Esanda Finance Corp Ltd v Peat Marwick Hungerfords

High Court of Australia|1997-03-18|Before: Brennan CJ, Gummow JJ

The application was based on the ground that the paragraphs disclosed no reasonable cause of action.

(a) discloses no reasonable cause of action or defence;

the Court may at any stage of the proceedings, order that the whole or any part of the pleadings be struck out. Furthermore, in accordance with r 46.04: (1) A pleading shall:

(f) subject to Rule 46.15 contain sufficient particulars of the claim, defence or other matter pleaded.

Bollen J heard the application and held that the statement of claim alleged sufficient facts to establish that Peat Marwick owed Esanda a duty of care [65] . Furthermore, he allowed Esanda to amend the statement of claim by inserting pars 84a, 84b, 84c and 85a. In those paragraphs, Esanda alleges that the members of Peat Marwick were members of the Institute of Chartered Accountants (the Institute) and that the Institute had adopted the Australian Accounting Standards (the Standards) which were to be observed by its members. Esanda contended before Bollen J and before this Court that Peat Marwick adopted those Standards by becoming a member of the Institute and undertook that it would maintain them for the benefit of creditors like Esanda.

Esanda Finance Corporation Ltd v Peat Marwick Hungerfords (1993) 11 ACLC 908.

The decision of the Full Court of the Supreme Court of South Australia

Peat Marwick appealed to the Full Court of the Supreme Court of South Australia which unanimously allowed the appeal [66] . The Full Court struck out pars 84a-86 and the relevant sections of par 87 of the statement of claim.

Esanda Finance Corporation Ltd v Peat Marwick Hungerfords (1994) 61 SASR 424.

King CJ (with whom Millhouse J agreed) held that, in the absence of evidence indicating an assumption of responsibility to a plaintiff in respect of the preparation of the audit certificate, an auditor is not under a duty of care to that person unless the auditor intended to induce him or her to act in reliance on the audit certificate [67] . His Honour found that the statement of claim in the present case did not allege facts which were capable in law of founding a duty of care. He said that it did not allege that Peat Marwick intended to induce Esanda, or a class of which Esanda was a member, to enter into financial transactions with Excel; it did not allege Peat Marwick was aware that Esanda was engaging in financial transactions with Excel or that they were in contemplation of doing so; and it did not plead any act on the part of Peat Marwick which indicated an assumption of specific responsibility to Esanda to exercise care in the audit. King CJ concluded that [68] :

It may be assumed that it was reasonably foreseeable by the defendant that persons contemplating financial transactions with the plaintiff might consult the financial statements and rely upon their accuracy and upon the audit certificate. The facts, however, fall short of establishing the relationship of proximity which is necessary to give rise to a duty of care. 1. Esanda Finance (1994) 61 SASR 424 at 431. 2. Esanda Finance (1994) 61 SASR 424 at 431.

In respect of the Australian Accounting Standards adopted by Peat Marwick by its membership of the Institute of Chartered Accountants, in particular AAS5, King CJ found that the Standards were merely concerned with the content of financial statements and not the creation of a legal duty of care. Any references in the Standards to providers of loan capital and creditors as potential users of the financial statements occur in the context of determining what is material for inclusion in the statements. It did not imply any assumption of legal responsibility to such users to exercise care [69] .

Application to strike out: the test in General Steel Industries Inc v Commissioner for Railways (NSW) [70]

The power to strike out pleadings under r 46.18 cannot be exercised unless "the case of the plaintiff is so clearly untenable that it cannot possibly succeed." [71] In General Steel, Barwick CJ warned that the power to strike out a pleading must be sparingly exercised; the mere fact that the plaintiff's prospects of success are slim is not enough to strike out a pleading.

The central issue therefore is whether Esanda's claim in negligence as pleaded in pars 84a, 84b, 84c, 85, 85a, 86 and the relevant portions of 87 disclose a tenable cause of action. These paragraphs allege that Peat Marwick owed a duty of care to Esanda because Peat Marwick audited the accounts of Excel, prepared a report on those accounts, and: (a) Peat Marwick should reasonably have foreseen that creditors of Excel of whom Esanda was one would rely on the report and accounts; and (b) Peat Marwick was a member of an institute of accountants which required its members, when preparing financial statements for a business entity, to have regard to creditors and potential creditors of that entity as users of those statements.

Until relatively recently, the common law precluded recovery in a tort action for pure economic loss [72] caused by negligent misstatement. It was not until 1964 in Hedley Byrne & Co Ltd v Heller & Partners Ltd [73] that the common law allowed recovery for such loss. Contrary to a once widely accepted view [74] , this Court now accepts that reasonable foreseeability of a risk of harm alone is insufficient to ground a duty of care in negligence [75] . If reasonable foreseeability of a risk of economic harm was sufficient, there would be a real risk in many cases of creating "liability in an indeterminate amount for an indeterminate time to an indeterminate class" [76] . Thus, in San Sebastian Pty Ltd v The Minister [77] , the Court held that no duty of care was owed to a developer who claimed damages from a council and a planning authority on the basis that it had suffered loss by relying on representations contained in documents adopting a scheme to redevelop a suburban area in Sydney. Because the defendants had done nothing to assume responsibility to the plaintiffs for the representations and had not intended to induce the plaintiffs to rely on the representations, they owed no duty of care to the plaintiffs. In a joint judgment Gibbs CJ, Mason, Wilson and Dawson JJ said [78] :

[T]here is no convincing reason for confining the liability to instances of negligent misstatement made by way of response to a request by the plaintiff for information or advice. The existence of an antecedent request for information or advice certainly assists in demonstrating reliance, which is a cornerstone of liability for negligent misstatement. However, such a request is by no means essential, though it has been suggested that instances of liability for misstatement volunteered negligently will be "rare" [79] . The maker of a statement may come under a duty to take care through a combination of circumstances or in various ways, in the absence of a request by the recipient. The author, though volunteering information or advice, may be known to possess, or profess to possess, skill and competence in the area which is the subject of the communication. He may warrant the correctness of what he says or assume responsibility for its correctness. He may invite the recipient to act on the basis of the information or advice, or intend to induce the recipient to act in a particular way. He may actually have an interest in the recipient so acting. Their Honours then referred to two American cases [80] which "dealt, and were expressed to deal, with the liability of accountants for careless financial misrepresentations in certified financial statements supplied by the accountants to their clients in the knowledge that they were to be used by the clients in support of their application to the plaintiffs for funds" [81] . Their Honours said [82] : The two decisions provide support for the proposition that, where a statement is made for the purpose of inducing the plaintiff, or the members of a limited class including the plaintiff, to commit themselves financially upon the basis that the statement is true, and the plaintiff acts in reliance on the statement, the law will impose a duty of care on the maker of the statement. But their Honours went on to say [83] : [I]t is necessary not only that A intends that B or members of a class of persons should act or refrain from acting in a particular way, but also that A makes the statement with the intention of inducing B or members of that class, in reliance on the statement, to act or refrain from acting in the particular way, in circumstances where A should realise that economic loss may be suffered if the statement is not true. In cases where the defendant intends the statement to operate as a direct inducement to action, the reasonableness of the reliance will not be a critical factor, although in other cases the defendant's appreciation of the reasonableness of reliance will be relevant. Their Honours concluded that [84] : It follows then that if the appellants' case is to succeed they must establish at least, amongst other things, (1) that the alleged representation was made, and (2) that the Authority and the Council made the representation with the intention of inducing members of the class of developers to act in reliance on the representation. 1. That is loss not occasioned upon damage to person or property. 2. [1964] AC 465. 3. See, eg, Stone, Precedent and the Law (1985), pp 254-255; Trindade and Cane, The Law of Torts in Australia, 1st ed (1985), p 279. 4. Jaensch v Coffey (1984) 155 CLR 549 at 552-554, 575, 582-587; Sutherland Shire Council v Heyman (1985) 157 CLR 424 at 441, 467, 477, 495; San Sebastian Pty Ltd v The Minister (1986) 162 CLR 340 at 355, 367-370; Hawkins v Clayton (1988) 164 CLR 539 at 579; Gala v Preston (1991) 172 CLR 243 at 254-255; Bryan v Maloney (1995) 182 CLR 609 at 617-619. 5. Ultramares Corporation v Touche (1931) 255 NY 170 at 179 [174 NE 441 at 444], per Chief Judge Cardozo. 6. (1986) 162 CLR 340. 7. San Sebastian (1986) 162 CLR 340 at 356-357. 8. Mutual Life & Citizens' Assurance Co Ltd v Evatt (1968) 122 CLR 556 at 571-572; Lambert v Lewis [1982] AC 225 at 264. 9. Rusch Factors Inc v Levin (1968) 284 F Supp 85; Rhode Island Hospital Trust National Bank v Swartz, Bresenoff, Yavner & Jacobs (1972) 455 F 2d 847. 10. San Sebastian (1986) 162 CLR 340 at 357. 11. San Sebastian (1986) 162 CLR 340 at 357. 12. San Sebastian (1986) 162 CLR 340 at 358. 13. San Sebastian (1986) 162 CLR 340 at 358.

Brennan J (as he then was), in a separate judgment, after referring to the judgment of Barwick CJ in Mutual Life & Citizens' Assurance Co Ltd v Evatt [85] stated the relevant principle in the following way [86] :

Where a representor gives information or advice on a serious or business matter, intending thereby to induce the representee to act on it, the representor is under a duty of care in giving that advice or information if three conditions are satisfied. First, (corresponding with the first condition expressed by Barwick CJ), if the representor realises or ought to realise that the representee will trust in his especial competence to give that information or advice; second (corresponding with the third condition), if it would be reasonable for the representee to accept and rely on that information or advice; and third (applying the underlying principle of the law of negligence), if it is reasonably foreseeable that the representee is likely to suffer loss should the information turn out to be incorrect or the advice turn out to be unsound. 1. (1968) 122 CLR 556. 2. San Sebastian (1986) 162 CLR 340 at 372.

The decision in San Sebastian, which is the leading case in this Court on tortious liability for negligent misstatements, gives no direct support to Esanda's claim that Peat Marwick owed it a duty of care. Indeed, in R Lowe Lippmann Figdor & Franck v AGC (Advances) Ltd [87] the Appeal Division of the Supreme Court of Victoria relied on the reasoning in San Sebastian to find that the auditors of financial accounts which had been improperly audited, and which had allegedly been relied upon by a major creditor of the audited company in advancing further money, did not owe a duty of care to the creditor. The Appeal Division held that the mere act of supplying a signed report stating the company's financial position, knowing that the company would in turn pass the statement on to its major creditor, was not enough to establish a duty of care in the circumstances [88] . No duty was owed even though prior to the audited accounts becoming available, the creditor had telephoned the auditors and told them that it required the accounts for review purposes and had requested confirmation that the company's annual profit would be the figure that the company claimed.

[1992] 2 VR 671. 2. R Lowe Lippmann [1992] 2 VR 671 at 682-683.

Brooking J, with whom Gobbo and Tadgell JJ agreed, said that an intention to induce the plaintiff, or a class of persons to whom the plaintiff belongs, to rely on the report need not always be present in order to establish a duty of care in cases of negligent misstatement. But his Honour said that, in a case such as the one before the Court, "there being no other combination of circumstances present sufficient to impose a duty of care, that duty will not arise unless the defendant made the statement with the intention mentioned". [89] Brooking J concluded that [90] :

The only intention on the auditors' part in making their report established in this case is an intention to discharge their statutory and contractual duties as Lyvetta's auditors by making the report required by the Companies Act. I am prepared to accept that they knew or believed that AGC would probably rely on the report in deciding what to do as regards Lyvetta's facility, but this knowledge or belief cannot be equated with an intention to induce AGC to act in reliance on the report. 1. R Lowe Lippmann [1992] 2 VR 671 at 679. 2. R Lowe Lippmann [1992] 2 VR 671 at 682.

The reasoning in San Sebastian was also applied in Columbia Coffee & Tea Pty Ltd v Churchill [91] but with a different result. Rolfe J, sitting in the Commercial Division of the New South Wales Supreme Court, held that a statement in an Auditor's Audit Manual which explicitly acknowledged that "there will be interested parties who read and rely upon our reports. And this extends beyond the persons who employ us in the first instance or those to whom the report is addressed initially" [92] , was sufficient to impose a duty of care for carelessly certified accounts in favour of a purchaser of shares who claimed to have relied on the report and suffered economic loss [93] . His Honour found that the statement in the manual amounted to an assumption of responsibility by the auditors to a class of persons wider than the company for which the audit was being conducted [94] .

(1992) 29 NSWLR 141. 2. Columbia Coffee & Tea (1992) 29 NSWLR 141 at 167. 3. Rolfe J held that on the facts the plaintiff had not relied on the audited accounts when purchasing the shares: Columbia Coffee & Tea (1992) 29 NSWLR 141 at 173-175. 4. Columbia Coffee & Tea (1992) 29 NSWLR 141 at 172-173.

Thus, the position in Australia to date with respect to liability for pure economic loss caused by negligent misstatement is that, absent a statement to a particular person in response to a particular request for information or advice or an assumption of responsibility to the plaintiff for that statement, it will be difficult to establish the requisite duty of care unless there is an intention to induce the recipient of the information or advice, or a class to which the recipient belongs, to act or refrain from acting on it. Mere knowledge by a defendant that the information or advice will be communicated to the plaintiff is not enough. With the exception of Columbia Coffee & Tea [95] no Australian decision supports Esanda's claim, and R Lowe Lippmann [96] is squarely against it. Nevertheless, the decisions have all emphasised that a lack of an intention to induce the plaintiff to act or refrain from acting is not necessarily fatal to a plaintiff's claim because other factors may be present that obviate the need for such an intention [97] .

(1992) 29 NSWLR 141. 2. [1992] 2 VR 671. 3. As Brennan J observed in San Sebastian (1986) 162 CLR 340 at 371, to hold otherwise would be to render "the tort of deceit otiose"; cf R Lowe Lippmann [1992] 2 VR 671 at 679, per Brooking J.

In its statement of claim, Esanda does not allege an intention to induce it to rely on the audit. The question that arises therefore is whether the facts pleaded nonetheless give rise to a duty of care owed by Peat Marwick to Esanda. That is to say, does the duty of care owed by an auditor extend to members of a class such as creditors or investors whom the auditor knows or ought reasonably to know will rely on the audit report. Alternatively, does the duty extend to members of such a class when the auditor belongs to a professional body which requires its members to consider the members of a class to be users of the audited accounts and report?

Significantly, the majority of courts that have considered the issue of auditor liability for negligent misstatement in England, Canada, New Zealand and the United States of America would hold that no duty was owed in the present case. It is therefore useful to examine the course of authority in those jurisdictions before examining whether in Australia auditors are or should be liable to third parties in factual situations like those pleaded in the present case.

In England, the leading case on auditor liability for negligent misstatement is Caparo Industries Plc v Dickman [98] which concerned a claim of negligence against the auditors of a company which had been taken over by the plaintiff. The plaintiff alleged that the auditors had negligently carried out their audit and negligently prepared their statutory report. It alleged that it had suffered a loss when it was later revealed that the company's profits had been overstated causing the share price to fall. The House of Lords held that the auditors owed no duty of care to the plaintiff.

[1990] 2 AC 605. See also Morgan Crucible Co Plc v Hill Samuel & Co [1991] Ch 295; Henderson v Merrett Syndicates Ltd [1995] 2 AC 145; Galoo Ltd v Bright Grahame Murray [1995] 1 All ER 16; Spring v Guardian Assurance Plc [1995] 2 AC 296. cf Possfund Custodian Trustee Ltd v Diamond [1996] 1 WLR 1351; [1996] 2 All ER 774, where on an action to strike out a plea of negligence, Lightman J held that it was arguable that persons responsible for the issue of a company's share prospectus owed a duty of care, and could be liable in damages, to subsequent purchasers of shares on the unlisted securities market in that company, provided that the purchaser could establish that he had reasonably relied on representations made in the prospectus and reasonably believed that the representor intended him to act on them, and that there existed a sufficient direct connection between the purchaser and the representor to render the imposition of such a duty fair, just and reasonable. Accordingly, the plaintiffs' claim was not struck out.

Their Lordships said that liability for economic loss caused by negligent misstatement was confined to cases where the statement or advice had been given to a known recipient for a specific purpose of which the maker was aware and the recipient had relied and acted upon the statement or advice to its detriment. Their Lordships held that these conditions were not satisfied in the case before them. The purpose of the statutory requirement for an audit was the making of a report to enable shareholders to exercise their class rights in general meetings. It was no part of that purpose to assist shareholders in the making of decisions as to future investment in the company. Furthermore, there was no reason in principle or policy to treat auditors as having a special relationship with non-shareholders who contemplated investment in the company in reliance upon the published accounts, even when the affairs of the company were such as to render it susceptible to a takeover. To find otherwise would be to stretch the concept of duty of care so widely it would be "difficult to see any reason why it should not equally extend to all who rely on the accounts in relation to other dealings with a company as lenders or merchants extending credit to the company." [99] This proposition had been, as their Lordships noted, expressly rejected in Al Saudi Banque v Clark Pixley [100] .

Caparo Industries [1990] 2 AC 605 at 623. 2. [1990] Ch 313.

In England, therefore, liability for economic loss caused by negligent misstatement is confined to cases in which the relevant statement is given to a known recipient for a specific purpose and the recipient relies on the advice or information to its detriment.

In Canada, the courts appear to have moved to the position that the auditor is not liable unless he or she knew that the audit report would be presented to the plaintiff or a class of persons including the plaintiff for a particular purpose. In 327973 British Columbia Ltd v HBT Agra Ltd [101] , the plaintiff sued an engineer over a report prepared by the engineer for an owner of land. The report stated that the property was "essentially free of risk of subsidence associated with abandoned mines". The land was subdivided, sold and then resold to the plaintiff who relied on the defendant engineer's report in purchasing the land. The plaintiff later incurred expense in repairing an area which was subject to subsidence.

The British Columbia Court of Appeal found for the defendant because it was not aware that the report was to be supplied to the plaintiff or a person in the plaintiff's position. The plaintiff was therefore not within a foreseeable class of users of the report. To constitute such a class, the Court said "either the actual identity of the members of this class must be known, or their nature and identity must be ascertainable and their intended use of the statement must be foreseeable". [102] . The Court relied on, inter alia, Caparo and the leading Canadian case on negligent misstatement, Haig v Bamford [103] - which dealt with financial statements prepared by accountants - in concluding that [104] :

In every case in which liability has been imposed in respect of a loss suffered by a third person, the professional advisor has been aware that his statements would be presented to and used by the third person for a particular purpose which was known to the professional advisor at the time the statement was made. 1. British Columbia (1994) 120 DLR (4th) 726 at 733. 2. [1977] 1 SCR 466; (1976) 72 DLR (3d) 68. See also Edgeworth Construction Ltd v ND Lea & Associates Ltd [1993] 3 SCR 206; (1993) 107 DLR (4th) 169. 3. British Columbia (1994) 120 DLR (4th) 726 at 736.

The Court adopted the criteria laid down by the House of Lords in Caparo in determining when liability for negligent misstatements is to be imposed [105] .

British Columbia (1994) 120 DLR (4th) 726 at 736-737.

In Scott Group Ltd v McFarlane [106] , however, a majority of the New Zealand Court of Appeal held that a prima facie duty of care arises if it was in the reasonable contemplation of the alleged wrongdoer that carelessness on his or her part may be likely to cause damage to the person who has allegedly suffered it [107] . Scott was followed in the English decision of JEB Fasteners Ltd v Marks, Bloom & Co [108] . In JEB Fasteners, Woolf J formulated the test for the imposition of a duty of care in relation to auditors as [109] "whether the defendants knew or reasonably should have foreseen at the time the accounts were audited that a person might rely on those accounts for the purpose of deciding whether or not to take over the company and therefore could suffer loss if the accounts were inaccurate". Both decisions were subsequently followed in the Scottish case Twomax Ltd v Dickson, McFarlane & Robinson [110] .

[1978] 1 NZLR 553. 2. Scott [1978] 1 NZLR 553 at 573, per Woodhouse J; at 583, per Cooke J. 3. [1981] 3 All ER 289. 4. JEB Fasteners [1981] 3 All ER 289 at 296. 5. [1983] SLT 98.

However, Scott was based on Anns v Merton London Borough Council [111] which essentially conflated the elements of proximity and foreseeability so that if the ultimate damage to the plaintiff was reasonably foreseeable, a prima facie duty of care arose. Anns is no longer good law in this country or in England [112] . Moreover, in Caparo [113] Lord Bridge of Harwick and Lord Oliver of Aylmerton distinguished JEB Fasteners on the basis that a duty of care had arisen because the information had been provided for a specific purpose [114] . The House also disapproved Twomax because it conflated foreseeability and proximity [115] . Their Lordships also preferred the dissenting judgment of Richmond P to that of the majority in Scott [116] .

[1978] AC 728 at 751-752: "[T]he position has now been reached that in order to establish that a duty of care arises in a particular situation, it is not necessary to bring the facts of that situation within those of previous situations in which a duty of care has been held to exist. Rather the question has to be approached in two stages. First one has to ask whether, as between the alleged wrongdoer and the person who has suffered damage there is a sufficient relationship of proximity or neighbourhood such that, in the reasonable contemplation of the former, carelessness on his part may be likely to cause damage to the latter - in which case a prima facie duty of care arises. Secondly, if the first question is answered affirmatively, it is necessary to consider whether there are any considerations which ought to negative, or to reduce or limit the scope of the duty or the class of person to whom it is owed or the damages to which a breach of it may give rise." The Anns two-stage approach as a determinant of duty of care continues to command respect in New Zealand: Brown v Heathcote County Council [1986] 1 NZLR 76; South Pacific Manufacturing Co Ltd v New Zealand Security Consultants & Investigations Ltd [1992] 2 NZLR 282; Invercargill City Council v Hamlin [1994] 3 NZLR 513 (NZCA); [1996] AC 624 (PC). 2. In Australia, Anns was emphatically rejected in Sutherland Shire Council (1985) 157 CLR 424; in England it was recently overturned in Murphy v Brentwood District Council [1991] 1 AC 398. 3. [1990] 2 AC 605 at 625, 647-648. 4. Lord Bridge was, however, prepared to take a more critical view of JEB Fasteners stating, in response to the conclusion in JEB Fasteners that duty could be derived from foreseeability alone, "I do not agree with this": Caparo [1990] 2 AC 605 at 625. 5. Caparo [1990] 2 AC 605 at 627, 629, 649. 6. Caparo [1990] 2 AC 605 at 624, 627, 629, 650.

In Jagwar Holdings Ltd v Julian [117] , Thorp J sitting in the New Zealand High Court, chose to follow Richmond P in Scott [118] who had said:

I would especially emphasise that to my mind it does not seem reasonable to attribute an assumption of responsibility unless the maker of the statement ought in all the circumstances, both in preparing himself for what he said and in saying it, to have directed his mind, and to have been able to direct his mind, to some particular and specific purpose for which he was aware that his advice or information would be relied on. In many situations that purpose will be obvious. But the annual accounts of a company can be relied on in all sorts of ways and for many purposes. 1. (1992) 6 NZCLC 68,040 at 68,058-68,060. 2. [1978] 1 NZLR 553 at 566.

A majority of jurisdictions in the United States allow recovery only in circumstances similar to those that would give rise to liability in England and Canada. Two early decisions - Rusch Factors Inc v Levin [119] and Rhode Island Hospital Trust National Bank v Swartz, Bresenoff, Yavner & Jacobs [120] - arguably support Esanda's position. But more recent decisions on auditor's liability in the United States have altered the standing of Rusch Factors and Rhode Island Hospital in the majority of jurisdictions.

(1968) 284 F Supp 85. 2. (1972) 455 F 2d 847.

Three different approaches have emerged from the cases in the United States governing liability in this area [121] . The first denies recovery by third parties for auditor's negligence in the absence of a third party relationship to the auditor that is akin to privity. For the relationship to exist [122] :

"(1) the [auditor] must have been aware that the financial reports were to be used for a particular purpose (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the [auditor] linking" him or her to that party, "which evinces the [auditor's] understanding of that party or parties' reliance." 1. The three approaches are summarised in Bily v Arthur Young & Co (1992) 834 P 2d 745 at 752-759. 2. The "privity rule" as described in Bily (1992) 834 P 2d 745 at 754 citing Credit Alliance v Arthur Andersen & Co (1985) 65 NY 2d 536.

Only nine states purport to follow the "privity rule" [123] .

The second approach, which is the approach that has found the least favour among courts in the United States, holds that auditors are liable to third persons if the risk of harm is foreseeable. However, the potential class of plaintiffs is limited to "recipients from the company of the statements for its proper business purposes, provided that the recipients rely on the statements pursuant to those business purposes." [124]

The third, and most popular, approach holds that all persons who supply information owe a duty of care when they intended "to supply the information for the benefit of one or more third parties in a specific transaction or type of transaction identified to the supplier". [125] Thus, under this approach, an auditor retained to conduct an annual audit and to furnish an opinion for no other purpose than to satisfy statutory obligations will generally owe no duty of care to third parties. This is so even though the auditor knows that the financial statements and the accompanying opinion may be used in a wide variety of circumstances and may be relied upon by a range of lenders and investors. This approach most closely mirrors the current Australian position.

It was applied by the Supreme Court of California in Bily v Arthur Young & Co [126] where investors in a corporation brought a negligence suit against an auditor who had examined and reported on the corporation's books prior to a public offering of shares. Lucas CJ, delivering the majority opinion of the Court, held that the investors could not recover against the auditor. Because the plaintiffs were not the clients of the defendant and the defendant did not intend to supply the information for their benefit, no liability arose [127] .

(1992) 834 P 2d 745. 2. Bily (1992) 834 P 2d 745 at 773-774.

This survey of authority in England, Canada, New Zealand and the United States shows that, absent some mutual relationship giving rise to an assumption of responsibility, the common law courts are reluctant to impose a duty of care on an auditor in favour of a third party unless the auditor intended that the audit report be given to the third party for a specific purpose. The trend is very much against expanding the liability of auditors for negligent misstatements [128] .

This trend is apparent even in New Zealand: see Jagwar Holdings Ltd v Julian (1992) 6 NZCLC 68,040.

In my opinion, the law in Australia was correctly stated and applied by the Appeal Division of the Supreme Court of Victoria in R Lowe Lippmann [129] and by the Full Court of the Supreme Court of South Australia in the present case. Those decisions correctly apply the principles laid down in San Sebastian to cases of auditor liability and they accord with the law as laid down in most common law jurisdictions. Moreover, I can see no good reason for extending the liability of auditors to those members of a class whom the auditor knows or ought to know will rely on the audit where the auditor has not assumed responsibility to those members or intended to induce them to rely on the audit.

Esanda concedes that reasonable foreseeability of harm to it from relying on the audit was not itself sufficient to impose a duty of care on Peat Marwick. But Esanda argues that a combination of circumstances exist in this and other audit cases which makes it proper to hold that an auditor in the position of Peat Marwick owes a duty of care to Esanda. The primary reason that Esanda gives for finding a duty of care in circumstances such as those pleaded in this case is that the auditor of a public company assumes a public position of trust and responsibility which demands the imposition of a duty of care. Esanda contends that by assuming responsibility for the task of auditing the accounts of public companies and providing audit certificates, auditors are representing to the world at large that the information contained in the audit and the certificate is accurate and can be relied upon. Moreover, auditors know or ought to know that persons in the position of Esanda will rely on the skill of the auditors to prepare accurate audit accounts and reports and that they may suffer loss if the audit work is done negligently. Esanda argues that it is, therefore, reasonable to impose on auditors a duty of care in order to ensure that the information prepared and disseminated by them in fulfilling their duties, statutory or otherwise, is correct because this will encourage auditors to do their work properly.

This reasoning is similar to the public interest argument put forward by those proponents of auditor liability in the United States who favour the "foreseeability rule". Thus, in Rosenblum v Adler [130] , the Supreme Court of New Jersey said, in support of its adoption of the foreseeability rule, that "[t]he public interest will be served by the rule we promulgate this day". The public interest argument is an important factor to be weighed. But in the field of auditor liability its weight tends to be exaggerated by those who invoke it.

In cases where audits are required by law, the law invariably imposes statutory duties on the auditors, breaches of which give rise to civil and criminal liability. Having regard to these sanctions, it is difficult to believe that giving third parties rights against auditors is likely to achieve any higher standard of care than is presently available. In cases where audits are not required by law, auditors have other incentives to maintain high standards. Clients are unlikely to retain or be attracted to an auditor who has a reputation for careless work [131] . Negligent work in non-statutory areas may also result in the non-registration or de-registration of auditors in areas where such registration is required by law. In any event, the increased standard of care argument is only one of a number of factors to be weighed in determining whether a duty of care to outsiders should be imposed on auditors. At least six other factors arise for consideration.

These incentives to produce high standard work are of course also applicable to auditors carrying out audits that are required by law.

Further factors relevant to the existence of a duty of care

First, whether or not imposing a duty in favour of third parties will deter auditors from being careless, extending liability will probably reduce the supply of their services. Courts often assume [132] that insurance against extended tort liability is readily obtainable and that the increased cost of an extension of liability can be spread among clients by the payment of additional premiums for insurance. But insurance in this field may not be as readily obtainable as courts assume. Insurers are reluctant to insure against risks which are difficult to quantify, as they usually are when the number and amount of the claims arising from the risk are difficult to estimate. Lord Oliver addressed this factor in Caparo [133] when he questioned the ability of auditors to insure against such risks if liability depended on "only the foreseeability of possible damage without some further control".

cf Rusch Factors (1968) 284 F Supp 85 at 91; Rosenblum (1983) 461 A 2d 138 at 151-152. 2. [1990] 2 AC 605 at 643.

Extending the liability of auditors for negligent misstatements may also reduce the demand for their services. Even when insurance is obtainable, increasing fees to pay for the cost of additional insurance may result in a reduction of demand for audit services in cases where the law does not require regular audits. Experience in the United States suggests that some of the smaller accounting firms may be forced out of business [134] . If demand slackens because of unsuccessful attempts to pass on the cost of increased premiums, auditors must either lose the business or absorb the whole or part of the cost in an attempt to regain that business. Unless auditors are making excessive profits (which is not likely in a competitive field), absorbing the cost of insurance may force them to reduce other overheads such as the time spent or the number of personnel engaged in audits. Ironically, such cost cutting may lead to a reduction in the standard of care. Or, as Lucas CJ suggested in the Californian Supreme Court in Bily [135] , auditors may respond by reducing audit services to high risk businesses where there is a greater likelihood of failure and therefore of liability to investors and creditors.

See Siliciano, Negligent Accounting and the Limits of Instrumental Tort Reform, Michigan Law Review, vol 86 (1988) 1929, at p 1971. 2. (1992) 834 P 2d 745 at 766.

Thus, the result of widening the circumstances in which auditors will owe a duty of care to third parties may be: (i) a significant increase in the cost of auditing services; (ii) a decrease in the competition for or the provision of such services; and (iii) a reduction in the standard of those services.

This would be detrimental to the interests of creditors, investors and business generally.

Second, no examination of the public interest should overlook the effect of an extension of auditor's liability on the administration of the court system. Experience of claims against auditors by public company liquidators [136] over the last thirty years in this country indicates that almost any claim is likely to take many months to hear, not to mention the time taken in interlocutory matters and appeals. This is not surprising. As Lucas CJ pointed out in Bily [137] :

[A]n audit report is not a simple statement of verifiable fact that, like the weight of [a] load of beans , can be easily checked against uniform standards of indisputable accuracy. Rather, an audit report is a professional opinion based on numerous and complex factors. [T]he report is based on the auditor's interpretation and application of hundreds of professional standards, many of which are broadly phrased and readily subject to different constructions. Although ultimately expressed in shorthand form, the report is the final product of a complex process involving discretion and judgment on the part of the auditor at every stage. Using different initial assumptions and approaches, different sampling techniques, and the wisdom of 20-20 hindsight, few CPA audits would be immune from criticism. When those standards have to be applied to hundreds, frequently thousands, of transactions, as is usually the case when an audit is alleged to have been performed negligently, litigation and lengthy hearings are almost inevitable. Any extension of auditor's liability to cover cases such as the present is likely to mean that courts and judges hearing such cases will be tied up for many months - sometimes for more than a year - to the detriment of other litigants. Only the most insistent demands of corrective justice should induce the common law courts to mould legal rules to cover cases that bring about this consequence in an era when court resources are already stretched to breaking point and courts are forced to send many cases out to private arbitrators for determination. 1. Even claims in respect of proprietary companies or unincorporated businesses are likely to be reasonably lengthy. 2. (1992) 834 P 2d 745 at 763.

However, the need for a rule to correct perceived injustice to third party plaintiffs in audit actions is not compelling. If the liability of auditors was extended to third parties in circumstances such as those alleged here, the common law would be conferring rights on a sophisticated group who have the means in most cases to take steps to avoid the risk of loss. The common sense test [138] of causation ensures that no litigant can succeed in an action against an auditor unless that person has read and relied on the auditor's accounts and report. That test and the costly nature of third party actions against auditors would confine most plaintiffs in those actions to well-informed creditors and investors who have lent or invested large sums of money and who have the means to litigate such actions. In Bily [139] , Lucas CJ pointed out that:

Investors, creditors, and others who read and rely on audit reports and financial statements are not the equivalent of ordinary consumers. Like plaintiffs here, they often possess considerable sophistication in analysing financial information and are aware from training and experience of the limits of an audit report "product" that is, at bottom, simply a broadly phrased professional opinion based on a necessarily confined examination. 1. March v E & M H Stramare Pty Ltd (1991) 171 CLR 506. 2. (1992) 834 P 2d 745 at 765.

It is by no means certain that the demands of corrective justice require auditors rather than these sophisticated creditors and investors to absorb the losses that flow from lending to or investing in the auditor's client. Auditors can have only a vague idea as to the potential loss that may flow from the failure to detect fraud or error in the affairs of the client being audited. The audited client can reproduce and disseminate the information from an audit at little cost to many persons including groups of potential creditors and investors. If these persons were owed a duty of care, the auditor's liability would effectively be indeterminate. Even if the auditors could obtain insurance, it carries with it the potential social, professional and economic costs to which I have referred. Moreover, an insurance indemnity that may have seemed more than adequate at the time of an audit may turn out at the time of verdict to be far less than is required to obtain full cover from the consequences of a negligent act or omission on the part of the auditor.

Creditors and investors on the other hand are likely to be in a better position than auditors to know the likely extent of their losses. The investor or creditor knows the maximum extent of any likely loss. Unlike most plaintiffs in negligence cases, these investors and creditors can take steps to protect themselves against loss. Some creditors and investors will have the staff or means to investigate and verify that part of the audited person's financial affairs that is relevant to the loan or investment. They can seek verification of the report and accounts from the auditors and rely on any representations or assurances (whether for reward or otherwise) that the auditors give. Creditors can assign debts to debt factoring organisations and in some cases may even be able to insure their debts. They can spread the loss against successive years of revenue by making provision for bad and doubtful debts. Investors can spread their risk by diversifying their investments. Of course none of these steps are cost free, and the result of taking them may, for example, increase the cost of credit [140] or deter investment. But the question is whether investors and creditors, as one class, or auditors as the other can most efficiently absorb the losses which flow from the conduct of the clients of auditors.

Citizens State Bank v Timm, Schmidt & Co (1983) 335 NW 2d 361 at 365.

Whichever class bears the loss, it is likely that the public will have to pay, directly or indirectly, for the risk of those losses. As Professor Siliciano has pointed out in his influential and illuminating article [141] :

Both potential loss spreaders - the accountant and the third party - can expend resources to minimise the losses incurred; the accountant can attempt to audit more thoroughly, while the third party can audit the client independently or bear the investment risks. Both actors can theoretically [142] pass on such costs, plus any residual losses, to the public: the accountant, through increases in the cost of its services; and the third party, through increases in the cost of its credit. Either way, the increased costs initially are imposed on the client class, which in turn passes it on to the public in the form of price increases. From the public's point of view, therefore, the primary question is, who is the more efficient absorber of the losses? 1. "Negligent Accounting and the Limits of Instrumental Tort Reform", Michigan Law Review, vol 86 (1988) 1929, at pp 1972-1973. Many points in his article were adopted and acknowledged in Bily (1992) 834 P 2d 745. 2. In a footnote at p 1972, Professor Siliciano notes that "the actual ability of an actor to pass on cost increases will depend on the elasticity of demand for the actor's product and the competitiveness of the market in which the actor operates".

Esanda put no material before this Court establishing that auditors rather than the likely class of third party plaintiffs can more efficiently absorb the losses that flow to those plaintiffs as a result of their dealings with the audited client. That being so, this Court should be extremely cautious before extending auditor's liability to cover cases like this one.

Third, creditors and shareholders already have an indirect remedy against the auditors in many cases. The liquidator or receiver can bring an action on behalf of the audited client. Situations may arise where the client has a cause of action but suffers no loss, but these situations are likely to be rare. Damages recovered by the liquidator or receiver from the auditor become assets of the client and are available to be paid to the creditors and, on a winding up, to the shareholders. It is true that, from the point of view of those investors and creditors who relied on the audit report, the liquidator's or receiver's remedy is not as effective as their own direct cause of action. For example, the damages recovered by the liquidator or receiver will have to be shared with all creditors, many of whom probably did not rely on the audit report. Unless the damages are sufficient to repay all creditors and shareholders, a creditor or investor who relied on the audit report will recover only a percentage of his or her loss. Nevertheless, because of the liquidator's remedy, an extension of auditor liability may mean only that creditors and investors who relied on the audit report increase the amount that they will already receive from an action by the liquidator against the auditor.

Fourth, the client's conduct is the primary cause of the plaintiff's loss; the auditor's role is secondary. In addition, the accounts are ordinarily prepared by the client and, in any event, are that person's responsibility [143] . Each case must be judged on its own facts. But it would have to be an exceptional case for the client and all its servants and agents to be innocent of fraud or negligence in relation to the publication of accounts that are false or misleading. In most cases, one would think that the major cause of the plaintiff's loss was the conduct of the client or its employees, rather than the auditor. Yet because auditors are sued only when the plaintiff cannot recover in full from the client, it is usually the case that the "auditor has now assumed center stage as the remaining solvent defendant and is faced with a claim for all sums of money ever loaned to or invested in the client" [144] which have not been repaid. The auditor is left to foot the bill even though on a comparative basis the auditor may bear only a minor and secondary responsibility for the plaintiff's loss.

Bily (1992) 834 P 2d 745 at 762. 2. Bily (1992) 834 P 2d 745 at 763.

Fifth, the need for a plaintiff to prove that he or she relied on the audit report means that the auditor's liability is often problematical even when the auditor has been guilty of gross carelessness. Years after the event, a court has to decide what was the plaintiff's state of mind at the time of extending the credit or making the investment. Where the plaintiff requires an audit to be carried out so that credit can be extended or an investment made, a court will probably have little difficulty in finding that the plaintiff relied on the audit. But that is the type of case where a duty of care will probably arise under the principles laid down in San Sebastian. Where the plaintiff has made no such demand or request, but merely relies on the audit, as the plaintiff in this case did, determining the issue of reliance is likely to be very difficult. An annual audit report is out of date, so far as the business of the client is concerned, when it is published. The report gives merely a picture of the business on a particular date, which may be from six to ten weeks or more before the audit is published. By publication date, the details of the business will have changed even if the fundamentals of the business have not. The gap between financial reality and the financial position represented by the audit increases as each week goes by. Those who are sophisticated enough to consult the audit report before giving credit or making an investment are likely to be well aware of this fact [145] . At a trial, years after the event, these creditors and investors may honestly testify that they relied on the audit in making their credit or investment decisions. But if the truth could be known, it may turn out that the audit was no more than background material for their decisions. Sophisticated creditors and investors who study audit reports before making decisions are unlikely to regard that study as sufficient "due diligence".

Consciously or unconsciously, they are likely to be influenced by a myriad of other factors. In the case of creditors, these may include such matters as the track record of the debtor in meeting its obligations, industry information as to the state of the debtor's business and the industry, the level of interest rates, and the general outlook for the economy. In the case of investors, they may include such matters as the returns on comparable investments, the trends in the industry, the belief in a continuing demand for the company's products, the lack of new competitors or competitive products, the barriers to entry in the industry and the general economic outlook. It does not follow from the fact that the creditor or investor read the report and would not have given the credit or made the investment if he or she had known the true state of the business that the creditor or investor relied on the report. Nor does it always follow that the creditor or investor would have changed his or her decision if the true facts had been stated. That person may genuinely testify that a contrary decision would have been made. But curial processes have no means for persuasively determining that issue in many cases. As Deane J pointed out in Theophanous v Herald & Weeky Times Ltd [146] "the investigation of subjective motivation is one of the areas in which our legal procedures are most likely to be found wanting". Would the creditor have refused to extend or give credit, for example, because the ratio of current assets to current liabilities was really much lower than the accounts showed or because provision for doubtful debts was inadequate? Would the investor have not purchased shares because profit margins were lower or the ratio of long term debt to equity was higher than reported? Except in clear cases, the tribunal of fact can do no more than make a decision on these matters based on intuition rather than logical inference.

The existence of these problems of proof is not determinative of whether a third party plaintiff should have a remedy against an auditor. Similar problems of proof arise in many areas of litigation. Nevertheless, it raises questions as to whether the demands of corrective justice require a remedy that in some, perhaps many, cases will lead to injustice between parties.

Sixth, the factual issues that arise in auditor's liability cases - was the auditor's opinion negligent, did the plaintiff rely on the audit? - make it almost impossible for an auditor to avoid a trial or settlement even when the auditor is not liable to the plaintiff. Summary judgment is rarely available in this class of case. That is true, of course, in many other cases including negligence cases. But perhaps more often than in those cases, the likely length and expense of most audit actions will mean that an auditor has to settle a case that, if tried, would be found to be without merit.

The prospect of vexatious or near vexatious litigation is a matter to be considered in fashioning a legal rule, as the United States Supreme Court pointed out in Blue Chip Stamps v Manor Drug Stores [147] . In dealing with a claim that potential purchasers of shares should have a right of action pursuant to the Securities Exchange Act 1934 US, the Court said [148] :

Obviously there is no general legal principle that courts in fashioning substantive law should do so in a manner which makes it easier, rather than more difficult, for a defendant to obtain a summary judgment. But in this type of litigation, where the mere existence of an unresolved lawsuit has settlement value to the plaintiff not only because of the possibility that he may prevail on the merits, an entirely legitimate component of settlement value, but because of the threat of extensive discovery and disruption of normal business activities which may accompany a lawsuit which is groundless in any event, but cannot be proved so before trial, such a factor is not to be totally dismissed. 1. (1975) 421 US 723. 2. Blue Chip Stamps (1975) 421 US 723 at 742-743.

Although considered individually none of the six factors to which I have referred points decisively against imposing a duty of care to cover a case such as the present, collectively they support the conclusion that the demands of corrective justice do not require the imposition of such a duty.

In the end, the most powerful point for holding that auditors owe a duty of care in cases like the present is that investors and creditors suffer their losses because they have relied, as the auditor knew or ought reasonably to have known they would, on his or her report, and the auditor has made that report carelessly. As against that, however, is the fact that the auditor did not invite or intend them to rely on it and they have paid nothing to the auditor for the preparation of the work. They require the auditor to compensate them for the loss that arose from their self-induced reliance, but they were not prepared to pay for the auditor's work.

In addition, the result of extending liability will ordinarily be to impose a financial burden on the auditor out of all proportion to his or her comparative fault, and the risk of imposing that liability and burden may be contrary to the public interest. Moreover, the plaintiff has failed to prove that the demands of corrective justice require a remedy for the plaintiff. In these circumstances, the case for extending liability to cover cases like the present is not compelling. In the absence of cogent evidence that the public interest or corrective justice requires an extension of auditor's liability to cases where no more appears than that the auditor knows that the plaintiff might rely on the audited accounts and report, this Court should not extend the liability of auditors to such cases.

An examination of pars 84a, 84b, 84c, 85, 85a and 86 of the statement of claim shows that Esanda has failed to plead any material facts that could possibly establish that Peat Marwick owed it a duty of care. King CJ was correct when he found that [149] :

There is no allegation that the defendant intended to induce the plaintiff, or a class of which he was a member, to enter into financial transactions with the company. Indeed there is no allegation that the defendant at the relevant times was aware that the plaintiff was engaged in financial transactions with the company or that any were in contemplation. There is no allegation of any act on the part of the defendant which could indicate or involve the assumption of a specific responsibility to the plaintiff to exercise care in the audit. Apart from the allegations with respect to the accounting standards the only relevant allegations are that the defendant certified the financial statements as auditors and that the plaintiff relied upon them. As his Honour stated, the mere fact that it was foreseeable by Peat Marwick that Esanda and other potential creditors of Excel might incur economic loss from consulting and relying upon the audit report was not enough to establish a duty of care. 1. Esanda Finance (1994) 61 SASR 424 at 431.

Esanda argues that by virtue of Peat Marwick's membership of the Institute of Chartered Accountants and the Institute's adoption of the Australian Accounting Standards, Peat Marwick assumed responsibility to creditors for the accounts and that this was sufficient to create a duty of care. This is the essence of the allegations contained in pars 84a and 84b, when read in combination with par 84c, of the statement of claim. But the Standards and the concept of "materiality" contained in pars 6 and 7 of AAS5 do no more than provide a description of the content of financial statements. They are no more than a reminder to auditors that one of the consequences of an audit is the provision of financial information to a range of users, both public and private, who may use the information in a variety of ways. Their aim is not to extend the breadth of responsibilities assumed by auditors in the provision of their services. Much stronger and more explicit language would have to be employed to reach that conclusion. By express words or necessary implication, the Standards would have to communicate an undertaking by the members of the Institute to persons like Esanda that the members assumed legal responsibility to them for the negligent conduct of audits. AAS5 was not a public undertaking of legal responsibility by members of the Institute; it was not even a Standard which had been approved by the Accounting Standards Review Board [150] . It carried no implication that auditors and accountants were accepting a duty of care beyond that already imposed by law. AAS5 may be a guide in determining the standard of care to be expected once a duty of care is found to exist; it does not create a duty of care.

Under s 266B(1) of the Code the Accounting Standards Review Board can approve accounting standards. Once approved, accounts are required to conform to that standard: ss 266B, 269.

On this aspect of the case, Esanda relied on the decision in Columbia Coffee & Tea [151] . However, I agree with King CJ that that case was wrongly decided. The mere adoption of an Audit Manual containing general accounting standards or guidelines is insufficient to ground liability in circumstances similar to the present case. In this respect, Columbia Coffee & Tea does not represent the law in this country and should be overruled.

In its submissions, Esanda also sought to make a distinction between "actual" and "known" reliance. "Actual" reliance, it was argued, went to causation; "known" reliance was a limiting criterion which warranted the imposition of liability on Esanda. However, "known" reliance is just another name for foreseeability. For the reasons I have already given, more than reasonable foreseeability of a risk of harm to the plaintiff must be shown before a duty of care can arise in a claim for pure economic loss. It is but one element in the duty equation.

Paragraph 85, pleaded in the alternative, does no more than assert that it was reasonably foreseeable that Esanda was in a class of persons who might suffer harm by reason of carelessly prepared accounts and that therefore Peat Marwick owed a duty to them. Again this bald assertion of foreseeability of class and harm is not enough to found a duty of care.

The facts pleaded in the statement of claim plead only breach of duty, causation and loss. No facts are pleaded from which the inference can be drawn that Peat Marwick owed Esanda a duty of care. The particulars found in pars 84 and 84a-c state only the fact that the accounts were not properly drawn up; that Esanda was a member of the Institute and accordingly was bound by the Australian Accounting Standards, in particular AAS5; and that Esanda was at all material times a member of a class of persons whom Peat Marwick foresaw or ought reasonably to have foreseen might rely on the accounts. Paragraph 85, for the reasons already discussed above, provides no assistance to Esanda. In the absence of any other factors pointing to a duty of care being owed, it was critical for Esanda to plead facts indicating that Peat Marwick intended to induce Esanda to rely on the audit accounts. It has failed to do so.

Because one of the elements essential to an action in negligence, namely, duty of care, has not been pleaded, the very onerous test in General Steel [152] has been satisfied.

(1964) 112 CLR 125. The test has been satisfied in similar, if not identical, factual situations. See Possfund Custodian Trustee [1996] 1 WLR 1351; 2 All ER 774; Galoo [1995] 1 All ER 16; Al Saudi Banque [1990] Ch 313.

This is an appeal from a Full Court of the Supreme Court of South Australia (King CJ, Millhouse and Olsson JJ) [153] . The respondent (the auditors) is a firm which, as auditors, certified the accounts of a company, Excel Finance Corporation Ltd (Excel) for the financial year ended 30 June 1989. The appellant (Esanda) is a finance company. It is not a member of Excel. By its statement of claim, Esanda claimed damages against the auditors. First, Esanda sought damages pursuant to s 84 of the Fair Trading Act 1987 SA in respect of alleged contravention of s 56 thereof by reason of the engagement by the auditors, in trade or commerce, in misleading or deceptive conduct. Nothing turns, for present purposes, upon that claim. Esanda also pleaded a claim in negligence against the auditors. It is that portion of the pleading which gives rise to this appeal.

Esanda alleges that, in what it says was reliance upon the audited accounts for the financial year ended 30 June 1989, it entered into transactions whereby it lent money to companies associated with Excel under a guarantee from Excel, and purchased debts from Excel upon terms which included an indemnity from Excel against any shortfall. It is alleged that these transactions resulted in loss to Esanda by reason of Excel's financial position. On 19 January 1987, Excel had entered into a debenture stock trust deed (the Trust Deed) with Executor Trustee Australia Ltd (the Trustee) to secure the issue by Excel of debenture stock. On 31 December 1988, there were five holders of such debenture stock, all of them banking corporations. After default by Excel in repayments of principal and payment of interest, the Trustee on 15 February 1991 appointed a receiver and manager over the assets of Excel.

The Full Court allowed an appeal by the auditors against the refusal of the primary judge to strike out the paragraphs of the statement of claim alleging a cause of action in negligence. Esanda appeals to this Court to obtain the reinstatement of its pleading.

No allegation has been made by Esanda of any statutory duty said to be owed to it by the auditors. Nevertheless, an appreciation of the statutory requirements to which Excel and the auditors were subject is important for the issues which do arise. Excel was not an exempt proprietary company to which s 278 or s 279 of the Companies (South Australia) Code (the Code), which were in force at the relevant time, could have applied. Accordingly, Excel was obliged by s 280 of the Code to appoint a person or firm as auditor of the company. Further, the directors of Excel were required by s 269(4) to take "reasonable steps" to ensure that the accounts of Excel were audited as required by Pt VI of the Code (ss 266-288). The auditors might be removed from office by resolution of Excel in general meeting and upon special notice of that resolution (s 282(1)); the auditors might resign only with consent of the National Companies and Securities Commission (s 282(6)). The auditors thus held an office protected by statute, as well as being linked to Excel by contract. Section 285 required the auditors to report to members of Excel on the accounts required to be laid before Excel at its annual general meeting and on the accounting records of Excel and other records relating to those accounts. The report was to be furnished by the auditors to the directors (s 285(2)) in sufficient time to be sent to all persons entitled to receive notice of general meetings (s 274(1)). The directors were obliged by s 269(5) to cause to be attached to, or endorsed upon, the accounts the auditors' report furnished to them in accordance with s 285(2).

Section 269(1) required the directors of Excel to cause to be made out a profit and loss account giving a true and fair view of the profit or loss of the company for the financial year. Section 269(2) obliged the directors to cause to be made out a balance sheet giving a true and fair account of the state of affairs of Excel as at the end of the financial year. In their report the auditors were commanded by s 285(3) of the Code to state, among other things, whether in their opinion the accounts of Excel were properly drawn up so as to give a true and fair view of the matters required by s 269 of the Code to be dealt with in the accounts.

On 19 October 1989, the auditors furnished to the members of Excel a report in respect of their audit of the accounts of Excel for the year ended 30 June 1989. The auditors reported that, in their opinion, the accounts were properly drawn up in accordance with the provisions of the Code so as to give a true and fair view of the state of affairs of Excel as at 30 June 1989 and of the results of the company for the year ended on that date. The auditors also reported that the accounts were in accordance with "Australian Accounting Standards and applicable Approved Accounting Standards". Esanda alleges that, in significant respects, the contrary was the true position. Furthermore, Esanda contends that there were substantial breaches of the terms of the Trust Deed which would have required the Trustee at that stage to exercise its powers to appoint a receiver to Excel under the Trust Deed.

The strike-out application was made under the summary procedure provided in r 46.18 of the Supreme Court Rules 1987 SA. It was accepted that this procedure should be reserved for a plain case, in accordance with the principles identified in General Steel Industries Inc v Commissioner for Railways (NSW) [154] . Rule 75.02(c) provides for what King CJ identified as a "demurrer type procedure" [155] . This was not utilised but may have been more appropriate.

(1964) 112 CLR 125. 2. Esanda Finance (1994) 61 SASR 424 at 433.

The Full Court reached what the Chief Justice described as the clear conclusion that the statement of claim did not disclose a cause of action in negligence. Accordingly, the appeal was allowed and certain paragraphs of the statement of claim and other consequential passages were struck out. Those elements of the statement of claim were the sole basis for the claim in negligence. However, on the grant of special leave by this Court, no condition was imposed which would shut out Esanda subsequently from seeking further to amend, for example, in the light of what might be disclosed on discovery. Esanda has not forgone any rights it may have in that respect.

The matter thus comes to this Court neither upon a demurrer nor after a trial in which the facts have been found. That is an important consideration for the framing of these reasons for judgment.

In that respect, this appeal resembles the dispute as it reached the House of Lords in Caparo Industries Plc v Dickman [156] . That case, nevertheless, is the leading English authority upon what has been described as "auditor's negligence".

In this litigation the Full Court allowed the appeal by the auditors on the footing that the impugned paragraphs of the statement of claim disclosed no reasonable cause of action in negligence. This was because the facts pleaded therein were insufficient in law to found a duty of care owed by the auditors to Esanda.

King CJ pointed out [157] that Esanda was not a member of Excel, the corporation in respect of which the Code imposed the statutory obligations I have described. Rather, Esanda relied upon the auditors' report in entering into financial dealings with Excel. His Honour concluded that, in the absence of some feature indicating an assumption of responsibility to Esanda to exercise care in relation to the preparation of the audit certificate, the auditors were not under a duty of care to Esanda unless the auditors intended to induce Esanda to act in reliance on the audit certificate. It is that holding which attracts the principal attack by Esanda in this Court.

Esanda Finance (1994) 61 SASR 424 at 431. Judgments to the same effect were delivered by Millhouse J and Olsson J.

The Chief Justice observed two respects in which particular allegations were missing from the statement of claim. The first was that there was no allegation that the auditors intended to induce Esanda, or a class of which Esanda was a member, to enter into financial transactions with Excel. Secondly, there was no allegation that the auditors at the relevant time were aware that Esanda was engaged in financial transactions with Excel or that any were in contemplation.

King CJ went on to note, and consider, a third deficiency. This was done in the following passage [158] :

There is no allegation of any act on the part of the [auditors] which could indicate or involve the assumption of a specific responsibility to [Esanda] to exercise care in the audit. Apart from the allegations with respect to the accounting standards, to which reference will be made shortly, the only relevant allegations are that the [auditors] certified the financial statements as auditors and that [Esanda] relied upon them. It may be assumed that it was reasonably foreseeable by the [auditors] that persons contemplating financial transactions with [Excel] might consult the financial statements and rely upon their accuracy and upon the audit certificate. Those facts, however, fall short of establishing the relationship of proximity which is necessary to give rise to a duty of care. 1. Esanda Finance (1994) 61 SASR 424 at 431.

King CJ and Olsson J referred with evident approval to the decision of a Full Court of the Victorian Supreme Court in R Lowe Lippmann Figdor & Franck v AGC Ltd [159] . That was an action by a creditor who claimed to have advanced further money to the company in question in reliance upon an admittedly careless audit of accounts by the defendant. The defendant was aware that the plaintiff was a major creditor of the company and signed the audit report knowing that the company probably would supply a copy of the accounts to the plaintiff for the plaintiff's review of the loan facility of the company. The Full Court held that a knowledge or belief that the plaintiff would probably rely on the auditors' report could not be equated with an intention to induce the plaintiff to act in reliance upon it. Rather, the only intention on the part of the auditors established on the evidence, and then purely by inference, was that in making their report the auditors intended to discharge their contractual and statutory duties as auditors for the company. For the plaintiff to succeed it would have been necessary to show that the purpose of the auditors, or one of their purposes, in signing the audit report had been to induce the plaintiff, or a class which included the plaintiff, to act on the statements made therein.

In the present case, the Full Court referred to paragraphs in the statement of claim which alleged that the members of the auditors were members of the Institute of Chartered Accountants and that the Institute had adopted certain Statements of Accounting Standards (AAS) to be observed by its members. Section 266B(1) of the Code provided for the approval by the Accounting Standards Review Board (the Board) of accounting standards with which company accounts were required to conform (s 269(8A)). The pleading did not allege the AAS had been approved by the Board. It is accepted by both sides that they had not been. It appears that the standards approved by the Board, called the ASRB Standards, were closely modelled on, but were not the same as, the AAS.

The allegation in the pleading was that, by reason of the AAS, the auditors assumed a responsibility to Esanda which gave rise to a duty of care towards it with respect to the auditing of the financial statements of Excel. The Chief Justice considered the text of these standards and concluded that membership of the body responsible for promulgation of the standards did not give rise to a duty of care to persons to whom a duty would not otherwise be owed. King CJ said [160] :

Apart from any other consideration, the standards themselves do not purport to create such a duty. They are not concerned with legal duty but with the content of financial statements. The concept of materiality is developed for the purpose of determining what should be included in financial statements. The reference to providers of loan capital and creditors as users of financial statements occurs in the context of determining what is material for inclusion in such statements. It does not imply any assumption of legal responsibility to such users to exercise care. 1. Esanda Finance (1994) 61 SASR 424 at 432.

Paragraph 7 of AAS5 stated that the test of materiality involved consideration of the users, or likely users, of financial statements and that the information presented therein might be used by various and often quite different classes of persons, each class having its own particular interest in the reporting entity. The paragraph continued:

Users of financial statements of a private sector entity would include the present and potential providers of equity or loan capital, and creditors. Users of financial statements of a public sector entity would also include parliament and other legislative bodies.

King CJ concluded [161] that, in the case of alleged liability of an auditor to persons other than the client or members of the client company, there was a need for an intention to induce reliance or, failing that, an assumption of responsibility. This, his Honour said, would exist only where there is a clear indication of willingness to be responsible to the particular plaintiff, or to a class of which the plaintiff is a member, for the careful auditing of financial statements. The inclusion in a set of standards of an acknowledgment of a professional responsibility to have in mind the interests of users other than the client in determining what is to be included in the accounts, or in carrying out the audit, could not enlarge the area of legal duty beyond that which would otherwise exist. In so concluding the Chief Justice departed from the reasoning underlying the decision of the Supreme Court of New South Wales in Columbia Coffee & Tea Pty Ltd v Churchill [162] .

Esanda Finance (1994) 61 SASR 424 at 433. 2. (1992) 29 NSWLR 141.

Esanda challenges the propositions which were accepted in the Full Court.

The present appeal raises specific issues as to the inadequacies found by the Full Court in Esanda's pleading. However, these will be better understood after some consideration of basic questions which have bedevilled the development of the tort of negligence over this century. These include (i) tortious responsibility in damages for non-deceitful statements, (ii) the relationship between negligence and contract, and (iii) recovery of "pure" economic loss occasioned by word rather than deed or failure to act.

As late as 1918, the phrase "action on the case for negligence" was used by the English Court of Appeal [163] . That serves to remind us that the modern tort of negligence has developed step by step in a manner reminiscent of the growth, in former times, of the action brought as Trespass on the Case [164] . It is only in this century that efforts have been made to elaborate a distinct and general doctrine for the tort of negligence whereunder liability is analysed in terms of duty and correlative right between the parties. Speaking of the resultant situation as it obtained in England in 1988, Lord Templeman said in CBS Songs Ltd v Amstrad Plc [165] :

Since Anns v Merton London Borough Council [166] put the floodgates on the jar, a fashionable plaintiff alleges negligence. The pleading assumes that we are all neighbours now, Pharisees and Samaritans alike, that foreseeability is a reflection of hindsight and that for every mischance in an accident-prone world someone solvent must be liable in damages. The present state of affairs has been further criticised as representing "a partnership between exhausted principle and obscured pragmatism" [167] . 1. Coldman v Hill [1919] 1 KB 443 at 449. 2. Winfield, The History of Negligence in the Law of Torts, Law Quarterly Review, vol 42 (1926) 184, at pp 197-198; Maitland, The Forms of Action at Common Law, Chaytor and Whittaker (eds) (1976), at pp 53-55; Malone, The Role of Fault in the History of Negligence in Essays on Torts (1986) 1, at pp 24-30. 3. [1988] AC 1013 at 1059. 4. [1978] AC 728. 5. Steele, Scepticism and the Law of Negligence, Cambridge Law Journal, vol 52 (1993) 437, at p 466.

What has been at stake in this modern development of the tort of negligence is what Sir Owen Dixon identified [168] as the very essence of accepted judicial method. This is the combined purposes of developing the law, maintaining its continuity and preserving its coherence. Accepted means of effecting those purposes include (i) extending the application of accepted principles to new cases; (ii) reasoning from the more fundamental of settled legal principles to new conclusions; and (iii) subsuming unforeseen instances under a category which, in reason, is not closed against them.

"Concerning Judicial Method", Australian Law Journal, vol 29 (1956) 468, at pp 472, 475. See also as to "the time-honoured methodology of the common law" the remarks of McLachlin J in R v Van der Peet (1996) 137 DLR (4th) 289 at 377.

I turn to consider tortious responsibility for non-deceitful statements. In cases such as Hedley Byrne & Co Ltd v Heller & Partners Ltd [169] , Mutual Life & Citizens' Assurance Co Ltd v Evatt [170] and Shaddock & Associates Pty Ltd v Parramatta City Council [No 1] [171] intention or purpose of inducing action was vital to the creation of a duty of care. However, such a duty is not imposed whenever a representation be made with an intention or purpose that it be acted upon. This was emphasised as follows by Brennan J in San Sebastian Pty Ltd v The Minister [172] :

It would be a mistake to impose a duty of care whenever the circumstances would give rise to a duty to be honest. The doctrine of Hedley Byrne has not made the tort of deceit otiose. His Honour's statement also serves to illustrate the point that a closer consideration of the principles which do or should animate the tort of negligence may serve also to emphasise those which animate other torts. The "fault principle" and accompanying doctrines of foreseeability, proximity and voluntary assumption of responsibility are inadequate determinants of the modern law of tort as a whole [173] . Nor do they displace carefully worked out equitable doctrines, particularly those of importance in daily practice of commercial law, such as the equitable doctrines which protect sureties [174] . 1. [1964] AC 465. 2. (1968) 122 CLR 556; rev [1971] AC 793. 3. (1981) 150 CLR 225. 4. (1986) 162 CLR 340 at 371. 5. See China & South Sea Bank Ltd v Tan [1990] 1 AC 536 at 543-544. 6. China & South Sea Bank Ltd v Tan [1990] 1 AC 536; see also Coroneo v Australian Provincial Assurance Association Ltd (1935) 35 SR (NSW) 391 at 394-395.

Then there is the matter of the interrelation between contract and tort. The existence or content of the obligations owed by A to B might be excluded or limited, subject to any particular overriding policy considerations or statutory provision, by the terms of the contract between A and B. Why then should A bear a greater responsibility to C, subject only to the defence of contributory negligence on the part of C? C is a party with whom there has been no dealing in respect of the subject matter of the contract. This concern was reflected in the principle identified by Pollock [175] as truly flowing from Winterbottom v Wright [176] . This was that if A breaks A's contract with B, which may happen without any default in A, that is not of itself sufficient to make A liable to C, a third party, for consequential damage. That this proposition is still a significant element in the reasoning in modern authorities dealing with recovery in tort of economic loss is illustrated by the dissenting judgments in Junior Books Ltd v Veitchi Ltd [177] , White v Jones [178] and Bryan v Maloney [179] .

The Law of Torts, 1st ed (1887), pp 448-449. 2. (1842) 10 M & W 109 [152 ER 402]. 3. [1983] 1 AC 520 at 551-552. 4. [1995] 2 AC 207 at 251, 281-282. 5. (1995) 182 CLR 609 at 639-640, 648.

Moreover, in his speech in Hedley Byrne [180] , Lord Devlin accepted that there could be a duty to take care in word as well as deed in the case of a relationship "equivalent to contract", that is, "where there is an assumption of responsibility in circumstances in which, but for the absence of consideration, there would be a contract". That statement was an element in the reasoning of Lord Goff of Chieveley and Lord Woolf in Spring v Guardian Assurance Plc [181] , and of Lord Goff of Chieveley in Henderson v Merrett Syndicates Ltd [182] .

[1964] AC 465 at 528-529. 2. [1995] 2 AC 296 at 317-320, 344-345. 3. [1995] 2 AC 145 at 178-181.

In the cases much attention has been given to such matters as antecedent request, assumption of responsibility, reliance, and intention to induce activity. In Hill v Van Erp [183] , I referred to the criticism engendered by the imprecise meaning of such terms. Nevertheless, emphasis upon them in a real sense reflects the quest for an alternative to consideration. The same might be said of the emphasis upon detrimental reliance in modern cases expounding equitable or promissory estoppel, notably Waltons Stores (Interstate) Ltd v Maher [184] .

(1997) 188 CLR 159 at 228-231. 2. (1988) 164 CLR 387 at 400-406, 426-429, 449, 458-459.

Dean Prosser pointed out [185] that Winterbottom v Wright was taken both in England and the United States to mean that the manufacturer or first seller of goods was not liable for damage caused by their defect to any party other than the immediate buyer or one in privity with that buyer. That view first was qualified in respect of goods dangerous in themselves, a matter later noted by Lord Devlin in Hedley Byrne [186] . Then it was overthrown in the United States as a result of MacPherson v Buick Motor Co [187] and subsequently in England as a result of Donoghue v Stevenson [188] . In that case, Lord Atkin [189] said that Judge Cardozo in MacPherson had stated the principles of the law as his Lordship should desire to state them. They fixed upon reasonable foreseeability of injury if proper care were not taken. In that way, as Judge Cardozo put it, there was nothing anomalous in imposing upon A who contracted with B a duty to C; "foresight of the consequences involves the creation of a duty" [190] .

Prosser and Keeton on Torts, 5th ed (1984), s96. 2. [1964] AC 465 at 524. 3. (1916) 111 NE 1050. 4. [1932] AC 562. 5. Donoghue [1932] AC 562 at 598-599. 6. MacPherson (1916) 111 NE 1050 at 1054.

Writing extrajudicially, Chief Judge Posner has said that neither of the judgments of Judge Cardozo and Lord Atkin [191] :

offered a practical reason for liability, such as the burden on the courts if the consumer sues the retailer for breach of warranty and the retailer then brings in the manufacturer as a third-party defendant, seeking indemnification on the basis of the manufacturer's warranty to the retailer, or the possibility that the retailer is judgment-proof. Both MacPherson and Donoghue are dogmatic opinions and laid unstable foundations for further judicial explorations of the "duty limitation" on liability. 1. Posner, Law and Legal Theory in England and America (1996), at p 45.

Any transition which proposed foreseeability of harm to economic interests as the chief determinant of a liability in negligence for careless words was checked by Chief Judge Cardozo himself in his judgment in Ultramares Corporation v Touche [192] . Like the present case, the plaintiff sought to recover damages from the auditors of a company to which it had provided finance. The company had gone into bankruptcy and the plaintiff turned unsuccessfully to seek recovery from the auditors. It was held that foreseeability of loss was insufficient to create a duty of care. The decision was taken in the United States to decide that auditors were immune from negligence actions by third parties with whom the auditors were not in contractual privity [193] . Courts throughout the common law world continue to discuss the reasoning in Ultramares in the course of deciding whether to strike the same or some different balance between the competing interests that are involved in such cases.

(1931) 255 NY 170 [174 NE 441]. 2. See, eg, First National Bank of Commerce v Monco Agency Inc (1990) 911 F 2d 1053 at 1058.

In a case of "auditor's negligence" the alleged damage flows not immediately from the making of the statement by the auditor but from the reliance by the plaintiff upon it and from the action or inaction of the plaintiff which produces consequential loss. Hence the submissions by the auditors that in such a case reliance is an essential link between the defendant's conduct and the plaintiff's injury, and is a cornerstone of liability in negligence [194] so that, in the present case, it is necessary for Esanda to plead and establish reliance. What is involved is foreseeability of reliance. Moreover, the auditors further contend that even this of itself is not sufficient to found a duty of care under Australian law in a case such as the present. More is required and it is said that it is not supplied by the Esanda pleading. The auditors illustrate the point by citation of the stipulation by Lord Goff of Chieveley in Spring v Guardian Assurance Plc [195] , with reference to Hedley Byrne, that there be an assumption or undertaking of responsibility by the defendant towards the plaintiff "coupled with reliance by the plaintiff on the exercise by the defendant of due care and skill".

See San Sebastian (1986) 162 CLR 340 at 353, 356-357; Bily v Arthur Young & Co (1992) 834 P 2d 745 at 772. 2. [1995] 2 AC 296 at 318.

Scott Group Ltd v McFarlane [196] was relied upon by Esanda to support its pleading. In that case, two members of the New Zealand Court of Appeal (Woodhouse and Cooke JJ) considered that the defendant auditors owed a duty of care to the plaintiff which had made a successful takeover bid for the shares in the client public company whose assets had been overstated. This was on the footing, still accepted in New Zealand [197] , that, in Anns v Merton London Borough Council [198] , Lord Wilberforce required as the first of a two-step inquiry no more than a consideration of whether harm was foreseeable. Thus, the requirement of a "proximate relationship" meant no more than foreseeability of harm.

[1978] 1 NZLR 553. 2. South Pacific Manufacturing Co Ltd v New Zealand Security Consultants & Investigations Ltd [1992] 2 NZLR 282; Invercargill City Council v Hamlin [1994] 3 NZLR 513 at 520, 530; affd [1996] AC 624 (PC). 3. [1978] AC 728.

Any such equation between proximity and mere foreseeability was denied by the House of Lords in Caparo Industries Plc v Dickman [199] . This is an authority upon which the auditors placed much reliance in the present appeal. Moreover, this Court has rejected foreseeability of loss as a sufficient criterion for the existence of a duty of care to avoid pure economic loss [200] . The auditors submit that, in substance, Esanda's pleading reverts to a view of the law which in this country is not open to it. This criticism is soundly based, so that Esanda's appeal must fail. For their part, the auditors would seek to press home any consequent advantage by having this Court determine that various alternative formulations of the Esanda claim would be necessary or would fail. However, as I will indicate, that invitation should not be accepted at this stage of the litigation between these parties.

[1990] 2 AC 605. 2. eg, San Sebastian (1986) 162 CLR 340 at 354-355, 367 and Bryan v Maloney (1995) 182 CLR 609 at 617-618, 652-653.

I turn first to consider some of the fundamental issues presented in claims of negligence by auditors and then the present state of authority in other common law jurisdictions. That review will confirm the conclusion then reached as to the particular, if not limited, basis upon which this interlocutory appeal should be disposed of in this Court.

As I see it, the fundamental issues presented in cases where auditor's negligence is alleged were identified by Millett J in Al Saudi Banque v Clark Pixley [201] . His Lordship said:

In cases of negligence which causes physical damage, it is seldom necessary to consider the concept of proximity in order to impose a reasonable limit on the ambit of the duty of care. The physical damage itself usually provides a sufficient limiting factor. Claims for damages for economic loss resulting from negligent misstatements, however, are very different. There is a potential for foreseeable but indeterminate and possibly ruinous loss by a large and indeterminate class of plaintiffs. Foreseeability of reliance by itself is not an adequate limiting factor. Ever since the celebrated case of Ultramares Corporation v Touche [202] , courts in the common law jurisdictions have been concerned to avoid, in the well-known words of Cardozo CJ [203] , "liability in an indeterminate amount for an indeterminate time to an indeterminate class".

Two control mechanisms for limiting the ambit of the duty of care can be discerned in the authorities: (i) to limit the transaction in which the defendant's statement may be relied upon to the transaction in which he intended it, or knew that it was intended, to be relied upon; and (ii) to limit the plaintiff or class of plaintiff to the person or persons to whom the defendant made the statement, or to whom he intended or knew that it was intended to be communicated.

[1990] Ch 313 at 330. 2. (1931) 255 NY 170; 174 NE 441. 3. Ultramares Corporation (1931) 255 NY 170 at 179 [174 NE 441 at 444].

On occasion, the need for such control mechanisms has been denied on the footing that accountants may guard against the burdens imposed by an expansion of liability with the purchase of insurance and charging the cost thereof to the client; those insurance costs in turn could be further dispersed by passing them on to the general public [204] . With good reason for doing so, one United States commentator has referred to the development of an unhealthy and unrealistic dependence on the mythical powers of insurance to offset expanded tort liability [205] . He points out that, if unable to discern the number, identity and characteristics of reliant third parties whose losses it must cover, the insurer of the auditor is likely to respond by raising premiums [206] . The availability of insurance and the characteristics of the insurance and reinsurance markets will vary from time to time. In any event, before the courts rely (expressly or tacitly) upon the present or prospective availability and cost of insurance, as a matter favouring the expansion of tort liability, attention is required to more than anecdotal or intuitive perceptions [207] .

Rosenblum v Adler (1983) 461 A 2d 138 at 151; see also as to the significance attached to the availability of insurance against the risk of liability under expansive tort doctrine Scott Group Ltd v McFarlane [1978] 1 NZLR 553 at 572; Shaddock & Associates Pty Ltd v Parramatta City Council [No 1] (1981) 150 CLR 225 at 252; Canadian National Railway Co v Norsk Pacific Steamship Co [1992] 1 SCR 1021 at 1123-1125. 2. Siliciano, Negligent Accounting and the Limits of Instrumental Tort Reform, Michigan Law Review, vol 86 (1988) 1929, at pp 1948-1950, 1976-1977. See also Feldthusen and Palmer, Economic Loss and the Supreme Court of Canada: An Economic Critique of Norsk Steamship and Bird Construction, Canadian Bar Review, vol 74 (1995) 427, at pp 443-445. 3. Siliciano, Negligent Accounting and the Limits of Instrumental Tort Reform, Michigan Law Review, vol 86 (1988) 1929, at p 1950. 4. Marc Rich & Co v Bishop Rock Ltd [1996] 1 AC 211 at 228-229, 239-240.

In framing any applicable principle in this area, including what have been called "control mechanisms", it is important to have regard to a number of considerations. First, in many cases the corporate client of the auditor will be insolvent and may be in receivership, liquidation or under some other form of administration; the third party seeks to elevate itself beyond the status of other creditors by seeking a solvent defendant from which to recoup the consequences of its poor business judgment in financing or otherwise dealing with the company. Secondly, the alleged negligence of the auditor necessarily will be subsidiary to the failures of the corporation which prepared the accounts the auditor certified.

Thirdly, the auditing process involves rather more than the statement of a verifiable fact, such as the zoning of a particular parcel of land. The discharge by the auditor of its statutory functions requires a complex process which may involve differences of professional opinion. Fourthly, the plaintiff in a case such as the present in substance seeks to render the auditor liable as if it had given, but without receipt of reciprocal value for doing so, a guarantee to a range of third parties who finance the operations of the corporation; this guarantee is unlimited in amount and lacks the protection of various doctrines by which the courts have shown a tenderness to sureties.

Finally, the recipients of that guarantee, such as Esanda, are in quite a different league to the consumer in product liability cases. A financier such as Esanda would not lack power to deal from a position of strength in ordering its commercial relationship with the party to whom it provided financial accommodation.

It is appropriate now to consider the state of relevant authority in other common law jurisdictions. I have already referred to the position in New Zealand and to the dependence upon the concept of foreseeability in cases of pure economic loss as being at variance with the settled law in England and Australia. Broadly, it may be said that the trend of authority in the United States, England and Canada with respect to auditor's negligence reflects an adherence or, in the case of the United States, a renewed adherence, to Ultramares. The authorities also reflect a rejection of mere foreseeability of economic loss itself as supplying a sufficiently proximate relationship between auditor and third-party plaintiff. Whereas once, when called upon to extend the frontiers of liability, some courts, reflecting academic enthusiasms, may have asked "Why not?", the time has arrived to ask instead "Why?" [208] .

Fleming, Tort in a Contractual Matrix, Osgoode Hall Law Journal, vol 33 (1995) 661, at p 672.

On most of the formulations in the recent authorities, the pleading by Esanda would be defective. It would survive probably only in New Zealand and in some jurisdictions in the United States.

I begin with the recent decision of the British Columbia Court of Appeal in 327973 British Columbia Ltd v HBT Agra Ltd [209] . The Court dismissed an appeal by the plaintiff which had failed in an action against an engineer. The engineer had prepared a report for the previous owner of land which incorrectly stated that it was essentially free of risk of subsidence. The plaintiff unsuccessfully sought to recover the expenses of consolidating an area of subsidence. The Court said that, in cases of pure economic loss, the law required "something more" than foreseeability in order to find liability, namely, sufficient proximity between the negligent act and the loss [210] . Their Lordships referred to various decisions, including Caparo, and concluded [211] :

In every case in which liability has been imposed in respect of a loss suffered by a third person, the professional advisor has been aware that his statements would be presented to and used by the third person for a particular purpose which was known to the professional advisor at the time the statement was made. 1. (1994) 120 DLR (4th) 726. 2. 327973 British Columbia (1994) 120 DLR (4th) 726 at 734. 3. 327973 British Columbia (1994) 120 DLR (4th) 726 at 736.

In Caparo [212] , the House of Lords dealt with an appeal in respect of the trial of a preliminary issue as to the existence of a duty of care in an action brought by a plaintiff which had accomplished the takeover of a corporation of which the defendants had been the auditors. The allegation was that the auditors had been negligent in carrying out their audit and in making their report in discharge of statutory requirements which were substantially the same as those under the Code. It was held that (i) liability for economic loss due to negligent misstatement was confined to cases where the statement or advice had been given to a known recipient for a specific purpose of which the maker was aware and upon which the recipient had relied and acted to the detriment of the recipient; (ii) the purpose of the statutory requirement for an audit of public companies under the Companies Act 1985 UK was the making of a report to enable shareholders to exercise their class rights in general meetings and it did not extend to the provision of information to assist shareholders in the making of decisions as to future investment in the company; and (iii) a fortiori, there was no reason in principle or policy to treat auditors as having a special relationship with non-shareholders who contemplated investment in the company in reliance upon the published accounts, and this was so even when the affairs of the company were known to be such as to render it susceptible to an attempted takeover. Accordingly, the auditors had not owed any duty of care to the plaintiff in respect of the purchase of the shares in the company.

In the United States there has been, as one might expect, variation between the common law as found in the various States. I have referred earlier to the decision of the Supreme Court of New Jersey in Rosenblum v Adler [213] . The Supreme Court followed a line of reasoning akin to that of the New Zealand Court of Appeal in Scott Group Ltd v McFarlane [214] . That is to say, Ultramares was rejected in favour of foreseeability as the touchstone of liability. The duty of the auditor was framed as one in favour of all those whom the auditor should reasonably foresee as recipients from the company of the statements for their proper business purposes, provided the recipients rely on the statements pursuant to those business purposes [215] . Such a doctrine would favour the adequacy of the case pleaded by Esanda.

(1983) 461 A 2d 138. The New Jersey legislature has since limited the liability of accountants to third parties for their negligent acts: Petrillo v Bachenberg (1995) 655 A 2d 1354 at 1360. See also the provision now made in New South Wales by the Professional Standards Act 1994 NSW for the approval of schemes limiting the civil liability of professionals. 2. [1978] 1 NZLR 553. 3. Rosenblum v Adler (1983) 461 A 2d 138 at 153; Rosenblum was followed in Touche Ross v Commercial Union Insurance (1987) 514 So 2d 315 at 322-323.

However, some jurisdictions continue to follow the decision of the New York Court of Appeals in Ultramares [216] . In Credit Alliance v Arthur Andersen & Co [217] , the New York Court of Appeals formulated criteria to establish a nexus between the parties, "sufficiently approaching privity" under "the principles of Ultramares " [218] . These criteria for the determination of liability of auditors in negligence to third parties were [219] :

(1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants' understanding of that party or parties' reliance. The requirement of intention that "a known party or parties" be intended to rely upon the reports has attracted the description of Credit Alliance as propounding a "near privity" rule [220] . 1. In Virginia, there is a general doctrine that privity of contract is an essential element of an action to recover for economic loss resulting from negligent performance of a contractual commitment: Ward v Ernst & Young (1993) 435 SE 2d 628 at 630-634. 2. (1985) 493 NYS 2d 435. 3. (1985) 493 NYS 2d 435 at 445. 4. Ultramares (1985) 493 NYS 2d 435 at 443. 5. First National Bank of Commerce v Monco Agency Inc (1990) 911 F 2d 1053 at 1058-1059.

Decisions in other United States jurisdictions have pursued a course based to some extent upon the more recent English decisions, and, in particular, upon s552 of the Restatement Second of Torts. Section 552 applies not only to auditors but, by reason of its generality of language, to parties who supply information for the guidance of others in business transactions. It is not as restrictive as the "near privity" rule nor as generous as the foreseeability doctrine of Rosenblum v Adler [221] . The essence of s552 is that the supplier will be liable in negligence to a third party only if the supplier intends to provide the information for the benefit of one or more third parties in a specific transaction or type of transaction which was identified to the supplier. Of the formulation in s552, Dean Prosser, the Reporter for the Restatement, said that, whilst not entirely satisfied with it, "if anyone can do better, it will be most welcome" [222] . Recently, the United States Court of Appeals for the Fifth Circuit identified s552 as founding "the approach that the majority of states have adopted" [223] .

(1983) 461 A 2d 138. 2. Restatement Second of Torts, Tentative Draft No 11, April 15, 1965, s552, p 56. 3. Scottish Heritable Trust Plc v Peat Marwick Main & Co (1996) 81 F 3d 606 at 612.

It is the Restatement which was the most significant influence upon the decision of the Supreme Court of California in Bily v Arthur Young & Co [224] . That decision offers, in its reasoned exposition and analysis of the considerations which are presented, assistance on the present appeal.

Section 552 of the Restatement Second of Torts is headed "Information Negligently Supplied for the Guidance of Others". It states:

(1) One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest [225] , supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.

(2) Except as stated in Subsection (3), the liability stated in Subsection (1) is limited to loss suffered

(a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and

(b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.

(3) The liability of one who is under a public duty to give the information extends to loss suffered by any of the class of persons for whose benefit the duty is created, in any of the transactions in which it is intended to protect them. (Emphasis added.)

In San Sebastian (1986) 162 CLR 340 at 358, this Court held that the general interest which a local authority has in promoting or encouraging the development of its area would not ordinarily be classified as a "pecuniary interest", so as to support the existence of a duty of care on its part in relation to statements in its development plans.

In Bily, the case had been tried before a jury for thirteen weeks and the jury returned a verdict in favour of the plaintiff based on professional negligence. Compensatory damages of approximately $4.3 million were awarded. The intermediate appellate court dismissed an appeal as to the adequacy of the directions which had been given to the jury on issues of law. A final appeal to the Supreme Court of California, by majority, succeeded. The case was remanded with instructions to direct judgment in favour of the defendant. The majority judgment was delivered by Lucas CJ.

The essence of the holding of the Supreme Court appears from the passage [226] in which the Court suggested the following jury direction for determination of whether the plaintiff belongs to the class of persons to whom or for whom the representations in the audit report in question were made. The direction is as follows:

The representation must have been made with the intent to induce plaintiff, or a particular class of persons to which plaintiff belongs, to act in reliance upon the representation in a specific transaction, or a specific type of transaction, that defendant intended to influence. Defendant is deemed to have intended to influence [its client's] transaction with plaintiff whenever defendant knows with substantial certainty that plaintiff, or the particular class of persons to which plaintiff belongs, will rely on the representation in the course of the transaction. If others become aware of the representation and act upon it, there is no liability even though defendant should reasonably have foreseen such a possibility. (Emphasis added.) The phrase "deemed to have intended", it would appear, is designed to mean no more than "is to be held or adjudged to have intended", the word "deemed" being used in one of the various senses identified by Windeyer J in Hunter Douglas Australia Pty Ltd v Perma Blinds [227] . 1. Bily (1992) 834 P 2d 745 at 772-773. 2. (1970) 122 CLR 49 at 65-67.

What emerges from this consideration of current authority in England, Canada and the United States is a trend favourable to the interests of the auditors. But there is no unanimity of view as to the way in which any particular criterion of stringency should be framed. This serves to emphasise the consideration that, in a case which arises as has this appeal, the court should be slow to suggest any answer to deficiencies found in the pleading under challenge.

I return now to the present appeal. It arises from a strike-out application. The issue before this Court does not require any affirmative holding as to the elements of the relevant cause of action. The issue is narrower. It is whether the Full Court was correct in holding that the claim as propounded by Esanda was deficient because it disclosed no reasonable cause of action in negligence. This Court may determine that the claim was so deficient without making any conclusive statement as to what would be needed to make it an effective claim.

Both the South Australian Full Court in this case and the Victorian Full Court in R Lowe Lippmann Figdor & Franck v AGC Ltd [228] naturally placed much reliance upon the decision of this Court in San Sebastian [229] . In that case, the plaintiff developers failed at the threshold to establish that the alleged representations in certain planning scheme documents had been made. In addition, this Court held that, if the developers were to succeed, they would also have had to establish, at least, that the representation had been made with the intention of inducing members of the class of developers to act in reliance on the representation [230] . The Court rejected the looser proposition submitted for the developers that where A engages in conduct which is intended to cause B or a class of persons to act in a particular manner, A comes under a duty of care to B or any member of the class who is induced to act in that manner. The deficiency found in that submission was that it is necessary not only that A intended that B or members of a class of persons should act or refrain from acting in a particular way, but also that A made the statement with the intention of inducing B or members of that class, in reliance on the statement, to act or refrain from acting in a particular way, in circumstances where A should realise that economic loss might be suffered if the statement was not true [231] .

[1992] 2 VR 671. 2. (1986) 162 CLR 340. 3. San Sebastian (1986) 162 CLR 340 at 358. 4. San Sebastian (1986) 162 CLR 340 at 357-358.

In both judgments in San Sebastian, reference was made to United States authorities dealing with claims against auditors and, in particular, Brennan J [232] referred to Ultramares. The analysis of the law of negligent misstatement in the joint judgment of Gibbs CJ, Mason, Wilson and Dawson JJ involved the following steps. First, on the footing that the plaintiff must show reliance on the negligent misstatement, the question was what further conditions were required for the finding of a duty of care [233] . Secondly, in Mutual Life & Citizens' Assurance Co Ltd v Evatt [234] , Shaddock & Associates Pty Ltd v Parramatta City Council [No 1] [235] and Hedley Byrne itself, the misstatement was made in response to a request for information or advice or both. That made it appropriate to hold that in responding to the request the defendant assumed or undertook responsibility (or disclaimed it, as in Hedley Byrne), and, perhaps, that the defendant intended or at least assumed that the plaintiff would act upon what it had been told [236] .

San Sebastian (1986) 162 CLR 340 at 367. 2. San Sebastian (1986) 162 CLR 340 at 355. 3. (1968) 122 CLR 556. 4. (1981) 150 CLR 225. 5. San Sebastian (1986) 162 CLR 340 at 356-357.

Thirdly, such a request is by no means essential in a case of negligent misstatement [237] . Fourthly, the plaintiff put its case on the footing of an engagement by the defendant in conduct intended to cause it, or a class of persons, to act in a particular manner. A case so framed could not succeed unless, as mentioned above, the intention was one of inducing the plaintiff or members of the class, in reliance on the statement, to act or refrain from acting in a particular fashion in circumstances where the defendant should realise economic loss might be suffered if the statement were untrue. For the reason explained above, the developers' case failed in any event.

However, San Sebastian is not authority for the proposition that the necessary duty of care can only be found in a negligent misstatement case if the statement is made in response to a request for information or advice or made with an intention of the nature discussed above. The range of relevant circumstances is indicated in the following passage from the joint judgment in San Sebastian [238] :

The maker of a statement may come under a duty to take care through a combination of circumstances or in various ways, in the absence of a request by the recipient. The author, though volunteering information or advice, may be known to possess, or profess to possess, skill and competence in the area which is the subject of the communication. He may warrant the correctness of what he says or assume responsibility for its correctness. He may invite the recipient to act on the basis of the information or advice, or intend to induce the recipient to act in a particular way. He may actually have an interest in the recipient so acting. 1. (1986) 162 CLR 340 at 357.

I prefer to approach the matter in a somewhat different fashion to the Full Court in the present case. I would not dispose of the appeal on the footing that the Esanda pleading necessarily disclosed no reasonable cause of action for negligent misstatement by reason of the lack of allegations of (i) intention or (ii) assumption of responsibility. The appeal should be dismissed on a limited basis. This is that, as it stands, the pleading is deficient for want of anything more than that which is put forward to found the duty of care. Once that conclusion is reached, it is inappropriate, on a strike-out application and with the law in its somewhat uncertain state, for the Court to identify to the pleader that which would remedy the deficiency which has led to the striking out of the pleading.

The paragraphs which plead the claim in negligence are pars 84a, 84b, 84c, 85, 85a and 86. Paragraphs 84a and 84b plead the AAS as binding the auditors, par 84c pleads membership by Esanda of a class or classes of persons, creditors and financiers of Excel, which the auditors foresaw or ought reasonably to have foreseen might reasonably rely upon the 30 June 1989 accounts and the auditors' report thereon. Paragraph 85 is pleaded further and in the alternative to par 84. It asserts that the auditors owed Esanda, as a member of a class of persons who might reasonably and relevantly rely upon the accounts and report, a duty to take reasonable care to ensure (i) that the accounts were in accordance with "the applicable Australian accounting standards" and (ii) that the opinions expressed in the auditors' report were based on reasonable grounds. Also pleaded in par 85 was a duty to take reasonable care to carry out sufficient tests to obtain reasonable assurance as to the reliability of the information provided by Excel to the auditors and the sufficiency thereof for the preparation of the accounts and the expression of opinions in the auditors' report.

The duty of care is pleaded in par 85A and breach in par 86. Paragraph 85A is in the following terms:

By reason of the matters pleaded in paragraphs 84a to 84c inclusive:

50a.1 Esanda was so closely and directly affected by the actions or conduct of [the auditors] in furnishing [the auditors' report] that [the auditors were] under a duty of care to Esanda in respect thereof; and

50a.2 [The auditors] accepted or must be taken to have accepted that in furnishing [the auditors' report], the duty of care referred to in paragraph 85 was owed to a class of persons including [Esanda].

In so far as the pleading rests, for the allegation of a duty of care, merely upon forseeability on the part of the auditors and actual reliance by Esanda, then the pleading is bad for the reasons given earlier in these reasons under the heading "Foreseeability and reliance". The matter is not advanced by reference in the pleading to the AAS. I agree, with respect, with what King CJ said [239] as to the effect of the AAS. Moreover, the relevant paragraphs in the pleading, 84a and 84b, which refer to accounting standards are not linked in any fashion immediately apparent with what follows save that it is said in par 85A that, by reason of matters pleaded in those paragraphs, the auditors accepted or must be taken to have accepted that in furnishing their report they owed to Esanda the duty of care pleaded in par 85. The duty of care pleaded in par 85 was to take reasonable care, inter alia, to ensure that the audited accounts were in accordance with the applicable AAS. 1. Esanda Finance (1994) 61 SASR 424 at 432.

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Cases Cited (24)