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Livent auditor Deloitte ordered to pay $84.8­million
for failing detect fraud
DREW HASSELBACK | April 6, 2014 4:21 PM ET
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Livent founder Garth Drabinsky was convicted of fraud 2009. He served three years in prison in Ontario. In January he was granted full parole for the final two years Peter J. Thompson/National Post
of his sentence
The Livent scandal has yet again made Canadian legal history, this time in the form of an $85.6­milllion lawsuit judgment that puts
accounting firms and corporate auditors under the legal microscope.
Livent’s former auditor, Deloitte, has been ordered to pay damages to the theatre company’s creditors after an Ontario judge ruled
the accounting firm failed to detect fraud at the company, even though there were plenty of warning signs that something fishy was
going on in the 1990s.
“In my opinion, Deloitte should have remained firm in its resolve to sever its relationship with Livent at the end of August 1997 at the
earliest,” writes judge Arthur Gans of the Ontario Superior Court of Justice in a 118­page ruling dated Friday. “The red flags were
certainly aflutter by that time.”
The judgment is a very rare situation. For years creditors and investors have been looking for ways to sue corporate auditors. This
decision shows one way it may be done.
Officials from Deloitte said Sunday they are still studying the decision. “Our final audit of Livent occurred close to 20 years ago. It
was a difficult audit and senior Livent officials have been convicted of fraud. We need time to carefully consider the decision before
deciding on our next step,” said Vital Adam, Deloitte spokesman.
Livent was a high flying theatre company in the 1990s, bringing popular shows like “Phantom of the Opera” and “Joseph and the
Amazing Technicolor Dreamcoat” to stages across North America. Behind the curtain, however, the company was ultimately revealed
to be a massive accounting fraud. Livent sought bankruptcy protection in the U.S. in 1998. Founders Garth Drabinsky and Myron
Gottlieb were convicted of fraud in Ontario in 2009.
For many Canadians, the Livent scandal was put to bed after Drabinsky and Gottlieb were packed off to jail. But the fallout from the
fraud trundles on in a series of regulatory and civil proceedings.
In 2002, the receiver in the Livent bankruptcy case took aim at Deloitte in an Ontario lawsuit that claimed the accounting firm had
failed in its duty as a corporate auditor. Had Deloitte detected the fraud, the suit alleged, the firm could have refused to sign Livent’s
improper financial statements. This, in turn, would have stopped Livent from using cooked books to solicit funds from investors and
creditors.
Livent v. Deloitte raises an issue that has perplexed Canadian judges and lawyers for years. Canadian law recognizes that a company
can sue an accounting firm that provides negligent advice or a flawed audit. Yet Canadian law doesn’t extend that right to a
company’s individual investors or creditors. Why? Because Canadian courts have decided that the purpose of an audit is to ensure
managers are properly protecting a company, not to help shareholders make individual investment decisions.
Livent v. Deloitte came with a legal quirk that enabled the judge to take the unusual step of ordering the auditor to pay creditors.
Because Livent has sought bankruptcy protection, what’s left of the company is in the hands of a receiver whose job is to track down
value for creditors. The law puts the receiver in the company’s shoes. That enables the receiver to do what ordinary creditors can’t —
such as sue the auditor for missing the fraud.
Even so, Livent v. Deloitte bumps into another legal issue. There’s a principle of law that says you can’t sue someone else when you’re
the author of your own misfortune. If Livent was responsible for its own fraudulent actions, this legal principle would prevent it from
shifting the blame to Deloitte in court.
The judge said that even though it looks on paper like Livent is suing Deloitte, the reality is different. It’s actually the receiver who’s
suing on behalf of the creditors, and they weren’t parties to the fraud. “Indeed, to attribute the fraud to the company in these
circumstances would have the perverse effect of depriving the innocent participants in the enterprise of a remedy for the negligence
of its auditor in precisely those cases where the services of an auditor are most critical — namely, the detection of wrongdoing by
high­level management.”
Though important, the Ontario ruling is not likely to be the end of the matter. Judge Gans hints that he thinks the parties might try to
appeal his ruling. “I am also not naïve enough to think that the issue will not receive further consideration by other courts in this
continuing saga.”
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Topics: Legal Post, Deloitte, Garth Drabinksy, Livent, Myron Gottlieb
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The Globe and Mail: Court upholds ruling on Deloitte's negligence over ...
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January 8, 2016
By JANET McFARLAND
The case has been closely watched in the legal community because it has been extremely difficult
for investors to sue auditors when companies collapse amid allegations of fraud
The Ontario Court of Appeal has upheld a landmark 2014 decision that ordered accounting firm Deloitte & Touche to
pay $118-million in damages for negligence in its work as the auditor of failed live-theatre company Livent Inc.
The case has been closely watched in the legal community because it has been extremely difficult for investors to sue
auditors when companies collapse amid allegations of fraud, and the Livent decision was seen as opening a new path
for future claims against auditors in other cases.
Appeal court Justice Robert Blair ruled Friday that the original trial judge was correct in concluding Deloitte was
negligent in its work on the audit of Livent's 1997 year-end financial statements, as well as the interim statements for
the second and third quarters of 1997.
"In my view, the record amply supports the trial judge's findings that Deloitte was negligent in the conduct of the 1997
audit and the Q2 and Q3 1997 engagement," he wrote in a decision supported by two other judges on the appeal
panel. "Indeed the evidence to that effect is overwhelming."
Justice Blair, however, rejected a counterclaim asking for greater damages to be awarded in the case, saying the
original $118-million award was appropriate.
Ontario Superior Court Justice Arthur Gans ruled in April, 2014, that auditors at Deloitte & Touche breached their "duty
of care" to investors.
He initially awarded $85-million in damages to the company's creditors, but increased the amount to $118-million in a
subsequent ruling that added interest costs onto the original award, stretching back to March of 1998 when Livent
released its inaccurate 1997 financial statements.
In his original ruling, Justice Gans said that auditors "seemed to turn a blind eye to warning signs" about a
controversial transaction in 1997 to sell air rights to develop a condominium-hotel above Livent's Pantages Theatre in
Toronto. He said he was "at a loss" to understand how Deloitte provided a clean audit opinion for 1997, and ruled that
another decision to allow $27.5-million of writedowns in 1998 "left me breathless."
Justice Gans's decision was widely watched because Canadian investors have faced an uphill battle suing auditors,
largely as a result of a 1997 Supreme Court of Canada decision involving Hercules Management Ltd., which set out
narrow parameters for lawsuits to succeed.
1/11/2016 9:37 AM
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The Livent decision, however, was seen as a break from that precedent, laying out a new path for aggrieved investors
and creditors to succeed in lawsuits against auditors. Because the Hercules decision concluded that auditors owe a
duty of care to the corporation that hires them – and not to shareholders or creditors directly – the Livent lawsuit was
filed by Livent itself through its special receiver, although the creditor group led and financed the litigation and will
receive much of the award.
Deloitte challenged the move in its appeal, saying the lawsuit was essentially filed by creditors in reality and not really
the corporation. But Justice Blair rejected the argument, saying he had "no difficulty" in concluding the losses were
suffered by Livent so it was the legitimate party suing.
He also rejected Deloitte's arguments that the company had no right to sue because the fraud was conducted by
Livent's own senior executives, which meant the company itself essentially conducted the fraud and should not be
allowed to sue over its own conduct.
Justice Blair said such a claim would effectively mean auditors could never be sued by a company for failing to act on
evidence of fraud by executives, which would "risk undermining the public audit system."
He said he agreed with Justice Gans's original decision that blaming the company for fraud by its executives "would
have the perverse effect of depriving the innocent participants" with a remedy for auditor negligence.
Justice Blair also agreed with Justice Gans's conclusion that Deloitte should have resigned as Livent's auditor in 1997
due to the number of problems it had identified at the company.
Deloitte spokeswoman Emily Richardson said the firm will review the appeal decision before deciding on its next
steps.
"The Livent matter has been before the courts for a considerable period of time and we need time to carefully consider
the recently released Ontario Court of Appeal decision," she said in a statement. "The audit and legal issues in this
case are exceptionally complex, and important not only to the audit profession but to the broader business
community."
Livent bondholder Richard Ross, who headed the creditor group suing Livent, said the group is "gratified" that the
appeal court upheld the trial decision, and he hopes the case will soon be over.
"We hope that this will be the end of this legal saga and that some measure of compensation will now be available to
the creditors for the massive losses they incurred in the Livent fiasco," he said.
Livent staged live-theatre shows such as The Phantom of the Opera and Show Boat. The company collapsed in 1998
after new investors raised concerns about accounting problems they had uncovered at the company.
Founders Garth Drabinsky and Myron Gottlieb were found guilty in 2009 of orchestrating a fraud that saw Livent's
financial statements misstated in every quarter between 1993 and 1998. They were sentenced to five years and four
years in prison, respectively, but have since been released.
1/11/2016 9:37 AM