The firm that audited the accounts of Garth Drabinsky's Livent should be held financially responsible for some — but not all — of the failed theatre company's losses two decades ago, the Supreme Court of Canada says.
In a 4-3 ruling Wednesday, the high court found Deloitte was liable for negligently auditing Livent's 1997 financial statements, though not for other conduct.
The court concluded that an audit firm can only be held responsible where a company's financial losses relate to the actual purpose of the auditors' work.
Lower court decisions left Deloitte on the hook for almost $85 million, but the Supreme Court ruling reduces the damages award to $40 million.
In the 1990s, Livent brought live theatrical productions such as Phantom of the Opera and Joseph and the Amazing Technicolor Dreamcoatto audiences across North America.
Drabinsky, a colourful impresario and public face of the company, was suspended as Livent's vice-chairman and chief creative director in 1998 amid allegations of accounting irregularities. Myron Gottlieb, who served as president, was also suspended. Livent subsequently filed for bankruptcy and went into receivership.
Drabinsky and Gottlieb were later found guilty of fraud and forgery. Both were handed prison sentences.
Livent, through its receiver, sued Deloitte in 2001, alleging that audits between 1992 and 1998 were done negligently.
The trial judge found Deloitte liable for damages, a decision upheld last year by the Ontario Court of Appeal. The appeal court said the auditors should have been able to detect serious fraud in the company's financial statements.
Deloitte argued in the Supreme Court that it was effectively being penalized for failing to resign as Livent's auditor.
Livent's bankruptcy receiver countered that a robust audit has an important place in the statutory corporate and securities framework for public companies. It argued that accepting Deloitte's position would make audit firms immune from civil responsibility to their clients for incompetent audits.
Writing for a majority of the Supreme Court, justices Clement Gascon and Russell Brown confirmed that Deloitte negligently audited Livent's financial statements, resulting in the company losing millions more than it would have if the auditors had uncovered the fraud earlier.
"As a consequence, Livent's corporate life was artificially prolonged, resulting in the interim deterioration of its finances," the judges wrote.
They reasoned that Livent would not have taken on greater debt through financing, instead limiting the damage by declaring bankruptcy sooner.
Specifically, the court found Deloitte liable for its April 1998 audit of Livent's 1997 financial statements, which prevented shareholders from properly scrutinizing the company. It said Deloitte was responsible for 75 per cent of the difference in the company's financial position between the time of the audit opinion and Livent's bankruptcy in November 1998.
However, the high court disagreed with the lower courts that Deloitte should be held responsible for losses allegedly related to Deloitte's approval of an August 1997 press release and comfort letter to investors. The Supreme Court said that work was intended to help the company attract investment, and its financial losses did not relate to this purpose.