The Principal Proceedings
4 Although the issues were confined during the hearing, it is necessary, in my opinion, to consider a wider factual matrix to give content to the decision to which I have come. This is also necessary to consider defences of election, waiver, acquiescence and delay raised by the plaintiffs and MSJ.
5 In setting out the nature of the dispute between the plaintiffs and the defendants, the Summons stated that the claim related to misleading and deceptive representations made by them, and each of them, in their audit report and audit opinion dated 10 October 1997 relating to and appended to the financial statements of Clifford Corporation Limited, ("Clifford"), including Clifford's consolidated accounts and those of its controlled entities for the financial year ended 30 June 1997, such that the audit opinion was misleading and/or deceptive or likely to mislead or deceive a person reviewing the financial statements, which the first plaintiff alleged it did, in breach of s.42 of the Fair Trading Act. Particulars were given of matters to which it is alleged attention should have been drawn in the audit opinion and to whether further qualifications, relating to those matters, should have been made in that opinion.
6 It was alleged that the first plaintiff purchased Subordinated Capital Notes issued by Clifford in reliance on the financial statements and the audit opinion and has suffered loss as a result of those investments.
7 Under the heading "Issues Likely To Arise", the plaintiffs stated that the principal issues likely to arise are whether:-
(a) further qualifications to the audit opinion, in respect of the particular matters identified or otherwise, should have been made;
(b) the provision of the audit opinion unqualified by the matters identified amounted to misleading and/or deceptive conduct on the part of the defendants; and
(c) the financial statements gave a true and fair view of the state of affairs as at 30 June 1997 in various particulars and were in accordance with the provisions of The Corporations Law , ("the Law"), and applicable accounting standards. It was also asserted that an issue likely to arise was whether the audit opinion was misleading and/or deceptive in that the audit on which it was based was not conducted in accordance with the Australian Auditing Standards and/or the provisions of the Law, and did not give a true and fair view of the state of affairs as at 30 June 1997 and of the profit and cash flow for that financial year in respect of Clifford and its controlled entities.
8 The particulars referred to the improper recognition of income and assets and the improper declaration and/or payment of a dividend from sources other than from Clifford's profits.
9 The plaintiffs' contentions traced the relationship between the plaintiffs, which on the pleadings is not really in issue, and the acquisition by the first plaintiff of the Subordinated Capital Notes. It pleaded that at a meeting of creditors held on 23 March 1999 Clifford was put into liquidation; that the liquidators informed creditors that there was no expectation of any dividend to unsecured creditors; and that either the first and/or the second plaintiff was and/or is an unsecured creditor of Clifford. The defendants' Defence, which was filed on 13 October 2000 by their solicitor, Mr Andrea Davide Martignoni, the present supervising partner of the principal proceedings in AAH, did not put these matters in issue.
10 The contentions continued that the defendants carried on their practice; that they were, at all material times, members of the Institute of Chartered Accountants; that they were appointed auditors of Clifford to audit its financial statements, including the consolidated accounts of the entities controlled by Clifford for, inter alia, the financial year ending 30 June 1997; that they did through the appointed partner, the second defendant, audit the financial statements for that year; and that by reason of the defendants' engagement as Clifford's auditors they were at all material times under a statutory duty to comply in all respects with the provisions of Division 2 of Part 3.7 of the Law as it applied in 1997 to the preparation of the financial statements. On the pleadings none of these matters was in issue.
11 Thereafter the pleadings set forth the applicable accounting standards, statutory requirements and legislative provisions and, in paragraph 35(a), pleaded at length the defendants' Audit Report of 10 October 1997. The defendants conceded that in giving an opinion in the terms thus pleaded, which was admitted, they represented that they held the opinion stated therein and had a reasonable basis for doing so. Paragraph 36 set out at length the allegations of breach.
12 It will be necessary to look more closely at the course the proceedings have taken.
How The Conflict Of Interest Arose
13 Mr Carl Jepson was formerly employed by the defendants as audit manager. He was the audit manager for the Clifford audit for the financial year ended 30 June 1997. On 18 August 1999 he received a letter from Australian Securities & Investments Commission, ("ASIC"), enclosing a notice, issued pursuant to s.19 of the Law, requiring him to appear before certain named people for examination on oath and to answer questions. The notice stated that the questions related to an investigation of suspected contraventions of ss.232, 292, 318, 999, 1001A and 1309 of the Law concerning the affairs of Clifford and its subsidiary companies between 1 January 1996 and 18 February 1999.
14 Mr Jepson advised the defendants immediately of receipt of the notice. The defendants informed their insurance brokers, J & H Marsh & McLennan Pty Limited, ("Marsh"), of the advice received from Mr Jepson; of various facts relating to the defendants' having been auditors of Clifford; that Mr Jepson had tendered his resignation as of 31 December 1997; and that in January 1998 the defendants had resigned as auditors of Clifford. Some further history was set out, including the fact that in March 1999 ASIC requested the defendants to provide audit working papers and other documents to it in relation to an investigation by ASIC concerning Clifford, and continued:-
"We believe that the Accounts as presented for the year ended 30 June 1997 disclosed a true and fair view of the affairs of Clifford Corporation Limited. We believe that there was sufficient information for the users of same to make valued judgments on those Accounts.
At no time have we received any enquiries or communications from third parties subject to the proceedings or from the Institute of Chartered Accountants as to the financial Accounts of Clifford Corporation for the year ended 30 June 1997.
As stated above, Mr Carl Jepson has been requested to appear at the Australian Securities & Investments Commission on Monday. Mr Jepson has had legal advice suggesting that a legal representative accompany him.
We wish to know if our Professional Indemnity Insurance cover will cover such legal representation. Would you please convey a copy of this facsimile to our Insurers, GIO requesting advice as to whether or not the Policy covers payment of legal representation in this case.
In view of the time constraints, an early reply would be greatly appreciated. If you require any further information please do not hesitate to contact the writer."
15 On 19 August 1999, GIO Insurance Limited, ("GIO"), wrote to another partner of MSJ, Mr Peter Stockdale. It stated it was the professional indemnity insurer of the defendants, briefly set out the relevant facts, and requested Mr Stockdale, in accordance "with the retainer agreement signed by your firm", to provide an advice on indemnity and generally in relation to the claim, and to act on the defendants' behalf on a "without prejudice" basis to the rights of GIO, until such time as indemnity was confirmed, to protect their interests.
16 Although the letter was addressed to Mr Stockdale, it was passed to Ms Robyn Ann Chalmers, another partner of MSJ. There was no suggestion that, in so far as Mr Stockdale was fleetingly involved in the matter, this gave rise to or was relevant to the conflict of interest issue. Ms Chalmers, who has been a partner since July 1984, and Mr Stockdale are the two partners in a practice group at MSJ known as the Professional Indemnity and Product Liability group, which is a sub-group of the Commercial Disputes group, and, generally speaking, part of the litigation group or section. She said that there are approximately ten or twelve solicitors working in that sub-group and that Ms Coleman is not a member of it, although she is a litigation partner.
17 Ms Chalmers has no independent recollection of the matter, save for receiving a telephone call from an employee of GIO, who told her that GIO had a new matter in which it would like MSJ to represent the insured. Whilst her recollection is unclear, she believed she was told the matter involved an examination of the insured under the Law and was urgent. She was given no details, she had no papers from GIO at that time and she does not have a specific recollection of receiving any. She said that it was her usual practice to allocate the matter to a solicitor in her group and that usually she read the papers briefly before doing so, although this was not an invariable practice. She did not recall reading the papers in this matter.
18 She recalled speaking to Ms Jacqueline Mary Dempsey, a solicitor then employed by MSJ, about the matter. Ms Dempsey commenced this employment in about June 1999 and resigned on or about 25 November 1999. Ms Chalmers does not remember whether she had the papers when she spoke to Ms Dempsey or whether she spoke to her before they arrived. However she told Ms Dempsey she had a new matter from GIO to which she wanted her to attend, and:-
"Ring the insured to tell them we are looking after it once you have looked at the papers. Do a conflict check. It is quite urgent. You should brief counsel. See who is available since it is pretty short notice."
19 A conflict search was carried out. There are within MSJ and, I would assume, most firms of solicitors, procedures whereby it can be ascertained when new instructions are sought to be given whether the solicitors would, by accepting those instructions, find themselves acting or potentially acting for parties on both sides of the record, such that a conflict of interest would or may arise.
20 The conflict report disclosed that there was, in truth, a conflict of interest in that Ms Coleman was acting for the plaintiffs in relation to their proposed claim against, amongst others, the defendants. Although the report was received by Ms Dempsey, she did not read it properly, as she said "unfortunately". Thus the conflict was not recognised. No submission was made that MSJ should not have left the consideration of that report to her or had her refer it to, e.g. Ms Chalmers. Nor was any submission made that the methods adopted by MSJ to ascertain the existence of conflicts, or potential conflicts, was in any way deficient.
21 The conflict arose in this way. In December 1998 MSJ received instructions to act in relation to the losses suffered by the first plaintiff in relation to its purchase of Subordinated Capital Notes issued by Clifford. Ms Coleman was the partner in charge of the matter and she was assisted principally by Ms Pearson. Following receipt of those instructions certain investigative steps were carried out by MSJ, with the assistance of an expert accountant, in relation to the circumstances surrounding the acquisition by the plaintiffs of the Notes including, in particular, the accuracy of the financial information which had been provided to the party through whom the plaintiffs purchased the Notes. As at August 1999, Ms Coleman, on behalf of the plaintiffs, was actively pursuing the matter with a view to deciding whether proceedings should be brought against, amongst others, the defendants. It was not in issue that in accepting instructions from GIO and the defendants, in those circumstances, a conflict of interest arose.
22 Ms Dempsey briefed counsel to appear for Mr Jepson at the ASIC examination and, on 20 August 1999, there was a conference between Ms Dempsey, Mr Meldrum, Mr Jepson and that counsel. The examination took place on 23 August 1999. Counsel, who, it was conceded, is in no way involved in the principal proceedings, attended with Mr Jepson at the examination. Ms Dempsey did not.
23 On 20 August 1999, Ms Dempsey drafted a letter to GIO for Ms Chalmers' consideration and signature setting out the position at that date. Whilst the letter was signed by Ms Chalmers and, on its face, indicated that she had done a number of things, the evidence satisfies me that she had not but rather Ms Dempsey had, a comment not made critically of Ms Chalmers, and Mr Stevenson did not submit to the contrary. The letter, which is the subject of a confidentiality order and, therefore, can only be mentioned in general terms, referred to the instructions, the briefing of counsel, the conference, and the general nature of the matters upon which Mr Jepson was to be examined. It also set out certain observations Ms Dempsey had made about Mr Meldrum and Mr Jepson and certain information, I infer, she had received about Mr Nissen's involvement in the audit. The letter concluded by stating that a detailed advice on indemnity would be provided after the examination.
24 On 20 August 1999, MSJ wrote to the defendants confirming that they had been instructed by GIO "to assist you and your former employee, Mr Carl Jepson, before the Australian Securities & Investment Commission on Monday 23 August 1999".
25 The letter stated that MSJ would protect "your interests on the basis that we also act for the insurer … and that any steps taken to assist you are on a without prejudice basis to the rights of the insurer and without admission of any entitlement on your behalf to indemnity under" the relevant policy. The letter continued:-
"We will only be able to obtain instructions from the insurer on your behalf at this time under the policy. We will assume conduct of the matter on your behalf when we have completed our consideration of the matter, the merits of the investigation of the Australian Securities & Investment Commission against your ex-employee, and the question of indemnity under the policy after we submitted our report to the insurer.
All information provided to us by you for the purposes of considering this matter may be disclosed by us to the insurers."
26 No written statements or proofs of evidence were taken from either the defendants, Mr Jepson or any of the defendants' staff by MSJ for the purposes of carrying out their instructions.
27 On 24 August 1999, counsel to wrote to Ms Dempsey setting out, in general terms, what had transpired at the examination. He forwarded to her six tapes of the examination, to which, after receiving Ms Chalmers' consent to spend the time and incur the costs, Ms Dempsey listened and about which she made notes.
28 Ms Dempsey requested this consent in an e-mail which she sent to Ms Chalmers between 24 August and 1 September 1999. That e-mail is under Tab 13 in Exhibit A and is one of a number of confidential documents in that exhibit, the others being those appearing under Tabs 3, 6, 7, 8, 9, 10, 11, 12, 15, 16, 17, 19, 21, 26 and 27. They are, accordingly, not documents to which I can make any but the most general reference. The e-mail under Tab 13 referred to a telephone call from counsel and Mr Jepson to Ms Dempsey during which there was discussion about the ASIC examination. It set out certain confidential information Mr Jepson gave about a matter arguably relevant to the plaintiff's present claim. The disclosure of this information to Ms Dempsey and, hence MSJ, was a matter on which Mr Stevenson, understandably enough, placed heavy reliance.
29 The e-mail formed part of the MSJ file. In circumstances to which I shall refer, that file was handed over to Mr Bates once the conflict issue was ultimately raised. It remained in his overall custody and in secure circumstances until recently when it was given by him to AAH. Mr Stevenson expressly conceded that none of those circumstances gave him any evidentiary basis for submitting that if Mr Bates read the memorandum or any other documents in the file, this would lead to a risk that its contents may be conveyed to any other person. It was not in issue that Mr Bates has nothing to do with the principal proceedings.
30 Because of the sensitivity of this document it became necessary to ascertain precisely where the original and any copies of it are. The original is with AAH. There was a copy in each of the bundles, which became Exhibit A. Thus Mr Robinson has access to one. Mr Robinson, whilst appearing for the plaintiffs on this application, informed me from the Bar table that he was not and would not be briefed for them in the principal proceedings. Mr Stevenson accepted this. Mr Stevenson has a copy. As he is acting for the defendants that can occasion no prejudice to them, the original being in the possession of AAH, who have briefed him. Mr Douglas and Ms Rees have a copy, but they are taking no part in the principal proceedings. I have a copy, but I shall not be hearing the principal proceedings. It was agreed that the original and all copies were thus accounted for. I was informed that all counsel had given confidentiality undertakings before being shown this and the other confidential documents. No submission was made by Mr Stevenson that the limited dissemination of the documents, in all these circumstances, would lead to any prejudice to the defendants in relation to any aspect of the principal proceedings.
31 An essential submission was that Ms Dempsey had been in possession of this information, which she had conveyed to Ms Chalmers and that either may, there being no evidence that either had, have passed it on to some other person at MSJ, who in turn may use it or convey it to some other person at MSJ, who may use it, to the prejudice of the defendants.
32 On 1 September 1999, Ms Dempsey drafted a letter to GIO for Ms Chalmers' approval and signature. Ms Chalmers signed it and it was sent. A copy was sent to Ms Carly Robinson of Marsh. The letter referred to the earlier letter of 20 August 1999 and confirmed that Mr Jepson attended for examination on 23 August 1999 with counsel. The letter said that six audio tapes of the interview had been received and that Ms Chalmers had reviewed them. It continued to deal with the matters being investigated; with certain advice Mr Jepson was given before the examination; and with the examination itself. The letter set out the information received from counsel and concluded by referring to questions of possible indemnity and the matter's future progress. It is important, in my opinion, that Ms Dempsey did not refer, in that letter, to the confidential information received from Mr Jepson. The significance of this is that whilst Ms Dempsey gave evidence that she had not communicated that information, she conceded that there was a possibility she may have. This concession was necessarily made because she had no recollection of having done so and, essentially denied having done so. However, it seems to me that if she did not mention it in reporting to GIO on 1 September 1999, the strong possibility is that the information made little, if any, impact on her. In those and all the other circumstances of this case, that assists me in concluding that she did not convey the information to anyone else.
33 On 1 September 1999, a finance clerk of MSJ sent an e-mail to Ms Dempsey in relation to a possible conflict of interest between the defendants and other clients of MSJ.
34 On 2 November 1999, Ms Coleman wrote a letter of demand to the defendants in relation to the present proceedings and enclosed a draft Statement of Claim.
35 On 24 November 1999, Ms Dempsey wrote a memorandum to Ms Bain, a solicitor employed by MSJ, setting out the history of the matter as she, Ms Dempsey, was leaving the employment of MSJ.
36 On 1 December 1999, Ms Coleman wrote to the defendants noting that no reply had been received to the letter of 2 November 1999 and stating that unless there was a response by 14 December 1999 "we are instructed to commence proceedings without further notice to you".
37 On 2 December 1999, Ms Robinson of Marsh sent a facsimile transmission to GIO noting that MSJ had been appointed to act on behalf of the defendants and GIO and were also acting "on behalf of the claimant". It concluded:-
"Could you please ask Mallesons to resolve this conflict of interest and revert to us as to the outcome."
38 On 6 December 1999, Ms Chalmers wrote to Ms Hasapis of GIO stating:-
"I refer to your conversation with Michelle Bain last Friday.
In light of the conflict that has occurred in this matter, which you kindly pointed out on Friday, we enclose our file relating to this matter and six audio tapes recording the examination of Mr Jepson. You will see that the file contains a succinct summary of this matter to date, which was prepared by Jacqueline Dempsey on 24 November 1999.
I apologise for any inconvenience caused by returning the file. Whilst we have conflict search procedures in place in the firm, unfortunately in this instance we overlooked the fact that Karen Coleman of Mallesons is acting for Clifford Corporation Limited in this matter."
39 Mr Martignoni stated that on 7 December 1999 AAH received instructions to act on behalf of the defendants in relation to "a claim which is now the subject of the present proceedings". The evidence has disclosed that at that time the partner, who was given charge of the matter, was Mr Oscar Shub, a highly experienced litigious and insurance solicitor with AAH. Mr Martignoni had some connection with the matter as did a solicitor employed by AAH, Mr L.P. Menzies. In early July 2000, Mr Martignoni became the supervising partner in place of Mr Shub.
40 Mr Martignoni stated that the instructions to AAH were accompanied by copies of documents, which he understood formed part of the file created by MSJ. Before continuing with the subsequent chronology it is necessary to go back to the circumstances giving rise to AAH's receiving such instructions.
41 On 7 December 1999, GIO wrote to Mr Shub setting out a brief history of the matter, including the fact that MSJ had been appointed to act on the defendants' behalf but:-
"Due to a conflict of interest we would now like you to take over conduct of this matter."
42 GIO enclosed a complete copy of the file including policy documentation, a copy of MSJ's file and the six audio tapes. On the same day GIO wrote to Ms Robinson advising that due to a conflict of interest it had transferred the file from MSJ to AAH and appointed Mr Shub to investigate the matter. Accordingly the question of conflict of interest was well known to all by December 1999.
43 It was a matter which, not unnaturally, caused Mr Meldrum concern. He was cross-examined about the attitude he had taken to what appeared to him to be a conflict of interest. Mr Meldrum was well aware that he, as an accountant, could not act for two clients with different interests at the same time in circumstances where there would be a conflict.
44 At Tp.21 Mr Meldrum said he believed that the matter was raised with Mr Shub in December 1999. His concern was how "Mallesons could be acting for me and against me in the one period of time" and that that was a matter he discussed with Mr Shub "more than likely at the first interview". He said:-
"A. I believe I expressed it in terms that I couldn't understand how it could happen that they could both be acting for me and then acting against me.
Q. You raised that concern with him, could I suggest to you, because you wanted him to consider the matter?
A. No. I don't think - I think it was just a general concern on my part not understanding the legal system as to how it could occur."
45 Although I am satisfied the matter was raised with Mr Shub, who did not give evidence, at that time no steps were taken to complain about MSJ's continuing to act. Mr Martignoni, who had some discussions with Mr Shub about the conflict question in late 1999 or early 2000, sought to explain it on the basis that at that time there was no litigious dispute between the parties and the situation was being explored as to whether there could be some resolution of the matter other than by recourse to litigation. None-the-less it must have been clear then, having regard to the correspondence from Ms Coleman and the draft Statement of Claim, that there was, at the least, a strong possibility that litigation would ensue.
46 In any event, if MSJ had received information from Mr Meldrum or Mr Jepson or otherwise concerning the circumstances the subject of the present litigation by dint of their having been retained to act on behalf of the defendants, there could be no guarantee that such information may not prejudice the defendants in any settlement negotiations. However, AAH made no attempt to find out the extent of the information obtained by MSJ for a lengthy period and, for the reasons to which I have referred which were advanced by Mr Martignoni, not only did not object to MSJ's continuing to act, but engaged in correspondence which assumed they would.