UK: England and Wales: auditor liability and trading losses

In 2017 the Financial Reporting Council sanctioned Grant Thornton UK LLP and one of its retired partners for misconduct in relation to the audits of AssetCo plc: see here. A negligence claim against Grant Thornton was brought, in which judgment was delivered by the High Court today: see Assetco Plc v Grant Thornton UK LLP [2019] EWHC 150 (Comm).

Damages of approximately £21 million have been awarded and Grant Thornton's claim that it should be relieved from liability under section 1157 of the Companies Act 2006 was strongly rejected, the trial judge (Bryan J.) stating (at para. [1268]): "The breaches consisted of a catalogue of failures over two audit years that were of the utmost gravity and that went to the very heart of an auditor's duties and the 'very thing' GT admits it was responsible for but failed to do".

One of the more controversial issues in the case was the extent to which Grant Thornton should be liable for trading losses.  It is worth, in this regard, quoting directly from the judgment (paras. [961] to [964],[966] emphasis in the original): 

In the present case GT's negligence deprived the decision-makers within AssetCo of the opportunity to "exercise their powers in general meeting to call the directors to book" for the dishonest way in which the business was being run, to "influence future policy and management" in that regard "and to ensure that errors in management" – i.e., that dishonesty – "were corrected". Thus, GT's (admitted) audit failures deprived AssetCo not only of the opportunity to call the directors to book but also to ensure that errors in management were corrected, and the company did not continue to trade, and be run in a "fundamentally dishonest" way. The losses that were suffered were not suffered simply because the company remained in existence and carried on trading, but rather as a result of AssetCo continuing to trade in a particular fashion in reliance on the (negligent) audit.

I therefore conclude and find that the trading losses fell within the scope of GT's duty on the basis that they were sustained through AssetCo's (continued) trading in a fundamentally dishonest manner, in reliance on the negligent audit, in circumstances where if GT had acted in accordance with its duties it would have uncovered most if not all of the instances of Mr Shannon's and Mr Flynn's dishonesty, and AssetCo would (as I have found on the Counterfactuals) have entered into a Scheme of Arrangement, carried out a refinancing, placed the LFEPA and Lincoln Contracts on a sustainable footing, whilst allowing other subsidiaries to "sink or swim" and would have focussed on securing business in Abu Dhabi.

GT's general points about how Caparo [[1990] 2 AC 605] shows that the auditor's duty is not to create financial statements but to review them, and that its duties in terms of any investigation into the company are somewhat limited as compared to the duties on directors themselves, are not in point in circumstances where it is common ground that GT's duty was sufficiently broad that GT should, in the proper exercise of that duty, have uncovered many, if not all, of the instances of management deceit carried out by Messrs Shannon and Flynn, consequent upon which AssetCo would have called the directors to book and ensured that the company did not continue to trade (given that the company was "ostensibly sustainable only on the basis of dishonest representations or unreasonable decisions made or taken by management – Revised List of Issues para 6(1)).

I am also unpersuaded by GT's submission that the effect of the conclusion that I have reached would be that an auditor that fails to identify a particular fraud effectively becomes an insurer of the company for any dishonesty or fraud within the company and trading losses suffered as a result. That is not the effect of my conclusion.

I also reject the suggestion that the consequences of my conclusion are either draconian or unfair to the auditor. On the contrary, I consider it entirely appropriate that GT assumed a responsibility to protect AssetCo against losses suffered as a result of fraudulent trading conducted by the AssetCo management in circumstances where it is agreed that GT should have detected that the business was being conducted fraudulently, and in circumstances where such fraudulent trading would not have continued had GT complied with its auditing duties".

UK: England and Wales: unfair prejudice and excessive remuneration

Judgment was given earlier this week in McCallum-Toppin & Anor v McCallum-Toppin & Ors [2019] EWHC 46 (Ch). The case concerned a successful petition under section 994 of the Companies Act 2006. This first instance judgment deserves a note here because it provides a very good illustration of the difficulties inherent in determining whether remuneration can be regarded as excessive in the context of a section 994 claim, including the appropriateness of benchmarking and comparators for a private company.

UK: encouraging effective stewardship

Under the banner of 'encouraging effective stewardship', there are several developments to report today. First, the Financial Reporting Council has published a consultation paper setting out proposed revisions to the UK Stewardship Code: see here. Second, and connected with the FRC's consultation, the Financial Conduct Authority has published two documents: (1) a consultation paper on regulatory measures to implement the provisions of the amended Shareholder Rights Directive for FCA-regulated life insurers and asset managers; and (2) a discussion paper, with the FRC, on the importance of effective stewardship, considering, for example, what should be the minimum expectations for financial services firms investing for clients and beneficiaries.

UK: England and Wales: a proper instrument of transfer?

Judgment was given yesterday in Yusuf v Yusuf & Anor [2019] EWHC 90 (Ch) by Mrs Justice Falk. The trial judge found that a company's affairs had been conducted in an unfairly prejudicial manner for the purposes of section 994 of the Companies Act 2006. I note the decision here not because of the discussion of section 994 but because the trial judge considered the requirement, under section 770(1)(a) of the 2006 Act, for there to be a "proper instrument of transfer" where a share transfer is registered.  According to the trial judge, such an instrument was "a document that is capable of being stamped" and she held that the document at issue in the case before her - a letter - was only an instruction to transfer which contemplated the execution of a further document.  It was not, as such, a proper instrument of transfer.

UK: England and Wales: terminating membership and an implied term

Judgment was given lat week in Dymoke v Association for Dance Movement Pyschotherapy UK Ltd [2019] EWHC 94 (QB) by Mr Justice Popplewell. The case concerned a company limited by guarantee and, in the context of a decision to terminate a member's membership, an argument based on the existence of an implied term concerning the manner of the termination. The trial judge held that an implied term existed and in doing so stated (paras. [60], [61] and [65]):

.... generally an implied term must not be inconsistent with any express term. The duty to act fairly in relation to decisions to terminate membership of a company must be consistent with the articles of association and with the fiduciary duties of the directors. However, I see no difficulty in the content of the duty of fairness in any given circumstance being fashioned to ensure such consistency. It is common ground in this case that the contract included the terms of the Ethics Code and Complaints procedure which confer powers to impose sanctions ranging from reprimand through suspension to withdrawal of registration and termination of membership. In the context of an organisation such as ADMP, there is every reason to treat those decision-making powers as subject to an obligation of procedural fairness in just the same way as would apply to decisions of a public body. Indeed one would only have the now out of fashion officious bystander ask, "Can the Council act unfairly in deciding to terminate membership?" for the testy suppression "of course not" to be forthcoming.

Expressed in this way, there is no inconsistency between implying a duty of procedural fairness and the fiduciary duties of a director, which include now those now statutorily defined in s. 172 of the Companies Act 2006.

I conclude that it was an implied term of the contract between ADMP and Ms Dymoke that she would be treated fairly in relation to her termination; and in particular that she would be informed of the complaints or concerns in sufficient detail to enable her to respond to them and would be given a reasonable opportunity to respond. That applies not only to the substance of the complaints or concerns, but also to the question whether they justified the sanction of termination of membership. Such a term satisfies the test in Marks & Spencer Plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72; [2016] AC 742, and accords with public law principles and those which govern the exercise of a contractual discretion"