B e f o r e :
THE HONOURABLE Mr. JUSTICE EVANS - LOMBE ____________________
BARINGS Plc (in liquidation) and anr Claimants - and - COOPERS & LYBRAND (a firm) and ors Defendants BARINGS FUTURES (SINGAPORE) PTE LTD (in liquidation) Claimants -and- MATTAR and 36 ors Defendants ____________________
Charles Aldous QC/Rhodri Davies QC/ (instructed by Slaughter & May for Plc) Michael Brindle QC/Craig Orr (instructed by Ashurst Morris Crisp for BFS) Jonathan Gaisman QC/Christopher Butcher QC/ David Bailey/ James Brocklebank (instructed by Clifford Chance for D&T) ____________________ Approved Judgment I direct that pursuant to CPR PD 39A para 6.1 no official shorthand note shall be taken of this Judgment and that copies of this version as handed down may be treated as authentic.
HTML VERSION OF APPROVED JUDGMENT ____________________
Crown Copyright ©
Mr. Justice Evans-Lombe :
INTRODUCTION
This is an application made by Deloitte & Touche (Singapore) (“D&T”) to strike out the claims brought against them by Barings Plc (“Plc”) and Bishopscourt (BS) Ltd (formerly Barings Securities Ltd) (“BSL”). It is made pursuant to RSC O.18 r.19 and the inherent jurisdiction of the court, as a result of an order for directions I made on 26th July 1999, which provided, inter alia, that the CPR were to apply to the combined action save as regards pleadings and discovery, which were to be governed by the Rules of the Supreme Court.
I must first set out the factual background although, given the number of times this ground has been traversed in other judgments, I shall try to do so reasonably briefly.
FACTUAL BACKGROUND
Plc was the holding company of the Barings group. It was based in London and did not trade on its own account. BSL was an indirect subsidiary of Plc. It conducted securities and futures trading, both on behalf of clients and (from 1993 onwards through a subsidiary, Baring Securities London Ltd (“BSLL”) ) on its own account.
Barings Futures Singapore Pte Limited (“BFS”) was an indirect subsidiary of BSL, and so of Plc. It was incorporated in Singapore to trade on the Singapore International Monetary Exchange (“SIMEX”).
D&T were the auditors of BFS in 1992 and 1993. In 1994, they were replaced by Coopers and Lybrand Singapore (“C&LS”). The other auditors involved in the action are Coopers and Lybrand in London (“C&LL”) , who were the auditors of Plc, BSL and the Barings group in all three years.
The Barings group collapsed on 27th February 1995. Plc and BSL are now in insolvent liquidation. The immediate cause of the collapse was unauthorised and loss-making trading by Nicholas Leeson, who was the general manager of BFS from 1992 until he disappeared shortly before 27th February 1995.
BFS undertook futures and options trading on SIMEX on behalf of BSL, BSLL, Barings Securities Japan (“BSJ”) and one external client, Banque Nationale de Paris. BFS was initially limited to executing trades on SIMEX only on the instructions of its clients. But from 1993 Leeson was permitted to carry out arbitrage trading at his own discretion, exploiting price differences that arose between matching contracts traded on SIMEX and the Japanese exchanges. He was given no authority to hold open overnight positions: all positions on one exchange were understood by Plc and BSL management to be matched by equal and opposite positions on the other exchange.
To maintain a contract on SIMEX, a broker such as BFS is required to deposit margin with the exchange. Limiting myself to futures trades for the time being, when first buying or selling the contract the broker is required to deposit with SIMEX initial margin as collateral. This may be deposited in cash or by instruments such as Treasury bonds. If the value of the contract moves against the broker, it is required to deposit variation margin, so that the contract is “marked-to-market” on a daily basis. Finally, in unusual circumstances such as extreme market volatility, SIMEX may require a broker to deposit additional margin.
Margin to be deposited with SIMEX is calculated daily and has to be deposited with SIMEX by the start of the next trading day.
Under SIMEX rules a broker conducting agency trading for clients (which did not include other Barings companies, but did include those companies’ clients) is usually required to obtain from its client at least as much margin as the broker is required to deposit with the exchange. Furthermore, a broker is required to obtain margin from clients on a gross basis. Therefore a broker will always hold more margin from its clients than it has to deposit with the exchange in relation to their trades.
BFS’ day-to-day trading and accounting records were maintained on a computer system known as CONTAC. At the end of each trading day information as to trades conducted and margin requirements was transmitted by electronic feed direct to BSL’s computer system, known as First Futures. BSL reconciled the information to its own information as to client orders. It was then able to update its clients’ positions, request any margin required from its clients, and transfer margin if required from the Barings Securities Group Treasury to BFS in time for the next trading day. BSLL, when it began handling proprietary trading in 1993, also used the First Futures system.
A similar, though less automated, process applied to BSJ.
In brief, Leeson’s fraud consisted in the following. Soon after BFS began trading in June 1992, Leeson opened an account, 88888, in the CONTAC system. It was described in both systems as an error account. Leeson used the account (i) to book speculative trades, without it being apparent that they were unmatched, (ii) to adjust the prices of legitimate trades, conducted on behalf of BFS’ clients, so as to make those trades appear more profitable than they in fact were, at the cost of the 88888 account, (iii) to hide unprofitable trades by transferring them into the 88888 account, and (iv), increasingly, to book the sale of options which Leeson wrote to raise money to finance his losses.
Using his knowledge of the BSL back office, Leeson persuaded the provider of the CONTAC system to omit information as to the 88888 account from the trade feed to BSL. It was included in the margin feed but, because BSL’s First Futures system did not have an account under that number, the system ignored the information as to the 88888 account. Information as to the 88888 account of course remained in the CONTAC system, but BFS’ monthly management accounts were prepared from a different, SUN, system and Leeson caused the 88888 trades to be omitted when trading results were transferred each month from CONTAC to SUN.
The losses on the 88888 account were £3.1 million in September 1992, at the time of the first audit of BFS by D&T. They fell to £2.1 million by December 1992. By December 1993, at the time of the second audit (BSL and BFS having changed their year-end to December in the meantime), the losses were £24.4 million; and by December 1994, £215.5 million. By the time of the collapse in February 1995, the losses were £848.5 million.
During 1992 and 1993, Leeson seems to have financed his losses on the 88888 account using the excess margins which, as described above, BFS called from its clients, and the premiums from the sale of options. However, beginning on 12 January 1994, Leeson began to request from BSL additional funding, in US dollars (“the Dollar Funding”). This was on top of the conventional funding in yen which BFS received through the operation of the margining mechanism I have described above. Leeson made these requests by e-mail, addressed to individuals in the BSL settlements department, and they arranged for the monies requested to be transferred to BFS’ account with Citibank in Singapore.
Leeson seems to have explained the need for the Dollar Funding by referring to factors such as additional margin calls by SIMEX and the difficulty of obtaining in time yen from BSJ for margins on its trading. However it is admitted by Plc and BSL in their pleading, which I quote below, that no proper investigation into the validity or accuracy of the funding requests was carried out. Furthermore for the first ten months BSL advanced the Dollar Funding without BFS providing any breakdown between the amounts required for client and house business. When in November 1994 BFS was required to provide such a breakdown, it usually split the amount requested 50:50 between the two, which could not have been the case. None of the Dollar Funding was reconciled by BSL to its own clients, so no attempt was made to recover it from clients. Instead, the amounts were simply recorded in BSL’s and BSLL’s books in two accounts, the BSINGCOLL and BSSHSECOLL accounts. In the solo consolidated balance sheet, which combined the financial positions of Baring Brothers & Co. and BSL, the imbalance between the amounts advanced to BFS and the amounts recovered from clients was shown as “client loans” , known within BSL as the “top-up” balance. This top-up balance existed before 12 January 1994, apparently because of timing differences, but increased from £21.7 million on 31st December 1993 to £306.3 million at 24th February 1995.
The amount of the Dollar Funding (combining the funding from both BSL and BSLL) was US$57 million by 9th February 1994, US$190 million by 10th June 1994 and by the time of the collapse was US$627 million. In addition Leeson persuaded BSJ to leave margin with BFS which at the date of the collapse amounted to ¥19 billion (S$292 million). By way of comparison, the total amounts held by BFS on behalf of Barings companies at the time of the collapse were:
BSL: S$770 million (US$530 million/£334 million)
BSLL: S$270 million (US$186 million/£117 million), and
BSJ: S$ 690 million (US$475 million/£299 million).
THE PROCEDURAL BACKGROUND
There are two actions, which are being heard together. In the first, Plc and BSL sue D&T and the two Coopers firms. D&T have joined BFS and BSJ as third parties. In the second, BFS sue D&T and C&LS only. D&T have joined Plc, BSL and BSJ as third parties.
In both actions, the claimants have alleged that the two Singapore firms of auditors conducted their audits negligently, with the result that Leeson’s activities were not detected and stopped. In addition, Plc and BSL allege that C&LL were negligent in their conduct of the audits of Plc and BSL and their supervision of the Singapore audits.
The trial of the combined action began on 2nd October 2001. During its second week, it was announced that the claimants in both actions had signed definitive and binding agreements with the Coopers firms, which would, when effective, settle the claims against those firms. The agreements are subject to approval by creditors and the Companies Court. I understand that the Companies Court will consider whether to give such approval on 11th and 12th December 2001.
I have not been shown the terms of the settlement. However, by a letter dated 9th October 2001 from BFS’ solicitors, Ashurst Morris Crisp, to those of D&T, Clifford Chance, BFS, Plc and BSL have proposed that, if the settlement is implemented, BFS will continue with its action against D&T, save that it will not claim against D&T in respect of any loss incurred after 31st December 1994. Plc and BSL have limited their claim against D&T similarly, and propose that their claim should be stayed. The stay should be lifted only if BFS are held at trial unable to recover from D&T on a ground which does not prevent Plc and BSL recovering. The example given is the issue as to the representation letter which I have ordered to be tried as a preliminary issue and which I describe below. Otherwise subject to any necessary involvement as a result of being part 20 defendants they will take no part in the trial and will be bound by any findings of fact and law.
I have indicated that I am not at present minded to agree to the proposed stay. If the settlement goes ahead, subject to the result of this application, Plc and BSL will have to decide whether to pursue their claims against D&T or discontinue them.
D&T’s response to the settlement involving the other parties has been threefold. Firstly, they indicated their intention of bringing third party claims for contribution against C&LL and C&LS, so as to bring them back into the main trial. Secondly, they applied to me to order the trial of a preliminary issue in the BFS action. If found in their favour, that issue would defeat BFS’ claim against them. I describe it in the next paragraph. Thirdly, they have made the present application in the Plc/BSL action to strike out Plc’s and BSL’s claims against them.
On 23rd October 2001 I ordered the trial of a preliminary issue in the BFS action. That preliminary issue is currently expected to be heard on 14th January 2002, before the resumption of the reconfigured trial of the main action against D&T. The issue is whether D&T have a complete defence based on circuity of action and/or set-off and/or estoppel, such as to bar BFS’ claim. D&T argue that this defence arises as a result of two representation letters, written to them by Mr Jones, a director of BFS, in advance of the completion of the 1992 and 1993 audits respectively, which D&T allege to have been recklessly fraudulent.
Plc’s AND BSL’S CLAIMS
After that description of the background to the present application, I shall set out the claims which are brought by Plc and BSL, and the objections taken to them by D&T.
D&T were appointed in 1992 as auditors to BFS, and therefore are sued by BFS in contract and tort. Plc’s and BSL’s claims against D&T are in tort only. They argue that D&T owed a duty of care to them arising out of the acceptance of group audit instructions to audit BFS’ consolidation schedules, to report to the group auditors on those schedules and to give an audit report on those schedules to the directors of the parent company. For the purposes of this application, D&T accept the existence of a duty of care, although there has been vigorous debate before me as to its scope.
It is important to note that the claimants allege that D&T owed BSL a duty of care in relation to the September 1992 audit only, and owed Plc a duty of care in relation to the 1993 audit. This is because the BFS accounts were consolidated into the BSL group accounts in 1992, but (as part of the consolidation of BSL into Plc) into the Plc group accounts in 1993. Thus D&T’s audit report on the consolidation schedules for BFS was addressed in 1992 to the directors of BSL, and in 1993 to the directors of Plc.
There are three categories of claim brought by Plc and BSL and which D&T seek to have struck out:
THE PLEADINGS
Insofar as relevant to this application, the claimants’ Re-amended Statement of Claim (“the Statement of Claim”) is pleaded as follows (references are to paragraph numbers, and I have substituted the abbreviations I have used above where necessary). I shall set out separately the paragraphs dealing with, firstly, duty, loss and reliance, secondly, the Dollar Funding and, thirdly, the claim for overpayment of bonuses:
DUTY, LOSS and RELIANCE
I interject here that, in relation to paragraphs 320 and 322, D&T asked Plc and BSL to provide further and better particulars of the matters relied upon in support of the alleged knowledge on the part of D&T. In relation to the bonuses claim (set out at paragraph 335 of the Statement of Claim, quoted below), the claimants specified a document on D&T’s audit file “which evidences D&T’s understanding that bonuses were declared by the holding company”. But in relation to the other claims the claimants did not point to any such specific document evidencing knowledge. They referred instead to matters which evidenced D&T’s knowledge that BFS was a subsidiary of BSL and that their report would be used in the group audit, in particular the terms of the audit instructions and the fact that the audit report was to be addressed to the directors of the parent company.
THE DOLLAR FUNDING
BONUSES
The Claimants did not serve a reply in the action brought by them. However in the action brought by BFS, D&T, as I have explained, brought third party proceedings against Plc and BSL. D&T alleged against Plc and BSL the management failings which D&T had already alleged in their defence in the Plc action. In this application, D&T relied upon the admissions which Plc and BSL made in their defence to the third party proceedings. Insofar as they are relevant to the claim for the Dollar Funding by BSL, the third party defence admits the following (where appropriate I have quoted below the sections of the D&T defence in the Plc action which are admitted):
THE APPLICATION TO STRIKE OUT
The grounds advanced by D&T in support of their application to strike out may be summarised in this way:
THE PURPOSE TEST
I will deal with D&T’s second ground first.
As I understand it D&T’s submission defines the Purpose Test in the following way: where a claimant claims damages in tort flowing from a negligent mis-statement he must plead and prove not only that the loss for which compensation is claimed was caused by the defendant’s breach of duty to the claimant, and was foreseeable, but also that the claim arises from a transaction or class of transactions, that was within the contemplation of the defendant at the time he undertook the relevant duty and for the purpose of which transaction, inter alia, he provided his services, and that the claimant relied on those services for the purpose of that transaction.
Thus in the case of a claim in tort against an auditor the claimant must plead and prove, in addition to a relationship between the auditor and the claimant capable of giving rise to a duty of care, and that the loss flowing from the auditor’s breach of that duty was caused by the auditor’s negligent report, and was foreseeable, that, at the time he undertook those services, the auditor had in contemplation that they would be relied on by the claimant for the purpose of a particular transaction or class of transaction that was likely to result and that the claimant, in fact, relied on the auditor’s report when embarking on such transaction which resulted in the loss for which compensation is claimed.
In Candler v Crane Christmas & Co [1951] 2 KB 164 the Court of Appeal was considering a case where the plaintiff, an investor, was considering the possibility of investing £2,000 in a company but, before doing so, wished to see that company’s accounts. The managing director of the company instructed the company’s accountants to speed up the preparation of the accounts so that they could be shown to the plaintiff. They were shown to him and he discussed them with the accountants and he invested £2,000. Some months later he invested a further £200 in the company. In his dissenting judgment Lord Justice Denning said this at page 182 of the report:-
Lord Justice Denning’s judgment in the Candler case was approved by Lord Bridge in the decision of the House of Lords in Caparo Plc v Dickman [1992] AC 605 at page 623 as a “masterly analysis” requiring “little, if any, amplification or modification in the light of later authority”. At page 624 of the report of his speech in the Caparo case Lord Bridge also approved a passage from the judgment of Richmond P in the New Zealand High Court in the case of Scott Group Ltd v McFarlane [1978] 1 NZLR 553 at page 566 where he says:-
In his speech in the Caparo case at page 620 Lord Bridge, having reviewed a number of earlier authorities, summarised their effect in this way:
Lord Bridge’s conclusion at the end of his speech at page 627 was:
In his speech in the Caparo case Lord Oliver says this at page 638 of the report:
In his speech in the Caparo case Lord Jauncey says this at page 661 of the report:
In the BBL case [1997] AC 191 the House of Lords was considering a claim based on the negligence of a valuer. At page 211 of the report Lord Hoffmann is reported as saying:
Again in his speech in Nykredit Plc v Edward Erdman Group Limited [1997] 1 WLR 1627 Lord Hoffmann was dealing with the case of an allegedly negligent valuer. He said this at page 1638 of the report:
Finally in Reeman v Department of Transport [1997] 2 Lloyd's Law Reports 648 the Court of Appeal was considering the case of an allegedly negligent survey of a fishing boat by a surveyor employed by the Department of Transport for the purposes of a certificate of seaworthiness to be given by the Department.
In his judgment at page 685 Lord Bingham says this:
The above quoted extracts from the cases, are in my judgment, ample authority for the propositions of law of D&T which I have sought to summarise. To perfect his cause of action for negligent misstatement a claimant must establish that the defendant had in contemplation the transaction by which the claimant suffered loss in order for the defendant to have assumed a duty to exercise due care and skill to protect the claimant from the loss resulting from it. To have in contemplation may mean either to be directly informed that the claimant either would or was likely to embark on the transaction in reliance on his advice or other statement or that, from the surrounding circumstances of the case, it can be inferred that he knew of the transaction and the reliance. As Lord Oliver said in Caparo at page 638 “it is clear that “knowledge” on the part of the [defendant auditors] embraced not only actual knowledge but such knowledge as would be attributed to a reasonable person placed as the [defendants] were placed.”
In both cases it is, in my judgment, clear that the claimant must plead the circumstances on the basis of which he alleges that the defendant knew of the intended transaction of the claimant and his reliance on the defendant for the purpose of it. The Caparo case was decided on a preliminary issue on the basis of facts alleged in the statement of claim. In the result the House of Lords restored the order of the Judge who held that the claim against the auditors failed because the pleaded facts did not disclose an actionable duty owed by the auditors to a purchaser of shares in the company being audited, albeit an existing shareholder of that company.
In Galoo Limited v Bright Graham Murray [1994] 1 WLR 1360 the Court of Appeal were considering a case, part of which involved a claim by one of the plaintiffs against auditors for losses resulting, firstly, from a purchase of shares pursuant to a contract under which the purchase price was to be calculated by reference to accounts to be prepared by the defendant auditors, secondly, from loans subsequently made by that claimant to the company and, thirdly, from losses sustained as a result of a subsequent purchase of further shares. The court dismissed the appeal against the Judge’s order striking out part of the claimant’s claims. In doing so the court concluded that the claim in respect of the first category of losses sustained was sufficiently pleaded, in that the statement of claim pleaded circumstances from which a court might conclude that the defendant auditors, in giving their opinion at the time of the original transaction, had in contemplation that the claimants were relying upon them to produce a competent audit for the purpose of calculating the price payable for the original purchase of shares. By contrast, no facts were pleaded which might have sustained the conclusion that the auditors, in preparing subsequent accounts, had in contemplation that the claimants would make advances to the company in reliance on their audited accounts or would purchase further shares in the same reliance.
In his judgment at page 1382 of the report Lord Justice Glidewell says this:
Applying that distinction to the facts before the court Lord Justice Glidewell continued at page 1385:-
In relation to the purchase of the second tranche of shares, Lord Justice Glidewell also agreed with the Judge’s conclusion that, since it was common ground that that purchase of shares took place independently of the original purchase agreement, in which the price was fixed without reference to any formulae based on any set of accounts, the pleading did not disclose an actionable duty to claim losses resulting from that further purchase of shares.
BSL’s CLAIM (including as assignee of BSLL’s claim) for loss of the amounts advanced by BSL and BSLL pursuant to the Dollar Funding and for the value of the BSL Group, consequent on D&T’s 1992 audit.
BSL’s claim is pleaded as the loss of the amounts advanced by it and BSLL, pursuant to the Dollar Funding loans, to BFS which, as a result of BFS’ insolvency, have become irrecoverable: see the Statement of Claim paragraphs 173 to 178, 182 and 334. It seems to me that BSL can only put their claim in this way, that is, that, had D&T conducted a competent audit which would have revealed the Leeson frauds for the year to September 1992, BSL and BSLL would not have started to make, or continued making, the Dollar Funding loans. It is not open to BSL to claim, in the alternative, in respect of the losses resulting from the unauthorised and fraudulent trading activity of Leeson, financed by the Dollar Funding loans. Such a claim can only be pursued by BFS see Prudential Assurance v Newman 1982 CH 204.
The relevant pleading in the Statement of Claim, so far as it concerns D&T, reads as follows: -
D&T sought particulars of the allegation in paragraph 322 that D&T knew, or ought to have known, that BSL would rely on their audits. The lengthy answers given do not, in my view, advance the point under examination and I will not therefore set them out here.
It is apparent, therefore, that no attempt has been made to plead in the statement of claim that D&T, at the time that they received group audit instructions or undertook the audit work consequent on those instructions, had in contemplation that the product of that work would be used by BSL or BSLL, or would be likely to be so used, in deciding whether to make the Dollar Funding loans to BFS at the request of Leeson or, having started to do so, to continue making them. This is to be contrasted with the way in which the statement of claim pleads Plc’s claim for overpaid bonuses (no particularised claim for overpaid dividends is actually made). The relevant pleading is at paragraphs 318 and 320 of the statement of claim, which I have already set out, supplemented by paragraph 335 as follows: -
It is conceded that this pleading, so far as the claim for overpaid bonuses is concerned, meets the Purpose Test. In particular it meets the test of Lord Oliver in the passages from his speech in the Caparo case cited above, in that it is possible to infer from the facts pleaded that D&T, when they received the group audit instructions, would have realised that Plc would use their consolidation schedules, when consolidated into the accounts of the Plc group, to calculate bonuses payable to the staff of the group companies.
In his judgment in the Galoo case Glidewell LJ at page 1383 of the report affirmed the decision of the Judge that paragraph 13 of the statement of claim in that case passed the Purpose Test in that it pleaded that “the 1986 audited accounts were to be prepared not only for the purposes of the audit but also for the purpose of fixing the purchase consideration under” the initial share sale agreement. No attempt has been made to amend the statement of claim in this case as was made in the Galoo case in accordance with the proposed paragraph 9A as set out in page 1375 of the report. For the sake of brevity I will not set out here the words of that proposed amendment save to highlight that at paragraph (4) it would have pleaded that the relevant plaintiffs, Hillsdown, “were year by year to the knowledge of the defendants advancing substantial sums to the second plaintiffs and supporting that company in reliance on the defendants’ work…” The proposed new paragraph was not sufficient to save the claim in respect of the purchaser’s loans made subsequent to the initial share purchase agreement from being struck out.
As I have said no attempt has been made to further amend the statement of claim to meet the Purpose Test. As at present advised it does not seem to me to be possible now to put forward an amendment which BSL would have a realistic chance of making good at the trial, given the following facts which are admitted by BSL on the pleadings or as to which there is no issue. The group audit instructions for the year to 30th September 1992 were sent by C&LL to D&T on 21st July 1992. On 17th August Mr Mah of D&T sent a letter to C&LL saying that D&T’s audit of BFS had revealed “no significant accounting/audit issues”. On 2nd October 1992 D&T commenced their fieldwork for the 1992 audit. On 16th October 1992 D&T sent the completed consolidation schedules for BFS to C&LL, subject to the ultimate certification of the local accounts of BFS in the process of preparation by D&T. D&T’s final and unqualified accounts of BFS for the year to September 1992 were sent to C&LL on 31st December. It was not until 12th January 1994 that the first of the Dollar Funding loans was made by BSL to BFS pursuant to requests made by Leeson. The Barings Group collapsed when administrators were appointed by the court on the 26th February 1995. It is not in issue that the overwhelming majority of the indebtedness incurred by the Plc group companies as a result of Leeson’s activities, including the BSL sub-group, was incurred between the beginning of December 1994 and the collapse on 26th February 1995.
Thus the Dollar Funding loans started some 15 months after D&T’s consolidation schedules were sent to C&LL, and the transactions which brought down the Barings Group occurred approximately two years later. In these circumstances it is hard to see how BSL could allege the necessary reliance on D&T’s 1992 audit to comply with the Purpose Test in respect of the Dollar Funding loans.
In Esanda Finance Corporation Ltd v Peat Marwick Hungerfords (1997) 71 ALJR. 448 the High Court of Australia was dealing with an auditors negligence case and affirmed the decision of the full court of the Supreme Court of South Australia to strike out parts of the statement of claim as failing to comply with the Purpose Test, citing the Caparo case. The following passage appears in the judgment of McHugh J at page 473 of the report:-
In Berg Sons & Co Ltd v Adams [1992] BCC 661 Hobhouse J was dealing with another auditors’ negligence case. At page 669 of the report the following passage appears in his judgment: -
Paragraph 178 of the Statement of Claim together with the pleading set out at paragraph 31 of this judgment contain admissions by the claimants of the improvident nature of the Dollar Funding loans, in particular, that they were made without any real attempt to reconcile the amounts ostensibly sought by Leeson to make margin payments in respect of alleged agency transactions to specific customer accounts. I accept D&T’s submission that it is hard to see how BSL could plead that D&T knew that its audit would be used for such an improvident purpose.
It was submitted on behalf of BSL that BSL’s claim to recover the amounts of the Dollar Funding loans was sufficiently pleaded and ought not to be struck out. The duty assumed to BSL by D&T included a duty to protect BSL from the consequences of fraud in the conduct of the business of BFS which ought, reasonably, to have been discovered by D&T in the course of their 1992 audit. It was submitted that the loss of the Dollar Funding loans was a result of a continuation of the fraudulent activities of Leeson which resulted from the failure, in the course of the 1992 audit, to detect that fraud. That Leeson would continue his fraudulent activities resulting in further losses to BSL was foreseeable. The fact that those losses were ultimately so substantial as to cause the loss of the entire BSL Group of companies was nothing to the point.
In support of this submission the case of Sasea Finance v KPMG [2000] 1 AER 676 was cited. In this case the Court of Appeal were considering a claim by a client company against its auditors in negligence and breach of contract based on the allegation that, in breach of duty, the auditors failed to uncover the frauds of a senior employee which led to massive losses. The claim concerned the losses suffered as a result of four transactions which took place at the time of or after the relevant audit was complete. Two of the transactions amounted to thefts of the company’s property, the other two to the diversion from the company of the proceeds of sale of shares held by the company, to other group companies. The auditors applied to strike out the claim for damage arising from all four transactions. At first instance the Judge declined to strike out the claim in respect of two of the transactions which amounted to theft. He struck out the claims as to the remaining two transactions on the ground that they were examples of the sort of transaction which it was in the company’s business to transact. On appeal, the Court of Appeal allowed the company’s appeal. Materially to the issues in this case, they found that the two share sale transactions could not be distinguished in their nature from the transactions treated as thefts. At page 682 of the report Lord Justice Kennedy says this: -
Then continuing at page 683 of the report under the heading “Causation or the opportunity to suffer loss”, he says:
I accept D&T’s submission that the Sasea case is no support for BSL’s contention. The Sasea case was a claim in contract as well as tort by a client company against its auditor and did not involve a claim by a third party for damages resulting from reliance upon the audit. For this purpose a third party means a party making a claim who is not in direct contractual relationship with the auditor: see per Lord Bridge in the Caparo case at page 619. Although passages from the speeches of Lord Bridge and Lord Oliver in Caparo , and from the speech of Lord Hoffmann in the Nykredit case are cited in Lord Justice Kennedy’s judgment, it has yet to be made clear in authority that concepts such as the Purpose Test are applicable where the relevant relationship is contractual or are applicable in the same way that they apply where the relationship is tortious only. The actual decision in the Sasea case turned on a point of causation, as is made clear from the second passage in the judgment of Lord Justice Kennedy which I have cited above and from the heading of the part of the judgment in which it appears. Kennedy LJ was distinguishing between losses of the kind which the audit client was unable to recover in Galoo (because the auditors’ breach did not cause the trading losses, but merely gave the companies the opportunity to incur them) and the losses in Sasea, which were brought about by the fraud which KPMG had failed to detect and therefore were caused by the breach. As is also seen in the BCCI case referred to below, lack of causation is often used as an explanation as to why the scope of duty is limited, while the converse is not true: proof that the breach did cause the loss in question does not establish that the scope of duty extends to that loss.
Accordingly it does not appear to me that the decision in the Sasea case helps at all on the issue whether the pleadings in the present case should be struck out, subject to the next submission of BSL with which I will now deal.
As I understand that submission, it is that the relationship between BFS and its auditor D&T, and BSL and its group auditor C&LL, was such that D&T is to be treated as if it had a contractual relationship with BSL at the material time of the audit. This arises, it is said, from the fact that BFS was the “in-house” broker in Singapore of the BSL Group of Companies. Its business was to execute trades on the Simex market in respect of group companies’ Agency and House business. As a result large amounts of money, the property of those group companies passed through its hands. The group was managed on the “Matrix” system. This meant that managers of particular aspects of the group’s business could be the employees of one of the group companies while the actual business to be managed was being conducted by another group company. Thus Leeson’s trading activities were notionally controlled by managers outside BFS. If this is correct, the submission goes, the result should be the same as in the Sasea case, namely, that D&T should be liable for all the consequences of failing to discover the frauds of Leeson in the course of the 1992 audit without any limitation such as might arise as a result of the application of the Purpose Test.
In support of this proposition the decision of the Court of Appeal in Bank of Credit & Commerce International (Overseas) Ltd (in liquidation) v Price Waterhouse (No 2) [1998] PNLR 564 was cited. That case concerned three companies in the BCCI group which were in liquidation known as “Holdings”, “SA” and “Overseas”. Messrs Price Waterhouse (“PW”) were the auditors of Overseas. Messrs Ernst and Whinney (“EW”) were the auditors of Holdings and SA. It appeared that those three companies each had a board consisting of the same six individuals and had been run as one enterprise conducting a banking business. It was alleged that both firms of accountants had been negligent in carrying out their audits of the companies so that their true financial position was not revealed until a substantial period had gone by, during which a number of transactions, including improvident loans, had been entered into whereby the company sustained losses. The claims were framed in contract and in tort.
In the course of the proceedings EW applied to strike out the action of Overseas against them on the basis that they disclosed no cause of action. They argued that in the circumstances they owed no duty of care to Overseas with whom they had no contractual relationship. It is apparent from the quotations from the judge’s judgment (Laddie J), contained in the leading judgment in the Court of Appeal of Sir Brian Neill, that the judge had struck out the claims by applying the Purpose Test in respect of which he found that the necessary pleading had not been made. The Court of Appeal allowed an appeal. It is apparent from the judgment of Sir Brian Neill that a matter which weighed particularly heavily with him was the way in which the group had been run in the past, with the result that there had to be extremely close co-operation between the two auditors in the exchange of information relevant to their audits. Application had been made to the judge to amend the statement of claim which was renewed before the Court of Appeal. It is difficult to tell from the report exactly what this amendment concerned or what its terms were. At page 588 of the report the following passage appears in the judgment of Sir Brian Neill: -
The matter returned to Laddie J when a further application was made to him to strike out various parts of the statement of claim. Laddie J’s judgment is reported at [1999] BCC 351.
At paragraph 64 of his judgment he says this: -
With respect, I cannot accept that such was the case. It seems clear from the passage from the judgment of Sir Brian Neill which I have cited and from other passages in that judgment that there was a difference between the judge and Sir Brian as to whether it was a necessary part of the Purpose Test that the claimant must plead and prove that the auditor, in undertaking his auditing services, intended that the product would be used for the purpose of the particular transaction being undertaken by the Claimant as a result of which he suffered loss. Sir Brian Neill’s judgment concluded that this was not necessary and it was sufficient that the claimant established that the defendant auditors had in contemplation the probability that the claimant would embark on such a transaction in reliance on their audit.
Be all this as it may it is apparent that the Court of Appeal were not deciding that it was not necessary for a claimant to plead facts which met the Purpose Test, albeit in a somewhat different form from that which the judge thought necessary. Rather, the focus of EW’s case, and therefore Sir Brian Neill’s judgment, was much more on whether the scope of EW’s duty extended to that claimant, rather than to particular transactions entered into by that claimant: to use Lord Bingham’s terminology in Reeman, whether the audit report was plaintiff-specific, rather than whether it was purpose- or transaction-specific.
In particular this case is no authority for the proposition that a subsidiary auditor is to be treated as subject to the same duties to a parent company as those to which the group auditor would be subject as a result of his contractual relationship with that parent. In the present case no attempt is made to plead reliance by BSL on D&T’s 1992 audit in deciding to make the Dollar Funding loans, or that D&T were aware that BSL was likely so to rely, at the time they accepted their group audit instructions and undertook their audit work. In my view the submissions for which the BCCI case is cited as authority, and which I have summarised above, cannot be accepted.
Before leaving that case it is perhaps notable that Sir Brian Neill concluded his judgment with a sentence pointing out that the facts of that case were most unusual and that he did not wish “the conclusion which I have reached on the pleadings to be used in support of an argument in some other case that the court should be more ready than in the past to impose liability whenever a close relationship between adviser and advisee was established.” See page 591 of the report.
It is then submitted by the claimants that it is not open to me to strike out BSL’s or Plc’s claim, on the ground of no sufficient pleading for the establishment of a duty of care, because I am bound by the decision of the Court of Appeal in the Barings case itself see: Barings Plc (in administration) and anr v Coopers & Lybrand (a firm) [1997] 1 BCLC 427 . In this case the Court of Appeal were dealing with an appeal from a decision of Chadwick J giving Plc leave to serve the proceedings on C&LS, outside the jurisdiction, under Order 11 rule1 (1)(c) and (f). So far as material that rule provides:
Chadwick J gave leave under both sub rules. However it is only the ruling under sub rule (f) which is material to this judgment. Under that sub-rule he concluded that the proper test was whether there existed, on the pleadings, a serious question of law to be tried as to the existence of the tort alleged and that this required “an examination of the relationship between Barings Plc and C&LS with reference to the work on which C&LS was engaged and the information which C&LS supplied”. Having examined certain documentary evidence, in particular the group audit instructions and C&LS’ audit report to the directors of Plc for the year to December 1994, the judge concluded that the test was met. The Court of Appeal dismissed C&LS’s appeal.
Before the Court of Appeal the matter was argued under two main heads, first, that Plc had not sufficiently established the existence of a duty of care owed by C&LS to Plc and, second, that the claim was barred by the rule in Prudential v Newman with which I will later deal. That part of the judgment of the Court of Appeal which dealt with the issue under the Prudential v Newman rule was subsequently disapproved by the House of Lords in the Johnson v Gore Wood case, to which again I will later turn.
Lord Justice Leggatt who delivered the lead judgment deals with the issue of the existence of a duty of care between page 435 (f) and the conclusion of his judgment on page 436. Although it is plain from the skeleton arguments put before the Court of Appeal, which I was shown, that the argument based on the Purpose Test was before the court, it is not identifiably dealt with in the judgment of Lord Justice Leggatt although he would have had to have disposed of it to arrive at the conclusion that he did. However the concluding sentence of his judgment reads: -
This concluding passage highlights the reason why, in my judgment, this decision of the Court of Appeal is not binding so as to preclude my striking out BSL’s and Plc’s claims on the ground of failure to plead sufficiently that D&T owed BSL and Plc a duty of care. There is no issue estoppel. D&T were not a party to the application. In fact I am informed that they were against it. The decision is not binding on the facts since the pleaded factual background of D&T is substantially different from that of C&LS. D&T were the auditors of BFS for 1992 and 1993. C&LS were the auditors for 1994. There was not the same time gap between the commencement of the Dollar Funding loans or the build up of indebtedness in the final months and the commencement of the audit work by C&LS as there was between those events and D&T’s audit work. But, most conclusively, the Court of Appeal was considering an application under Order 11 for service outside the jurisdiction. Had the appeal succeeded it would have stopped the proceedings against C&LS in limine. Conclusions of law arrived at in such applications cannot preclude the court of trial from re-examining those conclusions in the course of the trial. The trial of this case has started, although it stands adjourned while it is reconfigured consequent on the settlement of the claims against the Coopers defendants which requires the sanction of the court to become finally binding. This application is one which would have had to have been dealt with at the trial in any event and it has been convenient to deal with it during this period of adjournment. I have had the benefit of detailed legal argument extending over a number of days.
It follows that I cannot accept the submissions by BSL in opposition to the application. In my judgment the statement of claim does not sufficiently plead the claim based on an allegation of negligence against BSL to recover from D&T damages for the loss of the amount of the Dollar Funding loans or the value of the BSL group arising from D&T’s 1992 audit of BFS.
Plc’s claim for the value of the Plc Group consequent on D&T’s 1993 audit.
The relevant pleading in the statement of claim consists of paragraphs 318 and 320, the relevant parts of which I have already set out, and paragraphs 323 and 332 which materially provide as follows: -
In my judgment this claim must also be struck out on the same principles, upon which I have based my conclusion that the BSL claim should be struck out. No attempt is made in the pleading of the Statement of Claim to define any transaction or transactions of Plc which resulted in Plc losing the value of its entire group, which were embarked upon by Plc in reliance on D&T’s 1993 audit and which D&T had in contemplation when they undertook that audit.
The following matters are not in issue between the parties. As I have already pointed out, the substantial part of the indebtedness of the Barings Group was incurred in the last three months before February 26th 1995 and it was the loss of the money lent by group companies to finance this indebtedness, incurred in those months, which sealed the group’s fate. It is the claimant’s case, that had Leeson’s fraud been detected as late as the end of January 1995, the group could still have been saved. The collapse of the Barings Group was caused by the irrecoverable Dollar Funding loans and other advances by BSL, BSLL and BSJ, the liability of BFS for undiscovered option transactions to which Leeson committed group companies and the liability for open positions on futures markets as a result of unauthorised house trading by Leeson. The Barings Group collapsed because this indebtedness absorbed the whole of Barings’ capital base. A larger bank with a larger capital base would have survived.
I have already struck out the claims in respect of the Dollar Funding loans. No separate claim is made for loss arising from the loans to BFS by BSJ, the undiscovered options or the unauthorised dealings on the futures market, but these must also have contributed to the collapse.
It is circumstances like these which illustrate the necessity for a “control mechanism” highlighted in many of the judgments dealing with this area of the law. To the outsider it would seem far-fetched that the negligence of a subsidiary auditor of one of the minor subsidiary companies of a complex and substantial banking group should expose that auditor to liability for massive damages flowing from the collapse of the entire group, notwithstanding that it can be said that but for his negligence that collapse would not have taken place.
THE JOHNSON v GORE WOOD DEFENCE.
My conclusion on the Purpose Test point is enough to dispose of BSL’s claim for loss of the Dollar Funding and of Plc’s and BSL’s claim for the loss of the value of their respective groups, but, in case this matter goes further, I shall give my view also on the alternative ground upon which D&T apply to strike out that claim. This requires me to explain the background to D&T’s cross-claim which is the subject of the preliminary issue which is to be heard in January.
D&T’s claim arising out of the representation letters
When conducting their audit for the period ending 30th September 1992, D&T sent to C&LL their audit report on the BFS consolidation schedules on 16th October 1992. The report was expressed to be subject to, inter alia, the local statutory accounts. On 20th November 1992, D&T sent the draft statutory accounts for the various Barings companies in Singapore to Simon Jones, the Finance Director of BFS and the Chief Operating Officer of Barings’ South Asia operations. D&T asked him to sign or have signed the draft accounts and a number of other documents, including a directors’ representation letter in respect of, inter alia, BFS. They sent him a further draft of the representation letter on 10th December 1992. Jones seems to have returned the representation letter signed a few days later. On 31st December 1992, D&T signed off the statutory accounts.
For the period ending 31st December 1993, Jones signed a representation letter in respect of BFS on 27th January 1994, before D&T either sent the opinion on the consolidation schedule to London on 28th January 1994 or signed the statutory accounts on 28th February 1994.
The directors’ representation letter was a letter signed by Jones as a director of BFS. In 1992, he addressed it to D&T “in connection with your audit of the financial statements of [BFS] (“company”) as of [30th September 1992] and for the period then ended for the purpose of expressing an opinion as to whether the financial statements give a true and fair view of the financial position…” . Jones on behalf of BFS confirmed “to the best of our knowledge and belief” a number of representations. These included that “There have been no irregularities involving management or employees who have a significant role in the system of internal control or that could have a material effect on the financial statements” , that “The financial statements are free of material errors and omissions. There are no material transactions or related assets or liabilities that have not been properly recorded in the financial and accounting records” and that “We have recorded or disclosed all liabilities, both actual and contingent”.
The 1993 letter, written on 27th January 1994, included identical wording to that quoted above.
The evidence of Mr Mah of D&T is that, if D&T had not received a satisfactory representation letter from BFS, D&T would not have provided (or, in 1992, would have withdrawn) their opinion on the consolidation pack.
D&T argue that Jones signed both representation letters reckless of their truth or falsity. They argue that each letter contained an implied representation that Jones had reasonable grounds for making the express representations. D&T say that the evidence shows that Jones knew that he had no such reasonable grounds for making these representations, in that he knew that he neither had personal knowledge of the facts stated nor had made sufficient enquiry of those who had such knowledge. Therefore Jones made the implied representation fraudulently.
D&T argue that they were deceived by Jones into signing the audit opinions when otherwise they would not have done so. Therefore BFS is liable to D&T for all the loss flowing from that deceit, and BFS’ action against D&T for audit negligence fails for circuity, because D&T can set off its claim for deceit against BFS’ claim, alternatively BFS is estopped from claiming damages from D&T. D&T’s defence and counterclaim are pleaded at paragraphs 56, 149 and 157 of their Re-amended Defence and Counterclaim in the BFS action. They claim that BFS is “liable for deceit and/or is in breach of contract and/or duty towards D&T”; that D&T are entitled to claim from BFS any sum for which they would otherwise be liable to BFS; and that, if D&T are liable for any sums to BFS, BFS “are liable to them in the same amount, and that [BFS’] claim fails for circuity of action”.
The Issue
It is against this background that D&T apply to strike out BSL’s claim for the Dollar Funding loans. D&T argue that BSL’s claim is a claim by the (indirect) parent company of BFS which is reflective of BFS’ claim, and therefore BSL’s claim is excluded by the rule in Johnson v Gore Wood [2001] 2 WLR 72 .
BSL conceded in argument that its claim for the amount of the Dollar Funding loans was reflective of BFS’s claim against D&T arising from their failure to detect Leeson’s fraud and thus prevent the losses from his fraudulent continuation of the transactions which the Dollar Funding loans financed. But BSL argued that Johnson v Gore Wood does not operate to exclude a shareholder’s claim in circumstances where the defendant has, and always has had, a complete defence to the company’s claim, such as D&T allege in this case.
The Authorities
I start with the judgment of the House of Lords in Johnson v Gore Wood itself. Mr Johnson conducted his affairs through a number of companies, one of which was WWH, in which he held all but two of the shares. WWH brought a claim against Gore Wood, a firm of solicitors, for negligence in serving an option notice. After WWH’s claim had been settled, Mr Johnson brought his own, personal claim against Gore Wood. Gore Wood applied to strike out his claim. One of the issues for decision was whether the heads of damage pleaded by Mr Johnson were irrecoverable, as being reflective of damage which had been suffered by WWH. The House of Lords held that Mr Johnson was unable to recover in relation to (i) the diminution in value of his majority shareholding in WWH and (ii) payments which the company would have made into a pension fund for Mr Johnson. Both were reflective loss. He could recover heads of damage such as sums which, acting on Gore Wood's advice, he invested in other companies and lost, and interest on sums which he was obliged to borrow because of his lack of funds, caused by Gore Wood's breach of duty.
Lord Bingham explained the principles applicable, which he derived from a number of authorities including Prudential Assurance Co. Ltd. v. Newman Industries Ltd. (No. 2) [1982] Ch. 204:
Lord Millett delivered the other main judgment in the course of which he said:-
Lord Millett then quoted the well known example of the theft of the cash box given in Prudential v Newman at p. 222, continued:
At page 124, Lord Millett considered the decision of the New Zealand Court of Appeal in Christensen v. Scott [1996] 1 N.Z.L.R. 273 and decided that it did not represent the law of England:
I was next referred to Day v Cook [2001] Ll. Rep. P.N. 551. Here Mr Day was the principal shareholder in TL. He had been persuaded by his solicitor, Mr Cook, to invest through TL in a number of joint ventures. This advice was negligent and in breach of fiduciary duty. All the ventures failed and Mr Day sued for the loss in value of his shareholding. TL and its related companies were not parties to the litigation. By the time of the decision, they had all been dissolved and any claims they might have had against Mr Cook would have been time-barred.
The Court of Appeal held that all Mr Day’s principal claims failed because they were reflective loss (though one minor claim relating to a loan of £40,000 was remitted to the trial judge for further decision). Arden LJ cited at length the speeches in Johnson v Gore Wood and concluded:
Ward LJ, with whom Tuckey LJ agreed, concurred with Arden LJ in respect of the claims for loss of value of shareholding, stating that the “ losses fall squarely and unarguably within the first rule established by Lord Bingham of Cornhill in Johnson v Gore Wood & Co.”. He remitted the issue as to the £40,000 to the trial judge, noting that, among the questions with which the trial judge would have to deal were:
I was referred to two recent cases at first instance in which the principle has been applied. In John v Price Waterhouse (11th April 2001, unreported), Sir Elton John was not a shareholder of the corporate vehicle concerned, but was an employee entitled to a salary equal to 99% of its net income. The company was alleged to have suffered loss as a result of the defendant’s negligence. Its claim was time-barred. Sir Elton sued for the loss he suffered through the reduction in the company’s income. Ferris J held that Johnson v Gore Wood applied to bar his claim. The time bar did “ not produce a situation in which “the company … has no cause of action.” … [It] had a cause of action and strictly it still has it, although it is subject to a procedural bar which prevents it maintaining an action upon it. Moreover the shareholder’s (or in this case the employee’s) loss is attributable not to the action of the assumed wrongdoer but to the fact that the company has allowed its claim to become statute-barred.”
Finally Giles v Rhind (24th July 2001, unreported) was, as Mr Gaisman described it, undoubtedly a hard case. Mr Rhind, a 50% shareholder in a company, SHF, acted in breach of a contractual duty of confidence owed to SHF and to the other shareholder, Mr Giles. SHF sued, but discontinued after it was unable to raise security for Mr Rhind’s costs. By then in administrative receivership, it agreed not to bring any further proceedings. Mr Giles then sued and succeeded at the trial on liability. At the assessment of damages, the Johnson v Gore Wood point was taken against him, by which time the company’s claim was time-barred as well as barred by the settlement agreement.
Applying the principles which he drew from Johnson v Gore Wood , Blackburne J held that Mr Giles’ claim was clearly reflective and was barred by the rule, despite the company being unable to claim and therefore the outcome leaving “ a wrong without a remedy ”. Having quoted Lord Millett’s explanation, quoted above, why a shareholder should not be able to go behind a settlement of the company’s claim, he noted at paragraph 31:
Nevertheless Blackburne J held that he was bound by Johnson v Gore Wood and that there was “no basis for distinguishing the heads of loss which [Mr Giles] claims against Mr Rhind from the plaintiff’s claim to loss of dividend and diminution in share value which the House of Lords held to be irrecoverable in Johnson v Gore Wood.”
Is BSL’s Claim for The Dollar Funding Reflective Loss?
As I have stated, Mr Aldous for BSL conceded that, if there were no defence to a claim by BFS, BSL’s funding claim would be reflective of BFS’ claim. This is clearly correct. BFS is claiming from D&T the losses it incurred on SIMEX, which it argues would have been avoided if D&T had performed their audits competently. Part of the losses claimed by BFS were funded by loans from BSL which BFS remains liable to repay. If BFS’ claim were to succeed, it would be obliged to repay BSL’s funding and BSL’s loss would be made good. BSL’s claim is therefore within Lord Millett’s observations in Johnson v Gore Wood :
BSL’s Dollar Funding is in the same category as the pension contributions which Mr Johnson would have received from the company in that case if it had not been for the defendant’s breach, and which the House of Lords held to be irrecoverable.
Does a defence to the company’s claim oust the rule?
That being so, the argument before me came down to quite a narrow point. BSL argued that, although Johnson v Gore Wood would apply to its claim if BFS had an enforceable claim against D&T, it does not operate to exclude a shareholder’s claim in circumstances where the defendant has, and always has had, a complete defence to the company’s claim. BSL said that that is the position here. It referred to three defences:
I can deal with the first two points reasonably briefly. The first, in particular, has no substance. In almost all strike out applications and preliminary issues the defendant will deny liability but the application will proceed on the assumption that the case pleaded by the claimant is made out. If the defendant successfully defends the claim on the merits, the Johnson v Gore Wood point becomes unnecessary of decision along with most other issues. The whole point of this application is to decide whether, if D&T are proved to have been negligent, Plc and BSL can claim.
The second point arises out of D&T’s defence in the BFS action:
At paragraph 82AA, D&T contend that the correct measure of BFS’ loss is not, as BFS claim, the amount of the losses it incurred on SIMEX. Rather, it is BFS’ liability to the other companies in the Barings group who provided the monies used to fund the losses. D&T say that BFS has declined to plead its claim on that basis and as a result its claim fails. Alternatively, if BFS does advance an alternative case on the basis of liability to other companies, BFS must give credit for profits and interest received by those companies, and other factors.
At paragraph 82AB, D&T argue that, if (contrary to the above) BFS’ current basis of claim is correct, BFS must give credit for the funding from other group companies, commission and interest income of BFS, and profits and interest accruing to the other companies.
BSL argue that, if D&T’s point at paragraph 82AB is correct, it would eliminate BFS’ loss without affecting BSL’s claim. Therefore BSL’s claim is to recover a loss separate and distinct from that suffered by the company, within Lord Bingham’s formulation.
I think this argument goes too far. D&T’s point is that BFS have pleaded on the wrong basis. They emphasise that by saying that, if BFS’ basis of claim were correct, BFS would have to give credit for other companies’ funding to it. It has not been argued before me which is the correct basis of claim, and I do not decide the issue. But clearly it does not prevent Johnson v Gore Wood applying that the company’s claim might fail because it has been wrongly pleaded. That is on all fours with all the cases I have cited above, in each of which the company allowed its claim to be barred, by limitation and/or by settlement, and yet the rule applied. As Lord Millett observed in one of the passages from that case which I have quoted above:
The third argument put by BSL – that based on the representation letter argument – has more substance. D&T argue that Jones’ representation letters give them a complete defence to BFS’ claim for negligence. Furthermore BSL point out that D&T acquired their cause of action when they received the letters, whereas BFS only acquired its cause of action when the statutory accounts were signed, which in each year is a later date. Therefore BFS never had an enforceable claim against D&T.
Mr Aldous based his argument on Lord Bingham’s statement in Johnson v Gore Wood that the issue on a strike-out is “whether the loss claimed appears to be or is one which would be made good if the company had enforced its full rights against the party responsible” . Arden LJ used a similar formulation in Day v Cook : the court must “consider whether the loss would have been made good if TL … had enforced any action which it may have had against Mr Cook.” Mr Aldous pointed out that plainly a loss cannot be made good by the company enforcing its full rights if the company’s claim is subject to a complete defence.
Mr Aldous supported this argument by looking at the rationale for the Johnson v Gore Wood rule, and Lord Millett’s explanation that:
So Mr Aldous argued that the principle is aimed at protecting companies, for the benefit of their creditors and members, and defendants from paying out twice. It is not intended to protect defendants from having to pay at all.
This argument raises the issue of what Lord Bingham and Arden LJ meant by “ if the company had enforced its full rights” . Clearly it does not require that the company was in fact able to enforce its rights, since in all the four cases I have cited above the company was not in a position to enforce its rights yet the rule applied. Equally the principle is not limited to protecting companies, for the benefit of their creditors and members, and defendants from paying out twice: again, in each of those four cases the company recovered nothing and the rule relieved the defendant of most or all of its liability.
Mr Aldous’ answer was that those cases have involved only two types of defence – limitation and settlement. Both, he argued, are defences which arise subsequent to the accrual of the company’s cause of action, as a result of the company’s own act or default. He conceded that the same would apply where the company was estopped by its subsequent conduct from bringing a claim. As Lord Millett observed, in such cases the shareholder’s claim is barred as a matter of causation. But Mr Aldous argued that the same does not apply where the defence is available from the start. The test, he said, is to look at the situation at the date when the company’s cause of action arose. If at that date the company had an enforceable cause of action, the shareholder cannot claim, irrespective of whether the company does in fact recover in full. If at that date the company did not have an enforceable cause of action, the shareholder can claim.
Insofar as Arden LJ in Day v Cook seemed to extend the rule further, suggesting that the shareholder could not sue for reflective loss no matter what the nature of the defence to the company’s claim:
I agree with Mr Aldous that neither Johnson v Gore Wood nor the cases since (save perhaps for Arden LJ’s dictum) give a clear answer to the question raised by this application. The two reasons underlying the rule put forward by Lord Millett, of protecting the defendant from double recovery, and the shareholders and creditors from one shareholder scooping the pool, do not require Plc’s and BSL’s claims to be barred. Mr Gaisman for D&T relied also on Lord Millett’s discussion of causation and what Mr Gaisman termed Lord Millett’s circumvention argument. But the former amounts to saying that, if the shareholder cannot sue, his loss is caused by the company, not the defendant, rather than explaining why the shareholder cannot sue; and the latter is stated by Lord Millett as applying to a settlement of the company’s claim, rather than as a principle of general application.
It is clear from the cases that, as Arden LJ stated in Day v Cook , the rule is not rooted in avoiding double recovery and does apply where the defences of limitation and estoppel, at least, are available to the defendant. Beyond that, any general principle involves unsatisfactory distinctions between defences. Mr Gaisman contended, I think correctly, that the correct distinction is between cases where there was no claim at all and those where the claim existed but was subject to a defence. I can see that that might itself lead to some fairly narrow distinctions, but Mr Aldous was unable to come up with a more satisfactory rule.
As I have indicated above, Mr Aldous initially proposed that the dividing line was between defences that were available when the cause of action accrued and those that were not. So he conceded that, where the defendant has a defence to the company’s claim, of limitation, estoppel by convention, or estoppel by conduct, the shareholder cannot sue. But he argued that defences that arise prior to or at the same time as the cause of action do not bar the shareholder’s claim.
I am not sure that this distinction fits in with either BFS’ or Plc/BSL’s pleadings. Both contain significant allegations of negligence by D&T prior to their receipt of the representation letters and plead that, if it had not been for that negligence, Leeson’s fraud would have been discovered and/or prevented; and BFS argue that auditors have a duty to warn before conclusion of the audit, in line with Sasea v KPMG [2000] 1 All ER 676 . In any event, if the rationale for the rule in Johnson v Gore Wood is avoiding double-recovery and protecting the company, it is difficult to see why the time when the defence arose should be critical.
Furthermore, in argument I suggested a situation where an auditor, who is being sued for negligence in his audit, is owed fees for prior audits which exceed the amount of the negligence claim. Surely the auditor’s right to set off the claim for fees would bar the shareholder as well as the company, even though the fees claim arose before the company’s cause of action? Mr Aldous conceded that it would.
Accordingly there cannot be a distinction based only on timing. Mr Aldous found himself trying to argue that defences of limitation, estoppel by convention, estoppel by conduct and set-off, pre-existing or subsequent, all barred the shareholder suing; but D&T’s claim for deceit, giving rise to estoppel or set-off or a defence of circuity, does not. It is no criticism of him to say that he found it difficult, and he did not satisfactorily reformulate his contention as to what the distinction should be. That suggests that the correct distinction is that between claims that exist and those that do not and therefore, effectively, that Arden LJ in Day v Cook at para 38 meant what she said.
However it is not necessary for the purpose of deciding this application to decide whether that is right. I have said that Mr Aldous conceded that the fees set-off mentioned in argument would bar the shareholder’s claim. That must be correct: the company in that example has received value for its negligence claim, in that it has used it to reduce the auditor’s claim for fees. To allow the shareholder to bring a claim for negligence would indeed be to allow double recovery against the auditor.
Mr Gaisman contended that the present case is on all fours with the example of set-off of fees. Mr Aldous tried to distinguish that example from D&T’s counterclaim for deceit by arguing that, in the fees example, the fees claim is a free-standing claim. There are two independent, valid claims, each of which is enforceable and could be enforced were it not for the other. He contrasts that with D&T’s claim, which exists only as a defence to BFS’ claim against D&T, and would have no substance were it not for that claim.
I do not see any valid distinction between the two situations. On their case, D&T had a cause of action in contract against BFS when the representation letters were written, and in tort once they suffered damage. It is true that the damage suffered is their exposure to a potential liability to BFS and that their loss is to be quantified by reference to the amount of that liability. That makes it more difficult to talk of the company having received full value for its claim, given that on the facts the claim against which it is set off has no value other than to negate the company’s claim. But that does not justify treating the set-off of D&T’s claim for deceit differently from the set-off of the auditor’s fees in my example: both are separate claims arising out of facts related to those giving rise to the principal claim and which can be pleaded as a defence to that claim. In my view both prevent the shareholder suing for reflective loss.
For completeness, before I conclude this section I should deal with two further points argued by Mr Aldous:
Accordingly in my judgment D&T’s entitlement to set off its claim for deceit against BFS’ claim against them for negligence is not a circumstance which permits BSL, as a shareholder of BFS, to sue for reflective loss. BSL’s claim for its dollar funding is reflective. Therefore I conclude that for this reason also the Dollar Funding claim, pleaded at paragraph 334 of BSL’s statement of claim, discloses no reasonable cause of action and should be struck out pursuant to RSC O.18 r.19 (1)(a).
BONUSES
The third category of claim summarised at paragraph 29(iii) above which is the subject of this application is Plc’s claim for overpayment of bonuses. D&T applied to strike it out both on Johnson v Gore Wood grounds and on the facts as being an abuse of process. I shall deal with the two points in that order, but must first describe the claim as pleaded.
I have quoted in the Pleadings section at paragraph 29 of this judgment paragraph 335 of the Statement of Claim. The schedule referred to in that paragraph was never served. Instead the claimants served Amended Further and Better Particulars in February 2001, which pleaded as follows:
Johnson v Gore Wood
It is agreed between the parties that I cannot at this stage give a final decision on this ground. This is because the decision will depend upon the findings in the trial. The loss which is at the centre of the claim is the loss to BFS of £24.4m incurred by Leeson’s unauthorised trading during 1993. In the BFS action, BFS has claimed that from D&T on the basis that D&T were negligent in the 1992 audit: if D&T had performed that competently, Leeson’s fraud would have been stopped then and he would not have incurred the £24.4m of losses during 1993. On the other hand, Plc claim in relation to the 1993 audit that, if D&T had performed that audit competently, Plc would have known that the profits for 1993 were overstated and would not have made the £12.2m of excess bonus payments.
Plc concede that, if BFS succeed in proving negligence in relation to the 1992 audit, Plc’s claim for overpayment of bonuses in relation to the 1993 audit will be reflective loss and Plc will be unable to claim under this head. If BFS do not succeed in relation to the 1992 audit, it will (subject to D&T’s other ground of challenge, considered below) be open to Plc to seek to recover under this head in relation to 1993.
Inherent Jurisdiction
D&T submitted that a small number of documents which they tabled showed that, for the accounting year 1993, there were separate bonus pools for the BSL Group (which included BFS) on the one hand and the rest of the Barings Group on the other. 50% of BSL Group profits were paid out as bonuses to directors and staff of the BSL Group. Therefore the overpayment of bonuses was borne by BSL, not Plc. Plc did not seek to contest this.
D&T are not alleged to have owed a duty to BSL in relation to the 1993 audit. The claimants allege only a duty of care owed to Plc. Therefore, on the face of it, the only party which suffered loss was owed no duty of care and the only party which was owed a duty of care suffered no loss.
The claimants made no response to this argument, other than to state in their skeleton that:
I must decide this application on the basis of the current pleadings. No application has been made for leave to amend paragraph 335 or the Amended Further and Better Particulars, which plead a claim for overpayment, not a claim for loss suffered by the parent company as a result of an overpayment by its subsidiary. If such an application were made in the form of the current draft I would reject it as embarrassing to D&T. Plc must decide whether it accepts that the bonus payments in question were born by BSL and plead accordingly. I would also reject it on the ground that it is too late. The new case presented of loss of value to Plc’s group will require significant further factual and expert valuation evidence to support it which D&T should not now be required to meet. The claim is also now probably statute-barred.
The current pleading is a claim for the difference between the amounts paid as bonuses and the sums which would have been paid if D&T had not been negligent. The claimants do not dispute that the bonuses were overpaid by BSL, nor that D&T did not owe a duty of care to BSL in relation to the relevant year. Therefore as pleaded, in the light of the undisputed facts, the claim has no prospect of success and I shall strike out the current pleading under my inherent jurisdiction.
In the result I will accede to the application of D&T and grant the relief sought.