Equitable Life Assurance Society v Ernst & Young (a firm)

Factual and Procedural Background

The court considered an application by Company A for an order striking out almost all claims made against it by Company B in the draft Re-Amended Particulars of Claim ("the RAPC"). Alternatively, Company A sought summary judgment against Company B on those claims. The claims relate to alleged negligence by Company A as auditors to Company B for audits of the years ended 31 December 1997, 1998, and 1999. The application was made pursuant to CPR rules 3.4(2)(a) (strike out) and 24.2 (summary judgment), focusing on scope of duty, causation, and lack of damage. The only claim not covered by the application concerned certain tax liabilities, considered minor and not further addressed.

Legal Issues Presented

1. Whether the claims against Company A disclose reasonable grounds for bringing the claim under CPR rule 3.4(2)(a).
2. Whether Company B has a real prospect of success on the claims under CPR rule 24.2.
3. The scope of the duty of care owed by auditors to their audit client, specifically whether it extends to losses arising from failure to sell the business or reduce bonuses.
4. The issue of causation, particularly whether the alleged losses were caused by Company A's breaches.
5. The viability of claims for loss of a chance to sell the business.

Arguments of the Parties

Appellant's (Company B's) Arguments

• Company A owed a contractual duty of care as auditors to Company B, including a duty to report accurately on statutory accounts prepared under the Companies Act 1985.
• Company A breached this duty by failing to require adequate technical provisions for guaranteed annuity options ("GAOs") in the statutory accounts for 1997, 1998, and 1999.
• Had the provisions been properly included, Company B would have either avoided declaring certain bonuses or would have sold its business and assets at an earlier date, avoiding substantial losses.
• Losses claimed include lost sale value of the business, loss of chance of sale, and losses from bonuses declared that would not have been declared with proper provisions.
• Company A was aware of the high risk exposure of Company B due to unusual features including GAOs and the differential terminal bonus policy ("DTBP").
• Company B contended that the scope of Company A's duty extended to protecting it from losses arising from directors' decisions based on audited accounts, such as bonus declarations and business sales.
• Company B sought to rely on expert opinions that the provisions would have led to significant bonus reductions and possibly a sale or capital raising.

Appellee's (Company A's) Arguments

• Company B suffered no loss as a result of failing to sell the business; the alleged loss relates to diminution in goodwill or asset value not within the scope of auditor's duty.
• The lost sale claims fall outside the scope of Company A's duty of care as auditors.
• The alleged losses were not caused by Company A's breaches but by external factors such as the House of Lords decision in related litigation, market falls, and regulatory requirements.
• Any recoverable losses are subsumed within the bonus declaration claims.
• The board would not have resolved to sell the business prior to a final ruling in the related litigation, and after that ruling no purchaser would have bought Company B.
• Claims for loss of a chance to sell are unsustainable in principle.
• The bonus declaration claims are "utterly unrealistic," particularly for bonuses declared after the date when Company B knew of the invalidity of the DTBP and for policies not matured before that date.
• The decisions on bonuses were beyond the scope of Company A's duty.
• Company B has not established causation or suffered the loss claimed, and has mitigated losses through subsequent actions.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began by considering the applicable CPR rules for strike out and summary judgment, emphasizing that these rules focus on whether the claim has reasonable grounds or a real prospect of success. The court accepted that negligence was to be assumed for the purposes of the application but focused on whether the claims as pleaded had sufficient legal basis and evidential support.

The court examined the scope of the auditor's duty, relying heavily on the House of Lords decision in SAAMCO. It held that the auditor's duty is limited to losses that are the kind of loss contemplated when the duty was assumed and does not extend to all losses that happen to follow the breach. In particular, losses related to the diminution of goodwill or the failure to sell the business fall outside the scope of the auditor's duty.

The court found that the lost sale claims were essentially claims for losses arising from the failure to sell the business and the consequent fall in value, which are not recoverable because they are too remote and not within the scope of the auditor's duty. The court also found these claims lacked causation, as the alleged losses were not caused by the breach of duty but by external factors such as the House of Lords decision and market conditions.

Regarding loss of chance claims, the court held that such claims require the duty to be one whose purpose was to provide the claimant with the chance lost. The court found that this was not the case here, and loss of chance claims were unsustainable.

Turning to the bonus declaration claims, the court distinguished these from the lost sale claims. It accepted that the auditor's duty could extend to ensuring the accuracy of accounts on which bonuses were declared, and that Company B had a real prospect of success in pursuing claims related to overpayment of bonuses. However, the court found the pleaded claims to be presently fanciful and lacking in rigour and detail, particularly concerning the calculation of losses and the impact of events after 20 July 2000 when the invalidity of the DTBP became known.

The court noted that Company B had mitigated losses through bonus adjustments and a compromise scheme following the House of Lords decision. It also found that some pleaded claims were inconsistent with the factual matrix, such as the assertion that drastic bonus cuts would have been made earlier, which would have destroyed goodwill and violated policyholders' reasonable expectations.

Overall, the court concluded that the lost sale and loss of chance claims should be struck out or dismissed for lack of reasonable grounds and real prospects of success. The bonus claims should not be struck out but require more detailed and realistic pleadings. The court invited Company B to reconsider and possibly reformulate these claims within a defined timescale.

Holding and Implications

The court GRANTED Company A's application to strike out the lost sale claims and the loss of chance claims, finding they have no reasonable grounds and no real prospect of success. These claims fall outside the scope of the auditor's duty and lack causation.

The court DECLINED to strike out the bonus declaration claims at this stage, recognizing that Company B has a real prospect of success on these claims. However, the court emphasized that the current pleadings are inadequate and fanciful, and Company B must be given a defined opportunity to reformulate and present these claims with greater rigour and realism.

The decision means that Company A will not be liable for losses related to the failure to sell the business or loss of goodwill but remains exposed to claims concerning overpayment of bonuses allegedly caused by negligent audit. No new precedent was established beyond the application of established principles of scope of duty and causation in auditor negligence claims.