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DEVELOPMENTS IN THE LAW RELATING TO
NEGLIGENT MISSTATEMENTS:
ANY RECOURSE FOR INVESTORS AND CREDITORS?
Introduction
Traditionally, the courts have been reluctant to award damages for pure
economic loss which is not a consequence of physical damage to the
plaintiff’s person or property. The main exception is when the loss is
caused by a negligent misstatement. However, given that statements may
be widely disseminated and their effects are more far-ranging than that of
physical acts, the courts have been very cautious in imposing liability on
the maker for fear of exposing him to “liability in an indeterminate amount
for an indeterminate time to an indeterminate class.”1
Recovery for economic loss resulting from negligent misstatements was
first allowed in the landmark case of Hedley Byrne & Co Ltd v. Heller &
Partners Ltd.2 Since then, much litigation has ensued on the scope of the
new liability. Most of the cases have turned on the question of the
circumstances which would give rise to a duty of care. In order to keep
liability within reasonable bounds, the courts have generally required the
existence of a “special relationship” between the maker and recipient of
the statement. This special relationship is said to exist if: (a) the maker of
the statement possesses (or professes to possess) special skill or information), (b) the maker knows or ought to have known that the recipient
would rely on the statement, and (c) it was reasonable for the recipient to
rely.
Recent cases have indicated a major shift in judicial policy, brought about
by the fear of placing an unduly heavy burden on the professions. Whereas
earlier cases3 had allowed recovery on the basis of Lord Wilberforce’s test
of foreseeability and policy consideration laid down in Anns v Merton
LBC4, this test has been decisively rejected by the House of Lords in
Caparo Industries plc v. Dickman and others.5 The single general principle
approach previously used to determine the existence and scope of a duty of
care in every situation has been discarded in favour of a more cautious and
restrictive case-by-case approach, using the concepts of foreseeability,
proximity and fairness.
1 per Cardozo CJ, Ultramares Corp v. Touche (1931) 255 NY 170 at 179.
2 [1964] AC 465.
3 Scott Group Ltd v. McFarlane & Robinson [1978] NZLR 553, JEB Fasteners Ltd v. Marks
Bloom & Co (a firm) [1981] 3 All ER 289, Twomax Ltd v. Dickson McFarlane &
Robinson 1982 SC 113.
4 [1977] 2 All ER 492.
5 [1990] 1 All ER 568.
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Given the somewhat narrow ambit of the Caparo decision, and the varied
commercial situations to which professionals lend their advice, the new
approach has been criticised as giving rise to uncertainty and inconsistency
in the law. Many of the recent cases concerned the issues of whether and to
whom an accountant or auditor owes a duty of care when he is preparing or
auditing a set of acounts. It is pertinent to note that accountants today do
more than traditional book-keeping and preparation of accounts. They
also give advice as consultants on a wide range of activities from tax
planning, corporate structuring, information systems planning to takeovers
and mergers. In doing so, their exposure to the risk of liability for negligent
misstatements is far greater than ever before, and raises interesting
questions concerning their liability for professional negligence.
The aim of this article is to examine the cases decided in the aftermath of
Caparo, and to try and extract some principles which may help in
identifying the situations in which members of the accounting profession
(accountants and auditors) and other financial advisors may be held to owe
a duty not to make inaccurate and misleading statements which may cause
economic loss to a recipient who relies on them.
Caparo and other cases
In Caparo Industries plc v Dickman, The House of Lords had the
opportunity to review the caselaw relating to the duty of auditors for
statements made in a company’s annual audited reports. Caparo Industries
plc (Caparo), who were shareholders of Fidelity plc, purchased additional
shares in the company and subsequently took over the company in reliance
on the company’s audited reports. After the takeover, Caparo brought an
action against, inter alia, the auditors of Fidelity plc, alleging that the
auditors owed them a duty of care, either as potential bidders or as existing
shareholders. It was argued that the auditors had breached this duty of care
in preparing accounts that were inaccurate and misleading as the stocks
were overvalued and after sales credits had been underprovided for, thus
reflecting a profit when it should have shown a loss.
At the trial of a preliminary issue as to whether the auditors owed a duty of
care to Caparo, Sir Neil Lawson held that no such duty of care existed to
individual shareholders, although a duty may be owed to the shareholders
as a class. On appeal, the Court of Appeal by a majority (O’Connor LJ
dissenting), allowed the appeal in part on the ground that the auditors
owed a duty to the respondents as existing shareholders because there was
sufficient proximity between an existing shareholder and the auditors who
were considered to have voluntarily assumed a direct responsibility for the
accuracy of audited accounts. However, it was decided that no duty of care
was owed to Caparo as potential investors.
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The auditors appealed from this decision to the House of Lords which
unanimously allowed the appeal and held that no duty of care was owed by
the auditors to Caparo, whether as an individual shareholder or as a
potential investor. The law lords emphasised the importance of the need
for proximity of relationship between the parties in addition to the
requirement of foreseeability. Proximity was to be determined by the
circumstances in and the purposes for which the statements were made.
Since the statements in question had been contained in the company’s
audited accounts, it was decided that the statements had been made for the
purpose of fulfilling the statutory requirements of the Companies Act
1985. The purpose behind the statutory requirement for audited accounts,
their lordships reasoned, was to provide existing shareholders of the
company with reliable information to enable them to exercise their class
rights at the company’s general meeting. As such, the auditors owed no
duty of care to the takeover bidder because the accounts had not been
prepared specifically for the purpose of giving financial advice in relation
to a takeover bid. Nor was there a duty of care owed to Caparo in their
capacity as an existing shareholder because the audited accounts had not
been prepared for the purpose of assisting existing shareholders in deciding
whether or not to acquire additional shares.
Immediately after this judgement, there was a great deal of speculation as
to how the decision of the House of Lords would be interpreted and
applied in subsequent cases6. It did not take long for the courts to be faced
with another case on negligent misstatement within the context of another
takeover scenario. Applying Caparo, the Court of Appeal in James
McNaughton Paper Group Ltd v Hicks Anderson & Co7 applied the
concepts of foreseeability, proximity and reasonableness and held that a
firm of chartered accountants who had prepared a set of draft accounts for
a corporate group did not owe a duty of care to a takeover bidder who had
relied on the accounts. This was so in spite of the fact that the accountants
had met with the potential investor during negotiations for the takeover
and had made an oral representation concerning the financial status of the
company in question. The court placed a great deal of emphasis on the fact
that the accounts presented to the potential investor had been merely draft
accounts and thus it was not foreseeable that the bidder would rely on them
in the same way as one would rely on final accounts.
6 Robert Baxt, “The Shutting of the gate on shareholders in actions for negligence — the
Caparo decision in the House of Lords” 1990 Companies & Securities Forum, CCH 2;
Hugh Evans, “The Application of Caparo v Dickman” 1990 Vol 6 PN No 2 76; John G
Fleming, “The Negligent Auditor and Shareholders” 1990 V106 LQR 349.
7 [1991] 1 All ER 134.
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As for the accountants’ oral representation to the effect that the company
was breaking even or doing marginally worse, it was decided that this was
merely a general statement. According to Neill LJ, this general statement
did not affect the specific figures in the draft accounts and the accountants
could not have foreseen that the takeover bidder would rely on it without
further inquiry or advice. The Court of Appeal did not seriously consider
the question of proximity because the takeover bidder had failed to satisfy
the court that it was foreseeable that they would rely on the draft accounts
and the oral representation.
In a matter of months, the Court of Appeal had further opportunity to
consider the same issue in Morgan Crucible Co plc v Hill Samuel & Co
Ltd8, which arose out of similar facts. Here, the takeover bidder sought to
amend his statement of claim (in view of the decision in Caparo) to allege
that there was the necessary proximity for the defendants (including the
company’s directors, a firm of financial advisors and a firm of auditors) to
owe him a duty of care in relation to financial statements made after the
bid was announced. It was agreed by all parties to the action that no duty of
care could have arisen before the bidder was identified. The court then
decided that the moment the initial bid was made, there was an arguable
case for liability of the directors, financial advisors and auditors. Caparo
was distinguished on the ground that here there was an identified bidder
and this could give rise to sufficient proximity.
Referring to the pre-bid statements, Slade J rejected the argument that
they could be regarded as “continuing representations” which if not
withdrawn, could give rise to liability once the bid was first made.
However, he felt that there was an arguable case for liability for
representations made after the takeover bidder was identified and this
being a question of critical importance for the trial judge to consider, he
allowed the takeover bidder to amend his statement of claim and referred
the case to trial. Unfortunately, the case was eventually settled by the
parties just before the hearing of the trial.
Since then, the Caparo approach has been applied to situations other than
takeover bids. In Al-Nakib Investments (Jersey) Ltd v Longcroft,9 the issue
was the extent of the directors’ duty of care for financial statements other
than the information provided in the annual audited report. The directors
of a company were held not to owe a duty of care to shareholders who had
purchased shares in the market in reliance on alleged misstatements in a
prospectus and an interim report issued in relation to the incorporation of a
8 [1991] 1 All ER 148.
9 [1990] 1 WLR 1390.
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subsidiary company. The reason for the court’s decision was once again
based on the ground of a lack of proximity between the directors and the
shareholders as the prospectus and interim report had been sent by the
directors to the existing shareholders of the parent company for the
purpose of enabling them to decide whether or not to take up an offer of a
rights issue and not to assist them in deciding whether to purchase shares in
the market.
This requirement for proximity has also been applied and extended in AlSaudi Banque v Clarke Pixley10 to negate the existence of any duty of care
by auditors to existing or potential bank creditors of a company even
though it may be foreseeable that banks might give credit in reliance on the
company’s audited accounts. Millett J concluded that there was no close or
direct relationship between the auditors and the banks and thus the
element of proximity was lacking. This judgement was given after the
Court of Appeal decision in Caparo but before the final decision of the
House of Lords. However, it is consistent with the House of Lords’ view
that the purpose of the auditors’ report is only to enable the shareholders
to make an informed decision at the company’s general meeting.
Some important principles can be extracted from the abovementioned
cases and these will be dealt with in turn below.
Principles to be applied in determining whether a duty of care exists
1.
Foreseeabttity is not the sole criterion of liability.
Foreseeability of damage, per se, is not sufficient to impose a duty of care
on the maker of a statement. Additionally, there must be a relationship of
proximity between the maker and the recipient, and it must be fair, just
and reasonable to impose the liability.11 These three requirements are
necessary “to keep the law of negligence within the bounds of common
12
sense and practicality.”
Foreseeability of damage to the recipient is not difficult to establish. In the
10 [1989] 3 All ER 361.
11 This has been tirelessly reiterated in Caparo, ibid, at pp. 573–574, 584–587, McNaughton
Papers Group Ltd v. Hicks Anderson & Co (a firm) supra, at 141–142, Morgan Crucible
Co plc v Hill Samuel Bank Ltd and others supra, at 157.
12 Lord Oliver in Caparo, supra, at 585e. The learned judge was concerned that given the
far-reaching effects of statements which could be circulated with or without the consent or
knowledge of the maker, there was a need to impose some discernible limits to liability in
such cases. “To apply as a test of liability only the foreseeability of possible damage
without some further control would be to create a liability wholly indefinite in area,
duration and amount and would open up a limitless vista of uninsurable risk for the
professional man.” at 593c.
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words of Lord Oliver, “it is almost always foreseeable that someone,
somewhere and in some circumstances, may choose to alter his position on
the faith of the accuracy of a statement or report which comes to his
attention and it is always foreseeable that a report, even a confidential
report, may come to be communicated to persons other than the original or
intended recipient.”13
Invariably, it is the requirement of a relationship of proximity between the
maker and the recipient of the statement that poses the greatest obstacle to
recovery for the plaintiff. “Proximity” has been ascribed as being no more
than “a covenient label to describe circumstances from which the law will
attribute a duty of care.” Such a duty is “not a duty to take care in the
abstract but a duty to avoid causing to the particular plaintiff damage of the
particular kind which he has in fact sustained.”14
2.
The duty only extends to the particular transaction in the maker’s mind at
the time of making the statement, ie. the maker’s liability is restricted to
the purpose for which the advice or information was required to be given.
In order for “proximity” to exist between the maker of the statement and
the plaintiff, the maker when giving the advice or information must have
known that his statement would be communicated to the plaintiff, either as
an individual or as a member of an identifiable class, specifically in
connection with a particular transaction or transactions of a particular
kind, and that the plaintiff would be very likely to rely on it for the purpose
of deciding whether or not to enter on that transaction or on a transaction
of that kind.15 Lord Bridge observed that this was the salient feature in all
the cases allowing recovery to the plaintiff.16
Therefore, the mere possibility of reliance on a statement by strangers for
any one of a variety of different purposes which the maker had no specific
reason to anticipate would not impose a duty of care on the maker to the
recipient. In cases where the advice has not been given for the specific
purpose of the recipient acting on it, it should only be in cases where the
adviser knows that there is a “high degree of probability” that some other
13
14
15
16
Caparo, supra, at 593b–c.
Lord Oliver in Caparo, supra, at 599e–f.
Lord Bridge in Caparo, supra, at 576h.
Ibid, at 576c. He was referring to Cann v Wilson (1988) 39 Ch D 39, Denning LJ’s
dissenting judgement in Candler v Crane Christmas & Co Ltd [1951] 1 All ER 426, the
Hedley Byrne case, supra, and Smith v Eric S Bush (a firm) [1989] 2 All ER 514, Harris v
Wyre Forest DC [1989] 2 WLR 790.
4 S.Ac.L.J. Part II
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identifiable person will act on the advice that a duty of care should be
imposed.17
The above points are summarised in Neill LJ’s list of the factors to be
considered in determining whether a duty of care is owed by the maker to
the recipient.18 They include:
(a)
the purpose for which the statement was made;
(b)
the purpose for which the statement was communicated;
(c)
the relationship between the maker, the recipient and any relevant
third party;
(d)
the size of any class to which the recipient belongs;
(e)
the state of knowledge of the maker; and
(f)
reliance by the recipient.
3. It must be fair, just and reasonable to impose liability on the maker.
The courts have not dwelt at length on this point. Much of their attention
has been focused on “foreseeability” and “proximity”. However, Lord
Oliver in Caparo, ventured to suggest that “what have been treated as
three separate requirements are . . . in most cases, in fact merely facets of
the same thing, for in some cases the degree of foreseeability is such that it
is from that alone that the requisite proximity can be deduced, whilst in
others the absence of that essential relationship can most rationally be
attributed simply to the court’s view that it would not be fair and
reasonable to hold the defendant responsible.”19
What the cases have made abundantly clear is that it would not be fair and
reasonable to impose liability on a maker of a statement to unknown or
unintended recipients who have relied on his statement for one or more of
a variety of purposes which the maker had no reason to anticipate at the
time he made the statement.
17 Lord Oliver in Caparo, supra, at 591c. This high degree of probability was found to be
present in the cases of Smith v Eric S Bush (a firm), supra, and Harris v Wyre Forest,
supra, the appeals of which were heard together. Although the purpose of the surveyor’s
report was to advise the mortgagee on whether to make advances for proposed purchases,
it was highly probable that the purchaser would in fact act on its contents in deciding
whether or not to enter into a contract to purchase a house. The evidence adduced showed
that surveyors knew that approximately 90% of purchasers did so rely, and also that a
surveyor only obtains the work because the purchaser is willing to pay his fee.
18 James McNaughton Papers Group Ltd v Hicks Anderson & Co (a firm), supra.
19 Supra, at 585f-g.
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Circumstances in which the maker of a statement may be liable to the
recipient
Given that the above principles are to be applied on a case-by-case basis,
the question of the existence of a duty of care in each case will depend on
its own particular facts. Notwithstanding this, it is possible, given some
judicial clues, to identify the circumstances in which a duty of care may be
held to be owed by accountants, auditors and financial advisers to investors
and creditors in general.
a.
Investors (shareholders and takeover bidders)
It is clear from Caparo, that an auditor owes no duty of care to an existing
shareholder, a potential shareholder or a takeover bidder, who has relied
on audited accounts to sell or to buy shares and suffered economic loss.
The original, central and primary purpose of the auditors’ report,
statutorily required under the Companies Act, is to enable the shareholders, as a body, to exercise informed control of the company.20 As such,
any use of the auditor’s statement by any person for purposes other than
the statutory purpose would not attract any liability on the part of the
auditor.21 This poses significant problems for the average shareholder who
invariably has no option but to rely on the audited statements as his
primary, or perhaps, even as his sole source of information in investment
decisions22. He would therefore be investing in the stock market at his own
risk, without recourse to anyone if he relied on audited reports.
As for other financial statements made by accountants and other financial
advisers, it would appear from McNaughton’s case that the scope of
liability would be determined in the same way, that is, by looking at the
specific purpose for which the statement was required. As the draft
accounts in that case had been prepared for the company and not the
plaintiffs, the defendants were not liable when the plaintiffs, who were
unintended recipients, acted on the draft accounts to their detriment.
In ascertaining the purpose of the maker, the state of his knowledge at the
time of making the statement is relevant. It depends on whether he knew
20 Lord Oliver in Caparo, supra, at 584d–e.
21 The decision in Caparo has been heavily criticised for being “out of step with commercial
reality”. See Accountancy, Mar 1990 1. One author has noted that a reference to Hansard
would easily rebut the statutory purpose of the audit as divined by the House of Lords —
See Mullis & Oliphant, “Auditors’ liability”, PN Mar 1991 22.
22 Baxt, see note 6. As the average shareholder would not easily or cheaply be able to obtain
any additional information to determine whether to retain his investment or increase it,
the author argues that it would not be unreasonable for the shareholder to rely on the
auditor, since the auditor is appointed to look after the interests of all shareholders.
However, no duty is owed to a potential investor who is not a shareholder of the company.
4 S.Ac.L.J. Part II
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341
the purpose for which the statements were required and for whose use the
statements were intended. In Morgan Crucible, Slade LJ conceded that
there was an arguable case for liability of the financial advisers and the
auditors for statements made after the takeover bidder had been identified. The defendants had intended the bidder to rely on the statements and
they owed the bidder a duty of care not to be negligent in making
representations which might mislead him. Caparo’s case was distinguished
on the ground that it concerned an unidentified bidder. Thus, it can be
seen that if a bidder is identified and statements were made to him
thereafter, intending that he should rely on them for the purpose of
deciding whether or not to make an increased bid, and he did so rely, the
maker will be liable.
However, this did not appear to be the view held by the court in
McNaughton’s case, decided a few months before Morgan Crucible. In
McNaughton, apart from the draft accounts, the defendants had also
inaccurately stated, in response to a question by the plaintiff, that the
company, as a result of rationalisation was breaking even or doing
marginally worse. The court held that the statement was a very general
answer and the defendants could not have reasonably foreseen that the
plaintiff would rely on that statement without any further inquiry or
advice. With respect, the authors disagree. The defendants were aware
that the plaintiff was intending to make a takeover bid for the company. As
such, the plaintiff was an identified bidder. Given that the defendants were
the company’s accountants, and therefore the persons who were the most
well-acquainted with the company’s financial situation, it can be argued
that the defendants knew that the plaintiff would rely on the statement
without further inquiry or advice, and that it was reasonable for them to so
rely. In any case, one questions whether, in reality, independent inquiry by
the plaintiff would turn up any more information than what the company’s
own accountants are willing to divulge. Had McNaughton’s case come up
for determination after Morgan Crucible, perhaps the judge would have
decided differently.
The specific purpose approach has also been applied to other situations
involving statements contained in prospectuses and interim reports. In AlNaklb Investments (Jersey) Ltd v Longcroft, it was decided that the
directors of a company owed no duty of care to shareholders who had
purchased shares in the market in reliance on alleged misstatements in a
prospectus and interim report issued in connection with the incorporation
of a subsidiary company. This was so because the purpose of the
prospectus had been to enable the shareholders to decide on whether to
take up an offer of shares by way of rights issue, while the interim reports
had been issued for the purpose of informing the shareholders of the
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activities of the subsidiary company. However, the use of these documents
for a different and unrelated purpose would not attract any liability as the
necessary proximity is lacking.
b.
Creditors
It is common for creditors to examine a company’s audited accounts when
deciding whether or not to grant credit facilities. The auditors, when
certifying that the company’s accounts present a true and fair view, do not
owe a duty of care to a bank which lends money to the company in reliance
on audited reports, regardless of whether the bank is an existing creditor of
the company making further advances or is only a potential creditor of the
company.23 Millett J. likened the position of the banks which were not
already existing creditors to that of the potential investors in Caparo, to
whom no duty of care was owed by the auditor because the element of
proximity between them was lacking24. As for the banks which were
already existing creditors, their position was not the same as that of the
existing shareholders in Caparo, because the auditors were under no
statutory obligation to report to them nor did they do so. In the absence of
direct contact between the parties, mere knowledge on the auditor’s part,
that some person or persons may rely on the report, would not establish
the necessary proximity.
The learned judge also hastened to add that even if the requirement of
proximity were satisfied, it would not be just and reasonable to impose
liability on the auditors25. Although there would be no danger of exposing
the auditors to an indeterminate class (where the creditors were known to
them), they would be exposed to liability for an indeterminate amount.
The problem is all the more acute where the company is insolvent and the
advance is irrecoverable. The auditors’ maximum liability would fall to be
measured by the amount of the advance, which would be unknown to the
auditors and could not have been foreseen by them.
In relation to other financial statements made by persons other than
auditors, the ambit of the duty of care to creditors is likewise to be
restricted by the transaction in which the maker intended the statement to
be relied on, and the recipient or class of recipients to whom the maker
made the statement or to whom he intended or knew that it was intended
to be communicated. The same considerations of justice and reasonableness in imposing liability on the maker would probably apply. It would
23 Al Saudi Banque and others v Clark Pixley (a firm), supra.
24 at 370h.
25 at 371 j.
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343
not be fair to extend the duty of care to a prospective lender unless the
amount or at least the scale of the proposed loan was known to the maker.
Conclusion
In the light of the potentially wide dissemination of financial statements
and their far-ranging effects, the judges in Caparo and subsequent cases
have adopted a restrictive approach to imposing liability on the makers of
such statements. This approach has been considered as an overly cautious
one given that there are many factors which have to be proved before
liability for negligent misstatements can arise26. In addition to proving the
existence of a duty of care, there has to be an actual breach of that duty of
care by the accountants, auditors or financial advisers. The standard of
care required is that which is to be expected of an ordinary skilled
professional, thus accounting standards and practices would be relevant in
considering the issue of breach of duty. Next, the plaintiff would have to
establish that the loss suffered had been caused by actual reliance on the
statement made, using the “but-for test”, which does not follow as a matter
of course since it is possible that the error may not have had any influence
at all on the decision made by the plaintiff27. Furthermore the type of
damages claimed must also have been forseeable in the circumstances.
This restrictive approach is said to be justified on policy grounds, it being
unfair to expose the maker of a statement to liability which is indeterminate in scope and amount. Hence, the maker would be liable only if he
intended a known or identified recipient to rely on the statement for a
specific purpose and the recipient did so rely to his detriment.
However, this specific purpose approach does have its drawbacks. It has
been criticised as being too simplistic. While it works well where there is a
single, defined purpose behind the transaction in question, it ignores the
fact that there may be more than one purpose behind a document. Defence
documents, for instance, are intended to fulfil several purposes in
practice.28 When addressed to the shareholders of a company, they may
help the management to persuade the shareholders not to accept a
takeover bid. On the other hand, the information contained in the defence
document may be intended to elicit an increased offer from the bidder. The
latter purpose was clearly recognised in Morgan Crucible with regard to
financial statements made after the bidder had been identified. The court
took a step in the right direction when they conceded that a duty of care
26 Robert Baxt, see note 6 at 12.
27 FEB Fasteners Ltd v Bloom & Co (a firm) [1981] 3 All ER 289 at 305g.
28 Mary Percival, “After Caparo — Liability in Business Transactions Revisited”, 54 MLR
739.
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might be owed to an identified bidder in such a situation. Unfortunately,
the case was settled before the trial, otherwise it would have proved most
illuminating in this confused area of the law. Much depends on what
constitutes the “original, central and primary purpose” of financial
statements other than those contained in audited reports.
Given the uncertainty that shrouds the question of whether there is
sufficient proximity to found a duty to take care, the business community
has devised a means to side-step Caparo. Institutional lenders in England
have attempted to established the requisite proximity between them and a
company’s auditors by asking the latter to sign “privity letters”29. These
letters, in effect, amount to a confirmation by the auditors that the
proposed lender can rely on the auditors’ report for the purpose of
assessing whether or not to grant a specified credit facility to the company
concerned. It would thus create the required proximity between the parties
since the auditors’ report (which had originally been prepared for statutory
purposes) is now being relied on by an identified party, for the purpose of
deciding whether to grant a particular credit facility, with the consent and
knowledge of the auditors. The privity letter would also ensure that the
auditor has knowledge of the details of the loan, such as the repayment
period and the amount of the loan.
In the case of a takeover bidder who has made a bid and has been
identified, it is questionable whether he would be likely to succeed in
obtaining a privity letter from the company’s accountants or auditors in
relation to the audited reports and other financial information provided by
them, especially in the case of a hostile takeover. In any case, the privity
letter is essential to create proximity between the parties, which would
otherwise not exist, because at the instance prior to the disclosure of the
identity of the bidder and his intentions, the auditor would not realise that
a potential investor is relying on the accounts for the specific purpose of a
possible takeover bid. However, it must be noted that the privity letter
would, at most, only create proximity in relation to actions taken by the
bidder after the acknowledgement from the accountants or auditors has
been secured. So it would not create any proximity in relation to the initial
bid which had already been made, as it is unlikely that the courts will
accept the idea of a privity letter that is designed to be retrospective in
effect.
The ordinary stock market investor, who lacks the clout of an institutional
lender, would probably be unable to obtain a privity letter from the
29 Neil Cuthbert & Alan Berg, “After Caparo:can banks rely on audited financial
statements?” 1990 Apr IFLR 17.
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345
company’s accountants or auditors. In any case, it may not be a practicable
safeguard because investment decisions in the stock market are usually
decisions in which timing is crucial. The ordinary investor’s other source of
information are reports prepared by financial analysts in stockbroking
firms. Invariably, however, these reports are published with a disclaimer,
and reasonably so, since they are mostly based on information culled from
a company’s audited report.
Thus the ordinary stock market investor is left largely unprotected as far as
his rights in negligence against the accountants, auditors and financial
advisers are concerned. This group of investors belong to an indeterminate
class, which raises numerous policy issues, which, at this state of the
development of the law, are perhaps, more appropriate for the legislature
to consider. Given that the law since Hedley Byrne seems to have come full
circle, the burden of appropriating the loss in stock market investments
between investors and accountants, auditors and financial advisors should
no longer be left to the courts. Instead, it may be timely for Parliament to
decide whether statutory reform in this area of the law is necessary.
ANGELINA LIM — CHAN HUI LIAN*
ERIN GOH — LOW SOEN YIN
* Both lecturers at the Division of Legal Studies and Taxation, School of Accountancy and
Business, Nanyang Technological University.