Royal Bank Of Scotland Plc V. Bannerman Johnstone Maclay
| Jurisdiction | Scotland |
| Judge | Lord Justice Clerk,Lord Osborne,Lady Cosgrove |
| Date | 26 May 2005 |
| Docket Number | A2237/00 |
| Court | Court of Session |
| Published date | 26 May 2005 |
| SECOND DIVISION, INNER HOUSE, COURT OF SESSION | |
| Lord Justice Clerk Lord Osborne Lady Cosgrove
| A2237/00 OPINION OF THE LORD JUSTICE CLERK in RECLAIMING MOTION in the cause ROYAL BANK OF SCOTLAND plc Pursuers and Respondents; against BANNERMAN JOHNSTONE MACLAY, Chartered Accountants; and A G BANNERMAN, G J JOHNSTONE, D J MACLAY, R B McKERRAL, M G MacBETH and M G McCUSKER, the whole partners thereof as such partners and as individuals Defenders and Reclaimers: _______ |
Act: Currie, QC, D E L Johnston; Brodies
Alt: Dean of Faculty (C M Campbell, QC), Paterson; Brechin Tindall Oatts
26 May 2005
IIntroduction
[1]This is an action of reparation arising from the insolvencies of APC Limited (APC) and its subsidiary APC Civils Limited (APC Civils). The pursuers were the bankers of both companies. The defenders were the auditors of APC.
[2]The pursuers claim damages for losses allegedly sustained by them in consequence of negligence on the part of the defenders in the auditing of APC and of fraud on the part of Michael McMahon (McMahon) who, they allege, was one of the defenders' employees and was acting in the course of his employment with them at the material time.
[3]The Lord Ordinary heard a debate on the defenders' plea to relevancy. He dismissed the fraud case. Quoad ultra he allowed proof before answer. The defenders have reclaimed against the allowance of proof before answer. The pursuers have cross-appealed against the dismissal of the fraud case.
[4]In the reclaiming motion and in the cross-appeal some lesser issues have fallen away. There are now four main issues, namely (1) whether the pursuers have relevantly averred the existence of a duty of care on the part of the defenders; (2) the significance, if any, of the defenders' failure to issue a disclaimer of liability in respect of the audited accounts; (3) whether the pursuers have pled a relevant claim for damages for losses sustained through their lending to APC Civils, and (4) whether the pursuers have pled a relevant case of vicarious liability on the part of the defenders for the fraudulence of McMahon. Counsel have in all essentials renewed the submissions that they made to the Lord Ordinary. The Lord Ordinary has set them out at length (cf Royal Bank of Scotland Ltd v Bannerman Johnstone Maclay, 2003 SC 125, at paras [11]-[42]; [59]-[71]) and I need not rehearse them.
IIThe pursuers' relationship with APC and APC Civils
[5]The pursuers aver that APC was formed after a management buyout of Adam Bruce Plant Hire Limited (Adam Bruce), which had become insolvent. APC assumed liability for about £1,900,000 owed by Adam Bruce to the pursuers. APC began to trade as plant hirers in December 1994 or in January 1995. The pursuers give both dates. APC Civils began to trade in September 1997. Its business was to carry out some of APC's contracts for motorway work.
[6]The pursuers aver that they were the principal bankers to APC and APC Civils and provided both companies with overdraft facilities. They gave APC a term loan of £1,500,000 and a small firm's loan of £100,000.
[7]On 24 September 1998 the pursuers appointed joint receivers to APC. On 28 September 1998 they appointed joint receivers to APC Civils. At the dates of the receiverships the overdrafts of APC and APC Civils were £8,255,146 and £3,530,820 respectively.
[8]The pursuers aver that they appointed the receivers because they discovered that the accounts of APC included material inaccuracies and, as a result, greatly overstated the value of APC's fixed assets and of its profitability. The overstatements were the result of a fraudulent scheme.
[9]The pursuers aver that on completion of the buyout, they obtained an option to subscribe for 30%, later increased to 55%, of the share capital of APC. In 1996 they exercised that option and thereafter injected further equity into APC, all of which is now worthless. The pursuers specify the details of these transactions.
IIIAnalysis of the pursuers' case
- Duty of care
[10]The pursuers aver that the defenders had a close relationship with APC and an intimate understanding of its relationship with the pursuers. After the management buyout, the defenders, and in particular their partner Mr McKerral, prepared the business plan for APC on the basis of which the pursuers originally provided finance to APC. During 1995 the defenders were involved in preparing financial projections for APC for the three years ending on 30 November 1997 and a "Review of August 1995 Management Accounts" dated 7 November 1995.
[11]It was a condition of the overdraft facilities given to both companies, and set out in the relative facility letters, that the pursuers should be provided with annual audited financial statements as soon as they were available, and in any event within 180 days after the end of each company's financial year, and with management accounts shortly after the end of each month. The facility letters began to be issued by the pursuers before the first audit.
[12]On or about 26 September 1995 Paul Canning, an employee of the pursuers, attended a meeting at the offices of the defenders with one of the defenders' partners and a representative of APC for the purposes of reviewing APC's management accounts for July 1995.
[13]McMahon was seconded to APC as its financial controller from about December 1995 to March 1996 and APC was invoiced by the defenders for the provision of accountancy services. McMahon was responsible for the provision of financial information and forecasts. He was responsible for preparing the daily financial reports and monthly management accounts that were supplied to the pursuers as a condition of their lending. He also produced year-end figures for APC, which the defenders audited. During this period the final documentation for the audit to 30 November 1995 was being completed. The accounts for that period were signed on 16 April 1996.
[14]From the outset the defenders knew of the pursuers' involvement with APC and of their option to subscribe for a significant shareholding in the company. Through their audit of the accounts of APC, the defenders knew that the pursuers were APC's principal bankers, were shareholders in APC from October 1996 and were substantial creditors of APC. They knew that the business of APC was heavily reliant on its overdrafts with the pursuers. They knew that the shareholders of APC, including the pursuers, relied on the audited accounts in order to obtain assurances that the company's financial statements were free of material mis-statements caused by fraud or other irregularity or error. They knew that APC was a business making heavy demands for cash in order to fund the plant and machinery hired out by it. They knew or ought to have known that in these circumstances the critical consideration for those such as the pursuers who funded APC, by loan or by injection of equity, was its profitability. By reason of Statement of Auditing Standards 130, the defenders saw and were aware of the terms of the facility letters granted by the pursuers to APC, and accordingly knew that the provision of audited and management accounts to the pursuers was a condition of their funding APC to enable it to continue to trade.
[15]The pursuers therefore believe and aver that the defenders knew that the pursuers would rely on the audited accounts as a check on the reliability of the monthly management accounts provided to them by APC. The pursuers relied on the audited accounts for this purpose and in deciding whether to maintain, increase or withdraw their lending to and support of APC. The defenders knew that the statements and accounts audited by them constituted the main independent check on APC's own monthly management accounts and the main means of assessing the profitability of APC. They knew of the importance, especially in relation to a highly-geared business such as APC, of scrutinising closely the ability of the company to trade as a going concern. The defenders had a close relationship with APC and an intimate understanding of its relationship with the pursuers.
[16]The defenders audited the accounts of APC for the audit periods to 30 November 1995 and to 31 March 1997 and for those accounts signed unqualified audit reports dated 16 April 1996 and 15 January 1998 respectively. At the date of the receivership they were in the course of finalising the accounts of APC for the period to 31 March 1998 and had already prepared accounts to 31 March 1999 in draft.
[17]The pursuers aver that they made the overdraft facilities and the term loan available to APC and to APC Civils and injected the equity funds into APC in reliance upon the audited accounts and audit reports prepared by the defenders.
[18]The pursuers aver that it was the defenders' duty to the pursuers to take reasonable care in acting as the auditors of APC and that it was their duty to exercise the reasonable skill and care that would be exercised by any auditor of ordinary competence. It was also the defenders' duty in auditing the accounts of APC to have regard to any liabilities of APC Civils that might have a material impact on the accounts of APC itself and to satisfy themselves, either from audited accounts of APC Civils or from other adequate evidence, as to the existence and extent of any such material liabilities. In all these circumstances it was reasonable for the pursuers to rely on the defenders to exercise reasonable skill and care in auditing APC's accounts. Separatim, in all the circumstances the defenders in any event assumed responsibility towards the pursuers for exercising reasonable skill and care in auditing APC's accounts.
[19]The pursuers specify numerous reasons why the defenders failed to exercise reasonable skill and care in the auditing of the accounts. These relate to the interpretation of, and the conclusions to be drawn from, the vouchers; the implications of the change by APC in its accounting...
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