff’s interests in going about his or her business.”
Here on the evidence, I find that the foreseeability and proximity requirements are satisfied. Even though the class members never saw or even knew, at the time, about the Form 9s, the defendant auditor as a matter of simple justice had an obligation to be mindful of the plaintiff’s interests when auditing and filing the Form 9 reports with the OSC.
The Supreme Court explained the relationship between foreseeability and proximity in Imperial Tobacco:
Proximity and foreseeability are two aspects of one inquiry – the inquiry into whether the facts disclose a relationship that gives rise to a prima facie duty of care at common law. Foreseeability is the touchstone of negligence law. However, not every foreseeable outcome will attract a commensurate duty of care. Foreseeability must be grounded in a relationship of sufficient closeness, or proximity, to make it just and reasonable to impose an obligation on one party to take reasonable care not to injure the other. (Lavender ONSC at paras 19-22)
The Ontario Court of Appeal’s decision
The Ontario Court of Appeal ultimately granted an appeal from the lower court decision and largely rejected the statements of law promulgated by Belobaba J. The central authority upon which the ONCA’s decision rested was a recent Supreme Court of Canada decision, also an auditor liability case: Deloitte & Touche v. Livent Inc.  2 SCR 855 (“Livent ”). The ONCA confirmed that Livent represents a significant change to the Anns/Cooper test in general (and to the determination of negligent misrepresentation claims in particular).
Below is a brief summary of Livent as described by the Ontario Court Appeal:
In the Supreme Court’s recent decision in Livent, the court applied and refined the Anns/Cooper framework to define the duty of care owed by an auditor…
In order to understand the application of Livent to this appeal, it is helpful to briefly restate the facts of that case. The Livent appeal arose out of the receivership of a theatre company, Livent Inc. (“Livent”), whose principals were fraudulently manipulating the company’s financial records in order to attract investment. Its auditor, Deloitte & Touche (“Deloitte”), never uncovered the fraud, but did identify irregularities in the reporting of an asset sale in 1997. Nevertheless, Deloitte did not resign and instead assisted Livent in soliciting investment by providing a comfort letter and helping to prepare and approve a press release that misrepresented the basis for the reporting of Livent’s profit from the fraudulent sale. It also prepared Livent’s 1997 audit, finalized in 1998 after Deloitte’s discovery of the reporting irregularities. When the fraud was subsequently uncovered by new equity investors, Livent filed for insolvency protection and was placed into receivership.
Livent, through its receiver, sued Deloitte for damages in negligence and breach of contract. The trial judge concluded that Deloitte owed Livent a duty of care and fell below the standard of care on two occasions: (i) its provision of the comfort letter and approval of the press release containing misrepresentations in order to help Livent solicit further investment; and (ii) its completion of Livent’s 1997 statutory audit.
This court dismissed the appeal. Deloitte appealed to the Supreme Court. The principal issue before the Supreme Court was the nature and scope of the duty of care owed by Deloitte with respect to those two separate negligent acts. The appeal was allowed, in part. (Lavender v. Miller Bernstein LLP, 2018 ONCA 729 [“Lavender ONCA”] at paras 24-27)
The key update to the Anns/Cooper test is the affirmation that “foreseeability” and “proximity” are distinct and both elements must satisfied to establish a prima facie duty of care.
Most relevant for this appeal, the majority of the Supreme Court in Livent, at para. 20, reaffirmed that there is a prima facie duty of care where there exists a “sufficiently close relationship between the plaintiff and the defendant”. This stage of the analysis involves establishing both reasonable foreseeability and proximity. The majority stressed that these elements are conceptually distinct and must be considered separately.
The majority in Livent reiterated the statement from Cooper that “foreseeability alone” is not enough to establish a prima facie duty of care; the first stage of the Anns/Cooper framework requires “something more”. That “something more” is proximity. The majority observed, at para. 24, that it is useful to consider proximity before foreseeability in cases of negligent misrepresentation or negligent performance of a service because “what the defendant reasonably foresees as flowing from his or her negligence depends upon the characteristics of his or her relationship with the plaintiff, and specifically, in such cases, the purpose of the defendant’s undertaking.”.
The proximity analysis determines whether the parties are sufficiently “close and direct” that it would be “just and fair having regard to their relationship to impose a duty of care”: Livent, at para. 25, citing Cooper, at paras. 32 and 34. As most recently reaffirmed by the Supreme Court in Rankin (Rankin’s Garage & Sales) v. J.J., 2018 SCC 19 (CanLII), at para. 23, that close and direct relationship must be such that “the defendant is under an obligation to be mindful of the plaintiff’s interests.” (Lavender ONCA at paras 30-32)
In cases involving pure economic losses from negligent misrepresentations or negligent performance of a service, when determining whether there is a relation of proximity, the scope of the defendant’s undertaking of responsibility and the plaintiff’s reliance in a manner within the scope of the undertaking are the key factors.
In cases of pure economic loss arising from negligent misrepresentation or performance of a service, two factors are “determinative” of the proximity analysis: (i) the defendant’s undertaking; and (ii) the plaintiff’s reliance: Livent, at para. 30. Where the defendant undertakes to provide a representation or service in circumstances that invite the plaintiff’s reasonable reliance, the defendant becomes obligated to take reasonable care, and the plaintiff has a right to rely on the defendant’s undertaking to do so. These “corollary rights and obligations create a relationship of proximity”: Livent, at para. 30.
However, the plaintiff’s reliance must be within the scope of the defendant’s undertaking – that is, the purpose for which the representation was made or the service was undertaken. Anything outside that scope will fall outside the scope of the proximate relationship and the defendant’s duty of care; the defendant cannot be liable for a risk of injury against which it did not undertake to protect: Livent, at para. 31. Further, as the majority in Livent observed, at para. 31, “the proximity analysis not only determines the existence of a relationship of proximity, but also delineates the scope of the rights and duties which flow from that relationship” (emphasis in original). (Lavender ONCA at paras 35-36)
The Court of Appeal also stated that the determination of reasonable foreseeability must be decided with regard to the scope of a defendant’s undertaking of responsibility:
Although the proximity and reasonable foreseeability stages are analytically distinct, they are nonetheless connected. In cases of negligent misrepresentation or performance of a service, Livent explains that the proximate relationship informs the foreseeability inquiry: at para. 34. A plaintiff’s injury will be reasonably foreseeable in such cases where (1) the defendant should reasonably foresee that the plaintiff will rely on its representation; and (2) reliance would, in the particular circumstances of the case, be reasonable: Livent, at para. 35. This is also defined by the nature of the defendant’s undertaking. The plaintiff may rely on the defendant to act with reasonable care for the particular purpose of the undertaking, but not for a purpose outside the scope of that undertaking. (Lavender ONCA at para 37)
Ultimately, the entire action against MB was dismissed because its undertaking of responsibility did not include any responsibility towards Buckingham’s clients. The fact that there was no reliance because the clients never saw the reports was a factor in deciding the duty of care question (rather than only a factor in determining causation):
With respect, I am of the view that the motion judge’s finding that a relationship of proximity existed is unsupportable on the evidence. Simply put, it stretches proximity beyond its permissible bounds. I say this for the following reasons.
First, the primary reason I believe proximity has not been established turns on the nature of the Auditor’s undertaking and the connection between that undertaking and the loss claimed. Buckingham retained the Auditor to audit its Form 9 Reports, which Buckingham then filed confidentially with the OSC. Although the motion judge observed that the Form 9 Reports were used by the OSC to police securities dealers and that their purpose was to protect investor assets, it does not necessarily follow that the audit of the Form 9 Reports creates proximity between an auditor and those investors. The Auditor made no representations to members of the Class, most of whom never even knew of the Auditor’s existence or its involvement with Buckingham. The Auditor did not undertake to assist the Class in making investment decisions. The limited scope of the Auditor’s undertaking and lack of direct connection between the Auditor and the Class militate against finding proximity in this case.
A second related consideration weighing against holding that the Auditor and Class were in a proximate relationship for the purpose of the Form 9 Reports is the absence of any reliance, whether intended or not. Indeed, the Class conceded that the members did not rely on or review any of the Form 9 Reports. As I have indicated, the Form 9 Reports were held confidentially by the OSC. They were not shared with the Class and not intended to inform or induce the Class in making investment decisions. The absence of the class members’ reliance on the Form 9 Reports further supports my view there is no proximity between the Auditor and the Class in relation to the Reports.
In summary, I am of the view that the Class’s claim fails at the proximity stage of the Anns/Cooper analysis. When properly scrutinized in the light of the Livent decision and other jurisprudence, the Class’s claim cannot survive because there is no proximity between the Auditor and the Class in relation to the Form 9 Reports. (Lavender ONCA at paras 64-65, 67 and 73)
There are two main takeaways from the Court of Appeal’s decision:
- The test for negligent misrepresentation cannot be avoided by attempting to re-categorizing the claim as a claim in “negligence simpliciter” or ”negligent misstatement”; and
- The determination of the “undertaking of responsibility” is a pre-condition to determining foreseeability or proximity in cases involving negligent misrepresentation or negligent performance of a service that result in pure economic losses. In such cases, foreseeability and proximity will be determined with reference to the nature of the undertaking of responsibility accepted by the defendant.
- The Court of Appeal was silent on whether this same analysis would apply to other types of pure economic losses cases and whether it will apply to non-pure economic loss negligence cases. This is area for further clarification in future cases.