Liability of an Auditor in Delict

I consider it a privilege to have been invited to express my views on the liability of an auditor in the law of delict and I desire, for the sake of clarity, to express my views on that interesting subject on the assumption that the reader is a layman and not a lawyer. However, reference to decided cases and authorities cannot be avoided. I am also attracted by the novelty of the topic, because to my knowledge, there has been not a single judicial decision in Sri Lanka on the subject.

The dictionary meaning of the word ‘audit’ is – an examination of accounts by an authorized person or persons. A text – book definition of the same word is wider. And more exhaustive – it is a process whereby the accounts of business entities, including limited companies, charities, trusts, and professional firms, are subjected to scrutiny in such details as will enable the auditors to form an opinion as to their accuracy, truth and fairness.1 Probably a lawyer may usefully add immediately after the words ‘form an opinion’ in that statement, the words ‘and express the same’. It is the expression of that opinion, which is the important document called the ‘audit report’, that could generate legal relations between parties.

It is right to say that an auditor belongs to a profession and that auditing is certainly not a mere trade or business. What distinguishes a profession from other occupations is that it consists of a group of persons who are

a) identifiable by reference to some register or record

b) recognized as having a skill and learning in some field of activity, in which the public needs protection against incompetence, the standard of skill and learning being prescribed by the profession itself

c) holding themselves out as being willing to serve the public

d) voluntarily submitting themselves to standards of ethical conduct beyond those required of the ordinary citizen by law

e) undertaking to accept personal responsibility to those whom they serve for their actions, and to their profession for maintaining public confidence.2

————————————— 1. Emile Woolf, Auditing Today, 2nd Ed., 1979, Prentice Hall, International Inc., London.

2. A.R.B.Amerasinghe, Professional Ethics & Responsibilities of Lawyers, 1993, Lake House Investments Ltd, Colombo, Sri Lanka, pp. 23-26.

In Sri Lanka there is no statute governing the responsibilities of an Auditor and his responsibilities in delict will be governed by the Common Law of the Island, namely the Roman- Dutch Law. Reference to sophisticated foreign judgments relating to the legal liability of auditors in other jurisdictions, therefore, at times, could be misleading.

Section 159 of the Companies Act No. 17 of 1982 provides that the auditors of the company shall make, during the tenure of their office, a report to the members on the accounts examined by them, and on every balance sheet, every profit and loss account, and all group accounts, laid before the Company at a general meeting;that report shall contain statements as to the matters specified in the seventh Schedule to the Act.

Before one examines the legal position of the liability of an auditor in the law of delict, it is necessary and important to examine broadly, as to what categories of persons are likely to be adversely affected by, if I may loosely call at this stage, an incorrect report of an auditor. They are (1) primarily, persons who obtain the services of the auditor directly, – person or a company and the current directors and shareholders of the company; (2) third parties, namely (a) a person who seeks to invest in a company; (b) a creditor of a company; (c) a holder of a debenture issued by a company; (d) a person • making a take-over bid of a company.

These categories of persons are likely to suffer financial loss in consequence of an incorrect written opinion given by an auditor in the form of an audit report.

Let us go to the fundamentals. A delict or a tort is a civil wrong, as opposed to a criminal or a contractual wrong. Generally, it could be described as a breach of a general duty imposed by Law, which will ground an action for damages at the suit of any person to whom the duty was owed, and who has suffered harm in consequence of that breach. In Roman-Dutch Law the two main delicts are damnun injuria datum or the Aquilian action and actio injuriarum, which are extended to cover practically the whole field of delictual liability. The first of the two delicts mentioned above, relates to the causing of physical injury to person or property of another negligently, (culpa) or maliciously (dolus), resulting in patrimonial loss; whereas the second deals with aggression against personal reputation or dignity of another caused with intention (animus injuriandi).

Under the English Law, the Law of Torts is mainly a product of their common law, namely the judge – made law, and it deals with a series of specific separate torts (the reader will note at once the two different meanings attached to the term ‘common law’ in England and Sri Lanka). A tort in terms of the English Law is not necessarily a tort in Roman-Dutch Law. A random example of that proposition would be the tort of Conversion in English Law, that is where a person deals with the property of another not
belonging to him in a manner inconsistent with the rights of the owner. That tort is unknown to the Roman – Dutch Law, and therefore forms no part of our Law.[3]

The function of an auditor requires him to examine the relevant books and determine not only irregularities and inefficiencies, but also to determine the true financial position of the company or the business establishment. An audit report could be incorrect either because it was prepared negligently or fraudulently.

What is negligence? As I observed in the case of Prof Priyani Soysa v. Rienzie Arsecularatne,[4] ‘When a person’s conduct falls short of the standards of care the law demands from him, his conduct becomes negligent. The criterion of negligence is commonly described as the standard conduct of a reasonable man or diligens paterfamilias placed in the same circumstances as the person whose conduct is in question. In other words negligence is, doing or omitting to do something, a reasonable man would not do or would not omit to do, in a given situation… Whenever a person engages himself voluntarily in rendering professional services requiring a special skill, knowledge, or capacity for its performance, he is required to manifest a reasonable degree of such skill, knowledge, or capacity. When the conduct of a skilled professional is in question, naturally the standard of an ordinary reasonable man would be ill -equipped and unsuited to judge his competence; thus the notional reasonable man is substituted with the notional reasonable skilled professional. This is not an exception to the general principle in Roman-Dutch Law, but is merely an application of it; for the reasonable prudent man will not voluntarily undertake to perform a task for which he has not the requisite knowledge, skill or capacity’.

It is sufficient to say that fraud (in relation to an audit report) consists of false statements made with intent to deceive, or depriving someone by cheating or deceiving by making false statements.

Let me first take the case of a report which is inaccurate because of the professional negligence of the auditor. I have already explained the meaning of professional negligence within the meaning of the Roman-Dutch Law.

A negligent report of an auditor is a negligent statement made by him in writing. Such statement does not cause physical injury so as to fall within the ambit of the Aquilian action. Nor is it a statement made intentionally to damage the feelings of another so as to fall within the ambit of the actio injuriarum. The Roman-Dutch Law required that to be actionable a non – defamatory statement must have been made with the intention of causing damage, and that in fact damage was done as a result.[5]

3. See De Costa v.Bank of Ceylon, 72 NLR 457

4. [2001] 2 SLR 291

5. See Ficlmrdt Ltd .The Friend Newspapers, 1916 AD 1; Goods/mil s.Hoogendoom 1926 AD 11 ; Liability for non defamatory statements – McKerron, 47 SAU 359- The same principle was upheld in the local case of Chissel v. Chapman,(l954)56NLR 121.

Fraudulent conduct on the part of an auditor in writing an incorrect report is actionable in Roman-Dutch Law, if the intention on the part of the auditor to cause damage and if the resultant damage could be established. ‘This action fails away if great and manifest craftiness is not proved with sufficient clearness..[6].

The question whether the Courts in this Island could ‘develop’ the Roman-Dutch Law has been specifically considered in a few interesting decided cases, which I will refer to. By the word ‘develop’, what I mean is either to add a new cause of action not recognised by the Roman-Dutch Law;or to add a new feature to a recognised cause of action in the Roman-Dutch Law. This must not be confused with ‘adapting’ the Roman-Dutch Law to modern conditions of Sri Lanka, which is quite permissible. The case law I shall refer to, will illustrate the difference between ‘developing’ and ‘adapting’.

Let me first refer to ‘adapting’; but before I do that, for the sake of clarity, I shall briefly state what is meant by a ‘servitude’ because the illustration I am about to give, relates to a ‘servitude’. A ‘servitude’ is a right enjoyed by the owner of one land, over the land of another; for example a right of way or a right of lateral support of a building. Among the various servitudes enumerated by Voet one was, ‘of liberty to press grapes on another’s land, or to thresh corn or beans there'[7]. In the case of Tikiri Appu v. Dingirala[8] Dalton J. stated that, having regard to the fact that paddy is the principal plant cultivated in Ceylon, the term ‘corn’ as used by Voet is quite wide enough to include such a cereal plant as paddy. That, was ‘adapting’ the Roman-Dutch Law principles to local conditions.

I shall proceed to consider a few cases where attempts were made, quite unsuccessfully, to ‘develop’ the Roman-Dutch Law. In the case of De Costa v. Bank of Ceylon,[9] having considered the Proclamation of 1799 and the Adoption of the Roman-Dutch Law Ordinance of 1835, the Supreme Court held that the Courts are not empowered to introduce the tort of conversion which is a part of the English Law in to our Common Law. In the case of Prof. Priyani Soysa v. Rienzie Arsacularatne,[10] the Supreme Court, having considered the same Proclamation and Ordinance, stated that in an action based on the Lex Aquilia, the successful party will be entitled only to patrimonial loss suffered and that the courts cannot add a new feature to that action by granting compensation for the loss of care and companionship. I had the occasion to state in the case as follows: I think we are not entitled as judges, to change the material of the Roman-Dutch Law, but are only permitted to iron out its creases, whenever the necessity arises. Effecting structural alterations to the common law should be the exclusive preserve of the Legislature…’

6. Voel – Ad Pandectas IV -3- 13. Johannes Voet (1647 – 1713) was one of the greatest commentators on the Roman-Dutch Law. .

7. Voet, VII – 3 – II.

8. 36 NLR 267

9. 72 NLR 457.

10. [2001] (2) SLR 293.

In Chissel v.Chapman,[11] the defendant, a medical practitioner, was employed by Cable and Wireless Limited, to examine and report whether the plaintiff who had been accepted for service as a telegraphic – apprentice, was physically fit for permanent employment as a telegraphist. The defendant reported that the plaintiff had a certain cardiac condition and the plaintiff’s employment as an apprentice was terminated in consequence of that report. Two other medical practitioners who examined the plaintiff at his instance, found no abnormality in the heart of plaintiff. The plaintiff alleged negligence on the part of the defendant and claimed damages. The plaintiff made no allegation of malice or dishonesty on the part of the defendant. It was held by the Supreme Court that even if the plaintiff’s opinion was negligently arrived at, no action was maintainable. In order to succeed in an action based on injurious falsehood, the plaintiff must prove dolus or animus injuriandi on the part of the defendant.

Gratiaen J was constrained to remark in that case as follows;’In England, ‘less timorous’ common law judges sometimes find themselves free to invent a new cause of action to meet a new situation (if the problem is unencumbered by binding precedent). But those of us who administer the Roman-Dutch Law cannot disregard its basic principles although (on grounds of public policy or expediency) we may cautiously attempt to adapt them to fresh situations arising from the complex conditions of modern society. But we are powerless to alter the basic principles themselves, or to introduce by ‘judicial legislation’ fundamental changes to the established elements of an existing cause of action’.

The position in South Africa is different where the courts have no legal inhibition, unlike our courts, in amending or changing the Roman-Dutch Law. In the case of Administrateur Natal v. Trust Bank van Afrika Bpk.,[12] the Aquilian action was extended by court to cover the case where damages were caused by a negligent misstatement and where no physical injury was caused to person or property. In doing so, the South African court was influenced by developments in the English Law ‘beginning with the dissenting judgement of Denning LJ in Candler v. Crane Christmas & Co.,[13] and culminating in the decision in Hedley Byrne & Co.Ltd. v. Heller and Partners Ltd.[14] The Administrateur Natal’s case was thereafter followed in several cases in South Africa, including the case of International Shipping Co. (Pvt) Ltd v. Bendy [15]

For the foregoing reasons I am of the view that (1) The law governing the liability of an auditor in delict, is the Roman-Dutch Law; (2) Courts are not entitled to make structural alterations to actions recognised in Roman-Dutch Law,[16]; (3) An auditor is not liable under the Roman-Dutch Law in delict for a report made negligently. Although it

11. 56 NLR 121.

12. 1979 (3) SA 824 (A).

13. (1951) 1 AER426(CA)

14. (I963)2 AER 575.

15. 1990 (1)SA 680.

16. This view is endorsed by A.R.B.Amerasinghe, in ‘Judicial Conduct, Ethics and Responsibilities’, 2002, Sarvodaya Vishva Lekha Publishers, Ratmalana, Sri Lanka, at p.362; and in “The Dutch Influence on the Legal System of Sri Lanka’, at pp. 322-323 in 400 Years of Dutch – Sri Lanka Relations’, ed.by Saman Kelegama and Roshan Madawala, 2002, Colombo, Institute of Policy Studies, Sri Lanka.

has caused patrimonial loss to another (4) An auditor is liable under the Roman-Dutch Law in delict for the patrimonial loss caused to another, if his report is made fraudulently and with the intention of causing patrimonial damage to another, and further if a legal nexus is proved between the auditor and the person affected; (5) Legislation should be
passed making an auditor liable in delict for damage caused to another by his negligence;
particularly with a view to inspire confidence in the public who will seek the professional
services of auditors.