This blog was co-authored by: Kristin January and James Donald
On 6 May 2021, the Johannesburg high court reaffirmed that auditors do not generally owe a legal duty to the employees of an insolvent company and consequently no valid claim can arise on the part of the employees for any alleged misstatement concerning the company’s financial statements. The imposition of such a legal duty on auditors in claims of this nature would unacceptably raise the spectre of indeterminate liability.
Former employees who were retrenched by the contractors of the now insolvent VBS Mutual Bank, instituted a delictual claim for R230 million for emotional shock, medical expenses and loss of earning capacity arising out of an alleged negligent audit by the bank’s auditors of the financial statements of VBS Mutual Bank for the year ending 2017.
They alleged that if the auditors had complied with the Generally Acceptable Accounting Practice (GAAP), the 2017 financial statements would have accurately represented the bank’s financial position. Alternatively, a qualified audit would have been presented and subsequent measures would have been taken to ensure the bank was not liquidated. Thus, they alleged, but for the alleged misstatement by VBS’s appointed auditors for the financial year ending March 2017, they would not have been retrenched.
The plaintiffs alleged in their particulars of claim that KPMG’s directors and employees knew of the misstatement but did not disclose this fact, and as a result acted negligently; and that the auditor had a duty to report the matter to the regulator.
The plaintiffs submitted that the auditors acted wrongfully as it breached its duty to VBS Mutual Bank. The test for wrongfulness assumes that the defendant has acted negligently or wilfully and asks whether the law ought to impose liability. In contrast to cases of physical harm, conduct causing pure economic loss is not prima facie wrongful. Where the element of wrongfulness becomes less straightforward is with reference to liability for negligent omissions and for negligently causing pure economic loss. Wrongfulness in these scenarios is dependent on the existence of a legal duty not to act negligently. For such conduct to be classified as wrongful, a judicial determination based on considerations of public and legal policy is required. In such cases of liability for an omission or those which causes pure economic loss, wrongfulness is determined by asking whether the defendant had a legal duty to prevent harm or could reasonably been expected to act.
The SCA has confirmed on many occasions that conduct which may have caused pure economic loss is not prima facie wrongful. It is the responsibility of the plaintiff to demonstrate that a legally recognised interest has been infringed. In order to determine whether a third party has a claim against an alleged wrongdoer, one would have to determine whether a wrong was committed against the third party in breach of a legal duty they owed to a company. If the company suffers a loss as a result of this breach, only the company may claim for that loss, and not third parties.
In the consideration of the imposition of a legal duty on auditors in such circumstances, the court emphasised that the primary policy consideration is the avoidance of the imposition of liability in an indeterminate amount for an indeterminate time to an indeterminate class of claimants. What the court ultimately meant by this is that policy reasons will at times dictate the refusal of the extension of delictual liability in an effort to avoid an “unjustified limitation of the defendant’s activities.”
Limitation of liability is thus a key policy consideration in ascertaining whether a claim for pure economic loss is actionable. To impose such a duty and consequent liability in these circumstances would create of indeterminate liability.
The Johannesburg high court thus reiterated that auditors are generally accountable only to the companies they audit and not the shareholders and employees of such company, or any interested third party. Accordingly, the auditor owed the employees of the bank no legal duty and consequently a delictual claim on the basis of wrongfulness could not succeed in the circumstances.