Plaintiffs v Defendants

1. The plaintiffs seek documents relating to provisions on the ground that they represent the costs Arrium incurred up to the reporting date. The plaintiffs say that KPMG was required to obtain evidence that the forecast cash outflows in the impairment model appropriately included costs that were the subject of provisions. The plaintiffs gave the example of an environmental provision which indicates that a producing asset may become non-viable or less profitable, and the need for this to be accounted for when considering impairment. The plaintiffs say that the sections addressing provisions are directly relevant to the reliability and supportability of the cash flows predicted in the impairment model, and KPMG's audit of it.
2. KPMG agrees that unrecognised provisions may have an impact on predicted future cash outflows, but says that recognised provisions are excluded from cash flows prepared for impairment testing under AASB 136. KPMG submits (without evidence) that any unrecognised provision would only have a direct impact upon future cash flows if it posed an existential risk to business viability, and that any risk of this nature would be required to be disclosed to the market. KPMG points to the fact that there is no allegation in the SOC that provisions were not properly accounted for in the impairment testing. Further, KPMG points to provisions being governed by a different accounting standard (AASB 137) and thus is subject to different requirements to the assessment of impairment under AASB 136.
3. The parties are in agreement that provisions do impact impairment testing, but disagree as to whether particular provisions have relevance in this case. In light of this, in my view the plaintiffs have demonstrated the material in the audit files addressing provisions is directly relevant to the impairment issues the subject of this proceeding, and ought to be discovered.

1. The plaintiffs seek documents relating to inventory on the grounds that it provides evidence of the projected margins in the impairment cash flow model, and gives information of areas where Arrium was selling inventory below cost. KPMG argues that inventory value is governed by a different accounting standard (AASB 102) with a different approach to that which is taken in impairment testing. KPMG also submitted (without evidence) that the audit evidence supporting the actual and projected margins in the impairment models was directly sourced from Arrium's primary financial information for each business segment.
2. The parties are in agreement that projected margins are a component in the cash flows prepared for impairment testing. KPMG does not appear to submit that the inventory documents will not address margin, but rather, that the accounting standard for inventory testing takes a different approach to valuing inventory, which is focused on a sample group of individual assets over a short timeframe. Whereas impairment testing relates to overall margin for each cash generating unit over its useful life. In my view, the plaintiffs have demonstrated that inventory audit material is relevant to the value of the assets alleged to be impaired in this proceeding. Inventory material should be disclosed.

E.4.5 Audit Topic 5 - Restructuring provision

1. The plaintiffs seek documents regarding restructuring provision on the grounds that impairment testing can only include cash flows from restructuring to which Arrium is committed. KPMG argues that restructuring provision and impairment are different accounting and audit areas, governed by different standards. Further, it says that it has disclosed documents concerning restructuring provisions to the extent that they are relevant to impairment testing. KPMG submitted (without evidence) that it has not discovered documents such as 'management's estimate of restructuring' on the grounds that '[t]hey do not contain any information related to specific restructuring provisions recognised by Arrium'. As this analysis demonstrates, the parties are in agreement that restructuring provision documents are relevant to impairment testing, and the issues in dispute in this action. These materials have been discovered in part by KPMG. In my view it is appropriate that they be discovered in their entirety.

1. The plaintiffs seek documents relevant to journal entries on the grounds that they are relevant 'to see whether there were any non-cash entries to improve the reported performance of Arrium in FY14, considering that the base of the impairment tests in AASB136(33)(b) is that cash flows need to be consistent with results in FY14'. The plaintiffs say that the journal entries represent audit evidence as to Arrium's application of the requirements in AASB 136 for measuring the recoverable amount of the cash generating units, as set out at [16[63]] above.63
2. KPMG's response asserts (without evidence) that documents concerning journal entries in the Audit File Index are concerned with control testing on a random basis of journal entries and not with the financial information created by the journal entries. KPMG also asserts that the audit evidence as to Arrium's actual performance is directly sourced from Arrium's primary financial information contained in the impairment section of KPMG's audit files.
3. On the material before the Court, the plaintiffs have failed to identify a link of direct relevance between the audit testing of journal entries and the value of the assets. The particular paragraphs of AASB 136 which the plaintiffs point to for the purpose of identifying the relevance of the journal entry sections of the audit file do not readily identify their relevance, and little further explanation has been given to justify the relevance in light of KPMG's submissions. I do not consider that the journal entry material ought to be discovered.

1. The plaintiffs seek internal audit documents on the grounds that they may provide contradictory audit evidence as to the reliability of forecasting budgets or control over capital expenditure and may assist in the identification of slow moving inventory or underutilised assets, all of which they say are relevant to impairment. The plaintiffs say that to the extent that internal audit performed any work on nine specific topics,[64] that material will be relevant to the impairment issues the subject of this proceeding. KPMG has confirmed that no internal auditing work was undertaken in relation to the nine topics identified by the plaintiffs.
2. Given that there are no internal audit materials going to the topics identified by the plaintiffs to be relevant, I agree with KPMG's submissions that internal audit materials should not be the subject of discovery in this proceeding.

1. Audit topic 8 was not pressed by the plaintiffs.[65]

E.4.9 Audit Topic 9 - Derivative financial assets

1. The plaintiffs seek the materials regarding derivative financial assets on the basis that they are relevant to future predictions of foreign currency, steel prices, iron ore prices, and ability to finance future operations, all of which they say are relevant to impairment. The plaintiffs say that the estimates of commodity prices and demand for Arrium's product are directly relevant to the application of AASB 136, and the reliability and supportability of the predicted cash inflows. KPMG argues that derivative financial assets are excluded from impairment testing pursuant to AASB 136 paragraph [2(e)], such that audit evidence in these sections of the audit file will be irrelevant.
2. KPMG accepts that the derivative financial assets section contains valuations in respect of the derivative assets, but says that these are done on different cash flow timeframes and were tested on a sample group basis. This submission does not address the likelihood, as postulated by the plaintiffs, that regardless of the different audit testing conducted with respect to derivative financial assets, that the underlying material is relevant to the value of the assets the subject of this proceeding. In my view, the plaintiffs have demonstrated that the material addressed in the audit of derivative financial assets is directly relevant to the value of the assets alleged to be impaired in this proceeding. This material should be discovered.

1. The plaintiffs seek discovery of sales documents on the basis that cash inflow from sales is critical to predictions of future cash flows when considering impairment. The plaintiffs point to the requirements in AASB 136 for the impairment model to be consistent with the actual results Arrium had achieved.[66] KPMG opposes discovery on the grounds that all evidence regarding Arrium's predicted cash flows are contained in the impairment section of the audit files which has already been discovered. KPMG also submits that the examples of sales documents identified by the plaintiffs relate to accounting controls for the recording of sales and sample testing which is not representative. KPMG's submissions do not address the issue that actual sales data is relevant to the impairment cash flow modelling. I agree with the plaintiffs that sales data is relevant to the assessment of the reasonableness of the cash flows prepared for impairment purposes, and ought to be discovered.

E.4.11 Audit Topic 11 - Disposal groups and assets held for sale

1. The plaintiffs seek discovery of documents on the grounds that the impairment model is required to exclude cash flows from assets disposed of or which Arrium planned to dispose. The plaintiffs submit that these sections of the audit files are relevant to the question of whether KPMG had sufficient and appropriate audit evidence in respect of the cash flows that ought to be excluded from the impairment model, and thereby, the reliability of Arrium's impairment model.
2. KPMG argues that impairment of non‑current assets (or disposal groups) are classified as held for sale in accordance with a different accounting standard (AASB 5), and are specifically excluded from the impairment testing pursuant to AASB 136.[67] On this basis, KPMG says that they are irrelevant to the impairment issues in this proceeding. KPMG appears to accept that disposal groups and assets held for sale are relevant to the impairment testing cash flows, but only to the extent that the material is maintained in the impairment testing section of the audit file (which material has already been discovered). For the same reasons identified with respect to restructuring documents (see above at [111]), I consider that the parts of the audit file addressing disposal groups and assets held for sale are relevant and ought to be discovered.

E.4.12 Audit Topic 12 - Carrying value of investment in subsidiaries

1. Carrying value of investment in subsidiaries is governed by international accounting standard IAS 28. The plaintiffs submit that documents relating to the carrying value of investments in subsidiaries relate to the potential impairment and underperformance of the asset, such that any carrying value or impairment identified by applying IAS 28 is directly relevant to the application of AASB 136 to goodwill associated with those entities.[68] The plaintiffs point to the requirements of IAS 28,[69] to consider objective evidence of impairment of an investment in a subsidiary, and say that these documents will provide either corroborative or contradictory evidence of the impairment of the cash generating unit to which the subsidiary relates.
2. KPMG submits (without evidence) that the particular documents sought by the plaintiffs in the Audit File Index will not provide any corroborative or contradictory audit evidence in respect of the relevant cash generating units, as Arrium did not prepare a separate valuation model to determine the carrying value of investments in subsidiaries separate to the cash generating impairment model (which has already been discovered).
3. Despite these submissions, KPMG has identified that it is prepared to disclose at least some documents relevant to carrying value in investments in subsidiaries contained in the 2014 Head Office files, in an effort to minimise the issues in dispute.[70] It is not clear to what extent, if any, these documents are interconnected with other parts of KPMG's audit files. It is also not apparent whether a similar concession has been made in respect of the 2015 Head Office files.[71] In light of this concession, and the information from KPMG as to how Arrium determined the carrying value of investments in subsidiaries, discovery ought to be made of those documents that KPMG has agreed to discover in the 2014 Head Office files, together with any other documents referred to therein. Documents of a similar nature contained in the files relating to the subsequent half year review and 2015 audit should also be discovered.

1. The plaintiffs seek discovery of the tax documents on the basis that AASB 112 (Income Tax) provides that deferred tax assets in respect of carried forward tax losses can only be recognised if it is probable that the entity will generate future taxable profits. The plaintiffs submit that therefore, the audit work on recognition of tax losses involves analysis of Arrium's future profitability, and consequently it is relevant to KPMG's assessment of Arrium's impairment model. KPMG says that the material is irrelevant, as impairment is tested on a pre-tax basis. KPMG submits that there are technical differences between assessing the recoverability of deferred tax assets under AASB 112 and impairment testing under AASB 136. I am satisfied that the tax documents are relevant to the value of the assets for the reasons articulated by the plaintiffs, and they ought to be discovered.

E.4.14 Audit Topic 14 - Files for business components of Arrium

1. The plaintiffs say that all audit evidence that the head office obtained to opine on impairment was produced by the component auditor. The plaintiffs' therefore seek discovery of 'all instructions to the component auditor, all correspondence with the component auditor and all reporting from the component auditor'. KPMG says that these documents are stored in the head office files relating to impairment and that it has discovered all that is relevant. KPMG says that the balance of the material is not directly relevant to the reliability of Arrium's impairment model.
2. The parties agree that documents relating to the component auditor are relevant and discoverable, but the dispute is as to whether documents that KPMG has assessed as irrelevant ought to be discovered. In my view, for the reasons advanced by the plaintiffs, and my concerns as to KPMG's misunderstanding of the case against it as pleaded in the SOC, the remaining material ought to be discovered.

E.4.15 Audit Topic 15 - Permanent folder containing miscellaneous current agreements

1. The plaintiffs seek discovery of Arrium's contractual agreements stored on the permanent folder on the basis that these agreements will identify quantities, prices and cancellation clauses that directly impact the cash flows the subject of impairment testing. KPMG says that the contracts contained on the permanent folder do not relate to impairment or predicted cash flows adopted in the impairment testing model, due to them covering topics which are specifically excluded from the impairment testing model under AASB 136. On the basis of the information provided by KPMG as to the topics of the agreements in the permanent file, I am satisfied that they are not relevant to the impairment issues the subject of this proceeding.

1. I will therefore make orders with the effect that:

(a) discovery category 4 be as proposed by the plaintiffs;

(b) discovery category 5 be as proposed by the plaintiffs, save with the exclusion of the phrase 'or touch on'. Categories 5(e), (g), and (i), shall be further limited by the phrase 'provided that it concerns the carrying amount of the Assets, the recoverable amount of the Assets (as those terms are defined and employed in AASB 136), or KPMG's conduct of the audit of the value of the Assets';

(c) discovery category 11 be as proposed by the plaintiffs, save with the exclusion of the documents addressing the following topics:

(i) KPMG's internal budgeting tools, such as '1.3.3.0010 Arrium HO 16';

(ii) KPMG's audit fees, such as '1.3.3.0020 Copy of Consol billing schedule' and '1.3.3.0050 Arrium 2015 Fee Proposal';

(iii) fraud inquiries, such as '2.5.2.0010 AltaSteel Fraud Inquiries' and the documents referred to at rows 169 to 208 of 'Head Office - 2014 - 263584' of the Audit File Index;

(iv) litigation, claims and assessment;

(v) journal entries;

(vi) internal audit; and

(vii) the permanent folder containing miscellaneous current agreements.

1. I direct that the parties confer as to the appropriate form of order, including as to costs of the plaintiffs' Summons filed on 30 November 2021, and provide their respective proposals (if the order is not agreed) to my Chambers within 14 days, together with submissions of no more than five pages, so that any outstanding issues may be determined on the papers.

[1] Transcript of Proceedings, Bogan, Anthony vs The Estate of Peter John Smedley, Deceased, (Supreme Court of Victoria, S ECI 2020 03281, Steffensen JR, 4 February 2022).

[2] Smith 3 was filed on 26 October 2022.

[3] The 11 March 2022 submissions were filed on 26 October 2022.

[4] [2016] VSC 573, [34] (J Forrest J).

[5] Liesfield v SPI Electricity Pty Ltd (Ruling No 1) [2013] VSC 634; (2013) 43 VR 493, 500 [25] (J Forrest J).

[6] Transcript of Proceedings, Bogan, Anthony vs The Estate of Peter John Smedley, Deceased (Supreme Court of Victoria, S ECI 2020 03281, Steffensen JR, 29 March 2022) 55-56 ('Transcript'); KPMG, 'Submissions of the Fifth Defendant in Relation to Discovery', 1 March 2022, [25] ('KPMG's 1 March 2022 Submissions'); KPMG, 'Submissions of the Fifth Defendant in Relation to Discovery', 21 March 2022, [14] ('KPMG's 21 March 2022 Submissions').

[24] Annexure A to the 'Plaintiffs' Outline of Submissions: Outstanding Discovery Issues', 1 March 2022, ('Plaintiffs' 1 March 2022 Submissions').

[29] Ibid [41]. See also above at [17].

[30] KPMG's 1 March 2022 Submissions, [37]; KPMG's 21 March 2022 Submissions, [29].

[31] Ashurst letter dated 21 January 2022, [10]-[13]; Exhibit EDS-2 to Smith 2, 117-118.

[32] Ashurst letter dated 31 January 2022, [3]-[5]; Exhibit TMG-2 to Grieve 1, 1-2.

[33] Ashurst letter dated 21 January 2022, [12]-[13]; Exhibit EDS-2 to Smith 2, 118.

[34] Ashurst letter dated 31 January 2022, [3]; Exhibit TMG-2 to Grieve 1, 2.

[36] A copy of the Audit File Index is at pages 1 to 638 of Exhibit EDS-3 to Smith 3.

[37] KPMG's 1 March 2022 Submissions, [7].

[38] FY15 also included Arrium's manufacturing segment.

[39] KPMG's 1 March 2022 Submissions, [8].

[41] Plaintiffs' 1 March 2022 Submissions, [11].

[42] Ibid, subject to subsequent agreement between the parties with respect to certain of the documents.

[47] KPMG's 1 March 2022 Submissions, [8]-[9].

[48] 1: Going concern. 2: Litigation, claims and assessment. 3: Provisions. 4: Inventory. 5: Restructuring provision. 6: Journal entries. 7: Internal audit. 8: External experts. 9: Derivative financial assets. 10: Sales. 11: Disposal groups and assets liabilities held for sale. 12: Carrying value of investment in subsidiaries. 13: Tax. 14: Files for business components of Arrium. 15: Permanent folder containing miscellaneous current agreements.

[50] See paragraph [24] above for a summary of these particulars pleaded in the SOC, [171].

[52] KPMG's 1 March 2022 Submissions, [32].

[53] Shaw v Yarranova Pty Ltd [2011] VSCA 55, [26] (Redlich and Mandie JJA) (citations omitted).

[54] This submission was made with respect to topics 1 (Going Concern), 3 (Provisions), 4 (Inventory), 5 (Restructuring provision), 9 (Derivative financial assets), 10 (Sales), 11 (Disposal groups and assets liabilities held for sale), 12 (Carrying value of investment in subsidiaries), and 13 (Tax).

[56] Annexure 1 to KPMG's 21 March 2022 Submissions, Topic 1: Going Concern.

[60] See for example, '1.3.3.0020 Copy of Consol billing schedule' and '1.3.3.0050 Arrium 2015 Fee Proposal', also asserted to be relevant by reference to whether KPMG complied with ASA 330.

[61] See for example, '2.5.2.0010 AltaSteel Fraud Inquiries' and the documents referred to at rows 169 to 208 of 'Head Office - 2014 - 263584' of the Audit File Index.

[62] Audit Topic 8: External Experts, was not pressed by the plaintiffs (Transcript, 38, lines 26-29).

[63] In particular, the plaintiffs referred to the requirements set out in AASB 136, [33(a)-(b)], [34] and [44].

[64] Budgetary process, sales budgetary process, timing of completing revenue generating assets, identification of sole moving inventory, NRV issues Arrium's budgetary process, identification of impaired assets, identification of delays or cost overruns in completing major capital projects, managing liquidity, and managing environmental risk.

[68] Topic 12 in the Audit Topic Summary refers to AASB 126 in the column marked 'Plaintiffs' position (28/2/22)'. The Court has proceeded on the basis that this is a typographical error, and was intended to be a reference to AASB 136.

[69] Topic 12 in the Audit Topic Summary refers to paragraph 41C of AASB 128 in the column marked 'Plaintiffs' response (11/3/22)'. The Court has proceeded on the basis that this is a typographical error, and was intended to be a reference to IAS 28.

[70] See '6 Carrying value of investment in subsidiaries' and related documents in the 'Arrium Limited 247167' worksheet at rows 1378-1383.

[71] The document '2200 Note 22 - Int in Subs and JV' and related documents in the 'Head Office - 2014 - 263584' worksheet relating to the FY15 at rows 2416 to 2424 appear to relate to investments in subsidiaries, but KPMG does not propose to make discovery of these documents.