CANADIAN CASES on the LAW of TORTS Fourth Series/QuatriÈme SÉrie Recueil De Jurisprudence Canadienne En ResponsabilitÉ Civile VOLUME 10 (Cited 10 C.C.L.T

CANADIAN CASES ON THE LAW OF TORTS Fourth Series/Quatrième série Recueil de jurisprudence canadienne en responsabilité civile VOLUME 10 (Cited 10 C.C.L.T. (4th))

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CARSWELL, A DIVISION OF THOMSON REUTERS CANADA LIMITED One Corporate Plaza Customer Relations 2075 Kennedy Road Toronto 1-416-609-3800 Toronto, Ontario Elsewhere in Canada/U.S. 1-800-387-5164 M1T 3V4 Fax 1-416-298-5082 www.carswell.com Contact www.carswell.com/contact LeBlanc v. Vancouver Island Health Authority 173

[Indexed as: LeBlanc v. Vancouver Island Health Authority] Ceara Brienn LeBlanc on her own behalf and as personal representative of The Estate of Kelly Joseph LeBlanc, and Carter LeBlanc, Koen LeBlanc, and Kaden LeBlanc all by their litigation guardian Ceara Brienn LeBlanc, Plaintiffs and Vancouver Island Health Authority carrying on business as the West Coast General Hospital, Charles Craven, Jane Doe No. 1, Jane Doe No. 2, John Doe No. 1, John Doe No. 2, Defendants British Columbia Supreme Court Docket: Victoria 12-0641 2014 BCSC 755 J.L. Dorgan J. Heard: April 10, 2014 Judgment: May 1, 2014 Torts –––– Negligence — Practice and procedure — Evidence — Admissi- bility –––– Plaintiff’s husband died after being treated by defendant Dr. C, general practitioner working in emergency department of defendant hospital in Brit- ish Columbia — Plaintiff brought action alleging defendants were negligent in failing to diagnose and treat deceased properly — Plaintiff submitted expert reports from Dr. M, specialist who practiced in urban hospital in Ontario — Dr. C alleged that specialization and locale of practice of Dr. M precluded admissibility of his opinion for purpose of establishing relevant standard of care — Dr. C applied for summary trial to dismiss action — Application dismissed — It was inappropriate to decide admissibility of expert reports on summary trial; to do so would create injustice — Admissibility of expert evidence should be scrutinized at time it is proffered, and plaintiff was not proffering expert reports at present time — Authorities did not establish that specialist cannot provide expert opinion regarding standard of care applicable to non-specialist physician — It was not established that Dr. M’s credentials and locale of practice required trial judge to conclude his opinion was inadmissible — It was not simple “matter of law” that practitioner in Ontario cannot provide expert opinion regarding standard of care applicable in B.C. — Question of admissibility was best left to trial judge. Evidence –––– Opinion — Experts — Admissibility — Miscellaneous –––– Plaintiff’s husband died after being treated by defendant Dr. C, general practitioner working in emergency department of defendant hospital in British Colum- bia — Plaintiff brought action alleging defendants were negligent in failing to diagnose and treat deceased properly — Plaintiff submitted expert reports from Dr. M, specialist who practiced in urban hospital in Ontario — Dr. C alleged 174 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th) that specialization and locale of practice of Dr. M precluded admissibility of his opinion for purpose of establishing relevant standard of care — Dr. C applied for summary trial to dismiss action — Application dismissed — It was inappropriate to decide admissibility of expert reports on summary trial; to do so would create injustice — Admissibility of expert evidence should be scrutinized at time it is proffered, and plaintiff was not proffering expert reports at present time — Authorities did not establish that specialist cannot provide expert opinion regarding standard of care applicable to non-specialist physician — It was not established that Dr. M’s credentials and locale of practice required trial judge to conclude his opinion was inadmissible — It was not simple “matter of law” that practitioner in Ontario cannot provide expert opinion regarding standard of care applicable in B.C. — Question of admissibility was best left to trial judge. Civil practice and procedure –––– Trials — Summary trial — Availabil- ity — Miscellaneous –––– Plaintiff’s husband died after being treated by defendant Dr. C, general practitioner working in emergency department of defendant hospital in British Columbia — Plaintiff brought action alleging defendants were negligent in failing to diagnose and treat deceased properly — Plaintiff submitted expert reports from Dr. M, specialist who practiced in urban hospital in Ontario — Dr. C alleged that specialization and locale of practice of Dr. M precluded admissibility of his opinion for purpose of establishing relevant standard of care — Dr. C applied for summary trial to dismiss action — Application dismissed — Dr. C was essentially requesting that ruling on admissibility of expert opinion evidence be made within confines of summary trial instead of in context of full trial — Use of summary trial for that purpose conflicted with principle that admissibility of evidence was best determined in context of full evidentiary record — Determining admissibility of expert opinion at summary trial might fetter discretion of trial judge — Determination of admissibility of expert report was not simple matter of law — It was not appropriate to decide discrete issue raised by Dr. C, as to do so would create injustice. Cases considered by J.L. Dorgan J.: Chen v. Ross (2012), 2012 BCSC 1605, 2012 CarswellBC 3325 (B.C. S.C.) — considered Ewert v. Marshall (2003), 2003 BCSC 1429, 2003 CarswellBC 2318, 19 B.C.L.R. (4th) 131, [2003] B.C.J. No. 2202 (B.C. S.C.) — referred to Gichuru v. Pallai (2013), 2013 BCCA 60, 332 B.C.A.C. 272, 569 W.A.C. 272, 42 B.C.L.R. (5th) 91, 2013 CarswellBC 271, [2013] B.C.J. No. 188 (B.C. C.A.) — considered Grennan Estate v. Reddoch (2002), 176 B.C.A.C. 90, 290 W.A.C. 90, 2002 YKCA 17, 2002 CarswellYukon 125, [2002] Y.J. No. 119 (Y.T. C.A.) — considered LeBlanc v. Vancouver Island Health Authority 175

Hoskin v. Han (2003), 2003 BCCA 220, 2003 CarswellBC 857, 181 B.C.A.C. 130, 298 W.A.C. 130, 12 B.C.L.R. (4th) 21, [2003] B.C.J. No. 847 (B.C. C.A.) — considered Kivisalu v. Brown (2002), 2002 BCSC 1901, 2002 CarswellBC 3810 (B.C. S.C. [In Chambers]) — considered Lotocky (Litigation Guardian of) v. Markle (2006), 2006 BCSC 1295, 2006 Car- swellBC 2121, [2006] B.C.J. No. 1976 (B.C. S.C.) — considered Maher v. Sutton (2013), 2013 BCSC 1808, 2013 CarswellBC 2977, 4 C.C.L.T. (4th) 295 (B.C. S.C.) — considered McLellan v. Dickinson (2002), 2002 BCSC 1660, 2002 CarswellBC 2909 (B.C. S.C.) — referred to Phillips v. Central Cariboo Chilcotin Council (2002), 2002 CarswellBC 1329, 2002 BCSC 860, [2002] B.C.J. No. 1245 (B.C. S.C.) — followed R. c. J. (J.-L.) (2000), 2000 SCC 51, 2000 CarswellQue 2310, 2000 Carswell- Que 2311, 261 N.R. 111, 37 C.R. (5th) 203, (sub nom. R. v. J. (J-L.)) 192 D.L.R. (4th) 416, (sub nom. R. v. J. (J-L.)) 148 C.C.C. (3d) 487, [2000] 2 S.C.R. 600, [2000] S.C.J. No. 52, REJB 2000-20861 (S.C.C.) — considered R. v. Marquard (1993), 66 O.A.C. 161, 1993 CarswellOnt 995, 1993 Carswell- Ont 127, 25 C.R. (4th) 1, 85 C.C.C. (3d) 193, [1993] 4 S.C.R. 223, 108 D.L.R. (4th) 47, 159 N.R. 81, EYB 1993-67538, [1993] S.C.J. No. 119 (S.C.C.) — considered R. v. Mohan (1994), 18 O.R. (3d) 160 (note), 29 C.R. (4th) 243, 71 O.A.C. 241, 166 N.R. 245, 89 C.C.C. (3d) 402, 114 D.L.R. (4th) 419, [1994] 2 S.C.R. 9, 1994 CarswellOnt 1155, 1994 CarswellOnt 66, EYB 1994-67655, [1994] S.C.J. No. 36 (S.C.C.) — followed Turpin v. Manufacturers Life Insurance Co. (2011), 2011 BCSC 1159, 2011 CarswellBC 2300 (B.C. S.C.) — considered Statutes considered: Family Compensation Act, R.S.B.C. 1996, c. 126 Generally — referred to Rules considered: Supreme Court Civil Rules, B.C. Reg. 168/2009 Generally — referred to R. 9-7(15) — considered

APPLICATION by defendant for summary trial to dismiss action.

G.T. Rhone, for Plaintiffs C.G. Alexander, for Defendant, Vancouver Island Health Authority C.B.P. Elder, for Defendant, Charles Craven 176 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

J.L. Dorgan J.:

1 The plaintiff Ceara Brienn LeBlanc brings this action as a result of the death of Kelly Joseph LeBlanc, her husband and the father of her children, on her own behalf and on behalf of her children pursuant to the Family Compensation Act, R.S.B.C. 1996, c. 126. The plaintiff claims the defendants Dr. Craven, the Vancouver Island Health Authority (“VIHA”), and others were negligent by failing to diagnose and treat Mr. LeBlanc properly. 2 On June 21, 2010, Mr. LeBlanc was treated by the defendant Dr. Charles Craven, a general practitioner working in the Emergency Depart- ment of the West Coast General Hospital in Port Alberni. On July 8, 2010, Mr. LeBlanc died from complications related to an invasive strep- tococcal infection. 3 Dr. Craven applies by way of summary trial for a dismissal of the action against him, plus costs. He says that in order to prove the allegation that he was negligent the plaintiff must provide evidence to the court, in the form of expert opinion, regarding the standard of care applicable to an emergency room physician working at a rural British Colum- bia hospital in 2010. He argues that the plaintiff has served only the expert reports of Dr. Mazzulli and that these reports are inadmissible. He submits that it is therefore impossible for the plaintiff to prove the claim of negligence against him and that he should be dismissed from the action. 4 The defendant Dr. Craven acknowledges that the Mazzulli reports satisfy three of the four admissibility criteria from R. v. Mohan, [1994] 2 S.C.R. 9 (S.C.C.): there is agreement that the applicable standard of care is an issue on the case, that expert opinion is necessary to assist the court in determining the standard of care, and the Mazzulli reports meet all of the requirements of the Supreme Court Civil Rules regarding the tendering of expert reports and do not come within an exclusionary rule. 5 The defendant Dr. Craven’s challenge to the admissibility of the Maz- zulli reports is grounded in the fourth Mohan criteria: he says Dr. Maz- zulli is not a properly qualified expert. The defendant Dr. Craven submits that in order to be properly qualified to provide opinion evidence regarding the applicable standard of care an expert must be familiar with the practice of emergency medicine and the work environment of an Emer- gency Department of a rural hospital similar to the West Coast General Hospital. LeBlanc v. Vancouver Island Health Authority J.L. Dorgan J. 177

6 In other words, the defendant Dr. Craven argues Dr. Mazzulli’s specialization and the locale of his practice precludes admissibility of his opinion for the purpose of establishing the relevant standard of care. He points out that Dr. Mazzulli is a highly trained specialist, while Dr. Cra- ven is a general practitioner and that Dr. Mazzulli’s experience is limited to practising his specialty in a Toronto (“urban”) hospital while Dr. Cra- ven, at the relevant time, was practising in the Emergency Department of a “rural” hospital. In support of his argument, the defendant relies heavily on Chen v. Ross, 2012 BCSC 1605 (B.C. S.C.). 7 The plaintiff opposes the dismissal against Dr. Craven because she says the Mazzulli reports are admissible under the Supreme Court Civil Rules and according to the relevant authorities. The plaintiff character- izes Dr. Craven’s objections to Dr. Mazzulli’s qualifications as not relevant to the issue of admissibility, but rather, best considered as relevant to the question of weight. 8 The defendant VIHA takes no position. The parties’ 15-day trial starts May 26, 2014. I am not the trial judge. 9 The parties disputed whether it was appropriate to use a summary trial to determine the admissibility of the Mazzulli reports. A summary trial can be used to determine an issue as long as the court is able to find the necessary facts, decide the issues of law, and it would not be unjust to make a determination, Supreme Court Civil Rules, R. 9-7(15). In support of the claim that a summary trial is suitable the defendant Dr. Craven has attempted to narrowly define the issue before me. He says “the only issue Dr. Craven is seeking to have determined on this summary trial is the admissibility of Dr. Mazzulli’s standard of care opinion” and character- izes this issue as a “question of law that can be resolved summarily by reference to the report and other materials in the record.” He has placed Dr. Mazzulli’s c.v. and the Mazzulli reports before me on this summary trial. 10 The complication in this situation is that the defendant Dr. Craven is essentially requesting that a ruling on admissibility of expert opinion evidence be made within the confines of a summary trial instead of in the context of the full trial that is scheduled to proceed in five weeks. The use of a summary trial for this purpose conflicts with the principle that the admissibility of evidence is best determined in the context of a full evidentiary record which, in this case, would include evidence of the credentials of the proffered expert that can be tested through cross-examination. Furthermore, determining the admissibility of expert opinion at a 178 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

summary trial may fetter the discretion of the trial judge; this weighs against allowing the summary trial to proceed. 11 When the admissibility of an expert opinion is challenged, on the basis that the expert is not a “qualified expert”, the party tendering the opinion has the onus to prove that the opinion is admissible, Turpin v. Manufacturers Life Insurance Co., 2011 BCSC 1159 (B.C. S.C.). This onus does not shift because there is an application for judgment by summary trial, Gichuru v. Pallai, 2013 BCCA 60 (B.C. C.A.), para. 35. Con- sequently, if a summary trial was granted the plaintiff would have to prove the admissibility of the Mazzulli reports without the benefits provided by allowing the expert to testify on a voir dire. 12 I have determined that it is inappropriate to decide the discrete issue the defendant Dr. Craven raises, namely, the admissibility of the Maz- zulli reports on this summary trial. I am satisfied that to do so would create an injustice for the following reasons. 13 First, the plaintiff is not tendering the expert opinion at this time and it is not necessary to scrutinize it prior to trial. The defendant Dr. Craven has relied on Hoskin v. Han, 2003 BCCA 220 (B.C. C.A.), in which the Court of Appeal emphasized that a judge must act as a gatekeeper when expert opinion evidence is tendered and that the judge must be satisfied that an expert is qualified in the area for which their opinion is offered. However, at para. 70, Hoskin quoted R. c. J. (J.-L.), 2000 SCC 51 (S.C.C.), where the Court wrote “The admissibility of the expert evidence should be scrutinized at the time it is proffered”. It is clear that the plaintiff is not proffering the Mazzulli reports at this time. 14 Second, I do not take the authorities put before me as establishing that a specialist cannot provide expert opinion regarding the standard of care applicable to a non-specialist physician. The defendant Dr. Craven provides authorities that he says support his contention that a specialist can only provide an opinion regarding the standard applicable to another practice area when the specialist has experience and familiarity in that other practice area, see Kivisalu v. Brown, 2002 BCSC 1901 (B.C. S.C. [In Chambers]); Chen. 15 The plaintiff responds that Dr. Mazzulli clearly has expertise in the area of infectious diseases and medical microbiology and it does not matter that he did not acquire that expertise by working as an emergency room physician, referring to R. v. Marquard, [1993] 4 S.C.R. 223 (S.C.C.) in support. The plaintiff also refers me to Lotocky (Litigation Guardian of) v. Markle, 2006 BCSC 1295 (B.C. S.C.), where Macaulay LeBlanc v. Vancouver Island Health Authority J.L. Dorgan J. 179

J. was faced with a situation where an expert opinion from an Ontario obstetrician was tendered to address the standard of care applicable to a general practitioner. Mr. Justice Macaulay, in consideration of the law as stated in Phillips v. Central Cariboo Chilcotin Council, 2002 BCSC 860 (B.C. S.C.) and Grennan Estate v. Reddoch, [2002] Y.J. No. 119 (Y.T. C.A.), admitted the opinion of the obstetrician and determined that the divergence in expertise between the expert and the defendant went to weight, not admissibility. There is another line of judicial reasoning that follows Phillips for the proposition that the specialization of a medical expert is not a relevant consideration when determining admissibility: Ewert v. Marshall, 2003 BCSC 1429 (B.C. S.C.); McLellan v. Dickinson, 2002 BCSC 1660 (B.C. S.C.). 16 Similarly, I am not persuaded that it is a simple “matter of law” that a practitioner in Ontario cannot provide an expert opinion regarding the standard of care applicable in Port Alberni. The defendant Dr. Craven relies heavily on Kivisalu, Maher v. Sutton, 2013 BCSC 1808 (B.C. S.C.), and Chen, as establishing that a non-local practitioner’s opinion is inadmissible. 17 In Kivisalu the plaintiff relied on two expert opinions from doctors that practiced in the U.S. and McKinnon J. determined that one expert did not have the required expertise and the other had no experience in British Columbia. However, McKinnon J. avoided determining the issue of the admissibility of the opinion of the expert with no experience in British Columbia by stating that the opinion “if admissible” and “even if accepted” could “not establish any causal link”, para. 37. 18 In Maher, the expert, Dr. Fromer, had never practiced in Canada and Mr. Justice Sewell explained that he was concerned that Dr. Fromer had not consulted with either a practitioner in British Columbia nor “made any effort to consult any published standards of practice approved by professional bodies in British Columbia or Canada”, para. 56. This reference to professional bodies in Canada indicates a distinction between foreign experts and experts in Canada. 19 In Chen, Madam Justice Ballance determined that an expert, trained and working in China, lacked familiarity with the standard of care for Canadian doctors and that fact was “fatal to the admission of his evidence” and that his “opinion evidence would not assist [the court] is forming a correct judgment on the standard of care”, para. 66. 20 However, in reaching this decision Madam Justice Ballance analyzed the authorities regarding what she termed the “locality rule”. Her conclu- 180 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

sion was that a distinction could be made between doctors that trained and practised outside of Canada and those that were trained or qualified to practice medicine in a different locality within Canada and that opinion evidence of the latter was admissible. At para 47: Contemporary judicial thinking tends to endorse the approach that the differences in the locality of medical practices as between the defendant doctor and experts who have been trained and/or qualified to practise medicine elsewhere in Canada are considerations that go to the weight of the expert evidence, rather than to its admission: Phillips v. Central Cariboo Chilcotin Council, 2002 BCSC 860at para. 27; Lotocky (Litigation Guardian of) v. Markle, 2006 BCSC 1295; Larson v. Lucky, 2005 BCSC 829; and, generally, Lush v. Con- nell, 2012 BCCA 203. The rationale underlying the change is explained by E.I. Picard in her text, “Legal Liability of Doctors and Hospitals in Canada” (3d ed.) at p. 206: The rule was created by the judiciary for the limited purpose of protecting some doctors at a certain time in our history, but times have changed. Now, with national standards of competence set by professional examinations and the development of continuing medical education, there seems less need to lower the standard on the basis of locality alone. It is generally not essential that the expert be familiar with the available resources at the defendant doctor’s disposal or the accepted practices in the defendant doctor’s professional community in order for the opinion to gain admission. However, those factors may very well negatively affect the weight ultimately accorded to it: (See generally: Phillips; Robinson v. Sisters of St. Joseph of the Diocese of Peterbor- ough in Ontario (1999), 29 C.P.C. (4th) 184 (Ont. C.A.); Briffett v. Gander & District Hospital Board (1996), 29 C.C.L.T. (2d) 251 (Nfld. C.A.)). 21 Consequently, I am not satisfied that the determination of the admissibility of the Mazzulli reports is a simple matter of law. I am of the view that the cases relied upon by the defendant Dr. Craven do not unequivocally support his assertion that Dr. Mazzulli’s credentials and locale of practice require that a trial judge must conclude his opinion is inadmissible. I am persuaded that it would be unjust for me to determine the admissibility of the Mazzulli reports in a summary trial; in order that justice is done, the question of admissibility is best left to the trial judge in this case. LeBlanc v. Vancouver Island Health Authority J.L. Dorgan J. 181

22 Accordingly, the application of the defendant Dr. Craven for dismissal of the case against him is dismissed. Application dismissed. 182 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

[Indexed as: Livent Inc. (Receiver of) v. Deloitte & Touche] Livent Inc., Through Its Special Receiver and Manager, Roman Doroniuk, Plaintiff and Deloitte & Touche and Deloitte & Touche LLP, Defendant Ontario Superior Court of Justice [Commercial List] Docket: 04-CL-5321, 02-CV-225823 2014 ONSC 2176 Gans J. Heard: April 15-19, 22-26, 29-30; May 1-3, 6-9, 13-17, 21-24; June 3-7, 10-14, 17-21, 24-28; July 8-9, 11, 15-16, 23-25; September 9-13, 16-17; October 9-11, 15-17, 2013 Judgment: April 4, 2014 Professions and occupations –––– Auditors — Negligence –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Creditors Arrangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards (GAAS) and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Action allowed — Auditor owed duty of care to L Inc. for ultimate benefit of its shareholders — In period to end of 1995, auditor staff handling audits was reasonably competent — Auditor would have been able to discharge obligations of knowing and understanding operation of client as mandated by Canadian Institute of Chartered Accountants handbook — Although auditor did not conduct 1996 audit in accordance with GAAS in certain respects, it was not established that negligence caused any compensable harm — As to 1997 audit, auditor should have ended relationship with L Inc. in 1997, when warning signs were evident — As to tort claim, had matters come to head on relevant dates, auditor would have been obliged to make full and frank disclosure to audit committee and regulators — Also, auditor’s investigation of “Put” issue fell well short of GAAS and its legal standard of care — Auditor knew that management was involved in fraud, and therefore assumption of management’s good faith was, by definition, contradicted — Auditor did not collect all relevant papers for review, did not review with professional skepticism, never determined when Put was allegedly destroyed, and apparently performed audit by conversation, giving rise to all manner of GAAS deficiencies — Auditor would also have been obliged to withhold clean audit opinion for year-end 1997 in respect of pre-production costs, revenue transactions, and ancillary issues — Ac- Livent Inc. (Receiver of) v. Deloitte & Touche 183 tion in contract succeeded similarly, and no distinction was to be made on elements of contract and its breaches, all of which were incorporated by reference to finding of “negligence”. Torts –––– Negligence — Duty and standard of care — Duty of care –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Creditors Arrangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards (GAAS) and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Action allowed — Auditor owed duty of care to L Inc. for ultimate benefit of its shareholders — In period to end of 1995, auditor staff handling audits was reasonably competent — Auditor would have been able to discharge obligations of knowing and understanding operation of client as mandated by Canadian Institute of Chartered Accountants handbook — Although auditor did not conduct 1996 audit in accordance with GAAS in certain respects, it was not established that negligence caused any compensable harm — As to 1997 audit, auditor should have ended relationship with L Inc. in 1997, when warning signs were evident — As to tort claim, had matters come to head on relevant dates, auditor would have been obliged to make full and frank disclosure to audit committee and regulators — Also, auditor’s investigation of “Put” issue fell well short of GAAS and its legal standard of care — Auditor knew that management was involved in fraud, and therefore assumption of management’s good faith was, by definition, contradicted — Auditor did not collect all relevant papers for review, did not review with professional skepticism, never determined when Put was allegedly destroyed, and apparently performed audit by conversation, giving rise to all manner of GAAS deficiencies — Auditor would also have been obliged to withhold clean audit opinion for year-end 1997 in respect of pre-production costs, revenue transactions, and ancillary issues — Ac- tion in contract succeeded similarly, and no distinction was to be made on elements of contract and its breaches, all of which were incorporated by reference to finding of “negligence”. Contracts –––– Performance or breach — Breach — Miscellaneous –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Creditors Arrangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards (GAAS) and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Action allowed — Auditor owed duty of care to L Inc. for ultimate benefit of its shareholders — In period to end of 1995, auditor staff handling audits was reasonably competent — Auditor would have been able to 184 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th) discharge obligations of knowing and understanding operation of client as mandated by Canadian Institute of Chartered Accountants handbook — Although auditor did not conduct 1996 audit in accordance with GAAS in certain respects, it was not established that negligence caused any compensable harm — As to 1997 audit, auditor should have ended relationship with L Inc. in 1997, when warning signs were evident — As to tort claim, had matters come to head on relevant dates, auditor would have been obliged to make full and frank disclosure to audit committee and regulators — Also, auditor’s investigation of “Put” issue fell well short of GAAS and its legal standard of care — Auditor knew that management was involved in fraud, and therefore assumption of management’s good faith was, by definition, contradicted — Auditor did not collect all relevant papers for review, did not review with professional skepticism, never determined when Put was allegedly destroyed, and apparently performed audit by conversation, giving rise to all manner of GAAS deficiencies — Auditor would also have been obliged to withhold clean audit opinion for year-end 1997 in respect of pre-production costs, revenue transactions, and ancillary issues — Ac- tion in contract succeeded similarly, and no distinction was to be made on elements of contract and its breaches, all of which were incorporated by reference to finding of “negligence”. Business associations –––– Powers, rights and liabilities — Liability of corporations –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Creditors Ar- rangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Auditor took position, in part, that even if negligence or breach of contract was found, L Inc.’s losses were not recoverable because they were caused by its own illegal acts (corporate identification doctrine) — Action allowed — As to 1997 audit, auditor should have ended relationship with L Inc. in 1997, when warning signs were evident — Auditor knew that management was involved in fraud, and therefore assumption of management’s good faith was, by definition, contradicted — Corporate identification doctrine was not intended to and did not apply to action commenced by aggrieved company against third party for negligence or breach of contract. Civil practice and procedure –––– Actions — Cause of action — Ex turpi causa non oritur actio –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Cred- itors Arrangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards and should not have resulted in clean audit opinions — L Inc. brought action against defendant audi- Livent Inc. (Receiver of) v. Deloitte & Touche 185 tor for negligence and breach of contract — Action allowed — As to 1997 audit, auditor should have ended relationship with L Inc. in 1997, when warning signs were evident — Auditor knew that management was involved in fraud, and therefore assumption of management’s good faith was, by definition, contradicted — Although L Inc. conceded that it was not seeking to rely on doctrine ex turpi causa to defeat claim, court was obliged to consider its application — Pur- pose of doctrine would not be served by attributing fraud to company in this case — Plaintiff company had innocent shareholders and directors who were not party to fraudulent schemes of two individuals — If L Inc. were to recover damages from auditor, none of money would provide benefit to anyone who participated in fraud — No wrongdoer would be allowed to profit from his wrong or to evade criminal sanction, and integrity of legal system would not be called into question — To attribute fraud to company would have perverse effect of depriving innocent participants in enterprise of remedy for negligence of its auditor in precisely those cases where services of auditor were most critical: detection of wrongdoing by high-level management. Remedies –––– Damages — Damages in tort — Other torts — Miscellane- ous –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Creditors Arrangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Action allowed — Claims were established with regard to 1997 audit — “Raw” damage number with measurement date of August 31, 1997 was $113 million — That number was to be reduced by 25% to account for contingencies which should not be auditor’s responsibility, yielding net damage number of $84,750,000 — Court accepted notion that consequences of certain of “trading losses” should not be borne by auditor — Reduction percentage chosen reflected change in environment in which L Inc. was functioning after year-end 1995, and would account for “trading losses” that would be generated from unprofitable but legitimate theatre business. Torts –––– Negligence — Contributory negligence — Proof of contributory negligence — Miscellaneous –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Compa- nies’ Creditors Arrangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Action allowed — Claims were established with regard to 1997 audit — Fraud of various officers, directors and employees of L Inc. was not to be attributed to corporation for purposes 186 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th) of applying contributory negligence defence — While no doubt corporation would be found vicariously liable to victims of frauds perpetrated by its management and employees, policy underpinning such conclusion did not apply when frauds of management were being put forward as shield and not as sword — Purpose of audited statement, to insure that interests of shareholders are safeguarded by providing means to supervise management, would be undermined if auditor’s responsibility were reduced in proportion to egregiousness of misconduct which it failed to detect — Honest directors and innocent shareholders in this case were entitled to rely on audits to discharge their supervisory task without corporation suffering diminution in amount of recovery — Although not dispositive, absence of pursuit of third party actions reduced force of any complaint by auditor that it was not fair to hold it solely responsible for damages suffered by L Inc. — Section 3 of Negligence Act was not applicable and no reduction in amount of damages was appropriate in respect of this defence. Bankruptcy and insolvency –––– Effect of bankruptcy on other proceedings — Proceedings by bankrupt –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Creditors Arrangement Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Action allowed — Claims were established with regard to 1997 audit — Special defence concerned with “deepening insolvency” did not assist auditor in reducing damages — Court did not hear or see any evidence establishing that L Inc. was insolvent on any of measurement dates that court suggested applied — No evidence was led that creditors of L Inc. were beating path to its door and asking to be repaid before fraud was discovered and revealed to world — Restated consolidated balance sheets indicated that L Inc.’s assets, which had undergone deep discount from accounting point of view, still exceeded liabilities in each of year- end 1996 and 1997, albeit marginally as at December 31, 1997 — Fact that retained earnings had been eroded significantly in that time period, on restatement, and were in deficit position as at two year-ends, did not amount to insolvency. Remedies –––– Damages — Damages in contract — Contract for service or repair –––– Large-scale fraud arose from entertainment productions venture set up by two individuals — Defendant was engaged as auditor for plaintiff L Inc. from 1992 until L Inc. sought protection under Companies’ Creditors Arrange- ment Act in 1998 — L Inc. alleged that audits were not carried out in accordance with generally accepted auditing standards and should not have resulted in clean audit opinions — L Inc. brought action against defendant auditor for negligence and breach of contract — Action allowed — Claims were established with regard to 1997 audit — “Raw” damage number with measurement date of Au- Livent Inc. (Receiver of) v. Deloitte & Touche 187

gust 31, 1997 was $113 million — That number was to be reduced by 25% to account for contingencies which should not be auditor’s responsibility, yielding net damage number of $84,750,000 — Court accepted notion that consequences of certain of “trading losses” should not be borne by auditor — Reduction percentage chosen reflected change in environment in which L Inc. was functioning after year-end 1995, and would account for “trading losses” that would be generated from unprofitable but legitimate theatre business. Cases considered by Gans J.: Asiatic Petroleum Co. v. Lennard’s Carrying Co. (1915), [1914-15] All E.R. Rep. 280, 13 Asp. Mar. Law Cas. 81, 31 T.L.R. 294, [1915] A.C. 705 (U.K. H.L.) — followed B & Y Holdings Ltd. v. Best (2008), 45 B.L.R. (4th) 143, 275 Nfld. & P.E.I.R. 178, 842 A.P.R. 178, 2008 CarswellNfld 118, 2008 NLTD 78 (N.L. T.D.) — considered Barrington v. Institute of Chartered Accountants (Ontario) (2010), 4 Admin. L.R. (5th) 262, 260 O.A.C. 199, 2010 ONSC 338, 2010 CarswellOnt 1663 (Ont. Div. Ct.) — referred to Barrington v. Institute of Chartered Accountants (Ontario) (2011), 2011 ONCA 409, 2011 CarswellOnt 3623, 21 Admin. L.R. (5th) 216, 279 O.A.C. 148, (sub nom. Barrington v. Institute of Chartered Accountants of Ontario) 333 D.L.R. (4th) 401 (Ont. C.A.) — referred to Barrington v. Institute of Chartered Accountants (Ontario) (2011), 2011 Cars- wellOnt 13558, 2011 CarswellOnt 13559, 430 N.R. 398 (note), 297 O.A.C. 396 (note), [2011] S.C.C.A. No. 367 (S.C.C.) — referred to Bondi v. Citigroup, Inc. (February 28, 2005), Doc. BER-L-10902-04 (U.S. N.J. Super. L.) — referred to British Columbia v. Zastowny (2008), 2008 CarswellBC 214, 2008 CarswellBC 215, (sub nom. Zastowny v. MacDougall) 290 D.L.R. (4th) 219, [2008] 1 S.C.R. 27, 53 C.C.L.T. (3d) 161, (sub nom. X v. R.D.M.) 250 B.C.A.C. 3, 2008 SCC 4, [2008] 4 W.W.R. 381, 76 B.C.L.R. (4th) 1, (sub nom. X. v. R.D.M.) 370 N.R. 365, (sub nom. X v. R.D.M.) 416 W.A.C. 3, [2008] S.C.J. No. 4 (S.C.C.) — followed Canadian Imperial Bank of Commerce v. Deloitte & Touche (2013), 2013 Cars- wellOnt 4106, 361 D.L.R. (4th) 549, 2013 ONSC 2166 (Ont. S.C.J.) — referred to Canadian Imperial Bank of Commerce v. Deloitte & Touche (2014), 2014 ONCA 89, 2014 CarswellOnt 1772, 118 O.R. (3d) 508 (Ont. C.A.) — referred to Caparo Industries plc v. Dickman (1990), [1990] 1 All E.R. 568, [1990] 2 W.L.R. 358, [1990] 2 A.C. 605 (U.K. H.L.) — considered Capital Community Credit Union Ltd. v. BDO Dunwoody (2000), 2000 Cars- wellOnt 82, 4 B.L.R. (3d) 1, [2000] O.J. No. 65 (Ont. S.C.J.) — followed 188 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Capital Community Credit Union Ltd. v. BDO Dunwoody (2001), 151 O.A.C. 32, 2001 CarswellOnt 3791, 18 B.L.R. (3d) 162, [2001] O.J. No. 4249 (Ont. C.A.) — referred to Carmen Alfano Family Trust v. Piersanti (2012), 2012 ONCA 297, 2012 Cars- wellOnt 5668, 291 O.A.C. 62, [2012] O.J. No. 2042 (Ont. C.A.) — followed Carom v. Bre-X Minerals Ltd. (1998), 41 B.L.R. (2d) 246, 43 C.C.L.T. (2d) 310, 41 O.R. (3d) 780, 27 C.P.C. (4th) 73, 1998 CarswellOnt 4285, [1998] O.J. No. 4496 (Ont. Gen. Div.) — followed Central & Eastern Trust Co. v. Rafuse (1986), 37 C.C.L.T. 117, (sub nom. Central Trust Co. v. Rafuse) 186 A.P.R. 109, 1986 CarswellNS 40, 1986 CarswellNS 135, 42 R.P.R. 161, 34 B.L.R. 187, (sub nom. Central Trust Co. c. Cordon) [1986] R.R.A. 527 (headnote only), (sub nom. Central Trust Co. v. Rafuse) [1986] 2 S.C.R. 147, (sub nom. Central Trust Co. v. Rafuse) 31 D.L.R. (4th) 481, (sub nom. Central Trust Co. v. Rafuse) 69 N.R. 321, (sub nom. Central Trust Co. v. Rafuse) 75 N.S.R. (2d) 109, EYB 1986-67369, [1986] S.C.J. No. 52 (S.C.C.) — referred to Connor v. Shaparrall Ltd. (1998), 34 C.C.E.L. (2d) 208, 1998 CarswellOnt 432, 51 O.T.C. 161, [1998] O.J. No. 321 (Ont. Gen. Div.) — referred to Continental Assurance Co of London Plc (In Liquidation), Re (2001), [2007] 2 B.C.L.C. 287, [2001] B.P.I.R. 733 (Eng. Ch. Div.) — referred to Coopers & Lybrand Ltd. v. H.E. Kane Agencies Ltd. (1983), 23 C.C.L.T. 233, 1983 CarswellNB 70, 44 N.B.R. (2d) 374, 116 A.P.R. 374 (N.B. Q.B.) — followed Cosmetology Industry Assn. of British Columbia v. Nguyen (2010), 84 C.C.E.L. (3d) 257, 2010 BCSC 1051, 2010 CarswellBC 1998 (B.C. S.C.) — considered Dixon v. Deacon Morgan McEwen Easson (1993), 47 W.A.C. 14, 102 D.L.R. (4th) 1, (sub nom. Dixon v. National Business Systems Inc.) 28 B.C.A.C. 14, 12 B.L.R. (2d) 184, 1993 CarswellBC 522 (B.C. C.A.) — followed Ediger (Guardian ad litem of) v. Johnston (2013), 2013 CarswellBC 791, 2013 CarswellBC 792, 2013 SCC 18, 356 D.L.R. (4th) 575, (sub nom. Ediger v. Johnston) 442 N.R. 105, (sub nom. Ediger v. Johnston) [2013] 2 S.C.R. 98, 41 B.C.L.R. (5th) 1, [2013] 4 W.W.R. 643, 100 C.C.L.T. (3d) 1, (sub nom. Ediger v. Johnston) 333 B.C.A.C. 1, (sub nom. Ediger v. Johnston) 571 W.A.C. 1, EYB 2013-220183, [2013] S.C.J. No. 18 (S.C.C.) — referred to Fomento Ltd. v. Selsdon Fountain Pen Co. (1957), [1958] 1 All E.R. 11, [1958] 1 W.L.R. 45 (U.K. H.L.) — followed Frazer v. Haukioja (2008), 2008 CarswellOnt 4948, 58 C.C.L.T. (3d) 259, [2008] O.J. No. 3277 (Ont. S.C.J.) — considered Frazer v. Haukioja (2010), 261 O.A.C. 138, 101 O.R. (3d) 528, 73 C.C.L.T. (3d) 167, 317 D.L.R. (4th) 688, 2010 ONCA 249, 2010 CarswellOnt 1996 (Ont. C.A.) — referred to Livent Inc. (Receiver of) v. Deloitte & Touche 189

Galoo Ltd. v. Bright Grahame Murray (1993), [1995] 1 All E.R. 16, [1994] 1 W.L.R. 1360 (Eng. C.A.) — followed Glass v. 618717 Ontario Inc. (2011), 2011 CarswellOnt 3191, 2011 ONSC 2926 (Ont. S.C.J. [Commercial List]) — referred to Hall v. Hebert (1993), [1993] 4 W.W.R. 113, 152 N.R. 321, 15 C.C.L.T. (2d) 93, 101 D.L.R. (4th) 129, 45 M.V.R. (2d) 1, [1993] 2 S.C.R. 159, 26 B.C.A.C. 161, 44 W.A.C. 161, 78 B.C.L.R. (2d) 113, 1993 CarswellBC 92, 1993 CarswellBC 1260, [1993] S.C.J. No. 51, EYB 1993-67102 (S.C.C.) — followed Hart Building Supplies Ltd. v. Deloitte & Touche (2004), 2004 BCSC 55, 2004 CarswellBC 51, 41 C.C.L.T. (3d) 240, [2004] B.C.J. No. 49 (B.C. S.C. [In Chambers]) — referred to Hercules Management Ltd. v. Ernst & Young (1997), 31 B.L.R. (2d) 147, [1997] 2 S.C.R. 165, 1997 CarswellMan 198, 211 N.R. 352, 1997 CarswellMan 199, 115 Man. R. (2d) 241, 139 W.A.C. 241, (sub nom. Hercules Managements Ltd. v. Ernst & Young) 146 D.L.R. (4th) 577, 35 C.C.L.T. (2d) 115, [1997] 8 W.W.R. 80, [1997] S.C.J. No. 51 (S.C.C.) — followed Hill v. Hamilton-Wentworth (Regional Municipality) Police Services Board (2007), 2007 SCC 41, 2007 CarswellOnt 6265, 2007 CarswellOnt 6266, 87 O.R. (3d) 397 (note), 40 M.P.L.R. (4th) 1, 64 Admin. L.R. (4th) 163, 50 C.C.L.T. (3d) 1, 368 N.R. 1, 285 D.L.R. (4th) 620, [2007] 3 S.C.R. 129, [2007] R.R.A. 817, 50 C.R. (6th) 279, 230 O.A.C. 253, [2007] S.C.J. No. 41 (S.C.C.) — referred to Karrys Bros. Ltd. v. Ruffa (2014), 2014 ONSC 713, 2014 CarswellOnt 4190 (Ont. S.C.J. [Commercial List]) — referred to Kingston Cotton Mill Co. (No. 2), Re (1896), [1896] 2 Ch. 279 (Eng. C.A.) — considered Livent, Inc. Noteholders Securities Litigation, Re (2001), 151 F.Supp.2d 371 (U.S. Dist. Ct. S.D. N.Y.) — referred to London & General Bank (No. 2), Re (1895), [1895] 2 Ch. 673, 44 W.R. 80, 2 Ark. 282,55, 12 R. 263,502 (Eng. C.A.) — considered Meridian Global Funds Management Asia Ltd. v. The Securities Commission (1995), [1995] 2 A.C. 500, [1995] 3 All E.R. 918, [1995] B.C.C. 942, [1995] 2 B.C.L.C. 116, [1995] 3 W.L.R. 41, [1995] UKPC 5 (New Zealand P.C.) — followed Mustapha v. Culligan of Canada Ltd. (2008), 55 C.C.L.T. (3d) 36, 375 N.R. 81, 293 D.L.R. (4th) 29, [2008] 2 S.C.R. 114, 2008 CarswellOnt 2824, 2008 CarswellOnt 2825, 2008 SCC 27, 238 O.A.C. 130, 92 O.R. (3d) 799 (note), [2008] S.C.J. No. 27 (S.C.C.) — referred to NCP Litigation Trust v. KPMG LLP (2006), 901 A.2d 871, 187 N.J. 353 (U.S. N.J. Sup. Ct.) — referred to Official Committee v. RF Lafferty & Co. (2001), 267 F.3d 340 (U.S. C.A. 3rd Cir.) — referred to 190 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Pacific Acceptance Corp. v. Forsyth (1967), 92 W.N. (N.S.W.) 29 (New South Wales S.C.) — considered Parsons v. McDonald’s Restaurants of Canada Ltd. (2005), 2005 CarswellOnt 544, 7 C.P.C. (6th) 60, (sub nom. Currie v. McDonald’s Restaurants of Canada Ltd.) 250 D.L.R. (4th) 224, (sub nom. Currie v. McDonald’s Restaurants of Canada Ltd.) 74 O.R. (3d) 321, (sub nom. Currie v. McDonald’s Restaurants of Canada Ltd.) 195 O.A.C. 244, [2005] O.J. No. 506 (Ont. C.A.) — considered R. v. Drabinsky (2009), 2009 CarswellOnt 1642, 242 C.C.C. (3d) 449, [2009] O.J. No. 1227 (Ont. S.C.J.) — referred to R. v. Drabinsky (2011), 2011 ONCA 582, 2011 CarswellOnt 9323, 107 O.R. (3d) 595, 274 C.C.C. (3d) 289, 284 O.A.C. 222, [2011] O.J. No. 4022 (Ont. C.A.) — referred to R. v. Drabinsky (2012), 2012 CarswellOnt 3757, 2012 CarswellOnt 3758, 297 O.A.C. 399 (note), [2011] S.C.C.A. No. 491 (S.C.C.) — referred to R. v. McNamara (No. 1) (1985), (sub nom. Canadian Dredge & Dock Co. v. R.) 45 C.R. (3d) 289, (sub nom. Canadian Dredge & Dock Co. v. R.) 19 C.C.C. (3d) 1, (sub nom. Canadian Dredge & Dock Co. v. R.) 59 N.R. 241, (sub nom. R. v. Canadian Dredge & Dock Co.) [1985] 1 S.C.R. 662, 1985 Cars- wellOnt 939, (sub nom. Canadian Dredge & Dock Co. v. R.) 9 O.A.C. 321, (sub nom. Canadian Dredge & Dock Co. v. R.) 19 D.L.R. (4th) 314, 1985 CarswellOnt 96, [1985] S.C.J. No. 28 (S.C.C.) — followed Revelstoke Credit Union v. Miller (1984), 28 C.C.L.T. 17, 24 B.L.R. 271, 1984 CarswellBC 740, [1984] 2 W.W.R. 297, [1984] B.C.J. No. 2819 (B.C. S.C.) — followed Roman Corp. v. Peat Marwick Thorne (1992), 11 O.R. (3d) 248, 8 B.L.R. (2d) 43, 12 C.P.C. (3d) 192, 1992 CarswellOnt 149 (Ont. Gen. Div. [Commercial List]) — considered Sasea Finance Ltd. v. KPMG (1999), [2000] 1 All E.R. 676, [2000] B.C.C. 989, [2000] 1 B.C.L.C. 236, [2000] Lloyd’s Rep. P.N. 2 (Eng. C.A.) — followed Schacht v. Brown (1983), 711 F.2d 1343 (U.S. C.A. 7th Cir.) — considered Stone & Rolls Ltd. v. Moore Stephens Ltd. (2009), [2009] UKHL 39, [2009] 3 W.L.R. 455 (U.K. H.L.) — followed Suwary (Litigation Guardian of) v. Women’s College Hospital (2011), 2011 ONCA 676, 2011 CarswellOnt 11429, (sub nom. Suwary v. Women’s College Hospital) 285 O.A.C. 199, [2011] O.J. No. 4780 (Ont. C.A.) — referred to Sydney Cooperative Society Ltd. v. Coopers & Lybrand (2002), 2002 Car- swellNS 566, 213 N.S.R. (2d) 115, 667 A.P.R. 115, 2003 NSSC 35 (N.S. S.C.) — considered Tannereye Ltd. v. Hansen (2001), 201 Nfld. & P.E.I.R. 31, 605 A.P.R. 31, 2001 PESCTD 51, 2001 CarswellPEI 57, [2001] P.E.I.J. No. 58 (P.E.I. T.D.) — considered Livent Inc. (Receiver of) v. Deloitte & Touche 191

Thabault v. Chait (2008), 541 F.3d 512 (U.S. C.A. 3rd Cir.) — referred to Ticketnet Corp. v. Air Canada (1997), 105 O.A.C. 87, 154 D.L.R. (4th) 271, 1997 CarswellOnt 4273, [1997] O.J. No. 4638 (Ont. C.A.) — referred to Vischer & Co. v. Holt & Thompson (1979), [1979] 2 N.S.W.L.R. 322 (Australia C.A.) — considered 373409 Alberta Ltd. (Receiver of) v. Bank of Montreal (2002), 2002 SCC 81, 8 Alta. L.R. (4th) 199, 2002 CarswellAlta 1573, 2002 CarswellAlta 1574, [2003] 2 W.W.R. 1, 317 A.R. 349, 284 W.A.C. 349, [2003] R.R.A. 1, (sub nom. Bank of Montreal v. Ernst & Young Inc.) 220 D.L.R. (4th) 193, (sub nom. 373409 Alberta Ltd. v. Bank of Montreal) 296 N.R. 244, 29 B.L.R. (3d) 1, [2002] 4 S.C.R. 312, [2002] S.C.J. No. 82, REJB 2002-36137 (S.C.C.) — followed Statutes considered: Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 s. 2 “insolvent person” — considered Bankruptcy Code, 11 U.S.C. 1982 Chapter 11 — referred to Business Corporations Act, R.S.O. 1990, c. B.16 s. 149 — referred to ss. 153-156 — referred to Chartered Accountants Act, 1956, S.O. 1956, c. 7 Generally — referred to Chartered Accountants Act, 2010, S.O. 2010, c. 6, Sched. C Generally — referred to Companies’ Creditors Arrangement Act, R.S.C. 1985, c. C-36 Generally — referred to Merchant Shipping Act, 1894 (57 & 58 Vict.), c. 60 s. 502 — considered Negligence Act, R.S.O. 1990, c. N.1 s. 3 — considered Sarbanes-Oxley Act, 2002, Pub. L. 107-204 (U.S.) Generally — referred to Securities Act, R.S.O. 1990, c. S.5 Generally — referred to Securities Act of 1933, 15 U.S.C. 2A Generally — referred to Rules considered: Rules of Civil Procedure, R.R.O. 1990, Reg. 194 Generally — referred to 192 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Regulations considered: Securities Act, R.S.O. 1990, c. S.5 General, R.R.O. 1990, Reg. 1015 s. 2(1)-2(2) — referred to s. 34(3) — referred to Words and phrases considered: corporate identification doctrine [The defendant auditor] takes the position that even if I were to find negligence or breach of contract on the part of the Firm, [the plaintiff company’s] losses are not recoverable because such were caused by its own illegal acts. This proposition, otherwise described as the “corporate identification doctrine”, arises out of what Professor [Darcy L.] MacPherson observed is rather “unsettled law”, which he also argues is “in need of rationalization”...... Professor MacPherson, who has written on the doctrine, notes that the “identification doctrine was created as a device to ascribe or attribute a mental state to a corporate body for the purposes of civil or criminal liability. The original application of the identification doctrine was as a means to hold a corporation liable.” [footnotes omitted]

ACTION by company against auditor for negligence and breach of contract.

Peter F.C. Howard, Patrick O’Kelly, Jonathan Levy, Aaron Kreaden for Plaintiff John Lorn McDougall, Q.C., Brian Leonard, Matthew Fleming, Jeremy C. Mil- lard for Defendant

Gans J.: Part I: Liability 1. Prologue 1 In 1968, Mel Brooks wrote and directed the sometimes outrageous film, The Producers. In this film, which Brooks reprised in a 2001 Broadway musical of the same name, the protagonist, Max Bialystock, created a scheme through which he was able to convince a coterie of unsuspecting individuals to invest in his deliberately ill-fated Broadway ventures. He did so on the strength of his self-styled reputation as the “King of Broadway”. He enlisted the support of his star-struck accountant, the nebbish Leo Blum, whose function was to, among other things, doctor the books of account of the productions. Regrettably for Bialys- tock and Blum, the play which they first produced — and which they Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 193

hoped would sputter out on or shortly after opening night — became a resounding success. Their scheme failed miserably, resulting in their prosecution, conviction for fraud and ultimate incarceration. 2 In 1989, Garth Drabinsky and his long-time trusted colleague and soon-to-be co-conspirator and fellow inmate, Myron Gottlieb, left Cineplex Odeon Corporation after mounting an unsuccessful takeover bid. Their stated intention was to create a new vertically-integrated venture, the Live Entertainment Corporation of Canada (“LECC”), with the live entertainment assets of Cineplex that they obtained in their much- heralded, though unceremonious, leave-taking. I am not persuaded on the evidence adduced during the 68-day trial before me — the latest install- ment of this seemingly endless saga1 — that Messrs. Drabinsky and Got- tlieb set out to defraud the world, by which term I mean to include those who invested through equity or debt in their enterprises. In retrospect, however, it would seem that the consequences of their actions were almost preordained. Put otherwise, much like the intended actions of Messrs. Bialystock and Blum, Drabinsky and Gottlieb ended up separat- ing countless individuals and corporations, of varying degrees of sophistication, from significant sums, and later found themselves being charged, convicted of fraud and ultimately incarcerated.2

1The Livent debacle has formed the subject matter of multiple detailed judicial and quasi-judicial decisions and pronouncements, ranging from cross-border bankruptcy rulings (Livent, Inc. Noteholders Securities Litigation, Re, 151 F.Supp.2d 371 (U.S. Dist. Ct. S.D. N.Y. 2001) (“Marrero Decision”)), to hear- ings before the Securities and Exchange Commission (see e.g. In the Matter of Livent Inc., File No. 3-9806 (13 January 1999)), to prosecutions of certain of the partners of the defendant before the Institute of Chartered Accountants of On- tario (Discipline Committee decision and reasons dated February 11, 2007; Ap- peal Committee decision and reasons reported on Quicklaw at 2009 LNICAO 1) and appeals from those decisions to the Divisional Court (2010 ONSC 338, 260 O.A.C. 199 (Ont. Div. Ct.)) and Court of Appeal (2011 ONCA 409, 333 D.L.R. (4th) 401 (Ont. C.A.), leave to appeal to S.C.C. refused, [2011] S.C.C.A. No. 367 (S.C.C.)) (collectively referred to as the “ICAO Proceedings”), and, by no means least, the criminal trial of Messrs. Drabinsky and Gottlieb and their subsequent appeal (R. v. Drabinsky, 242 C.C.C. (3d) 449 (Ont. S.C.J.), aff’d 2011 ONCA 582, 107 O.R. (3d) 595 (Ont. C.A.), leave to appeal to S.C.C. refused, (2012), [2011] S.C.C.A. No. 491 (S.C.C.)). 2After all is said and done, I am not certain which of Gottlieb or Drabinsky would be cast as Bialystock or Blum. Unlike the criminal trial before Benotto J., 194 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

3 As a consequence of their actions Deloitte & Touche (“Deloitte”)3 and, in particular, certain of the Firm’s senior partners, became casualties of a monumental fraud that followed from the Drabinsky and Gottlieb “productions” and a fraud which still reverberates around the business and arts community of this country and south of the border today. 4 Deloitte was first engaged as auditor of MyGar Partnership (“MyGar”) for the year ended December 31, 1989. It continued in that capacity for each fiscal year, to December 31, 1992. It was thereafter engaged to, among other things, perform the annual audits for the successor entity, Live Entertainment of Canada Inc. (“Livent”4), a role in which it continued until Livent sought protection under the Companies’ Credi- tors Arrangement Act5 (“CCAA”) in November 1998. 5 At its simplest, this is an auditor’s negligence case in respect of the audits performed by Deloitte between 1992 and the second quarter of 1998, which Livent alleged were not carried out in accordance with generally accepted auditing standards (“GAAS”) and should not have resulted in “clean audit opinions”. Alas, this is anything but a simple case: it involves the application of sophisticated legal and accounting principles to complicated facts.

2. Synopsis 6 Gottlieb and Drabinsky created MyGar in September 1989. Shortly thereafter, MyGar purchased all the assets and assumed certain of the liabilities of the live entertainment division of Cineplex, including the production Phantom of the Opera (“Phantom”) and the Pantages Theatre in downtown Toronto (“Pantages”). The acquisition was initially financed by a $60 million two-year credit facility which Drabinsky and Gottlieb obtained from and guaranteed to the Royal Bank of Canada

on the evidence adduced before me, it would appear that both of these gentlemen were equally complicit, although the cach´e associated with Drabinsky was clearly the allure that attracted the investors. 3The terms “Deloitte” or “Firm” will be used throughout to refer to the Cana- dian partnership. If reference is made to the U.S. partnership, which was involved in certain accounting and auditing issues, it will be designated as “Deloitte U.S.”. 4The term “Livent” will be used interchangeably with the term “Company”. 5R.S.C. 1985, c. C-36. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 195

(“RBC”). In addition, Gottlieb and Drabinsky were “credited” with capital contributions totaling some $7.8 million (presumably financed through their severance package from Cineplex). The entire operation was carried on through LECC, as the nominee corporation for MyGar. All the assets utilized in the Drabinsky-Gottlieb ventures were, as will be described later, “owned” by that corporation, the beneficial ownership of which remained, at least notionally, with Gottlieb and Drabinsky. 7 MyGar seemingly flourished over the next several years, acquiring along the way “domestic and international theatrical stage rights and ancillary rights (including foreign licensing rights, merchandising rights, sponsorship rights and cast album rights)”.6 It realized box office and critical successes from its productions of Phantom, Joseph and the Amazing Technicolor Dreamcoat (“Joseph”) and Kiss of the Spider Wo- man — The Musical (“Kiss”) and was poised to launch its major new production Show Boat, under the direction of Harold Prince, in the fall of 1993. It owned and operated one live performance theatre, the Pantages, and would acquire interests in theatres in New York, Chicago and Van- couver. All of these activities were undertaken to ensure that it would be a large, if not the largest, vertically-integrated live theatrical entertainment company.7 8 In May 1993, Livent was formed as the vehicle through which Drabinsky and Gottlieb were going to make their initial public offering (“IPO”) in Canada. From a corporate perspective, Drabinsky and Got- tlieb transferred all their interests in MyGar (including LECC) and all of the shares of a related company called MyGar Realty Inc. (“MyGar Re- alty”) to Livent in exchange for its common shares. Thereafter, Livent owned all the assets and assumed all the liabilities previously owned or owed by MyGar or MyGar Realty. The principal asset of the latter company was land adjacent to the Pantages Theatre in Toronto which was intended to be used for a proposed development referred to as “Pantages Place”.8

6Livent Prospectus, 7 May 1993, JBD 1215, at p. 3. 7This case is replete with hubris, as seen, in instances where neither Gottlieb nor Drabinsky thought that their fraudulent activities, described in more detail below, would ever see the light of day. During the course of the trial, I heard examples of the frauds that left me shaking my head, both at the brilliance of the schemes and the unbridled gall of the participants. 8Letter from Davies to OSC, 3 March 1993, JBD 1561, at p. 2. 196 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

9 Livent filed the following the financial information with its IPO Pro- spectus,: (1) audited consolidated financial statements of MyGar for the three-year period ending December 31, 1992; (2) an audited balance sheet of MyGar Realty as at December 31, 1992; and (3) a consolidated forecast for Livent for the year ended December 31, 1993. 10 In May 1995, Livent filed a Registration Statement with the United States Securities and Exchange Commission (“SEC”) as a precondition to listing its common shares on the NASDAQ exchange, the effective date for which was August 3, 1995. From time to time thereafter, until June 1998, Livent returned to the capital markets in Canada and the United States seeking financing through the issuance of notes, debentures and additional stock through both private and public offerings. These several offerings and underwritings are set out below in the table excerpted from the report of one of the damage experts, Ian Ratner, and attached as Appendix A to these Reasons.9 Over the five years from May 1993 to June 1998, inclusive, Livent went to the capital markets at least seven times. It raised Cdn. $77.5 million by share and warrant offerings, US $125 million through the issuance of senior unsecured debentures, and a further US $77 million by share offerings, $34 million of which was obtained through two separate private placements in the spring of 1998.10 11 As part of one of the last two mentioned private placements, Drabin- sky and Gottlieb agreed to permit the new investors, Michael Ovitz (Lynx Ventures L.P.) and Roy Furman (Furman Selz Incorporated) to

9Expert Report of Ian Ratner, 26 February 2010, Exhibit 19, at p. 6 (the “Ratner Report”). The numbers set out in Appendix A, which I initially accepted at face value, were called into question when I reviewed the Livent Inc. 1996 Annual Report, JBD 9461. On close examination of p. 39 of that Report, under the heading “Liquidity and Capital Resources”, it appeared to me that Mr. Ratner may have missed or misstated the fact that Livent floated two separate debenture issues in 1996, the first in July for U.S. $8.5 million and the second in December for Cdn. $72.5 million This error, while quite significant, did not alter my assessment of the threshold issues attendant to the instant action. 10As will be discussed later in these reasons, it is interesting to observe that at the time that Livent entered into the last mentioned private placements in the spring of 1998, it had already “suffered” a net loss reported in its December 31, 1997 statement of $44.1 million, and as well took an additional $27.5 million write-off of preproduction costs in Q1, 1998 and a further write off of $12.2 million, consisting primarily of costs associated with a refinancing in Q4, 1997. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 197

appoint part of a new management team, as a consequence of which they gave up some of the control of the day to day management of the operation. New management, in the person of Robert Webster, a former KPMG partner, was appointed as the Executive Vice President of Livent, reporting to the newly expanded Board of Directors, at the head of which was Furman, who performed double duty as the new Chairman and CEO. 12 Shortly after his appointment, in early August 1998, Webster learned of “serious accounting irregularities” in the company’s financial records.11 The new board immediately issued press releases, disclosing, in summary, that the suggested irregularities involved significant improper recognition of revenue and a failure to record or the improper deferral and capitalization of expenses, all of which might have a significant impact on the previously issued financial statements of Livent. Drabinsky and Gottlieb were immediately suspended; KPMG was appointed to conduct an investigation; an announcement was made that there would likely be a restatement of the previously issued financial statements; and share trading on the TSX and NASDAQ was suspended. The new board continued to issue press releases throughout the month of August, updating the capital markets as the results of the investigation became apparent. 13 The response to the news was swift. Multiple class actions were filed in the U.S. against, inter alia, Gottlieb and Drabinsky, Deloitte & Touche (Canada and the United States), past and present directors and officers, and Livent as a “nominal” defendant. Indeed, there were at least 12 such actions filed in the month of August 1998 alone. These actions, which were undertaken on behalf of the Livent noteholders and the Livent shareholders were ultimately consolidated into four actions, two on behalf of the noteholders and two on behalf of the shareholders (collectively referred to as the “US Actions”).12 14 PricewaterhouseCoopers (“PwC”) was retained as an independent accounting advisor for the Audit Committee on the re-audit, after Deloitte

11Livent Press Release, 10 August 1998, JBD 16012; articles from The New York Times, The Wall Street Journal and The Financial Post, JBDs 14733- 14737. 12The details of the various actions are fully explained in the decision of His Honor Judge Victor Marrero, United States District Judge, by way of judgment dated June 29, 2001, rendered after a summary judgment motion: Marrero Deci- sion, supra note 1. 198 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

withdrew its clean audit opinions in respect of Livent’s financial statements for the 1996 and 1997 fiscal years. On November 18, 1998, Livent issued restated financial statements, audited again by Deloitte, for the years ended December 31, 1996 and 1997, as well as making several adjustments to the financial results in prior years.13 15 A snapshot of the reconciled net income (loss) as previously reported and subsequently restated for the years 1996 and 1997, is set out as follows:14 Year ended December 31 (CDN $ Millions) 1997 1996 Net income (loss) as previously reported (44,131) $11,054 Reduction of performance and merchandising revenue improperly recorded (2,398) (1,526) Reduction of other revenues improperly recorded (23,262) (19,355) Improper recording of operating costs (68) (4,303) Improper recording of general and ad- ministrative expenses (421) (440) Operating costs improperly capitalized to preproduction costs (6,076) (3,129) Operating costs improperly capitalized to fixed assets (4,648) _____ Change in amortization of preproduction costs resulting from the proper recording of preproduction costs 1,056 (11,084) Change in depreciation resulting from the proper recording of fixed assets 105 (200) Consequential adjustment of income taxes (18,829) 10,067 Net loss as restated $(98,672) $(18,036)

13Formal Admissions, Exhibit 1, at para. 92; Deloitte & Touche, Report to the Audit Committee: Results of the Audit of the Restated 1997 and 1996 Financial Statements, 18 November 1998, JBD 7828. 14Formal Admissions, supra note 13, at para. 204. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 199

As is evident from a review of the above table, the income swing was significant, if not staggering. 16 With the release of the restated consolidated financial statements in mid-November 1998, Drabinsky and Gottlieb were dismissed for cause and sued for fraud and breach of fiduciary duty, and Livent voluntarily made a petition for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code. On the next day, Livent filed for protection under the CCAA in Canada and Ernst & Young was appointed its moni- tor.15 Trading in the stock was resumed and, as might have been expected, its value fell from US $6.75 per share to US $0.28 per share.16 17 In September 1999, Livent was placed in receivership, and Ernst & Young was appointed receiver and manager of all property, assets, and the undertaking of Livent. In November 2001, Roman Doroniuk was appointed the Special Receiver and Manager of Livent17 in respect of, inter alia, a potential action against Deloitte. In due course he commenced the instant action in the name of Livent Inc. by Notice of Action dated Feb- ruary 28, 2002.18

3. The Claim — Dramatic Theme 18 The claim against Deloitte, as originally formulated in the 118-page Amended Statement of Claim (“Claim”) can best be understood from a summary of certain of the paragraphs buried deep in the body of the Claim.

15Formal Admissions, supra note 13, at para. 205. The Ratner Report indicates that the trading price was C$10.15 at August 7, 1998: supra note 9, at p. 8, n. 37. 16Marrero Decision, supra note 1, at p. 392. 17Facts Admitted by the Plaintiff in Response to Requests to Admit, 17 April 2013, Exhibit 7, at para. 1. 18In Hercules Management Ltd. v. Ernst & Young, [1997] 2 S.C.R. 165 (S.C.C.), the Supreme Court of Canada held that a company’s auditor does not owe a duty of care to the shareholders of its corporate client. The purpose of audit reports is to allow shareholders, as a class, to supervise management — not to assist them in making individual investment decisions. Therefore, shareholders do not have individual causes of action against an auditor. If the corporation suffers losses attributable to its auditor’s negligence, then the corporation itself has the cause of action, which may if necessary be pursued by way of a derivative action. 200 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

19 Paragraph 207 deals with the duty of care. It starts by claiming that “Deloitte and Deloitte U.S. owed a duty of care, in contract and in tort as well as a fiduciary duty, to Livent on behalf of its creditors, shareholders and other stakeholders”. By the end of trial, this claim had been narrowed considerably. Deloitte U.S. was dropped as a defendant, as was the claim that Deloitte owed Livent a fiduciary duty. Furthermore, the plaintiff eventually made it plain that it was not, in fact, asserting any duty to or on behalf of “stakeholders” in the enterprise that went beyond that described by the Supreme Court in Hercules Management Ltd. v. Ernst & Young,19 the parameters of which will be described in more detail below. 20 Paragraph 207 goes on to claim that Deloitte owed a duty to ensure that Livent’s financial statements were reported in accordance with its own accounting policies and generally accepted accounting principles (“GAAP”). This duty was to be satisfied by performing audits of Livent’s books in accordance with GAAS and Deloitte’s own manuals. It was suggested that Deloitte represented that it would meet an exceptionally high standard of care — above the normal standards of the profession — and that it should be held to that exceptionally high standard. In the end, the latter point proved to be insignificant since I found that the Deloitte manuals upon which the argument was based did not provide guidance that was materially different than GAAS. 21 In para. 208, the plaintiff pleaded that Livent’s “Original Statements” were all materially and fraudulently misstated at the time they were issued. These included the annual financial statements for 1993-97, the quarterly financial statements in 1996-98, the MyGar financial statements included in Livent’s IPO Prospectus, and a September 2, 1997 press release announcing an adjustment to Q2 financial statements. 22 Paragraph 209 particularized the fraudulent activities that Deloitte ought to have detected. Generally, they can be grouped into four categories. First, the payment of false or inflated invoices to complicit third parties who would then provide kickbacks to Gottlieb and Drabinsky. Second, “expense rolls”, which involved moving expenses to different quarters or to different productions. Third, the improper transfer of preproduction costs between shows. Fourth, transactions that were dis- guised to look like sales of assets, but which were in substance loan ar-

19Ibid. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 201

rangements. The final three categories of fraudulent activities were undertaken for the purpose of inflating Livent’s reported net income. 23 In para. 210, Deloitte was alleged to have fallen below the standard of care by failing to follow GAAS and thereby detect and expose the fraud. Its alleged negligent issuance of unqualified opinions, in turn, deprived the honest directors and shareholders of the opportunity to put a stop to the fraud, and the losses eventually caused to the company by the fraud, at an earlier date. 24 More particularly, in para. 212, the plaintiff went on to allege that Deloitte ought to have known that the Original Statements were materially false and misleading and that Deloitte should not have endorsed them by (a) issuing unqualified audit opinions; (b) failing to withdraw on a timely basis previously issued unqualified audit opinions; (c) acquiescing to the misstatements contained in Livent’s press releases when Deloitte knew or ought to have known that they contained material omissions and misrepresentations; (d) failing to resign as auditors on a timely basis and disclosing the reasons therefor; (e) failing to further investigate potential material omissions and misstatements; and (f) failing to separately disclose to the appropriate level of authority material omissions and potential misstatements of which they became aware.20 25 Livent further alleged that because Deloitte did not discover the fraudulent misstatements particularized in para. 212 of the Statement of Claim, the Firm effectively facilitated the continuance of the fraud. Drabinsky and Gottlieb were permitted to continue reporting inflated revenues, net income, total assets, and shareholder’s equity, which in

20If I understand Volume 2 of the plaintiff’s written argument, which in the aggregate exceeded 500 pages, Livent seems to have moved away from any suggestion of a claim for actionable negligence in respect of any of the MyGar statements before year end 1992. 202 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

turn permitted them to continue to access the capital markets.21 From a damages perspective, so the plaintiff’s theory goes, the lack of timely disclosure meant that the net realizable value of its remaining assets upon liquidation was less than it would have been had the fraud been discovered and disclosed earlier.

4. The Fraud a. Globally 26 Livent alleges that the Original Statements were all false and misleading and did not fairly represent the financial condition of the Company. As a consequence, none of the Original Statements was prepared in accordance with GAAP. I am not satisfied on the evidence, however, that the Original Statements contained any errors, material or otherwise, caused by an unintentional act or omission.22 27 On the contrary, it was Livent’s position throughout the trial that the Original Statements were replete with fraudulent statements and other “irregularities”23 created by management and others in concert with

21There was never any suggestion, implicit or otherwise, that Deloitte was complicit or assisted in perpetrating the fraud in any respect. While Maria Messina, a manager and then partner at Deloitte until the spring of 1996, acknowledged before me — and before Benotto J. — that she was aware of and participated in certain fraudulent conduct while employed with Livent, Livent’s counsel acknowledged in open court at the commencement of the trial that there was not a scintilla of evidence to support any suggestion of fraud by any partner or employee of Deloitte engaged in the audits for any of the years in question. 22Livent’s Claim, at para. 96, asserted that Deloitte “ought to have detected and disclosed the errors and irregularities contained in Livent’s books, records and financial reporting” (emphasis added). Having regard to Livent’s written argument and the evidence and the manner of its presentation, I did not understand the plaintiff to be arguing that the misstatements in the Original Statements were the result of management’s negligence or inadvertence, at least in any material way. 23“Irregularities” is an accounting term of art used to refer to all intentional misstatements, including fraud. “Errors”, on the other hand, refers to unintentional misstatements. See the CICA Handbook, June 1997, s. 5135.02, JBD 15993. The term “irregularities” appears no less than six times in the Deloitte & Touche, Report to the Audit Committee, supra note 13. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 203

management. The means used to perpetrate the fraud included, among other things: (i) the use of deception, such as manipulation, falsification or alteration of accounting records or documentation; (ii) misrepresentation or intentional omission of events, transactions or other significant information; and (iii) intentional misapplication of accounting principles relating to amount, classification, manner of presentation or disclosure.24

b. The Cast of Characters 28 The parties readily acknowledge that Livent was rife with fraud, which burrowed deep into the operation, involved senior management and extended well into most, if not all, levels of the accounting staff of the Company. During the trial, I heard that in addition to Drabinsky and Gottlieb, the knowing and willing participants in various aspects of the frauds included Robert Topol (Chief Operating Officer), Maria Messina (former Deloitte partner and Chief Financial Officer), Gord Eckstein (Se- nior Vice President of Finance), Jerald Banks (Livent’s General Coun- sel), Dan Brambilla (Director and Executive Vice President), and Bill Connor (Senior Vice President North American Touring).25 29 I also heard that at least four members of the accounting staff, including a former Manager at Deloitte, Chris Craib, also participated in the frauds and aided in the alteration of Livent’s books and records. They were assisted by Livent’s Manager of Information Services, Raymond Cheong, who modified Livent’s accounting software to, among other things, (i) allow entries to the general ledger to be reversed or unposted and then posted to a different account or to a different accounting period;

24CICA Handbook, s. 5135.02, supra note 23. See also R. v. Drabinsky, supra note 1, at para. 353, where Benotto J. found that the accounting system was “fraudulent”, in the sense that the financial statements were manipulated to ensure that reported income was kept as close as possible to that which was budgeted. I am of the view that the object of the fraud was not simply limited to the element described in Gottlieb and Drabinsky’s criminal trial. As will be discussed later in these reasons, I am persuaded that the manipulations had the broader purpose of ensuring that Livent could access the capital markets. 25Facts Admitted by the Plaintiff, supra note 17, at paras. 4-6. 204 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

and (ii) permit staff to change the date on selected invoices.26 It is undis- puted that the purpose of these modifications was to conceal Livent’s accounting manipulations and to ensure that no trail existed which could be uncovered by Deloitte during the course of the audit. 30 Furthermore, Deloitte asserts in its argument, that of the four directors of Livent who sat on its audit committee between 1995 and 1997, three (Gottlieb, Martin Goldfarb and Andrew Sarlos) participated, in some manner, in misleading the Firm.27 The only member of the audit committee who did not know anything about the frauds during the relevant time period was H. Garfield Emerson who was appointed to the audit committee in 1995 and became its Chair in 1997.28 31 In addition to those on the inside, several representatives of third party suppliers, consultants, or business associates and partners of Livent knowingly assisted in the frauds. These included Peter Kofman, Presi- dent of Kofman Engineering; Roy Wayment, President of Execway Con- struction; John Wilner of LeDonne, Wilner & Weiner, Inc. (“LeDonne, Wilner”); and Len Gill and Robin Pullen of Echo Advertising (“Echo”). Deloitte argued that others who were engaged in certain revenue transactions (“Revenue Transactions”) were similarly involved in fraudulent activities or irregularities in concert with the management and other staff of Livent. More of that will be discussed when I review certain of the Reve- nue Transactions, on an individual basis, later in these reasons.

c. The Details 32 It is common ground between the parties that the cast of characters described above made a concerted effort to conceal the accounting frauds and irregularities from Deloitte. There were essentially four categories into which the accounting irregularities fell: (a) kickbacks; (b) expense rolls; (c) amortization issues; and (d) Revenue Transactions.

26Ibid., at paras. 22-25; Closing Argument of Deloitte & Touche LLP, vol. 1, at paras. 48-55. 27Closing Argument of Deloitte & Touche LLP, vol. 1, para. 52. 28Facts Admitted by the Plaintiff, supra note 17, at paras. 35-37. Deloitte & Touche, Report to the Audit Committee, supra note 13, at p. 58. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 205

i. Kickbacks 33 Between the years 1991 - 1993, at the behest of Drabinsky and Got- tlieb, Kofman Engineering and Execway Construction rendered false or inflated invoices to MyGar. When the invoices were discharged, the money received by Kofman and Wayment made its way back to Drabin- sky and Gottlieb personally or to King Commodity Services Ltd., a company controlled by the two of them. Gottlieb and Drabinsky received approximately $7.5 million, directly or indirectly, during this period of time. I was told that the kickbacks were undertaken to permit Gottlieb and Drabinsky to receive money from MyGar in excess of the limits placed upon their “draws” under the RBC loan agreement.29 Evidently, each felt constrained to live on a monthly stipend of $75,000. 34 Eckstein was aware of the kickbacks, but neither he nor Drabinsky and Gottlieb ever disclosed them to Deloitte. A significant percentage of the inflated amounts associated with theatre engineering investigation work for intended productions and the Pantages construction development were capitalized as assets on the books of LECC, and later in MyGar Realty, creating a significant distortion to the balance sheet of each from the early days of the operation and well before the date of the IPO.30

ii. Expense Rolls 35 As previously indicated, Cheong, the manager of Information Ser- vices, modified the software used by Livent to permit the reworking of entries in the accounting system. He was directed to do so by Eckstein with the concurrence of Gottlieb and Drabinsky. These changes permitted Eckstein and those who worked for him to manipulate expenses either by backing them out of a particular accounting period, from quarter to quarter or into another year end, or moving them into and charging them against other activities or productions. The changes to the software went undetected not only by Deloitte, but also by RBC and Coopers & Lybrand, the latter of which conducted a review of the books of LECC on behalf of RBC while the debt obligation of MyGar remained outstanding.

29Facts Admitted by the Plaintiff, supra note 17, at paras. 18-21. 30Amended Statement of Claim, at paras. 107-109, 232-33. 206 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

36 The juggling of expenses was particularly rampant in relation to the recording of advertising charges incurred with LeDonne, Wilner (in New York and elsewhere) and Echo (in Toronto and other locales in Canada). I was told that at least 10 officers and employees of Livent were impli- cated in this aspect of the fraud.31

iii. Amortization Issues 37 The largest fraudulent activity in terms of dollar value undertaken by the Company concerned the manipulation of millions of dollars-worth of costs and expenses that fell under the general heading of preproduction costs (“PPC”). PPC included all costs incurred to mount a production prior to its opening, such as those costs associated with set design and construction, costume design and fabrication, pre-opening advertising and promotion, and salaries and fees paid to the cast, crew and musicians during rehearsals. 38 Initially, Livent employed the “cost recovery method” in accounting for its investment in its stable of productions. This accounting policy was utilized by another large player in the live theater production business, namely, the Real Useful Group (“RUG”), an Anthony Lloyd Webber company, from which Livent received various production rights, including those in respect of its first signature production, Phantom. This amortization method permitted Livent to accelerate the amortization of its PPC and defer income recognition until all preproduction costs had been recouped. 39 As Deloitte observed when a review of this policy was undertaken in early 1996, the cost recovery method had advantages of simplicity and conservatism since it avoided having to forecast “the length of, and the revenues from, a live theater production run”.32 40 While I was urged to speculate that the reason Drabinsky and Gottlieb adopted this policy in the early years of MyGar’s existence was to tax- shelter income generated from operations, or from their respective payouts from Cineplex, I am satisfied on the evidence that the choice of this accounting policy was, initially, reasonable in the circumstances. Livent ultimately changed its policy in 1996, retroactive to fiscal year

31Facts Admitted by the Plaintiff, supra note 17, at paras. 4-6, 22-31. 32Letter from Messina (at Deloitte) to Gottlieb, 4 January 1996, JBD 3299, at p. 1. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 207

1995, to the “income forecasting method”, about which I will have more to say later. 41 Regardless of the policy used, Livent was able to engage in the improper transfer of preproduction costs from specific shows to fixed assets or from show to show, and, in particular, from one show to another that had not as yet opened, all of which permitted the Company to amortize the PPC over an extended period of time, or avoid amortization in any particular period. The net effect of these activities was to overstate income for the period, which became the watchword of the operation from about 1994 on to early 1998. 42 The plaintiff’s theory is that Deloitte should have undertaken a more rigorous analysis of PPC right from the beginning of the LECC undertaking and ultimately when and after Livent became a public issuer. Put otherwise, it is the plaintiff’s position that Deloitte failed to analyze the amounts of amortization taken in any particular year in accordance with its own audit plans and neglected to ensure that the PPC taken or deferred as a capitalized asset bore any resemblance to what was projected. This failure on the part of Deloitte, the plaintiff argues, resulted in an overstatement of income in all the years of MyGar and Livent’s operations, with the possible exception of 1997, and underscores the fact that Deloitte failed to conduct its audits in accordance with GAAS. To borrow the oft-repeated phrase found in the plaintiff’s written argument, had Deloitte done its job, it would have been able to “unravel the tapestry of lies that had been woven by Drabinsky and Gottlieb”,33 which proposition the plaintiff suggests applied particularly to Deloitte’s review of PPC.

iv. Revenue Transactions 43 The end of 1995 was something of a watershed for Livent. The company had no less than six shows in varying stages of presentation. Show Boat had just opened, Phantom was in the waning stages of its glory days, Kiss was garnering critical acclaim but was not a resounding success at the box office, and Music of the Night was also not meeting expectations. Sunset Boulevard was an artistic and commercial disaster, which would mandate a wholesale write-down of millions in PPC. In addition, Livent had five other productions under development, including

33Initial Closing Submissions of the Plaintiff, vol. 2, at paras. 383, 438, 475, 593, 954, 1280. 208 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Ragtime. Furthermore, in the vain attempt to be a completely vertically integrated company, Livent was spending significant amounts acquiring and renovating the Lyric and Apollo Theaters in New York and the Ori- ental Theatre in Chicago. While revenue appeared to have gone up by some 25% from year end 1994 to year end 1995, the net income before taxes, as then reported, did not grow proportionately. The Livent ship was experiencing some rough waters. 44 In an effort to buttress the bottom line, Livent, primarily on Gottlieb’s initiative, entered into a series of transactions, each of which involved the sale of Livent assets to third parties. From 30,000 feet, the Revenue Transactions included the sale of exclusive rights to arrange and schedule tours of Livent shows, the sale of interests in production rights of various Livent shows, the sale of sponsorship rights or naming rights associated with Livent theaters or productions, and the sale of certain lands and density rights associated with the redevelopment and expansion of the Pantages.34 In total, Livent purported to conclude, four Revenue Trans- actions in fiscal 1996 and five in fiscal 1997, permitting it to record around $40 million in income in those two years. 45 While it is fair to say that Deloitte devoted a significant amount of “partner time” to analyzing the Revenue Transactions, it is also fair to say that Deloitte was misled about the true nature of the transactions. In essence, the transactions were not true sales of assets, but loan or financing agreements. Livent colluded with the purported purchasers to misrep- resent the true nature of the transactions by concealing certain side agreements (“Side Agreements”), some oral and some written, from Deloitte. These Side Agreements described a completely different deal than that disclosed to Deloitte. In many instances, the Side Agreement permitted the “purchaser” to recover the payments made or to be made and to recover the purported investment, even if the shows proved unsuccessful. Again, at its simplest, when Deloitte was able to discover the true essence of the transactions during the re-audit, they were none of them out- right sales of assets, but simply loan or financing agreements. 46 The plaintiff argued that Deloitte breached its duty to Livent by allowing the transactions as presented to be included in the Original State- ments and in failing to critically examine these transactions, which,

34Closing Argument of Deloitte & Touche LLP, vol. 1, at para. 70; Facts Ad- mitted by the Plaintiff, supra note 17, at paras. 32, 38. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 209

“upon proper scrutiny, ought to have led to the revelation of the fraudulent schemes of Drabinsky and Gottlieb”.35

5. Framework of Legal Issues 47 As I alluded to before, there is a myriad of legal issues essential to the resolution of this case. Again, the action, at its simplest, is one of negligence and/or breach of contract, by which latter term I mean the negligent performance of Deloitte’s contract for service.36 For purposes of this preliminary analysis, and because the case was argued by both sides primarily as an action in negligence, I am going to set out the principles applicable to the tort action first and then deal with any additional considerations introduced by the contract. Counsel for Livent acknowledged during argument that the damages on either front would be identical. That concession notwithstanding, I have come to the same conclusion, which will be developed (much) later in these Reasons. 48 To succeed, the plaintiff has to establish that Livent was owed a duty of care, that there was a breach of the appropriate standard of care, that compensable damages resulted from this deviation from the appropriate standard of care, and that the damages complained of were factually and legally caused by the negligence or breach of contract of the defendant.37 At this stage of the decision, I will restrict my comments to the first two of these elements, namely whether Deloitte owed the plaintiff a duty of care and whether there was a breach of that duty.

6. Duty of Care 49 The duty question can be answered in the affirmative without too much difficulty. The starting point is to be found in the statutory framework within which Livent functioned. Livent, as an OBCA company, was obliged to have an auditor, appointed by the shareholders annually, to prepare a report on the financial statements of management. The function of the auditor is to determine whether the financial statements “present fairly, in all material respects, the financial position of the com-

35Amended Statement of Claim, at para. 250. 36See Central & Eastern Trust Co. v. Rafuse, [1986] 2 S.C.R. 147 (S.C.C.), at pp. 204-206 (establishing that a plaintiff can sue concurrently in both tort and contract where the facts support both causes of action). 37Ediger (Guardian ad litem of) v. Johnston, 2013 SCC 18, 356 D.L.R. (4th) 575 (S.C.C.), at para. 24. 210 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

pany... in accordance with generally accepted accounting principles in Canada”.38 In addition, as a “reporting issuer” under the Securities Act, Livent was obliged to file its financial statements accompanied by a report of its auditor that the statements were prepared in accordance with GAAS.39 Finally, because Livent was listed in the U.S. on NASDAQ, it was similarly obliged to have audited financial statements.40 50 While many jurists have struggled with the test for determining whether a person owes a duty of care to another in a negligence case, which is a two-part test repeatedly articulated in the case law,41 in the wake of the Supreme Court of Canada (“SCC”) decision in Hercules there can be little doubt that auditors owe a duty of care to the company for the benefit of the corporate collective, the shareholders. In coming to this conclusion, the SCC adopted the following passage from the decision of Lord Oliver in Caparo Industries plc v. Dickman: It is the auditors’ function to ensure, so far as possible, that the financial information as to the company’s affairs prepared by the directors accurately reflects the company’s position in order, first, to protect the company itself from the consequences of undetected errors or, possibly, wrongdoing... and, secondly, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company’s affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided.42 The above conclusion was heralded in an earlier decision of Farley J. in Roman Corp. v. Peat Marwick Thorne: It would appear that as a matter of law the only purpose for which shareholders receive an auditor’s report is to provide the shareholders with information for the purpose of overseeing the management and

38Livent Inc. Annual Report 1995, JBD 10157, at p. 28. See also Business Cor- porations Act, R.S.O. 1990, c. B.16, ss. 149, 153-56; General, R.R.O. 1990, Reg. 62, ss. 40-41. 39Securities Act, R.S.O. 1990, c. S.5, s. 78. See also General, R.R.O. 1990, Reg. 1015, ss. 2(1)-(2), 34(3). 40Initial Closing Submissions of the Plaintiff, vol. 1, at p. 37, n. 5. 41Hill v. Hamilton-Wentworth (Regional Municipality) Police Services Board, 2007 SCC 41, [2007] 3 S.C.R. 129 (S.C.C.), at para. 20. 42[1990] 2 A.C. 605 (U.K. H.L.), at p. 630; Hercules, supra note 18, at para. 48. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 211

affairs of the corporation and not for the purpose of guiding personal investment decisions or personal speculation with a view to profit.43 51 While I am satisfied that Deloitte owed a duty of care to Livent for the ultimate benefit of its shareholders, it remains to determine the nature and extent of that duty. Both in oral and in written argument, Mr. How- ard on behalf of Livent attempted to reduce the duty to what he suggested was its lowest common denominator, namely, a duty not to provide a clean opinion on materially misstated financial statements.44 In support of this proposition, he relied on, inter alia, the decision of Mr. Justice LeBlanc of the Nova Scotia Supreme Court in Sydney Cooperative Society Ltd. v. Coopers & Lybrand and the cases therein referred to.45 While he impressed upon me the necessity of distinguishing between the “duty”, on the one hand, and the “standard of care” on the other, I am not sure that throughout the course of his argument, he did not conflate the two concepts. But I am persuaded, however, that the Howard definition of duty defines the concept too narrowly. 52 In considering the appropriate legal duty of care, I found the excerpts from the text, The External Audit by R.J. Anderson FCA, to be most instructive since the author attempts to compare the professional concept of due care, which is defined by the Rules of Professional Conduct and by GAAS, with the legal standard of care found in the cases. Mr. Ander- son acknowledged that the two concepts are not necessarily inconsistent and bear a close relationship one with the other. He draws comfort from the American Institute of Certified Public Accountants (“AICPA”) State- ment on Auditing Standards, No.1, which provides as follows: Every man who offers his service to another and is employed assumes the duty to exercise in the employment such skill as he pos- sesses with reasonable care and diligence. In all these employments where peculiar skill is prerequisite, if one offers his service, he is understood as holding himself out to the public as possessing the degree of skill commonly possessed by others in the same employment... But no man, whether skilled or unskilled, undertakes that the task he assumes shall be performed successfully, and without fault or error. He undertakes for good faith and integrity, but not for infalli- bility, and he is liable to his employer for negligence, bad faith, or

43(1992), 11 O.R. (3d) 248 (Ont. Gen. Div. [Commercial List]), at p. 260. 44Initial Closing Submissions of the Plaintiff, vol. 1, at paras. 112-15. 45(2002), 2003 NSSC 35, 213 N.S.R. (2d) 115 (N.S. S.C.), at para. 159. 212 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

dishonesty, but not for losses consequent upon pure errors of judgment.46

7. Standard of Care: What Was It? a. The Cases 53 When R.J. Anderson discusses whether or not a breach of legal duty had taken place, he noted, quite rightly, that this analysis first required defining the applicable standard of care. He observed that this challenge was to be gauged against the backdrop of the following propositions: Professionals are required not only to exercise care in what they do, but also to possess a minimum standard of specialized knowledge and ability. In defining this standard, the law looks neither to the highest nor the lowest standards which exist in the profession, but rather to the skill and learning commonly possessed by members of the profession.47 54 I agree with the Defendant that the standard of care owed by an accountant varies in degree, depending on the nature of the service provided. However, I do not accept the statement that the “general standard for all tasks is that of a ‘reasonably competent and cautious’ accountant”.48 Respectfully, that quotation, which is attributed to Matheson J.’s decision in Tannereye Ltd. v. Hansen, was taken out of context. The actual quotation is as follows: The standard of care owed by an accountant to his client may vary in degree, depending upon the services provided. However, the minimum standard required for all tasks appears to be that of a “reasonably competent and cautious” accountant generally.49 Circumstances may dictate that more than the minimum standard is required. 55 Furthermore, I am not persuaded that the standard of care applicable to auditors in 1990s Canada is limited to that described in the two nine-

46R.J. Anderson, The External Audit, 2nd ed. (Toronto: Copp Clark Pitman, 1984), at p. 109 (emphasis added). 47Ibid., at p. 110. 48Closing Argument of Deloitte & Touche LLP, vol. 1, at para. 260. 492001 PESCTD 51, 201 Nfld. & P.E.I.R. 31 (P.E.I. T.D.), at para. 10 (emphasis added). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 213

teenth-century English cases relied on by Deloitte, namely London & General Bank (No. 2), Re50 and Kingston Cotton Mill Co. (No. 2), Re.51 56 Counsel for Deloitte have excerpted and underscored a passage from the speech of Lord Lindley, in the former case, and from the speech of Lord Lopes in the latter case, which they suggest provide the lens through which auditors’ negligence cases should be viewed, particularly where an auditor relied on fraudulent representations of management, as in the situation at hand: Lord Lindley: An auditor, however, is not bound to do more than exercise reasonable care and skill in making inquiries and investigations. He is not an insurer; he does not guarantee that the books do correctly shew the true position of the company’s affairs; he does not even guarantee that his balance-sheet is accurate according to the books of the company. If he did, he would be responsible for error on his part, even if he were himself deceived without any want of reasonable care on his part, say, by the fraudulent concealment of a book from him. His obligation is not so onerous as this.... What is reasonable care in any particular case must depend upon the circumstances of that case. Where there is nothing to excite suspicion very little inquiry will be reasonably sufficient, and in practice I believe business men select a few cases at haphazard, see that they are right, and assume that others like them are correct also. Where suspicion is aroused more care is obviously necessary; but, still, an auditor is not bound to exercise more than reasonable care and skill, even in a case of suspicion, and he is perfectly justified in acting on the opinion of an expert where special knowledge is required.52 Lord Lopes: It is the duty of an auditor to bring to bear on the work he has to perform that skill, care, and caution which a reasonably competent, careful, and cautious auditor would use. What is reasonable skill, care, and caution must depend on the particular circumstances of each case. An auditor is not bound to be a detective, or, as was said, to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watch-dog, but not a blood- hound. He is justified in believing tried servants of the company in

50[1895] 2 Ch. 673 (Eng. C.A.). 51[1896] 2 Ch. 279 (Eng. C.A.). 52London & General Bank (No. 2), supra note 50, at p. 683. 214 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

whom confidence is placed by the company. He is entitled to assume that they are honest, and to rely upon their representations, provided he takes reasonable care. If there is anything calculated to excite suspicion he should probe it to the bottom; but in the absence of anything of that kind he is only bound to be reasonably cautious and careful.53 57 While those cases may have been the progenitor for the analysis that is brought to bear in auditors’ negligence cases, in my view, the law has changed significantly since that bygone era. The cases that counsel for Deloitte cited thereafter, but for McEachern C.J.S.C.’s decision in Revelstoke Credit Union v. Miller,54 do not capture the obligations of auditors that existed at the close of the last century around the time of the Livent audits. 58 That said, I hasten to observe that when the subject Livent audits were undertaken, the standard of care had not moved anywhere near the standard expressed in either Public Company Accounting Reform and In- vestor Protection Act (in the United States Senate) or Corporate and Au- diting Accountability and Responsibility Act (in the House of Representa- tives), more commonly referred to as the Sarbanes-Oxley legislation, passed in the wake of the corporate and accounting scandals of the late 1990s, including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. 59 What then is the standard of care that should be applied? In my view, the following excerpts from three cases, referred to in the decision of my colleague McKinnon J. in Capital Community Credit Union Ltd. v. BDO Dunwoody,55 correctly describe the legal principles that are applicable to the instant case. 60 Lord Denning made the following observation in Fomento Ltd. v. Selsdon Fountain Pen Co., which I believe heralded the modern era of the standard of care of auditors: What is the proper function of an auditor? It is said that he is bound only to verify the sum, the arithmetical conclusion, by reference to the books and all necessary vouching material and oral explanation; and that it is no part of his function to inquire whether an article is covered by patents or not. I think this is too narrow a view. An audi-

53Kingston Cotton Mill Co. (No. 2), supra note 51, at pp. 288-89. 54[1984] 2 W.W.R. 297 (B.C. S.C.). 55(2000), 4 B.L.R. (3d) 1 (Ont. S.C.J.), aff’d (2001), 151 O.A.C. 32 (Ont. C.A.). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 215

tor is not to be confined to the mechanics of checking vouchers and making arithmetical computations. He is not to be written off as a professional “adder-upper and subtractor”. His vital task is, to take care to see that errors are not made, be they errors of computation, or errors of omission or commission, or downright untruths. To perform this task properly, he must come to it with an inquiring mind — not suspicious of dishonestly, I agree — but suspecting that someone may have made a mistake somewhere and that a check must be made to ensure that there has been none.56 61 Next in sequence is the decision of Moffitt J. in Pacific Acceptance Corp. v. Forsyth: The legal duty, namely, to audit the accounts with reasonable skill and care, remains the same, but reasonableness and skill in auditing must bring to account and be directed towards the changed circumstances referred to. Reasonable skill and care calls for changed standards to meet changed conditions or changed understanding of dan- gers and in this sense standards are more exacting today than in 1896. This the audit profession has rightly accepted, and by change in emphasis in their procedures and in some changed procedures have acknowledged that due skill and care calls for some different approaches. It is not a question of the court requiring higher standards because the profession has adopted higher standards. It is a question of the court applying the law, which by its content expects such reasonable standards as will meet the circumstances of today, including modern conditions of business and knowledge concerning them. However, now as formerly, standards and practices adopted by the profession to meet current circumstances provide a sound guide to the court in determining what is reasonable. The changes in accepted auditing standards are evidenced in that now, for some decades, in appropriate cases the auditor, after due inquiry and testing, relies on the company’s system of internal control and by this method may avoid the time and cost involved in endless “surface” checking of all transactions in favour of checking samples “in depth”. While this approach dispenses with some of the plodding and mechanical checks by audit clerks of former years, it calls for some care, skill and experience as the inquiries regarding the system and the selection, and to some degree the following through of appropriate samples, require an appreciation of the purpose of the procedures in relation to the company’s system of carrying out its

56(1957), [1958] 1 All E.R. 11 (U.K. H.L.), at p. 23 (emphasis added). 216 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

activities and documenting its dealings. In this sense it might be said that the modern procedures call for more sophistication and higher standards on the part of those who perform the work. By way of further example, it would seem that due skill and care calls for a more searching and critical approach today on matters of stock and provision for bad and doubtful debts than it did fifty years ago, and to some extent even ten years ago.57 62 I now return to the decision of McEachern C.J.S.C. in Revelstoke, which I believe correctly encapsulated the standard of care that existed pre-Sarbanes-Oxley: As is so often the case, there is great wisdom in the old authorities but the application of these cases depends upon many circumstances. Mr. Gibson, in a carefully constructed submission, referred to certain passages in the handbook published by the Institute of Chartered Ac- countants which are commonly described as generally accepted accounting standards (“G.A.A.S.”), and he urged me to conclude that an auditor is not liable if he accepts the assurances of a manager who has the complete trust of the directors provided he follows G.A.A.S. A distinction must however be drawn between different kinds of cases. The typical case against an auditor is one where, without any reason to be suspicious of anyone, the auditor performs such tests and makes such enquiries as he thinks necessary, and then gives a favourable opinion on the financial statements without uncovering shortages of funds, security, or inventory which have been concealed by falsehood and deceit. In such cases, generally speaking, the auditor has not been liable if he followed G.A.A.S. in accordance with the standards of his profession in the class of work in which he was engaged. It is for this reason that most cases against auditors have failed — often to the surprise of businessmen — because the test that has been applied in most cases is not reasonable care but rather the standard of the profession. As the accounting profession assumes an increasing importance in almost all financial matters it is likely, in my view, that the standards of the profession must be reexamined, as they have with other learned professions, and the obligation of enquiry is probably greater today than it was when the earlier cases were decided. Some dicta in these cases regarding the nature and scope of an auditor’s duty seem to me to be out of date. Greater emphasis must be placed upon Lord Lindley’s dictum that an auditor does not discharge his duty without

57(1967), 92 W.N. (N.S.W.) 29 (New South Wales S.C.), at p. 74. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 217

making reasonable enquiries. Re Thomas Gerrard & Son Ltd., [1968] Ch. 455 at 475, [1967] 2 All E.R. 525, suggests the law is moving in this direction. Another class of case is where an auditor who is following or attempting to follow G.A.A.S. has an opportunity to acquire or is ex- posed to knowledge or information which might affect his opinion but he fails to recognize and act on that information. Such an omission cannot, in my view, always be excused even if the auditor is following G.A.A.S.58 63 Indeed, the Revelstoke decision foreshadowed the results of a commission of inquiry (the “MacDonald Commission”) established by the Canadian Institute of Chartered Accountants (the “CICA”) in 1988 in the wake of the failures of the Northlands Bank and Canadian Commercial Bank in Alberta. The following excerpts from the MacDonald Commis- sion’s report are very instructive: The CICA Auditing Standards Committee should extend its guidance to audit procedures related to the discovery of management fraud. Since normal audit procedures provide a lower level of assurance with respect to the discovery of management fraud than they do with respect to the discovery of simple errors, the auditor should extend his or her work to give specific consideration to the possibility that such fraud may have occurred. If that consideration raises any question in the auditor’s mind about the validity of the traditional assumption of management honesty, additional audit procedures should be devised to provide additional assurance...... The auditor cannot and should not be held responsible for detecting all material frauds, particularly those involving careful concealment through forgery or collusion by members of management or management and third parties. Auditors nonetheless should be responsible for actively considering the potential for fraudulent financial reporting in a given audit engagement and for designing specific audit tests to recognize these risks...... Financial statements may be made instruments of management fraud by recording fictitious assets or omitting or understating liabilities. Financial statements may also be misleading as a result of improper valuations and estimates or a failure to adhere to GAAP. If done with

58Revelstoke, supra note 54, at pp. 303-304 (emphasis added). 218 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

an intention to deceive, these actions by management are also fraudulent, although there is not always a sharp line of division between mere optimism and fraudulent deception. Since the auditor’s duty is to report upon the financial statements, it is self-evident that the auditor must plan the audit program to catch fraudulent financial reporting and require appropriate correction of the financial statements.59

b. The Experts 64 As in all cases involving allegations of professional negligence, the Court had the benefit of hearing experts in the field opine on the appropriate standard of care. Three liability experts testified: D. Paul Regan on behalf of the plaintiff, and Ken Froese and David Yule on behalf of Deloitte. Additionally, the parties referred to the CICA Handbook and Deloitte Audit Manuals throughout the trial, all of which was aimed at helping me demystify the requisite standard of care.

i. Paul Regan 65 Paul Regan is a Certified Public Accountant (“CPA”), licensed to practice in the State of California. He is chairman of a medium-size firm of CPAs located in the San Francisco area, Hemming Morse LLP, with which he has practised since 1975. The firm, which has a complement of 80 professionals, has a book of business that is heavily weighted to forensic accounting. While no doubt he worked in the auditing trenches for some time after his articles with Peat, Marwick, Mitchell & Co., which commenced on his graduating university in 1968, he has spent the bulk of his practice in the last 20 years as a fraud examiner and a professional witness in countless cases and depositions, as his curriculum vitae and his cross examination during the qualification stage of his evidence demonstrates. 66 Deloitte urged me to reject Mr. Regan’s evidence entirely. Counsel argued that he had no relevant Canadian audit experience, nor any first-

59William A. Macdonald, Report of the Commission to Study the Public’s Ex- pectations of Audits (Toronto: Canadian Institute of Chartered Accountants, 1988), at pp. 98-99 (emphasis added). The MacDonald Commission was discussed, and these passages were quoted as accurate statements of an auditor’s professional responsibility, in Ken Froese, LECG Castor Report, vol. 1, Exhibit 41, at pp. 140-42. Mr. Froese adopted this aspect of his Castor Report while under cross-examination in the trial of this matter: Transcript, Froese Cross-Ex- amination, 23 July 2013, at pp. 383-84. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 219

hand familiarity with the relevant CICA standards. They further suggested that his methodology and analysis were flawed and based on hindsight. Lastly, they argued that he did not provide fair, objective and non- partisan expert evidence, as the Rules of Civil Procedure60 and the case law demand. 67 Mr. Regan testified before me for almost 13 days. During the qualification stage in the beginning of May, I ruled that Regan could testify on the subject of proper auditing and accounting practices, without limitation as to any differences that might exist between Canadian and U.S. standards, but sounded a cautionary note that if I determined in the full- ness of time that the differences sought to be established from the evidence in respect of Canadian and U.S. GAAS were more significant than originally thought, such might pose difficulties for the plaintiff in the final analysis. I have concluded that the differences in some of the GAAS principles, particularly in relation to the concept of professional skepticism and the treatment of misstatements, are more substantial than Mr. Regan suggested, although not to the extent that it warrants the rejection of his evidence in its entirety. 68 I do not, however, accept Deloitte’s argument that Mr. Regan set out to purposefully mislead the court. As the plaintiff quite properly re- minded me in its reply argument, I was satisfied that any lack of specific- ity in recalling the assistance Mr. Regan might have received from Messrs. Lipton Wiseman, a Canadian firm of accountants which is part of the network of firms associated with Mr. Regan’s own firm, during the preparation of his first report was more probably a function of an error committed by one of Mr. Regan’s associates, than anything else. I have no doubt that Mr. Regan realized that the Canadian information on the applicable standards obviously had to come from a Canadian accountant or auditor. And while I was mildly miffed by the fact that he did not completely “come clean” about the fact that his partner Mr. John was not a Canadian but a Scottish-qualified C.A., in the final analysis, I am not sure that this oversight was critical to my assessment of his overall evidence. 69 Nor was I persuaded that Regan was not attempting to be fair or objective, particularly when he was advised by me of his responsibilities to assist the Court, respond to questions appropriately and not act as an ad-

60R.R.O. 1990, Reg. 1943, rr. 4.1.01, 53.03(2.1). 220 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

vocate. While there is little doubt that the bulk of his practice is restricted to testifying as an expert, having testified before all manner of tribunals in the U.S., I am not persuaded that such should automatically disqualify him. I dare say that Ken Froese, one of Deloitte’s experts, seems to have adopted the same m´etier of late, and would not be disqualified on that basis alone. 70 But I am concerned that Mr. Regan’s first report, and even his reply report, was rooted to some extent in incomplete information, if not information that might have been hand-selected by counsel or delivered to him and members of his firm piecemeal. Unlike the experts opposite, the background information received by Regan was provided him by counsel in the form of briefing books that spanned approximately 50 binders and was not delivered all at one time. Furthermore, he, unlike Messrs. Froese and Yule, did not have access to the entire Deloitte work papers organized by year and audit category, but was given material which I was told was organized by topic matter. It was difficult, therefore, for me to assess whether or not the manner in which the material was delivered to Hem- ming Morse LLP, was of any moment to his conclusions in the final analysis. 71 I was, however, a tad uneasy about the fact that he was not able to reconstruct the audit, as it were, on a year-by-year basis in order to view the evidence in the same way it would have been viewed by the Deloitte engagement or review partners who would have been overseeing the field work by the managers and more junior staffers. In other words, a review by subject matter might have had the unintended consequence of skewing the analysis and might have provided Mr. Regan with a somewhat jaundiced view of the issues which he was later heard to criticize. 72 I am also persuaded that Mr. Regan was operating from the vantage point of hindsight, if not engaged in the conduct of a forensic investigation as opposed to commenting on the adequacy of an audit, per se. The frailties of his methodology are reasonably captured by counsel for Deloitte in following excerpts from their written argument: Regan began receiving documents from the Plaintiff’s counsel in April 2009 when he received copies of the pleadings, amongst other documents. He next received in June, July and August of 2009 pack- ages of material including documents explaining how certain of the frauds at Livent were carried out and significantly, a binder with the restatement adjustments and restated financial statements. Thus, before receiving Deloitte’s actual work papers for the relevant period, he received details of the adjustments made to Livent’s finan- Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 221

cial statements identified as part of the re-audit and forensic investigation of KPMG, thereby enabling him and his team to work backward from the adjustments with the full benefit of hindsight. Regan next received copies of some of the work papers but not in their original form. Instead, by way of example, on August 31 and September 1, 2009 he received several binders organized by topic including: “DCC Debenture Binder,” “NYPAC Deferred Costs Binder,” “PPC Phantom Tour Binder,” “PPC Joseph Binder,” “Pace Binder” and “Dewlim Binder,” amongst others. Several of Regan’s binders related to preproduction costs (such as the Joseph, Phantom, Ragtime 1 and 2 and Showboat 1, 2 and 3 binders) each included, as the first page, a schedule of the adjustments made to those costs as part of the audit of the re-stated financial statements prepared by Plaintiff’s counsel. As Regan acknowledged, this permitted his team to work backward from the restatement. Several binders on other topics included documents from the restatement as the first documents in the binders, such as the Kofman-Execway binder, in order to help shape Regan’s evidence...... Had Regan been provided with all of the documents in Deloitte’s working papers (or considered all of the documents provided to him) it is not clear whether it would have impacted his opinion in view of his willingness to act as an advocate for the Plaintiff’s position. How- ever, he did not even get the chance to consider all of the relevant documents in their original form because certain documents were withheld from him, while the documents he did receive were carefully organized to lead him to certain conclusions.61 73 In a review of Margaret MacMillan’s recently published book, The War That Ended Peace: The Road to 1914, Tim Cook made the following observation: “MacMillan cautions against reading history backward through time and resists the easy temptation to see all the puzzle pieces coming together in a kind of inevitability about the past”.62 At the risk of doing a disservice to Professor MacMillan’s thesis, I am not persuaded

61Closing Argument of Deloitte & Touche LLP, vol. 1, at paras. 228-30, 233 (emphasis added). 62Tim Cook, “The War that Ended Peace: Historian Margaret MacMillan deftly reconsiders the Great War’s inevitability”, The Globe and Mail (8 November 2013) online: . 222 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

that Mr. Regan’s view of the matters in issue was not jaded by the end result. 74 Interestingly enough, and for reasons that were never explained to me during his testimony, Mr. Regan did not refer to ss. 5000 and 5135 of the CICA Handbook in his first report. He testified that he “operationalized” those sections in his analysis at first instance and he did actually refer to them in his reply report. As will be discussed later in these reasons, each of these two sections expresses important guiding principles for the conduct of audits in Canada. I will consider the impact of this omission when discussing the evidence of Ken Froese and whether or not in the final analysis there is any difference in approach between Regan and Froese. But, in light of the important issues which the omitted sections address, I consider this omission to be of some significance and not one that can be readily rationalized. 75 It is also important to observe that the Canadian standards are principles-based, while the American standards are rules-based; again, a difference that is more than a minor nuance, as an article by two of Mr. Re- gan’s partners demonstrates.63 As the evidence finally unfolded, I am of the view that there is a material difference between the U.S. and Cana- dian positions on the principle of professional skepticism. 76 At the base of a Canadian audit is the “fundamental auditing postulate” that an auditor, when planning his audit, can assume management’s good faith in the preparation of the statements at first instance.64 The U.S. Standard on the other hand, assumes that management is neither honest nor dishonest.65 In Canada, the “benefit of the doubt” is extended to management once a misstatement is discovered by an auditor. Under the Canadian principles, a misstatement is prima facie considered an error, that is, a misstatement created through inadvertence, in the absence of evidence to the contrary. In contrast, under the U.S. standards, if a

63Stuart H. Harden & Andrew M. Mintzer, “Rules vs. principles — accounting standards”, California CPA (September 2002), Exhibit 15. 64CICA Handbook, s. 5090.05, JBD 15991. For a side-by-side comparison of Canadian and U.S. standards, see Exhibit 1 to D. Paul Regan, Reply Report, 7 May 2012, Exhibit 17. 65AU 230.09. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 223

misstatement is identified, then “the auditor should consider whether such misstatements may be indicative of fraud”.66 77 In my opinion, these differences in approach could not but permeate Regan’s opinion and colour his evidence, from his analysis in respect of the audits undertaken from the early days of MyGar’s existence to the waning days of Livent’s operation at the time of the 1997 audit in April 1998. Ironically, notwithstanding his self-described “outrage” at the du- plicity of Gottlieb and Drabinsky even in Livent’s early years, which he said might have lead him to decline any further engagement, Regan concluded as follows: Had D&T complied with GAAS in its audits of the financial statements of Livent for the years ended December 31, 1996 and 1997, it should have detected the underlying fraud that resulted in the material misstatement of those financial statements, and had [D&T] complied with GAAS in its audits of Livent and its predecessor’s financial statements for the years ended December 31, 1991, 1992, 1994 and 1995 it may have detected the underlying financial fraud that resulted in the material misstatement of those financial statements.67 78 Mr. Regan was cross-examined on this statement on Day 10 of his testimony. I have reproduced the exchange below because of its importance to many of the issues: Q. [Y]ou were asked to opine on whether, had D & T complied with GAAS in its audits of the financial statements of Livent, it should have detected the underlying fraud? A. Correct. Q. And as you just told us moments ago, I believe, that you concluded that Deloitte should have detected the fraud for the years ended December 31, 1996 and 1997? A. Yes. Q. And you also concluded that, had Deloitte complied with GAAS in its audits of Livent’s financial statements for each of the years ended December 31, 1991, 1992, 1994 and 1995, Deloitte may have detected the fraud? A. Correct.

66CICA Handbook, s. 5135.04, supra note 23; AU 312.04, 316.34. 67D. Paul Regan, Expert Report, 8 March 2010, Exhibit 16, at p. 2. 224 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Q. You were not asked to opine on whether Deloitte may have discovered the fraud? A. I don’t understand your question. I — what I was asked is whether — had Deloitte complied with GAAS, it should have detected the fraud. And my response was — I bifurcated it into two sections; that it should have for ’96 and ’97; and it may have for the other years. That was my response to the assignment. Q. So you volunteered the opinion that Deloitte may have detected the fraud for the years ’91 through to ’95? A. Yes, sir. Q. And so the answer to the question as to whether Deloitte should have detected the underlying fraud from ’91 to ’95, based on your conclusion, the answer to that question is “no”? A. Could I hear your question again, please. Q. You were asked whether Deloittes should have detected the fraud. You concluded that it should have detected the fraud in 1996 and 1997. The answer for those years is “yes”, Deloitte should have detected the fraud? A. Yes. Q. The answer to the question for 1991 through to 1995 is “no”? A. That’s correct, I did not reach that conclusion. THE COURT: Sorry. Now I’m confused, because I thought I had understood it when I read it. I apologize, Mr. Fleming. I thought I read that they might have detected fraud, ’91 through ’95; but they should have detected the fraud, ’96, ’97. THE WITNESS: You’re correct. THE COURT: That’s how I read that response. THE WITNESS: You’re — you’re exactly right. I agree with that.68

ii. Ken Froese 79 Mr. Froese is a Canadian-trained chartered accountant, having first received his designation while working with Doane Raymond in Nova Scotia in the early ’80s and latterly with Grant Thornton (“GT”) both in the Maritimes and in Ontario. At GT, he worked out of the National Of-

68Transcript, Regan Testimony, 14 May 2013, at pp. 1118-20. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 225

fice, where he was assigned the task of assisting its various offices on GAAP and GAAS issues. As well, during several of his formative years as a partner with GT, he was engaged in the design of training programs for the firm and assisted in the provincial education of young accountants seeking qualification as CAs. 80 He changed the focus of his practice after 1992, when he began de- voting at least two thirds of his time to forensic accounting and investigation and the balance of his time to auditor performance issues, which included investigations on behalf of the ICAO or assisting counsel as a consultant or witness on matters before various tribunals, principally in Ontario and Quebec. 81 No issue was taken with respect to his testimony on GAAP and GAAS issues associated with the Livent audits. Nevertheless, many of the same criticisms levelled against Mr. Regan, but for his knowledge of the applicable Canadian standards, were raised in argument in respect of the Froese evidence as it related to whether or not Deloitte had conducted the audits from 1995 to 1997 in accordance with GAAS. 82 Simply put, I did not find Mr. Froese to be a fair, objective and non- partisan expert witness. In my view, he adopted the mantle of an advocate during the course of his evidence, and more than just occasionally. While never belligerent and always unfailingly polite, he refused to answer questions put to him by counsel in cross-examination in a straightforward and helpful manner if they undercut his thesis, namely that Deloitte had conducted the 1995, ’96 and ’97 audits in accordance with GAAS and should not have uncovered fraud or other irregularities in all the years in question. 83 I must confess that I found certain of his responses to be frustrating, which at times diminished the helpfulness of his opinions in understanding some of the complex accounting and auditing issues. In my view, he fell victim to the harm that both sides cautioned against when each cited the decision of the Court of Appeal of Ontario in Carmen Alfano Family Trust v. Piersanti for their own purposes: When courts have discussed the need for the independence of expert witnesses, they often have said that experts should not become advo- cates for the party or the positions of the party by whom they have been retained. It is not helpful to a court to have an expert simply parrot the position of the retaining client. Courts require more. The critical distinction is that the expert opinion should always be the result of the expert’s independent analysis and conclusion. While the 226 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

opinion may support the client’s position, it should not be influenced as to form or content by the exigencies of the litigation or by pressure from the client. An expert’s report or evidence should not be a plat- form from which to argue the client’s case. As the trial judge in this case pointed out, “the fundamental principle in cases involving qualifications of experts is that the expert, although retained by the clients, assists the court.”69 84 Mr. Froese acknowledged that an expert’s approach to the issue of auditors’ negligence should not vary depending on the side for which he is called to testify; but I was disappointed to learn that he did not adopt that even-handed approach in the instant action. In contrast to what he did when he was retained by RSM Richter Inc., as Trustee in Bankruptcy in the Castor Holdings Ltd. (“Castor”) case, which was an action against Coopers & Lybrand Ltd. (“C&L”), in the instant case he neglected to mention or simply ignored certain Deloitte manuals, texts and Commis- sion material that arguably undercut his conclusions. I thought that the omitted material, which proved to be at least worthy of consideration and inclusion by a GAAS expert, negatively impacted his credibility and use- fulness as an “independent” expert. He was almost guilty of “cherry picking”, a concept recently commented upon by Moore J. in Frazer v. Haukioja.70 85 In addition to the foregoing, there were two concepts which were either down-played in his report and evidence-in-chief or not referenced at all: the first was the notion of “red flags” or warning signs; and the second was the concept of “audit by conversation”, or a reliance on representations by management without adequate audit evidence to support such representations. The notion of red flags was addressed in Mr. Froese’s report. But they were, at best, rationalized away in the instant case, while they featured prominently in the Castor report. The second concept, audit by conversation, which was mentioned several times in the Castor report, was singularly absent from his work-up of the Deloitte audits. Indeed, in cross, he would only acknowledge that avoiding audit by conversation was but “practical advice for auditors in doing an audit with

692012 ONCA 297, 291 O.A.C. 62 (Ont. C.A.), at para. 108 (emphasis added). 70(2008), 58 C.C.L.T. (3d) 259 (Ont. S.C.J.), aff’d 2010 ONCA 249, 101 O.R. (3d) 528 (Ont. C.A.), at paras. 154-55. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 227

professional skepticism”.71 I did not find this observation to be as much of a concession as it should have been.

iii. David Yule 86 David Yule obtained his CA designation in 1961 and thereafter practiced with Clarkson Gordon and its present-day incarnation, Ernst & Young, until his retirement in 1997. He then assumed various executive and board positions with a variety corporations and institutions, including Datalex Corporation, the Deposit Insurance Corporation of Ontario, and the Shareholders Auditors Advisory Committee to the Superinten- dent of Financial Institutions for the Province of Ontario. His auditing experience was unquestioned and his expertise as a past chairman of the Auditing Standards Committee of the CICA added to his overall expertise. While he initially prepared a report that covered the audits of MyGar from 1989 to 1993 and thereafter Livent, to and including year- end 1997, his evidence before me was restricted to an opinion on the early years up to year-end 1994. No issue was taken by counsel for Livent as to his qualifications as an expert in GAAS and GAAP in Canada. 87 In addition, and as is evident from the comments contained in the Stikeman Elliott written arguments, counsel did not have much to criticize Mr. Yule in respect of the manner in which he gave his evidence. But for certain matters which he had modest difficulty rationalizing, I found his evidence overall to be helpful, credible, and above all balanced.

c. The Deloitte Partners 88 During the course of the trial, five former partners and one current partner of Deloitte testified before me (the “Deloitte Partners”). In addition, I heard from Maria Messina who, as a previously indicated, was a manager and partner at Deloitte before she moved to Livent. While each of the Deloitte Partners was called as a “fact” witness, and was not being put forward to provide me with an opinion on the appropriate standards, their evidence was replete with references to practice issues, which shed light on the applicable standards at the time, for better or for worse. It would be difficult for me now to divest myself of the information I received during the course of some of this evidence.

71Transcript, Froese Testimony, 23 July 2013, at p.416. 228 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

d. The CICA Handbook 89 As previously indicated, several of the witnesses, including certain of the Deloitte partners and the experts, were confronted with excerpts from the CICA Handbook. Some time was spent parsing many of the sections to which reference was made. I think it is fair to say that both sides relied on various sections, as it suited their purposes. The sections to which reference was made included those which described concepts underlying the use of accounting principles in general purpose financial statement preparation, changes to accounting policies adopted by management, overarching GAAP issues, uncertainty associated with estimating or measuring, the preparation of interim financial reports and related-party transactions, to name but a few of the headings taken directly from the Handbook. 90 While reference will be made to certain of the sections as each becomes relevant, it might be of some assistance to set out, verbatim, portions of two sections, which form part of the backdrop to an understanding of the applicable standards. Section 5000 - Audit of Financial Statements - An Introduction .01 The objective of an audit of financial statements is to express an opinion whether the financial statements present fairly, in all material respects, the financial position, results of operations and changes in financial position in accordance with generally accepted accounting principles, or in special circumstances another appropriate disclosed basis of accounting. Such an opinion is not an assurance as to the future viability of an entity nor an opinion as to the efficiency or effectiveness with which its operations, including internal control, have been conducted. .02 The operations of an entity are under the control of management, which has the responsibility for the accurate recording of transactions and the preparation of financial statements in accordance with generally accepted accounting principles. These responsibilities include those related to internal control such as designing and maintaining accounting records, selecting and applying accounting policies, safe- guarding assets and preventing and detecting error and fraud. An audit of the financial statements does not relieve management of its responsibilities. The auditor may make suggestions as to the form or content of the financial statements or the auditor may draft them in whole or in part, based on management’s accounting records. How- ever, financial statements remain the representations of management. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 229

.03 In the performance of an audit of financial statements, the auditor complies with generally accepted auditing standards, which (as set out in GENERALLY ACCEPTED AUDITING STANDARDS, paragraph 5100.02) relate to the auditor’s qualifications, the performance of the audit and the preparation of his or her report. .04 The auditor performs the audit with an attitude of professional scepticism, and seeks reasonable assurance whether the financial statements are free of material misstatement. The auditor normally designs auditing procedures on the assumption of management’s good faith, and exercises professional judgment in determining the nature, extent and timing of those procedures, in evaluating their results and in assessing determinations made by management. Absolute assurance in auditing is not attainable as a result of such factors as the use of judgment, the use of testing, the inherent limitations of internal control and the fact that much of the evidence available to the auditor is persuasive rather than conclusive in nature. .05 The assumption of management’s good faith is a fundamental auditing postulate. This assumption is normally necessary for an audit to be economically and operationally feasible. This assumption means, in the absence of evidence to the contrary, the auditor can accept accounting records and documentation as genuine and representations as complete and truthful. The assumption of management’s good faith is not a source of audit evidence nor a substitute for the requirement to obtain sufficient appropriate audit evidence to afford a reasonable basis to support the content of the auditor’s report. .06 An attitude of professional scepticism means the auditor assesses the validity of evidence obtained and is alert to evidence which con- tradicts the assumption of management’s good faith. For example, the auditor is alert to evidence which may indicate accounting records and documentation have been altered or representations are false. It does not mean the auditor is obsessively sceptical or suspicious. Without an attitude of professional scepticism, the auditor may not be alert to circumstances which should lead him or her to be suspicious and he or she may then draw inappropriate conclusions from evidence gathered. [Emphasis added] Section 5135 - Auditor’s Responsibility to Detect and Communicate Misstatements GENERAL ASSURANCE AND AUDITING - SECTION 5135 230 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

INTRODUCTIONS AND DEFINITIONS .01 This Section deals with the auditor’s responsibility to detect material misstatements in an audit of financial statements or other financial information. Misstatements arise from “error” or “fraud and other irregularities”. This Section also sets out the auditor’s responsibility to communicate error or fraud detected in an audit of financial statements. Additional guidance on the content, documentation and timing of the communication of misstatements is provided in COM- MUNICATION OF MATTERS IDENTIFIED DURING THE FI- NANCIAL AUDIT, Section 5750. .02 The following definitions have been adopted for purposes of the Assurance and Related Services Sections of this Handbook. (a) “Error” refers to an unintentional misstatement in financial statements, including an omission of amount or disclosure. Error may involve: (i) a mistake in gathering or processing accounting data from which financial statements are prepared; (ii) an incorrect accounting estimate arising from oversight or misinterpretation of facts; or (iii) a mistake in the application of accounting principles relating to amount, classification, manner of presentation or disclosure. (b) “Fraud and other irregularities” refers to an intentional misstatement in financial statements, including an omission of amount or disclosure, or to a misstatement arising from theft of the entity’s assets. Fraud also involves: (i) the use of deception such as manipulation, falsification or alteration of accounting records or documentation; (ii) misrepresentation or intentional omission of events, transactions or other significant information; or (iii) intentional misapplication of accounting principles relating to amount, classification, manner of presentation or disclosure. .03 The word fraud is used in this Section, although in practice the auditor will normally be concerned with a suspected rather than a proven fraud. Final determination of whether fraud has occurred will probably be made by a court of law. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 231

.04 One of the factors distinguishing fraud from error is whether the underlying cause is intentional or unintentional. Intent is often difficult to determine, particularly in matters involving the use of judgment. In the absence of evidence to the contrary, a misstatement arising from management’s bias in selecting and applying accounting principles or in making accounting estimates would be considered an error. PROFESSIONAL SCEPTICISM .05 An attitude of professional scepticism is inherent in applying due care in accordance with the general standard (see GENERALLY AC- CEPTED AUDITING STANDARDS, Section 5100). Such an attitude is necessary for proper consideration of factors which increase the risk of material misstatements and evaluation of evidence obtained. The auditor recognizes that conditions observed and evidence obtained, including information from previous audits, need to be evaluated with an attitude of professional scepticism to assess the risk of material misstatement. In particular, an attitude of professional scepticism means the auditor is alert to: (a) factors which increase the risk of material misstatement.... (b) circumstances which make him or her suspect the financial statements are materially misstated. (c) conditions observed or evidence obtained which con- tradicts the assumption of management’s good faith. The auditor needs to be aware of factors which increase the possibility of management misrepresentation. For example, management can direct subordinates to record transactions or conceal information in a manner that can materially misstate financial statements. .06 • An audit of financial statements should be performed with an attitude of professional scepticism. DETECTION OF MISSTATEMENTS .07 The auditor’s assessment of inherent risk and control risk at the planning stage of the audit affects the nature, extent and timing of the procedures performed by the auditor. For example, higher risk assessments may cause the auditor to: (a) perform audit procedures which provide more reliable evidence, such as confirmation obtained from a third party as compared to internal documentation obtained from the entity; 232 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

(b) expand the extent of the audit procedures performed; or (c) apply audit procedures closer to or as of the balance sheet date. .08 The auditor’s assessment of risk may also affect the staffing of the audit. A higher risk assessment would normally require more ex- tensive supervision of assistants and/or assistants with more experience and training. .09 Because the auditor maintains an attitude of professional scepticism when performing the audit, he or she will consider whether circumstances encountered indicate the possibility of a material misstatement existing in the financial statements. Examples of circumstances which, either individually or in combination, may make the auditor suspect misstatements exist are: (a) Unrealistic time deadlines for audit completion imposed by management. (b) Reluctance by management to engage in frank communication with appropriate third parties, such as regulators and bankers. (c) Limitation in audit scope imposed by management. (d) Identification of important matters not previously disclosed by management. (e) Conflicting or unsatisfactory evidence provided by management or employees. (f) Unusual documentary evidence such as handwritten alterations to documentation or handwritten documentation which would usually be electronically printed. (g) Information provided unwillingly or after unreasonable delay. (h) Seriously incomplete or inadequate accounting records. (i) Unsupported transactions. (j) Unusual transactions, by virtue of their nature, volume or complexity; particularly, if they occurred close to the year-end. (k) Significant unreconciled differences between control accounts and subsidiary records or between physical count and the related account balance which were not appropriately investigated and corrected on a timely basis. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 233

(l) Inadequate control over computer processing. For instance, too many processing errors or delays in processing results and reports. (m) Significant differences from expectations disclosed by analytical procedures. (n) Fewer confirmation responses than expected or significant differences revealed by confirmation responses. .10 When circumstances exist which make the auditor suspect the financial statements are materially misstated, the assessment of the components of audit risk made at the planning stage of the audit may need to be revised and the nature, extent and timing of the auditor’s procedures may need to be reconsidered. .11 If the auditor confirms or is unable to dispel the suspicion that the financial statements are materially misstated, he or she needs to consider the implications for the audit.... .12 If the auditor confirms or is unable to dispel the suspicion that a fraudulent act has occurred, he or she needs to reconsider the reliability of evidence previously obtained since there may be doubts about the completeness and truthfulness of representations made and about the genuineness of accounting records and documentation. The auditor would also consider the possibility of collusion involving employees, management or third parties when reconsidering the reliability of evidence. If management is involved in fraud, it can direct subordinates to record fictitious transactions, create fictitious documentation or conceal information. .13 If management, particularly at the highest level, is involved in fraud, the assumption of management’s good faith may be contradicted and the auditor may not be able to obtain the evidence necessary to complete the audit and report on the financial statements. In such circumstances, the auditor would consider obtaining legal advice about his or her contractual or statutory responsibilities and the appropriate course of action. .14 • The auditor may encounter circumstances which make him or her suspect the financial statements are materially misstated. In that event, the auditor should perform procedures to confirm or dispel that suspicion. 91 I have reproduced only a portion of s. 5135 in the body of the judgment. However, it is worth paraphrasing some of the essential elements remaining in this section: 1. An auditor’s professional responsibility is discharged if an audit is conducted in accordance with GAAS. 234 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

2. In order to comply with GAAS, an auditor must design procedures to reduce the risk of not detecting material misstatements to an appropriately low level. 3. An audit does not guarantee that all material misstatements will be detected because of the use of judgment, the use of testing, inherent limitations on internal control and the fact that much of the evidence available to an auditor may be persuasive rather than conclusive. 4. An auditor is not an insurer and his report does not constitute a guarantee. 5. Compliance with GAAS is in some respects determined by the adequacy of the procedures undertaken in each case, and the suitability of the auditor’s report, based on the results of the procedures undertaken. 6. An auditor is less likely to detect material misstatements arising from fraud because fraud is generally accompanied by acts of deceit and concealment. Concealment can include the manipulation or falsification of accounting records or other documentation in an effort to mask the fact that the accounting records may not reflect the actual state of affairs of the company. 7. Accordingly, audit procedures that might be effective for detecting an unintentional misstatement may fall short of revealing intentional misstatements. 92 While no doubt there are other sections that have to be considered, if not referenced in the instant case, s. 5140, “Knowledge of the Entity’s Business”, is important since it touches on many of the issues at play in the instant action. The salient points from s. 5140 may be paraphrased as follows: 1. Auditors must obtain and apply knowledge of the client’s business continuously and cumulatively. The knowledge obtained from the moment of the decision to accept the engagement, together with knowledge amassed over the course of the subsequent audit periods must be updated to ensure that it reflects the current circumstances of the client. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 235

2. Knowledge obtained when planning an audit for the current period must be refined and supplemented as the audit progresses. 3. As a corollary, the planning and execution of an audit must reflect the auditor’s knowledge of the client. 4. Knowledge of the client’s business affects multiple components of the audit, including a determination of materiality levels, assessing the inherent risk associated with the audit, understanding and obtaining sufficient information in respect of the client’s internal controls, identifying the nature and sources of available audit evidence, designing audit procedures, and understanding the nature of the client’s business in order to better understand the substance of transactions. 5. Assessing whether sufficient appropriate audit evidence has been obtained, including evidence related to significant management representations. 93 As an adjunct to this last mentioned section, an auditor is required to assess the information accumulated during the course the audit to determine whether or not decisions made during the planning stage remain appropriate. In this respect, an auditor has to be live to the issue of whether or not audit evidence sought has been obtained and whether it is sufficient in the circumstances to support the contents of the auditor’s report. Additionally, an auditor must use knowledge of the client’s business to assess the appropriateness of management’s selection and application of accounting principles. Last, but not least, the auditor must determine whether or not the financial statement presentation, namely, the form of the report, taken as a whole, is consistent with the auditor’s knowledge of the entity. 94 The importance of this section, aspects of which permeated much of the evidence, sometimes in a different form, can be seen from the appendix that is attached by the CICA to this portion of the Handbook. With- out reproducing it, the appendix fleshes out further subcategories, which instruct an auditor to identify the business environment of the client, the characteristics of ownership and management, and the operating characteristics of the client. Each of the last mentioned general headings provides the auditor with a virtual checklist of matters that have to be considered, almost routinely, and repeatedly if an auditor is to discharge its 236 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

responsibility to conduct the audits for any particular period in accordance with GAAS.

e. The Deloitte Manuals 95 The large accounting firms have national offices, the managers and partners of which provide support to the regional offices. The national offices are staffed by accountants and auditors with expertise in specialized areas, such as GAAS and GAAP. In addition, the national and international offices prepare manuals for the field staff, which, among other things, provide instruction, information and guidance on accounting and auditing issues. Deloitte not only had a national office, whose members were from time to time involved in the subject audits, but prepared manuals that were in use during the relevant time. I was told that there was a Canadian manual72 that was operative during the MyGar and early Livent years and an international manual73 that was introduced during the 1995 audit and used during the 1996 audit. 96 I have no intention of reproducing the 346-page Deloitte Manual in the body of the judgment or even as an appendix. It is to be distinguished from the Canadian Manual which was a collection of the Firm policies that applied to all professionals in all services. From my review of the latter document, it does not appear to provide those undertaking an audit with any greater direction on the detection of fraud and error than is contained in the CICA Handbook. I find the following excerpt from the Deloitte Manual on the topics of fraud and error, however, to be of some significance since it is applicable to all audits conducted by Deloitte for the years subsequent to 1995: Consideration of fraud and error 1.34 We need to plan and perform the audit with an attitude of professional skepticism, recognizing that circumstances may exist that cause the financial statements to be materially misstated as a result of fraud or error. 1.35 Owing to the inherent limitations of an audit and any system of internal control, there is a possibility that material misstatements resulting from fraud and, to a lesser extent, error may not be detected.

72Deloitte Touche Tohmatsu International, AuditSystem/2: The Audit Ap- proach, JBD 16391 (“Deloitte Manual”). 73Deloitte & Touche, Canadian Professional Practice Manual, JBD 16113 (“Ca- nadian Manual”). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 237

Because fraud usually involves acts designed to conceal it, the risk of not detecting a material misstatement resulting from fraud is greater than one resulting from error. 1.36 Fraudulent acts include deliberate failure to record transactions, forgery of records and documents, and intentional misrepresentations to the engagement team. Fraud may include intentional acts by management or employees acting on behalf of the entity, as well as employee fraud where management or employees are involved in actions defrauding the entity. 1.37 We neither assume that management is dishonest nor assume unquestioned honesty. Rather, we exercise professional skepticism and recognize that conditions observed and evidential matter obtained, including information from prior audit engagements, need to be objectively evaluated to determine whether the financial statements are presented fairly in all material respects. Fraud and Error 17.75 If the results of our tests of controls indicate the possible existence of fraud or error, we should consider the potential effect on the financial statements. If we believe the indicated fraud or error or risk thereof could have a material effect on the financial statements, we should perform appropriate modified or additional procedures. 17.76 The extent of such modified or additional procedures depends on our judgment of: • Types of fraud and error indicated • Likelihood of their occurrence • Likelihood that a particular type of fraud or error could have a material effect on the financial statements. 17.77 Unless circumstances clearly indicate otherwise, we cannot assume that an instance of fraud or error is an isolated occurrence. If necessary, we need to adjust the nature, timing, and extent of planned substantive procedures. 17.78 Performing modified or additional procedures would ordinarily enable us to confirm or dispel a suspicion of fraud or error. Where suspicion of fraud or error is not dispelled by the results of modified or additional procedures, we discuss the matter with the appropriate level of management and consider whether it has been properly reflected or corrected in the financial statements. We also consider the possible impact on our report. 17.79 We also consider the implications of fraud and significant error in relation to other aspects of the audit engagement, particularly the 238 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

reliability of management representations. In this regard, we reconsider our risk assessment and the validity of management representations, in case of fraud and error not detected by internal controls or not included in management representations. 17.80 The implications of particular instances of fraud or error discovered by us will depend on the relationship of the perpetration and concealment, if any, of the fraud or error to specific control procedures and the level of management or employees involved.

8. Standard of Care: Was It Met? a. The Pre-1996 Audits i. Generally 97 The parties are in agreement that the standard of performance against which an auditor’s actions are to be gauged is to be determined by the Court. What then am I to draw from the evidence summarized above, particularly as it relates to the obligation to conduct the audits in accordance with GAAS and whether such would have resulted in the detection of fraud? 98 Mr. Howard suggested that in the final analysis there was little to choose between the evidence of Froese and Regan in relation to the general standard of diligence and care to be brought to bear in an audit. It was his position that when the above cited sections of the Deloitte Man- ual were inserted into the equation, the seemingly high standards set by Regan were virtually congruent with the position of Froese, even though Howard quite rightly acknowledged that it is not just a matter of melding the CICA Handbook with the Deloitte Manual to arrive at the appropriate standard of care. 99 I have already expressed my views on the evidence of each of these two gentlemen, neither of whose evidence I have rejected nor accepted in its entirety. In my view, and to repeat my conclusion, the Canadian and American approaches to professional skepticism and the detection of fraud and irregularities differed significantly to at least the end of audit year 1995. If it were otherwise, Deloitte would have been obliged to plan for the detection of intentional misstatements in all pre-1996 audits, which it did not,74 notwithstanding the recommendations contained in

74Transcript, Glassman Cross-Examination, 5 June 2013, at pp. 220-21. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 239

the MacDonald Commission report and the seeming concession made by Mr. Froese in cross-examination that such planning was necessary.75 100 All the evidence suggests, however, that the detection of fraud during the course of an audit is difficult even if the audit is conducted in accordance with GAAS. Indeed, the standard engagement letter used by Deloitte and signed by the client during the relevant period of time underscores this proposition: It should be noted that an audit conducted in accordance with generally accepted auditing standards is based on selective tests. Because detailed examination is not performed on all transactions, there is a risk that material fraud or error may exist but not be detected.76 101 Cycling back to the plaintiff’s theory of liability and damages, had Deloitte detected and disclosed the fact that Livent’s Original Statements contained material misstatements as a result of fraud or other irregularities, its ability to access the capital markets would have been brought to a screeching halt. Implicit in this thesis is the notion that Deloitte would not have been able to issue an unqualified opinion in any year in which the fraud was detected. In addition, Deloitte would have had to report the matter first to the Audit Committee, in this case to its chairman, Emer- son, who was basically the last honest man standing, whereupon the matter would have been disclosed to the non-Drabinsky-Gottlieb appointees of the Board and then to the regulators. This is precisely how the situation unfolded in early August 1998, and I have no reason to doubt that it would not have occurred in any of the years previous had the fraud been detected. 102 Livent’s counsel takes the position that with respect to the audits up to and including 1992, there were at least 14 red flags that afforded Deloitte the opportunity “to unravel the tapestry of lies that had been woven by Drabinsky and Gottlieb by increasing their scepticism, questioning management’s good faith and/or arousing their suspicions that fraud may be the best explanation”.77 These transactions, to which plaintiff’s counsel repeatedly referred, included misrepresentations on the part of Gottlieb and Drabinsky that transcended the Kofman-Wayment kick-

75Transcript, Froese Cross-Examination, 23 July 2013, at pp. 383-84. 76Engagement Letter, 24 October 1996, JBD 4946, at p. 1. 77Initial Closing Submissions of the Plaintiff, vol. 2, at para. 383. 240 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

backs, the latter of which payments by all accounts would have been virtually impossible to detect. 103 I digress to observe that several witnesses attempted to provide me with a primer on materiality and how that notion comes into play in the assessment of whether or not Deloitte discharged its obligation to conduct the audits in accordance with GAAS. I was told that the principle of materiality, which is conjoined with the further principle of “audit risk”, drives, in large measure, the nature, extent and timing of the audit procedures themselves. I was also told that both concepts are employed in the final stages of the audit, as well, when the auditor assesses whether or not management’s assertions that the financial statements are presented fairly in accordance with GAAP are correct. Underlying both principles is the understanding by auditors that the figures presented by management “are not necessarily precise and that the audit does not provide absolute assurance that the financial statements are not materially misstated”.78 104 At the risk of doing a disservice to these concepts, which are anything but easy to grasp, there is a point at which the cumulative dollar value of all the individual misstatements identified by the auditor is so great that the financial statements cannot be said to fairly present the financial affairs of the enterprise. At that point, the financial statements would be “materially misstated” and the auditor would be obliged not to endorse them with a clean opinion until and unless the client were to successfully reduce the cumulative dollar value of the misstatements to below the point of materiality. The test for whether a misstatement (or the aggregate of all misstatements) is material is whether “it is probable that the decision of a person who is relying on the financial statements, and who has a reasonable knowledge of business and economic activities (the user), would be changed or influenced by such misstatement or the aggregate of all misstatements”.79 This is not a test that admits of bright- line answers. There is a grey area between misstatements that are clearly material and those that are clearly immaterial. Determination of materiality is therefore a matter for the auditor’s professional judgment. 105 With that explanation as the backdrop, the plaintiffs suggest that if the net income for the fiscal years ending 1993 - 1995 were adjusted for

78CICA Handbook, s. 5130.02, JBD 16372. 79CICA Handbook, s. 5130.05, JBD 16372. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 241

misstatements that Deloitte missed, net of tax, and were in excess of planning materiality, individually or in the aggregate, then the following would have been a more accurate representation of net income in the audit years under consideration:80 Net Income (Loss) as: Year Originally Reported Adjusted for Errors 1993 $7,807,922 $5,426,095 1994 5,835,077 3,332,936 1995 11,766,969 2,748,452 1996 11,053,702 (19,318,500) 1997 (44,130,869) (89,814,090) 106 I return to Regan’s conclusion that, while Deloitte should have uncovered the fraud in 1996 and 1997, he could only put it as high as Deloitte “may have” uncovered the fraud in the pre-1996 years. Both Froese and Yule were in agreement with the latter conclusion. Having regard to Regan’s starting position about the level of professional skepticism that he would bring to bear in the circumstances, which I found was too high a standard from a Canadian perspective, and at the risk of merg- ing liability and causation principles, I think it is safe for me to conclude that the plaintiff did not cross the “balance of probabilities” finish line on the liability issue for these early audits. 107 In other words, even if I were wrong and Deloitte did not meet the requisite standard of care during the 1993, ’94 and ’95 audits, I am not persuaded that the alleged breaches during those years caused any damage to Livent, an issue to which I will return in the damages portion of this judgment. 108 But Deloitte, as best as I understand from its argument, did not reduce its position to the above “simplified” proposition about proof on a balance of probabilities even though Mr. Fleming, one of Deloitte’s counsel,

80I have included the chart found in the Reply Submissions of the Plaintiff, at p. 44. The numbers in this chart were modified from those in the Initial Closing Submissions of the Plaintiff, vol. 2, at pp. 21, 36, 47, 77, 171, so as to take account of the effective tax rate, an issue raised in the Closing Argument of Deloitte & Touche LLP, vol. 2, Appendix 6. Having regard to my conclusion on the materiality of these numbers, I do not have to consider the debate over the issue of pre-and post-tax materiality. 242 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

developed this theme in his cross-examination of Mr. Regan, excerpted above. Therefore, I propose to touch on a few of the matters upon which the plaintiff led evidence and which occupied a significant portion of its multiple detailed facta. To do this analysis, I have appended as Appendix B to this judgment various tables (the “Impact Charts”) setting out by line item, the alleged errors and their impact on tax-adjusted net income, the final snapshot of which is depicted above.81

ii. PPC 109 From my review of the Impact Charts, it appears that the overwhelm- ing bulk of the alleged errors, individually or collectively, were generated through increased amortization of PPC not initially taken. Increased PPC as an alleged error represented 85% of tax adjusted errors in 1993, 78% in 1994, and 73% in 1995. Without getting into the math, even these ratios overstate the alleged errors since the numbers are cumulative from one year to the next and include a reversal of some $4,557,528 of PPC previously reported for the Show Boat original preproduction costs as a result of the change in accounting policy effective as of year-end 1995. In other words, because of its retroactive change in accounting policy, Livent was able to “overstate” its net income in 1995, which Livent’s counsel suggests was done purposefully. 110 Without detailing the evidence in respect of the debate surrounding the change in policy, the supposed rationale for same and whether or not it should have been done on a go-forward as opposed to a retroactive basis, suffice it to say that it was a policy change that was not done sur- reptitiously, and not without significant discussion with Deloitte and others, including Richard Ivey Business School accounting professor Ross Archibald. I am not satisfied, contrary to argument by Mr. O’Kelly on one of the many days that was devoted to this issue, that the plaintiff has established that the change in policy was another example of Gottlieb and Eckstein’s deceptive number-juggling. In my view, whether Deloitte was correct or not in permitting the change in policy to be implemented on a retrospective basis, if at all, was clearly a matter of judgment and was acceded to only after reasonable consideration.

81I have included in Appendix B the Impact Chart prepared by Deloitte’s counsel for the 1993 Audit, with which the plaintiff does not take issue. I have used the plaintiff’s charts for the balance of the years to 1997 so that I can employ an “apples to apples” comparison for purposes of describing this issue. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 243

111 I am also not persuaded that for the years ending 1993-1995 Deloitte did not properly plan for and undertake reasonable procedures when auditing the PPC amortized and capitalized in any year. While there may be some argument that Deloitte missed or did not insist on the taking of increased amortization for Phantom and Joseph in the early years, it was live to the risks inherent in management evaluations and undertook a “tailored program” to safeguard against failure to comply with GAAS. 112 In addition, I agree with Deloitte that the PPC issue in the pre-1996 period has to be considered in context. It is not as if significant amounts of PPC were not taken in any of the years in question.82 Indeed, when it was determined as it was, for example, in 1994 with Kiss, that the remaining PPC had to be taken since the show was destined for the trash heap of great theatrical ideas, close to $10 million was taken in that year. Furthermore, at this stage in the relationship, there was little if any evidence to suggest that Deloitte should have been on guard with the representations and judgment of front-line and back office management on the production side of the operation. To that extent, where the evidence of Mr. Regan on pre-1996 PPC conflicts with that of Mr. Yule, I accept the evidence of the latter over that of the former. 113 This last observation carries me into three additional areas which clearly had an impact on the Regan take on some of the matters in issue, namely (a) the early reputation of Drabinsky and Gottlieb and initial due diligence of a “new client”; (b) the “DCC debenture”; and (c) the continuity and experience of the audit team.

iii. Reputation 114 We now know that Drabinsky in particular, if not Gottlieb, was something of an enfant terrible as he was making a name for himself first at Cineplex and latterly at Livent. The plaintiff tried to lever their individual or collective reputations at the time of the creation of MyGar into a matter of accepted notoriety. To that end, counsel for the plaintiff attempted to introduce into evidence certain newspaper and magazine articles which suggested that Drabinsky and Gottlieb operated on, or very close to, the integrity line. I was not persuaded that the articles themselves should be received in evidence for the truth of their contents when the defendant’s witnesses to whom the articles were put had not seen them. The witnesses were also not prepared to acknowledge that they

82Closing Argument of Deloitte & Touche LLP, vol. 2, at paras. 155-64. 244 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

knew the integrity of management to be in question. Had the plaintiff wanted to establish the poor reputations of Drabinsky and Gottlieb, which it suggests were borderline disreputable, they could have easily called the Hon. Leo Kolber or Allen Karp Q.C., the Chair and CEO, respectively of Cineplex at the time of their ouster. 115 Aaron Glassman, the first Deloitte partner who assumed the role of MyGar and Livent’s Engagement Partner and in later years became the Lead Client Services Partner (“LCSP”), was aware that Drabinsky and Gottlieb were aggressive in their approach to accounting matters and had been involved in a messy take-over fight. But he had not heard that either of them should be viewed with suspicion on the integrity front. Indeed, MyGar — i.e., Drabinsky and Gottlieb — came to Deloitte from C&L, and from a well-respected partner at that firm, and was introduced to Deloitte through Leonard Barkin, Glassman’s longstanding partner, who knew Gottlieb both on a business and social level and acted as the LCSP from 1989-1993, inclusive. 116 The plaintiff attempted to persuade me that Glassman in particular and Deloitte in general failed to discharge their due diligence obligation when taking on this engagement, contrary to the provisions of the Deloitte Manual, if not the Handbook. I am not persuaded that this proposition is correct or that whatever standard existed in the late 1980s and early 1990s was not met by the discussions among partners. Furthermore, to demand anything further by way of due diligence would have set the bar too high in that era of professional engagements or retainers, particularly in a city such as Toronto, where the competition for business was fierce.

iv. The DCC Debenture 117 I preface my remarks in respect of this transaction by observing that the evidence was anything but clear even though the parties concluded an Agreed Statement of Facts which set forth some, but not all, of the attendant constituent elements.83 But for the testimony of Aaron Glassman and Maria Messina,84 who were not involved in the transactions per se, I

83Agreed List of Documents and Facts Relevant to the Pantages South Develop- ment, Exhibit 5. 84Part of the problem in understanding and resolving this issue stemmed from the fact that Mr. Glassman, whose integrity is unquestioned, did not have a firm grasp of the facts of this and other transactions. His evidence at trial was obvi- Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 245

did not hear from any of the actual participants. In the final analysis, I was compelled to review, for the umpteenth time, some of the documents filed as part of the 16000 plus Joint Book of Documents, a task which, notwithstanding the hyperlinked facta of counsel, was not easy.85 118 In June 1990, LECC entered into an agreement with the City of To- ronto (“Master Agreement”) which provided for the swap of lands that Drabinsky and Gottlieb intended to buy at the Bond/Dundas intersection in exchange for lands contiguous to the Pantages, which came to be known as the Victoria/Shuter lands. The Bond/Dundas lands were purchased in September 1990 for $7.875 million, with a down payment and a subsequent capital payment totaling approximately $1.1 million and the balance financed with two vendor take-back mortgages. Title was taken in the name of LECC, subject to a trust declaration in favour of Drabin- sky and Gottlieb as the “undisclosed” beneficial owners. In late Decem- ber 1991, the two partners, as equal shareholders, caused MyGar Realty Inc. to be incorporated. They immediately transferred the Bond/Dundas lands from LECC to MyGar Realty Inc., subject to a second declaration in favour of the same “undisclosed owners”, namely, Drabinsky and Gottlieb. 119 In the middle of May 1991, LECC, as nominee for MyGar Partner- ship, entered into an Amending and Restating Loan Agreement with RBC, in which, among other covenants, it agreed that it would not enter into any debt agreement other than for debt incurred in the ordinary and

ously tied to and rooted in his discovery evidence which was taken in November 2003, when his recollection of events was not much better than it was at trial. To some extent, his failures of memory are excusable since the events in question occurred 10-plus years before to the date of the discovery and 20 years or more before the date of trial. However, as was evident from the familiarity with the facts demonstrated by the liability experts, had Mr. Glassman spent the same amount of time reviewing the Deloitte work papers as they apparently did in preparation for the giving of evidence, his recollection of events might have been markedly improved and my task would have been made appreciably easier. 85I would hasten to observe, as a self-styled “technovangelist”, that I could not have undertaken this review during and after trial without the electronic data base — and the instructions in respect of the use of same — that the parties provided me. 246 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

normal course of its business (the “Negative Covenant”).86 At the end of May, LECC, again acting as nominee for MyGar Partnership, issued a debenture to DCC Equities Limited (“DCC”) for $5 million (“DCC De- benture”). Contemporaneously with its execution, Drabinsky and Got- tlieb executed a Beneficial Owners Agreement and Guarantee in favour of DCC in which they pledged their respective interests in LECC and MyGar Partnership to cover the obligation under the DCC Debenture.87 120 In early March 1992, but on a date that was never really buttoned down on the evidence, LECC and RBC entered into an agreement “made as of December 31, 1991”, amending the May RBC Agreement.88 In- cluded in this agreement was a paragraph which specifically exempted the DCC Debenture from the effects of the Negative Covenant. In other words, RBC acknowledged the obligation to DCC and gave approval to the transaction notwithstanding its “creation” a scant few weeks after the execution of the May RBC Agreement. 121 The plaintiff takes the position that the DCC Debenture and the obligations arising thereunder were those of MyGar Partnership at the end of 1991 and should have been disclosed by management to Deloitte prior to the completion of the 1991 audit. In fact, the plaintiff argues that since management did not disclose this transaction to Deloitte before the completion of the 1991 audit, it specifically mislead the Firm by not coming clean on the deal during the relevant time and by signing a representation letter for that year which failed to disclose the DCC Debenture. 122 On the plaintiff’s view of the evidence, the DCC Debenture was not discovered by Deloitte until during the preparation of the 1992 audit, in

86Amending and Restating Loan Agreement, 17 May 1991, JBD 13275, s. 7.15 (“May RBC Agreement”). 87Beneficial Owners Agreement and Guarantee, JBD 12143, s. 3.02. 88RBC Amending Agreement, 31 December 1991, JBD 15107, s. 2(3) (“De- cember Amending Agreement”). See also Letter from Glassman to Eckstein, 6 March 1992, JBD 11598 (requesting copy of revised loan agreement, with handwritten marginal note that it had been received on March 9, 1992); Letter from Eckstein to Glassman, 9 March 1992, JBD 11594 (enclosing letter confirming amended loan agreement); Letter from RBC to Gottlieb, 5 March 1992, JBD 11595 (setting out amendments to loan agreement). I am satisfied from a review of this correspondence that Deloitte had a copy of the December Amending Agreement as late as March 9, 1992, before the 1991 Original Statements were completed. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 247

early 1993.89 It argues that this revelation, late as it was, amounted to anything but a frank disclosure. Furthermore, the full circumstances surrounding the DCC Debenture should have “outraged” Deloitte, as they did Regan, and should have raised their suspicions that Drabinsky and Gottlieb were playing fast and loose with their obligations of, among other things, full disclosure to the Firm as a precursor to the audit process.90 123 The Defendant argues, in spite of Glassman’s poor recollection of the subject, that Deloitte had been informed of the pending DCC Debenture transaction as early as November 1990, as the documents suggest.91 Fur- thermore, it is Deloitte’s position that there was nothing untoward about the transaction since the debt created as a consequence was not, in fact, an obligation of LECC/MyGar Partnership but was that of the “partners”, Drabinsky and Gottlieb, until the bank financing and the Negative Cove- nant had been renegotiated or some other arrangements had been put in place. 124 I have struggled mightily with this transaction. I vacillate between the positions expressed by Regan, which, as I indicated, was one of outrage, and Yule, who was prepared to give the transaction a pass, and the arguments of counsel for each side. I am further troubled by the fact that no one at Deloitte thought to “follow the money” paid under the DCC De- benture, if in fact any payment was made, about which Mr. O’Kelly cautioned me on several occasions. 125 In the final analysis, I prefer Mr. Yule’s take on this transaction over that which is propounded by Mr. Regan — and, indeed, by Mr. O’Kelly through his compelling and persuasive advocacy. I am satisfied, however, on a balance of probabilities that the Bond/Dundas land and the $5 million DCC debenture were beneficial assets and liabilities of Drabin- sky and Gottlieb personally, as at December 31, 1991. They were subsequently transferred to MyGar Realty, as of December 24, 1991 and in the months following as a precursor of and to facilitate the IPO. Hence, they

89Memorandum describing financing of Pantages Place development, 2 Febru- ary 1993, JBD 12473; Letter from Kofman to Gottlieb, 4 January 1993, JBD 12474. 90Initial Closing Submissions of the Plaintiff, vol. 2, at para 328. 91Letter from Gottlieb to Deloitte, 8 November 1990, JBD 13543; Memoran- dum re: “Royal Bank - Financing Proposals”, 7 November 1990, JBD 13544. 248 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

did not have to form part of the asset and liability mix of MyGar in 1991 and need not have been disclosed in the Original 1991 Statements. 126 I am satisfied that RBC was in the loop on what was going on after the DCC Debenture was concluded at the relevant time and why. Had RBC thought that it was being played for a fool by the end of 1991, or as late as early March 1992, it would not have entered into the December Amending Agreement, and a further amending agreement in early May 1992, and in all probability would have called the loan under the May RBC Agreement. I am also satisfied that Deloitte was aware of the DCC Debenture by virtue of the fact that it apparently received a copy of the December Amending Agreement in early March 1992 before it completed the 1991 audit even though a copy of same was not to be found in its files. Glassman must have concluded that the DCC Debenture was the separate obligation of Gottlieb and Drabinsky even though, as I indicated, he has no present recollection of the details of the transaction. 127 Whether or not Drabinsky and Gottlieb were merely keeping their op- tions open until they determined what made the most sense from an economic, personal or corporate point of view is something about which I can only speculate. Furthermore, the various memos and letters penned by certain Davies, Ward and Beck lawyers, Livent’s counsel on the underwriting, in the months ramping up to the IPO are instructive in that regard.92 I am not, therefore, persuaded that the plaintiff has proven that Deloitte failed to conduct a proper of audit of this very complicated transaction in accordance with GAAS.

v. Continuity and Knowledge of the Client’s Business 128 From time to time during his evidence, Mr. Regan took the position that the Deloitte audit team in all the years in question did not possess adequate technical training and proficiency in auditing. I do not recall hearing any evidence from him or seeing anything in his report that would permit him to come to this conclusion absent any knowledge of the training, education and experience of those who staffed the audits. I did not hear any evidence that either Glassman, the first audit engagement partner, or Messina, his successor, lacked the skill sets required to first audit a partnership operating through a nominee company, and then

92Memorandum from Davies, Ward & Beck, 14 July 1992, JBD 1267; Memo- randum from Davies, Ward & Beck, 13 March 1993, JBD 1496; Letter from Davies, Ward & Beck to OSC, 3 March 1993, JBD 1561. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 249

a publicly-listed company. It is unquestioned, as well, that Glassman had a wealth of experience with aggressive entrepreneurial managers such as Gottlieb and Drabinsky. 129 It is also apparent that for the first years of the audit, from 1989 to 1995, Deloitte deployed senior staff and senior managers up to the position of audit engagement partner and LCSP, who were familiar with MyGar and Livent.93 130 As the audit engagement partner for the first five years of the engagement, Glassman was responsible for all aspects of the audit. He was obliged to, among other things, participate in a supervisory role in the audit planning, respond to questions from the staff while the audit was being conducted in the field and ultimately review the finished product for conformity with the audit plan before signing the audit opinion. He had the same senior managers working the engagement during his tenure: first Ron Cutway and then Maria Messina. Furthermore, there was some measure of continuity with the senior and field staff accountants during this period. 131 Messina succeeded Glassman as the engagement partner in 1994 and continued in that capacity through the end of the 1995 audit. Because Livent was her first posting as an engagement partner, I was told that Glassman stayed more involved than he might otherwise have done in the first year of her appointment. In addition, her support staff was comprised of many of the same senior and junior accountants. Similarly, Pe- ter Chant and Bob Wardell, two senior partners working out of the Na- tional Office, remained in the picture as Advisory or Quality Assurance Partners. 132 In the final analysis, I am not persuaded that in the period to the end of 1995 the Deloitte staffing complement handling the audits was anything but reasonably competent. I am also satisfied that Deloitte would have been able to discharge the obligations of knowing and understanding the operation of the client as mandated by s. 5140, summarized above, with the teams that had been assigned to the audits in the years up to 1995. To foreshadow what is to come, I am satisfied that Deloitte did have issues in this regard in the two years thereafter, even though certain

93See the “Continuity Schedule” in the Closing Argument of Deloitte & Touche LLP, vol. 2, Appendix 8. 250 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

senior partners working out of the National Office remained involved in the audit to some extent.

b. The 1996 Audit i. Backdrop 133 1996 was something of a watershed year for Livent and, as a consequence, Deloitte. It was a company that was seemingly in the limelight all the time, in part because of the nature of its core business, its flam- boyant and headline-seeking CEO, Drabinsky, and because of all the attention it was getting in the popular press through articles in business media, investment analysts’ reports, The Financial Post, and Forbes magazine. Because of the nature of its business, it incurred significant upfront costs, irrespective of the success of the multiple productions that were then operating or under development. Furthermore, Livent had invested heavily in theatre and other real estate in New York, Chicago and Vancouver, in addition to the Pantages development in Toronto, all of which had to be financed. 134 As a consequence, Livent was always casting a covetous eye to the capital markets, seeking to raise money either by way of debenture offerings or through public or private placements of its common stock. In 1996 alone, it raised in excess of $96 million, with an increase in liabilities, net of production trade accounts, of almost $70 million from 1995.94 Revenues from productions were not keeping pace with the demands of the operation and it became apparent that Livent was going to have to look away from its core business to fund its debt burden, at the very least. Indeed, in 1996 Livent took an $18.5 million write-off in respect of the Sunset Boulevard production, which was by no means insignificant. In the meantime, and perhaps unexpectedly, Livent convinced Messina to leave the Deloitte partnership and join the Company as VP, Finance in May 1996, where she assumed the additional role of CFO in November. 135 As Deloitte started planning for the year-end 1996 audit, it was faced with the unenviable task of having to re-staff its audit team, while in the meantime maintaining some level of continuity to ensure transference of client knowledge and information. Deloitte thought that this had been ac-

94See n. 9 above regarding the seeming conflict between Appendix A of the Ratner Report and the numbers shown in the Livent Inc. 1996 Annual Report, JBD 9461, at p. 39. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 251

complished by appointing John Cressatti as the day-to-day Engagement Partner, with support from Bob Wardell as the Advisory Partner and Glassman as the LCSP. Cressatti, who was a relatively new audit partner, had no experience with Livent or, indeed, with the Drabinskys and Got- tliebs of this world, even though in 1994 he had done a review at Mes- sina’s request of the capital accounts for the Pantages development from a real estate perspective only. And Glassman’s evidence was that he had minimal involvement with the client in 1996 and was rarely called upon, if ever, to speak with either Drabinsky or Gottlieb. That said, and for what it is worth, the senior manager, Christopher Craib, and the other senior staff were carryovers from the time when Messina was last En- gagement Partner. 136 There is no doubt that Deloitte assessed the engagement risk for the 1996 audit to be “greater than normal”, which was a Firm euphemism for “high risk”. When preparing the 1996 audit plan in which the overall assessment of the engagement risk was defined, the Deloitte senior staff and, presumably, the partners considered the following criteria: 1. The Company faced internal and external business and industry risks. 2. The Company had entered into a number of material and unique revenue-generating transactions, which created reporting issues. 3. The Company was publicly-traded in both Canada and the U.S. and attracted a high level of scrutiny and public observation. 4. Management of the Company was sensitive to reported net earnings levels, and was aggressive in arriving at its bottom line. 5. The valuation of preproduction costs was subject to management estimation and financial projections. In addition, resultant amortization and/or write-offs of PPC were known to have a significant impact on net earnings.95 137 While not specifically identified as an engagement risk for 1996, previous audit planning memos underscored the fact that senior management (Gottlieb and Drabinsky) was very demanding and expected timely, high-quality service at relatively low cost. It was previously understood

95Audit Planning Memorandum, 1996, JBD 5640. 252 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

that the pressures on the audit partners were and would be significant. Deloitte recognized that its tax group in particular might be able to provide additional services to Livent, although there was a strained relationship in that area, which had to be safeguarded in some fashion.96 Whether this inherent conflict between the Firm’s professional obligations, on the one hand, and its attempts to earn additional fees and satisfy the demands of its client, on the other, drove the audit agenda was never directly addressed in evidence, but sometimes appeared to be the ele- phant in the room. 138 In addition, I had some difficulty reconciling certain other matters that made their way into the 1996 Audit Planning Memo. On the one hand, there was a clear mandate that the level of professional skepticism had to be increased on all fronts, which had to be and was supposedly communicated to all staff. In addition, it was anticipated that there would be more than normal Engagement Partner involvement, if not the utiliza- tion of two audit partners to ensure compliance with the audit plan, which suggests that there were concerns that had to be dealt with at the experienced-partner level only. 139 What remained something of mystery to me, however, and one which was not readily explained by Deloitte, was the fact that the planning materiality level for 1996 was set at $1,670,000, an increase of roughly 30% from the previous year. This meant that, by definition, less drilling down would be undertaken by the audit staff even though there were some new and looming issues, as the planning memo suggested. 140 I have reviewed the areas of alleged GAAS failure for 1996. I have concluded that Deloitte failed to meet its standard of care in the way it dealt with PPC, the Musicians’ Pension Surplus Receivable and the Rev- enue Transactions. Notwithstanding the detail to which Livent’s counsel went in marshalling the evidence and arguing its case, the plaintiff has not persuaded me that the other areas of concern, including Ticketmaster Exclusivity, Accounts Payable testing and Westsun Inducement Fee revenue, demonstrate on a balance of probabilities that Deloitte did not conduct the audit in accordance with GAAS. I now propose to canvass the three items listed above which occupied much of the trial and remain to be considered.

96Audit Planning Memo, 1995, JBD 2812. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 253

ii. PPC 141 PPC was the first area of continuing if not growing concern for Deloitte and Livent’s Audit Committee. In May 1996, Bob Wardell was asked by Gottlieb on behalf of the Audit Committee to provide an over- view of the appropriateness of the valuation of unamortized PPC, which stood at $55.5 million at year-end 1995. Wardell co-authored a letter to the Audit Committee in which he and his colleagues represented to the Committee that because of the “uncertainty inherent in projecting future revenues to be derived from individual productions”, Deloitte undertook a “focused audit approach” that would better enable them to ensure that the net recoverable amount and the actual amortization taken were properly computed in accordance with the new income forecasting policy put into place in early 1996, retroactive to 1995.97 142 He then went on to describe in detail the steps that Deloitte had taken during the 1995 audit, which permitted Wardell to conclude that Deloitte was satisfied that “unamortized preproduction costs and the amortization calculations were adequately documented and properly computed and that the financial statement presentation and disclosure was appropriate”.98 143 Leaving aside from this discussion whether or not Deloitte actually undertook the 1995 audit in the manner set forth in the Wardell/Deloitte memo to the Audit Committee, and, indeed, whether Wardell himself was aware of the enormity of the impact of the retroactive application of the new policy, there is no doubt that PPC and all aspects of PPC should have been front and center in the Deloitte collective mindset when it came to the completion of the 1996 audit. 144 This proposition is further underscored by the nature of the tailored PPC audit plan that Deloitte designed as part of its overall audit. First, in one of its many pre-audit memos, we find the following observation: The Company’s accounting policy for the deferral and amortization of preproduction costs is subject to estimates involved in predicting the potential success of individual shows. Although the Company’s experience in this area is growing significantly it remains an area of

97Letter from Deloitte to Livent Audit Committee, 13 May 1996, JBD 3281, at p. 1. 98Ibid., at p. 2. 254 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

considerable subjective estimation in which differing results could materially alter reported earnings.99 145 Leaving aside for the moment my cynical view that Deloitte seems to have spent as much time preparing planning memos as it did conducting the audits, the tri-partite plan the Firm developed in respect of PPC included the following steps: 1. Test additions for the year to supporting documentation by obtaining the preproduction continuity by show...; 2. Test the amortization of the preproduction costs for reasonability; 3. Test the carrying value of the preproduction costs by testing the show forecasts, for selected shows, on a show by show basis.100 146 Critical to every aspect of this analysis was the fact that Deloitte undertook to “[o]btain operating projections for each production” and to “[c]ompare projected results with historical results where data available”.101 147 I do not intend to analyze in these reasons the detailed position of the parties found in either the evidence of Messrs. Froese or Regan or in arguments of counsel.102 If I understood the evidence in this very complicated area correctly, Deloitte selected Show Boat I, II, and III for testing. While I understood these shows were “big ticket” productions in 1996, it resulted in Deloitte not reviewing projections for Ragtime, Jo- seph or Phantom tour, which collectively represented $29.9 million or 30.6% of the $77 million of unamortized preproduction costs on Livent’s books at year-end. Hence, notwithstanding the Audit Plan, Deloitte arguably did not “obtain operating projections for each production”, as promised.

99Assessment of Engagement Risk and Control Environment, 11 December 1996 (prepared), 27 January 1997 (reviewed), JBD 5924, at p. 8. 100Preproduction Cost - Model Audit Program, 25 February 1997, JBD 5565. 101Presentation of 1996 Audit Plan, 5 November 1996, JBD 4714, at p. 10. 102The plaintiff’s counsel did a very detailed analysis of the productions chosen for testing and those that should have been chosen for testing in the Initial Clos- ing Submissions of the Plaintiff, vol. 2, at pp. 97-121. I could not begin to distill the information that is contained in the multiple tables and evidence references found in that portion of the argument, which I found to be compelling. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 255

148 It would also appear that Deloitte did not “compare projected results with historical results” for any production other than Show Boat II, which was done for the first three quarters of 1996 only. Furthermore, there is no record that the audit team compared budgeted amortization to actual amortization for the year even though it was aware that the productions universally performed poorly that year. Deloitte was aware that after amortization of PPC, the Livent shows lost, in the aggregate, $22.9 million, while they were projected to earn a net income of $20.6 million, a variance or swing of 218%. Indeed, while isolated instances of this kind of analysis were performed by the audit manager, Craib, it does not appear that others at Deloitte, including Cressatti (who was ultimately responsible) asked for, received and reviewed the 1996 budgets. The star- tling effects of this “oversight” are seen in the tables contained in Exhibit 33, which are self- explanatory:103 Performance Revenue - 1996 Budget Actual Variance % Joseph Tour 48,780,506 36,774,182 (12,006,324) (25) (RTA, para. 199) Show Boat 1 Tour 48,949,595 40,582,104 (8,097,491) (16) (RTA, para. 253) Show Boat 2 54,661,539 47,043,511 (7,618,028) (14) (RTA, para. 264) Show Boat 3 51,698,250 45,950,839 (5,747,411) (11) (RTA, para. 288) MOTN Tour 33,881,200 22,356,065 (11,525,135) (34) (RTA, para. 99)

Income (Loss) before amortization of PPC (“Operating Profit”) - 1996 Budget Actual Variance % Joseph Tour 10,166,644 7,022,203 (3,144,441) (31) (RTA, para. 200) Show Boat 1 Tour 9,071,651 6,816,658 (2,254,993) (25) (RTA, para. 255)

103Budget to Actual 1996-1997, Exhibit 33. 256 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Budget Actual Variance % Show Boat 2 4,108,157 (373,887) (4,482,044) (109) (RTA, para. 263) Show Boat 3 12,342,783 6,770,703 (5,572,080) (45) (RTA, para. 287) MOTN Tour 6,562,522 4,494,442 (2,068,080) (31) (RTA, para. 99)

Profit (loss) after Amortization of Touring PPC - 1996 Budget Actual Variance % Joseph Boston 2,542,427 (3,948,448) (6,490,875) (255) (RTA, para. 203) Show Boat 1 Tour 4,153,263 (132,586) (4,285,849) (103) (RTA, para. 257) Show Boat 2 No tour in ’96 Show Boat 3 No tour in ’96 MOTN Tour 3,461,930 (436,823) (3,898,753) (113) (RTA, para. 99)

Net Profit (loss) - 1996 Budget Actual Variance % Joseph Tour 4,529,144 (1,095,515) (5,624,659) (124) (RTA, para. 201) Show Boat 1 Tour 4,153,263 (132,586) (4,285,849) (103) (RTA, para. 257) Show Boat 2 3,086,747 (1,395,297) (4,482,044) (145) (RTA, para. 265) Show Boat 3 7,642,657 4,364,663 (3,277,994) (43) (RTA, para. 290) MOTN Tour 381,163 (436,823) (817,896) (214) (RTA, para. 99) 149 Notwithstanding the second portion of the three-pronged test that Deloitte undertook to perform, namely a determination of the reasonableness of the amortization taken in the year, which I understood required a review of actual results to budgeted results, Mr. Cressatti steadfastly indicated to me throughout his evidence that such a review was satisfied Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 257

simply by considering the end carrying value of the PPC by production. In other words, Mr. Cressatti was of the view that a review of the projections of revenues into the future by show, based on the estimates of management, without more, was sufficient to vouchsafe the numbers. 150 First, in my view, this type of analysis thrust Deloitte into the realm of “audit by conversation” since it relied on and obtained by way of audit evidence the representations of management as to potential revenue for any one show. Second, they simply neglected to test these estimates for accuracy by failing to look long and hard at the recently experienced results, which, as the above tables suggest, had to cast doubt on the accuracy, if not the veracity, of what they were being told. 151 What is a tad ironic, and what foreshadows some of the problems that became apparent in 1997, are the comments found in the post-audit Points Forward Memo, which is a memo to the Deloitte staff assigned to conduct future audits. Tina Patel, the senior auditor assigned to the team, made the following observation in respect of preproduction costs: The selection of shows for which the performance forecasts are to be done should be made from interim reporting schedules. The forecasts should be made available preferably at the beginning of the audit. The shows to keep a close eye on for future is Show Boat#1,2,3, Ragtime and Phantom tour. We should determine if the clients [sic] forecasting is reasonable by looking at the past forecasts vs. actual results[.] [W]e have the 1997 forecast for all three by city and in 1997 we will get the operating statements for each tour by city.104 152 Again, as best as I understand the Patel memo, it would seem that she and Deloitte were putting off until 1997 that which they had agreed to undertake in 1996, if the audit plans and the memos to the Audit Com- mittee were to govern. That failure leaves me shaking my head. Even accepting, as Froese suggested,105 that the auditor should defer to management’s judgment when that judgment is within a reasonable range, Deloitte’s approach to the 1996 PPC audit cannot be said to have been in accordance with GAAS by any measure. 153 Finally, the evidence indicates that Deloitte did not insist that management take a reserve for PPC in 1996 even though one was taken in

104Points Forward Memo, 26 February 1997, JBD 5639, at p. 1 (emphasis added). 105Transcript, Froese Cross-Examination, 24 July 2013, at pp. 496-97. 258 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

each of 1994 ($2 million) and 1995 ($5.275 million) when the total capitalized PPC was significantly less than what it was in 1996. In fact, as I recollect this was not even a topic of discussion at Deloitte, notwithstanding the fact that Livent’s PPC issues should have given rise to a high degree of professional skepticism. 154 In the final analysis, during the re-audit, an $11 million charge was taken against 1996 Net Income in respect of PPC not sufficiently amortized in the year. This amount is in addition to the $3.1 million that was improperly recorded or moved from account to account between various productions. The number in absolute and relative terms was beyond material. What should have been done along the way is another matter.

iii. Musicians’ Pension Surplus Receivables 155 For the 1995 audit, Deloitte selected two pension surplus receivables for testing: those associated with the Kiss of the Spider Woman tour of New York and Show Boat New York. The audit of these receivables was conducted by Tina Patel and overseen by Messina, the audit engagement partner. 156 Some explanation of the nature of these receivables is required. Livent had to use musicians from the New York Local 802 of the Ameri- can Federation of Musicians union (“Local 802”) for performances in New York theatres. Under New York law, the theatres were required to deduct 4.5% from box office receipts and remit 23% of that amount to Local 802 on account of the musicians’ pension entitlement. 157 Livent’s position was that Local 802 was entitled to less under the collective agreement than it was receiving by way of deductions from box office receipts, resulting in an overpayment that Livent was entitled to recover from the union and record in its books as a receivable. 158 It turns out that Local 802 never acknowledged the alleged liability to Livent. Instead, it disputed the claim and ultimately prevailed. The receivables were written off on the re-audit. 159 At the time of the 1995 audit, however, Deloitte did not confirm the receivables with the union and therefore did not find out that they were disputed. Instead, Deloitte accepted management’s representation that the receivables could be recovered from the union and that the receivables could be carried forward to off-set payments that Livent would have to make to the union from future shows in Chicago. 160 Ms. Patel dutifully made a note of this explanation, and thereupon matched the payments to the accounts of the theatre at which the “receiv- Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 259

able” was originally generated and passed on the receivables as appropriately tested. Deloitte accepted this explanation as reasonable for the 1995 audit because the Actors Equity Union had apparently agreed to a similar arrangement in the past. I do not agree with the plaintiff’s contention that the audit work undertaken by Ms. Patel for year-end 1995 did not accord with GAAS. I prefer the evidence and argument put forward by the defendants for that year. Given that the amounts in issue and the explana- tions for how they were being dealt with were reasonable, Deloitte was entitled to rely on management-prepared schedules and information and was not required to confirm those representations with the union. 161 Patel tested the same receivables during the 1996 audit. Both Kiss and Show Boat had toured during the previous year. If Livent’s representation that the amount of the receivable would be set-off against future payments to the union was accurate, then one would have expected the amounts of the receivables to have declined. Instead, the receivable associated with Kiss remained the same, while that associated with Show Boat actually increased. 162 This was a red flag and should have been recognized as such, especially considering that the audit risk for the 1996 audit was set at “high”. Unfortunately, it appears that Ms. Patel not only failed to raise her own level of professional skepticism, but also failed to even audit by conversation. She copied, verbatim, the notations she made during the 1995 audit to the effect that the receivables would be carried to Chicago. There was no apparent regard for the unexplained increase in the amount of the receivable, nor for the plainly contradictory notation made by Livent at the bottom of the same page on which Ms. Patel copied her note: “Sur- plus to be applied against future New York Productions”.106 When these work papers were put to Cressatti in cross-examination, he indicated that further inquiries should have been made to drill down to the bottom of the alleged receivable.107 Indeed, after some waffling under cross-examination, even Froese grudgingly acknowledged that the work done by Patel did not conform to GAAS.108

106Musicians’ Pension Surplus Work Paper, 1996 Audit, JBD 5064. 107Transcript, Cressatti Cross-Examination, 12 June 2013, at p. 592. 108Transcript, Froese Cross-Examination, 9 September 2013, at pp. 785-87. It is worthy of note that initially, Froese would have found fault with this audit work in 1997 but not 1996. 260 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

iv. Revenue Transactions 163 To but repeat what was set out above, as the fortunes of its core business headed south at the end of 1995 and into 1996, Livent entered into multiple “material and unique revenue generating transactions” which Deloitte observed motivated management to select reporting methods that were “less favourable than potential alternatives”, whatever that term meant.109 These transactions throughout the course of the trial were referred to as the “Dewlim”, “Pace-Show Boat”, “Pace-Ragtime”, and the “Ticketmaster Exclusivity” agreements. There were two other agreements which covered the naming rights and exclusive sponsorship rights for the yet-to-be-built theatres in New York and Chicago (“the Ford Agreements”), which also became the subject matter of much debate within the Firm and Deloitte U.S. 164 The details of these agreements appear multiple times throughout the course of the evidence and in each of the expert reports. Indeed, to make matters more manageable and understandable, counsel provided me with an agreed statement of facts, Exhibit 29, setting out the elements of each of the transactions. Central to each of these agreements, save for the Ford Agreements, is the fact that Deloitte was not given the full story and, in each case, there were companion agreements, written or oral, which modified the written agreements provided to Deloitte. However, having regard to my conclusion in respect of whether or not Deloitte audited these transactions in accordance with GAAS, at least to the fall of 1997, I do not find it necessary to pr´ecis Exhibit 29. 165 The starting point for any analysis of the Revenue Transactions is the Audit Planning Memos for 1996, which included a financial statement presentation memo tailored to the reporting of theater naming and touring production rights.110 As previously indicated, the Deloitte audit team was well aware of the issues associated with the then-identified Revenue Transactions. Like the PPC issues, these transactions were highlighted for specific review and it was determined that “focused substantial tests” would be undertaken. This analysis anticipated, further, that the transactions would be reviewed “by senior audit personnel” with “direct discussion and analysis with senior client management”.

109Audit Planning Memorandum, 24 December 1996 (prepared), 27 January 1997 (reviewed), JBD 5640, at p. 4. 110Livent Inc. Theatre Naming Rights and Touring Production Rights, 31 De- cember 1996, JBD 4675. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 261

166 In addition, it was anticipated that the Revenue Transactions would receive special treatment in the financial statements as follows: • all items will be identified in SCFP [Statement of Consolidated Financial Position] as non cash transactions • disclosure of commitment under agreements, especially the touring productions • separate line item disclosure of non-production revenue sources with an accounting policy • long-term receivable note will indicate all details of transactions, and amounts that have been credited to income in the current period, (pursuant to 1994/5 disclosure).111 167 Interestingly enough, and for reasons that were never explained, I was told that none of these four planned disclosures were separately identified as part of the 1996 Original Statements. 168 An important piece of evidence is the chronology of events prepared by Bob Wardell in late July 1997. It was prepared in anticipation of a meeting between Martin Calpin, Deloitte’s National Risk Management Partner, and Gottlieb, who was continually threatening to drop Deloitte as Livent’s auditors.112 The Wardell Chronology, as the document became known during the trial, detailed the events leading up to the inclusion of revenue generated from these transactions in accordance with Ca- nadian GAAP, in March, and U.S. GAAP, in July, but only after a significant amount of partner time was devoted to the issue. Some of the items worthy of highlighting from the Wardell Chronology are as follows: • In late January 1997, Messina was asked by Wardell to assemble an information package containing the relevant agreements and schedules pertaining to the Dewlim, Pace, and Ford Agreements in preparation for the audit. The Ticketmaster Exclusivity Agree- ment was not given “special” consideration for GAAP purposes as it was considered to be a straightforward agreement, much like other exclusive rights deals, for which the total up-front fee received from Ticketmaster was included in income in 1996.

111Ibid., at p. 5. 112Bob Wardell, Memorandum to File: Chronology of Events Relating to Livent’s Revenue Recognition Issues, 21 July 1997, JBD 9465 (“Wardell Chronology”). 262 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

• Messina was not able to provide signed copies of all the agreements in a timely fashion, which did not seem to faze Wardell. • He and Cressatti met with Messina, Gottlieb and Topol, who negotiated the Pace agreements, on several occasions before the statements were finalized for presentation to the Audit Committee on the 7th of March. • After much discussion locally, Wardell agreed that the following amounts would be included in income from a Canadian GAAP perspective for 1996: (a) $2,048,250 - Ticketmaster Exclusivity Agreement; (b) $6,231,549 - Pace Show Boat agreement; (c) $4,231,015 - Dewlim Agreement; (d) $5,965,016 - Pace Ragtime agreement; (e) $6,251,925 - Ford Right of First Negotiation; (f) $7,024,175 - Ford Naming Agreement; • Gottlieb was not pleased that Deloitte was questioning Livent management on the agreements and felt that Deloitte U.S. was dragging its feet in agreeing with the inclusions of the same amounts for U.S. GAAP purposes. He threatened to pull the account if Deloitte did not accept Livent’s accounting treatment of the transactions. • After consultation with Peter Chant, the Canadian National Ac- counting and Auditing Technical Partner, Wardell reported to the Audit Committee that he was prepared to accept the income numbers set out above and was confident that Deloitte U.S. would follow suit shortly. • As matters progressed through the end of March, Deloitte U.S. was still not prepared to accede to the demands of Livent and remained firm that some or all of the income to be generated under certain of the Revenue Transactions had to be deferred to other years. This position, again, did not sit well with Gottlieb. • At the end of March, Wardell met with two other senior partners of Deloitte, Bruce Richmond and Paul Cobb. The latter was responsible for the Dundee Bancorp audit. Wardell “was concerned not only with the impact these events were having with respect to our relationships with Livent, an important public client, but also the possible fallout to Dundee Bancorp given Myron’s relation- Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 263

ship with Ned Goodman and his position as Chairman of Dun- dee’s audit committee”.113 • Multiple conversations were held among Chant and Wardell, on the one hand, and various of their U.S. partners, on the other, in an attempt to persuade the latter group to accept the proposed accounting from a U.S. GAAP perspective. Further information was solicited from Livent’s senior management which was used to bol- ster what was now the Wardell-Chant position in an effort to have Deloitte U.S sign off on the transactions. To this end, Chant prepared a detailed memo reviewing the transactions, in which he provided an opinion justifying the inclusion of income in the 1996 Original Statements. • The U.S. Partners were unmoved by the arguments. In June, Rod Barr, a senior Canadian partner in the National Office and a specialist on SEC matters, was asked by his American counterparts to weigh in on the argument. He reviewed the transactions but remained adamant that the Canadian position was flawed and “would NOT withstand the scrutiny of a professional skeptical challenge”.114 In this prophetic memo, he raised four areas of concern, which ultimately formed the basis of the plaintiff’s criticism of Deloitte in respect of the transactions: (a) Was Deloitte certain that there were no side deals “or other relationships among the counterparties” that would alter the nature of the agreements? (b) Why were the agreements silent on refundability? (c) What analysis had been undertaken to ensure that the counterparties had the ability to meet their commitments under the agreements? (d) What audit procedures were actually undertaken to check on the legitimacy of the agreements, since the U.S. partners were under the impression that much of the work comprised an audit by conversation, only?

113Ibid., at p. 6 (emphasis added). 114R.N. Barr, Memorandum to File: Livent Revenue Recognition, 20 June 1997, JBD11382 (“Barr Memo”). 264 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

• Wardell was not persuaded that the complaints and warnings articulated by Barr were warranted. While he was more inclined to accept that the deals reached were obtained because of the “level of sophistication, business acumen and negotiating skills of Messrs. Drabinsky [and] Gottlieb”, a position which he believed was lost on his U.S. partners, he was in large measure, relying on the “written and verbal representations from Livent’s senior in- house counsel and all senior executives”, including his former partner Messina, that there were no undisclosed agreements or amendments. He went on to observe: “If we were not prepared to accept such representations, it seems to me we should resign as auditors as we effectively would be questioning the fundamental integrity of our client”.115 • Gottlieb insisted on a face-to-face meeting with partners from the US firm in New York. On July 10 a meeting was held with four senior partners from Deloitte US, three partners from the Firm, including Chant, Wardell and Barkin, and Drabinsky, Gottlieb, Messina, Topol and Eckstein on the Livent side. • After a lengthy meeting in which the issues were reviewed yet again, the US partners met separately with Peter Chant and determined that they were prepared to accept immediate revenue recognition in respect of Pace-Show Boat and the Ford agreements only. They were not prepared to accept revenue recognition for Pace- Ragtime. They were only prepared to accept revenue recognition of the Dewlim agreement after certain pre-conditions were satisfied. • In the final analysis, Deloitte US was only prepared to accept $16 million of the originally requested for $26 million. • Finally, Rod Barr was asked to perform an independent review of the audit files to ensure compliance with the Deloitte manual, which he did and which was signed off on as at July 15, 1997. 169 As previously suggested, the Wardell Chronology was prepared as an aide m´emoire for Martin Calpin in preparation for a meeting that was scheduled to take place with Gottlieb in late July, during which Gottlieb wanted to discuss “relationship and client services issues”. Gottlieb clearly believed that the best defence was a good offence and, as I assess

115Wardell Chronology, supra note 112, at p. 9 (emphasis added). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 265

the evidence, bullied the Deloitte partners to bend to his positions, with the added leverage of his connection to Dundee Bancorp and its CEO, Ned Goodman, which he threw in for good measure.

v. Conclusion 170 I have concluded, and not without some misgivings, that Deloitte, as of middle of July, could not be faulted for the work it did in respect of the Revenue Transactions and the conclusions it reached. A significant amount of partner and staff time on both sides of the border was spent reviewing these transactions. That said, the criticisms leveled by Regan in this action, which to some extent parallel the concerns expressed by Barr in June 1997, are not without merit. However, I am not persuaded that, had Deloitte undertaken any of the audit steps suggested by seeking further confirmation from the counterparties to the Dewlim and Pace Agreements, such would have revealed the frauds. The simple fact is that Deloitte was lied to and misled about the nature of the transactions up and down the management line, which included, to a greater or lesser extent, prevarications from in-house counsel, executives other than Got- tlieb, and Messina, a former partner. When attempts were made to vouchsafe the credit of Dewlim, for example, Deloitte was misled yet again by a client, if not by the silence of Andy Sarlos, a Livent board member and the person who initially negotiated the deal with Gottlieb. I have no reason to conclude that, had Deloitte undertaken the investiga- tory steps beyond the audit standards suggested by Regan, the results at that moment in time would have yielded more or different information. 171 While I have concluded that Deloitte did not conduct an audit in accordance with GAAS in respect of the PPC and Musicians’ Pension Sur- plus Receivable accounts, I am not satisfied that a confrontation with management over these accounts as deductions from revenue would similarly have revealed instances of fraud or other irregularities sufficient to close Livent down. 172 First, even if Deloitte had concluded that the PPC, for example was overstated in 1996 and greater amortization had to be taken, I saw little, if anything, that would permit me to conclude the “amortization rolls” would have come to light. The PPC issues at this time did not focus on which accounts should have been written off, but rather on whether the new policy recently adopted was being complied with. 173 Secondly, from what I learned about practice issues, when an auditor uncovers items or misstatements that, individually or collectively, would 266 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

exceed materiality, rather than simply withholding a clean opinion, the issues are first discussed with management to see if some middle reporting ground can be achieved. In the instant case, and even though it was often “Gottlieb’s way or the highway”, I have no reason to conclude that, when push came to shove, Gottlieb as the pragmatist would not have yielded to the suggested write-offs rather than pull the plug on the enterprise. His hubris and the conceit of Drabinsky, and their collective view that their frauds would not be discovered, would have driven that agenda. Indeed, as will be discussed when reviewing the facts leading up to the sale to Ovitz and Furman in early 1998, Gottlieb and Drabinsky were prepared to take massive write-offs first before the deal was done and then in Q2, 1998. Those write-offs speak volumes in terms of the prag- matism of Drabinsky and Gottlieb, which, in my view, undercut Mr. Howard’s argument to the contrary. Hence, on balance I am not persuaded that the negligence had caused any compensable harm as of the signing of the opinion in 1997 for the 1996 Original Statements. I will return to the causation issue in Part II of these Reasons.

c. The 1997 Audit i. The Pantages Air Rights Agreement and the Now-Infamous Put 174 This Revenue Transaction that formed the subject matter of a letter of intent between Dundee Realty Corp. (“Dundee”) and Livent in May 1997 is, on many levels, the most critical of the transactions and the one that, in the final analysis, amounted to the Achilles heel of Deloitte’s defence. Accordingly, because of its importance to the Deloitte-Livent saga, I have devoted a considerable amount of space to the chronology of events in these Reasons.116 175 In May 1997, Dundee and Livent entered into a letter agreement by which Livent purported to transfer to Dundee, through a joint venture development company (“Newco”), the air rights existing above the Pantages Theater and the lands contiguous to the Pantages for purposes of the erection of a condominium-hotel tower and a new theater (collectively referred to as the “Air Rights”). The total consideration for the

116The facts recited in this section not only come from the evidence as elicited in court but from the Revenue Transactions Agreed Statement of Facts, Exhibit 29, and the Paragraphs of Claim Admitted by Deloitte & Touche LLP, Exhibit 1. Counsel also provided me with a joint book of documents dedicated to the air rights transaction and the put and another chronology of events. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 267

transfer of the Air Rights was $7.4 million. The letter of intent also contained a put in favor of Dundee, which allowed Dundee to exit the deal, among other reasons, if construction had not commenced by December 31, 1999 (“Put”). The transfer was memorialized in an unexecuted agreement dated December 10, 1997 (“Master Agreement”), which included, among other things, the details of the Put. Wardell was provided with a copy of the Master Agreement and was well aware of the intention of Livent to generate more income through another of the Revenue Transac- tions with which he was then dealing on other fronts. 176 Wardell prepared another memo to file in early August 1997, which I find to be just as telling as his previously described Chronology. Some of the highlights are as follows:117 (a) The proposed deal formed the subject matter of several meetings and discussions between Wardell and Chant, on the one hand, and Gottlieb, Messina and Eckstein, on the other, in late July and the first week of August. (b) Deloitte objected to the inclusion of any amount of revenue in respect of the transfer in Q2 since it was of the view that the deal was but a contingent agreement. First, the agreement was still unexecuted. Secondly, from a GAAP point of view, Dundee was not paying upfront all or enough of the balance of the transfer price for the transaction to qualify as a sale. Thirdly and more importantly, the Master Agreement contained a Put, that effectively allowed Dun- dee to “avoid responsibility for the repayment [sic] of the balance of the $4.9 million that would ultimately be owed to Livent”. (c) Additionally, and by no means least, Wardell believed the transaction raised valuation issues since the sale could not be recorded at a zero cost base as Livent apparently wanted having regard to the almost $21 million of capitalized iated with the investigation and development of the site to that date. (d) Finally, Wardell alerted Gottlieb to certain U.S. GAAP issues that would have to be attended to, like the others that

117Bob Wardell, Memorandum to File: Pantages Place Transaction, 6 August 1997, JBD 9823 (“Air Rights Memo”). 268 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

had just been “resolved” on the other Revenue Transac- tions, because the American regime in respect of the sale of density rights was different than that in Canada. (e) Messina informed Wardell on August 6th, just before he went on vacation, that “Myron was... pushing to have a significant gain (i.e. $6 million) on the Pantages transaction reflected in Livent’s second quarter results and to have no disclosure relative to such inclusion”,118 meaning to include the amount as revenue from operations and not as a separate line item. 177 I hasten to observe that Wardell was aware at the time that he prepared the memo that Livent proposed to access the capital markets, yet again, in the Fall and needed strong Q2 results. 178 Wardell concluded the Air Rights Memo with the following paragraph, which I quote verbatim: On Wednesday, August 6, 1997, I called Myron to inform him that I was extremely concerned that he would even consider this course of action in that: (1) the transaction clearly was not a second quarter transaction. (2) I was skeptical as to the quantum of the so-called gain; and (3) non-disclosure was not acceptable under GAAP. I advised him that if the second quarter results were to include a material gain on the Pantages transaction, we would not be in a position to provide any comfort to any regulators, underwriters or audit committee members as to the interim financial statement’s conformity with GAAP. 179 Notwithstanding the strong wording of Wardell’s warning, Gottlieb nevertheless went to the Audit Committee and tabled the draft audited consolidated financial statements for the quarter and six months ending June 30, 1997, which included a purported $6 million gain on the sale of the Air Rights, albeit showing it as a separate line item, but as part of theatre revenue. 180 Interestingly, the minutes of the Audit Committee meeting do not show that Gottlieb, Eckstein or, indeed, Messina advised the Committee

118Ibid., at p. 2 (emphasis added). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 269

about the strong position previously taken by Deloitte in opposition to the inclusion of any amount in Q2 for the sale of the Air Rights.119 181 The statements were approved by the Committee as tabled and a press release which showed a modest increase in Q2 income from the year before was issued without a word of explanation or delineation. I note that Livent would have shown an operating loss for that period but for the inclusion of the gain on the Air Rights sale. 182 Wardell heard about the Air Rights accounting from Messina shortly after the Audit Committee meeting and his return from vacation. He and Chant were understandably upset and one or the other of them advised Gottlieb that Deloitte was going to exercise its statutory right as an auditor to insist that an Audit Committee meeting be convened, at which time Deloitte intended to tell the Committee that the Firm had concluded that the “second quarter results of operations [were] materially misstated as a result of the second quarter accounting treatment of the Pantages Place Project”.120 183 In the meantime, and before the meeting could be convened, Gottlieb purported to pre-empt or eliminate certain of Deloitte’s concerns by having Livent’s lawyer, Rod Seyffert of Smith Lyons, redraft the Master Agreement by, inter alia, specifically deleting the Put or at least any reference to the Put in that Agreement. What went undisclosed until the following April was the fact that the Put had instead been inserted, presumably by Seyffert, into a side agreement that was kept secret from Deloitte (“First Put Side Agreement”). The net effect was that in reality nothing had changed from a GAAP point of view and the transfer was at, best, the subject matter of a contingent agreement. In other words, no revenue could or should have been recognized in income, regardless of the quarter, so long as the Put remained outstanding.

119Minutes of a Meeting of the Audit Committee of Livent Inc., 8 August 1997, JBD 6252. Messina testified that she thought that Deloitte was on side with the accounting for the Air Rights Sale, which evidence I found to be incredible having regard to how adamant Deloitte was in respect of this issue. 120Letter from Deloitte to Gottlieb, 25 August 1997, JBD 9857. The positions of the parties over several witnesses seemed to change in respect of the authorship of this letter. Deloitte took the position that it was authored by Wardell while the plaintiff suggested that it was drafted by Chant. Regardless, it is clear that it was a Firm letter and both Wardell and Chant were directly involved in the events as they were then unfolding. 270 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

184 The first of three Audit Committee meetings was held on August 26th. Chant, Wardell, and a third Deloitte partner and Vice Chairman of the Firm, Doug Barrington, were in attendance, together with the usual sus- pects from Livent’s top management. At that meeting, Deloitte’s position and concerns about the inclusion of the sale revenue in the Q2 results were reiterated for the other reasons described above, even though the Put had been purportedly removed from the Master Agreement as at the actual closing date for the transfer, namely August 15th. 185 The discussions accelerated and intensified over the next several days, with Deloitte remaining firm in its resolve to oppose the inclusion of any revenue from the Air Rights transaction in Q2 income. The Firm maintained this position even though: (a) Dundee provided a letter, which turned out to be misleading, confirming that the Put “was removed from the master Agreement at the request of Livent Inc.” and that Dun- dee was committed to closing the deal (“Dundee Acknowledge- ment”);121 and (b) Seyffert delivered multiple opinions, which turned out to be misleading as well, stating that there was a firm deal for the sale of the Air Rights, effective as of June 30th (“Seyffert Opinions”).122 Both these letters were delivered to Deloitte at the second meeting with the Audit Committee during the morning of the 27th, at which Messrs. Bar- rington, Chant and Wardell were again in attendance. 186 As late as August 28th, Deloitte, in a further letter to Gottlieb, again maintained its position that the Q2 statements were still materially misleading, notwithstanding receipt of the Dundee Acknowledgement and the Seyffert Opinions. This bit of brinksmanship caused Gottlieb to shop for other opinions from KPMG and his now go-to accounting guru, Pro- fessor Archibald, both of whom supported the Livent position that the transaction was, arguably, properly reportable in Q2. Deloitte came to the August 28th meeting again reiterating its position that the sale revenues could not be reported in Q2 because no tangible consideration had passed prior to June 30th, the transaction had not closed as of that date, and the appropriate GAAP guidelines would not permit revenue recognition. 187 The matter appeared to come down to whether or not Deloitte would resign as auditors or whether or not some accommodation could or

121Letter from Cooper to Gottlieb, 27 August 1997, JBD 9791. 122Letter from Seyffert to Gottlieb, 27 August 1997, JBD 9861. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 271

should be negotiated. Gottlieb and Eckstein were now content to let Deloitte resign since they felt that Livent would be able to obtain a satisfactory opinion elsewhere, presumably from KPMG. Others at the meeting, including Emerson and Goldfarb with support from Banks and Mes- sina, felt that Livent would be adversely affected if Deloitte resigned prior to the proposed debt placement in the fall. Emerson included the following observation in his notes on the effects of a Deloitte resignation on, among other things, sponsors such as Ford, which seems to have captured the mood of the debate: Other sponsors may have second thoughts about a relationship with Livent if there was a public dispute about the integrity of Livent’s accounting policies and accounting principles and the resignation of Livent’s auditors because of a reportable difference with Livent.123 188 In my opinion, what would have been of equal concern had Deloitte resigned over differences over accounting principles would have been the fact that Deloitte would have had to advise the regulators of this dispute, if not the successor auditors. This might very well have sounded the death knell to the proposed debenture offering. 189 At the conclusion of the August 29 meeting, however, Deloitte and the Livent executives and audit committee members came to a resolution of the issue, which brought Deloitte back from the brink of having to “disassociate” itself from the Company. The evidence I heard suggests that the proposed solution, which had not been raised prior to the 29th, came from Peter Chant. The essence of the solution was embodied in a press release issued on September 2nd: Livent Inc. announced today that in contemplation of a possible issuance of U.S. $100 million debt securities in the United States, it has adjusted its accounting treatment for non-theater real estate transactions in order to be consistent with US GAAP. This adjustment, which has no effect on prior years’ income, will result in the recognition of income before income taxes of $4.8 million ($0.17 per share) in the third quarter of 1997 rather than in the second quarter, as previously announced. The adjustment is in connection with the sale by the Company of air rights to a real estate developer pursuant to a

123Garfield Emerson, Notes, 31 August 1997, JBD 14916, at p. 6. 272 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

binding contractual arrangement in place prior to the end of the second quarter.124 190 I make three observations about the September 2 Press Release: (1) The draft press release, which I assume was first prepared by Livent, indicated initially that $6 million would be removed from second quarter results and not the $4.8 million that appeared in the actual Press Release. (2) The Press Release “did not tell the whole story” and left the reader with the mistaken view that the decision was not driven by the articulated concerns of Deloitte, but by a U.S. GAAP issue that appeared to be a mere technicality. Im- plicit in the Press Release was the suggestion that recognizing the revenue in Q2 complied with Canadian GAAP, or that the decision was undertaken because of a change in Livent’s accounting policy.125 (3) I wonder how Deloitte could countenance a press release that suggested there was a binding deal as at the end of Q2 when the deal was materially amended in August by, minimally, the dropping of the Put, especially given Deloitte’s strongly-worded objections in late August to treating the deal as a Q2 transaction, at all. 191 While the evidence was anything but crystal clear on this point, the net effect of the backing out of the $4.8 million meant that $1.2 million referable to the Air Rights sale was left behind in Q2. This seemed to be done at the insistence of Gottlieb and without the prior concurrence of Deloitte. There was some debate among counsel, subsequent to oral argument, and at my request, which seemed to leave the rationale for the change in amount very much at issue. In any event, when the matter came to the Firm’s attention, it did not make it an issue. 192 Wardell struck me as a no-nonsense fellow, which in retrospect did not sit well with Gottlieb even though he, Wardell, went to bat for Livent in the early days of the Revenue Transactions debates between the Firm and Deloitte U.S. However, Wardell took the position that even if the September 2nd Press Release did not tell the whole story, and Deloitte

124Press Release, 2 September 1997, JBD 7453 (“September 2nd Press Re- lease”) (emphasis added). See also Draft Press Release, JBD 9876. 125Transcript, Wardell Cross-Examination, 17 June 2013, at pp. 299-300. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 273

was aware of this, it was not obliged to rectify the situation in its capacity as auditor. What concerns me about this evidence is that it paints Deloitte perilously close to being negligent by omission, which has the same fatal results for an auditor as acts of commission. In my view, the line between an auditor responding to the will of management, as in this instance, and its obligations to the company and its shareholders has a tendency to become blurred. 193 In the final analysis, I was not comfortable with the fact that Deloitte, for all intents and purposes, not only countenanced a misleading representation to the public on the eve of a public offering for which it was going to have to provide a comfort letter, but provided its initial inspira- tion. Ultimately, I believe Deloitte lost sight of the stated rationale for the deferral of the revenue from this transaction to Q3. 194 But the issues surrounding the Revenue Transactions, and the Air Rights transaction in particular, did not die with the September 2nd Press Release. Indeed Gottlieb, as part of his “hurry-up” offence, summoned Barrington and Tom Cryer, the Deloitte chairman, to a meeting on Sep- tember 19th to discuss the future of the Deloitte/Livent relationship.126 He took the position that Wardell had to be relieved of his duties as the “uber” Engagement Partner, let alone as the Review Partner, because he had compromised himself. Based on the notes of this meeting and correspondence in the days ramping up to the Air Rights closing from Seyffert in particular, it seems that Gottlieb was trying to blame Wardell for the Air Rights controversy by suggesting that the issue of the Put had been canvassed with him and his prior approval obtained in the early days of the first draft of the Master Agreement. Otherwise, Gottlieb was trying to suggest that Wardell made a significant error in advising Gottlieb that the U.S. GAAP issues on the other Revenue Transactions would be resolved to his satisfaction. 195 During their meeting with Gottlieb, Cryer and Barrington repeatedly expressed the view that they believed Livent constantly pushed the envelope. They wanted Livent to adopt a more conservative approach to accounting issues. But they still agreed to make a change in the audit team rather than considering Gottlieb’s request as a “red flag” warranting a review of the entire relationship from Deloitte’s perspective, rather than from the client’s perspective. I am not sure the Livent-Dundee and

126Mark Hayes, Notes of Meeting at Livent Inc. Re: Dispute with Deloitte & Touche, 19 September 1997, JBD 15032. 274 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Goodman-Gottlieb relationships were not forming part of the backdrop against which this decision was made. 196 Whatever might have been Deloitte’s motivation to continue as auditor, I have concluded that it was too accommodating at this point and put itself in a most curious if not fatal position by changing the audit team, virtually from top to bottom. While Barrington and Chant assumed the role of joint Advisory Partners, with the appointment Tony Power as the LCSP, Cressatti was dropped from the roster as the Engagement Partner to make room for Claudio Russo, who had previously worked for Power. In fact, none of the support and field staff remained the same as there was a wholesale change on that front, as well, with not even one staff auditor kept in place for minimal continuity purposes. Putting the matter bluntly, but for whatever information could be gleaned from the Perma- nent File, a file that forms part of the work papers that moves from audit year to audit year, there was no one on the team who had any past connection to the client and had any sense of the history to which the audit team should have been alert. 197 This problem is underscored by the error made by Deloitte in accepting the Air Rights revenue for inclusion in Q3 in any event, but minimally, in a manner which was inconsistent with the September 2nd Press Release. At the time that Chant sowed the seed for the aforesaid compro- mise, he was mistakenly of the view that the transaction could be recognized in Q3 under U.S. GAAP when, in fact, it could not.127 While this problem was brought to Power’s attention, which he communicated to Gottlieb, he went on to say: It is, however, our opinion that the sale would qualify for gain recognition under Canadian generally accepted accounting principles, the basis on which Livent normally reports. We have received from management and reviewed the calculations with respect to the allocation of costs associated with the Pantages Place Project to the sale of density rights. We are satisfied that a fair allocation of costs has been made and it is appropriate to record a gain on the sale of the density

127The Financial Accounting Standards Board (FASB) regulations indicated that sales of real estate could only be recognized in the quarter in which at least 20% of the purchase price had been paid. This criterion had not been reached as of Q3. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 275

rights in the amount of $4.8 million under Canadian generally accepted accounting principles.128 198 I agree with Mr. Regan’s conclusion that it was not open for Livent to recognize a gain on the sale of Air Rights in Q3 1997 when it had issued a press release that stated unequivocally that it was backing out the gain to accord with U.S. GAAP — and then did not adhere to the restrictions described by U.S. GAAP. In fact, Barrington ultimately agreed with this conclusion in his cross-examination where he said that “[i]f you adopted U.S. GAAP and it didn’t qualify, then it shouldn’t be in Q3”.129 199 The issue of lack of continuity and the companion notion of cumulative knowledge were next seen in the manner in which the new audit team accounted for the costs associated with the recording of the Air Rights net revenue when they signed off on the number in November. Without getting into the numbers per se, and where the inconsistencies actually lay, it became apparent in the Russo cross-examination that he was unaware of the earlier assessments of costs that had been done by prior audit teams or that was found in the 1997 budget. Indeed, when Russo consulted with one of the national office’s technical gurus and was told that the Air Rights transaction would not pass the “smell test” because “all of their income of late [was] from ancillary non-recurring items”,130 a comment that was reminiscent of the Barr analysis expressed the previous July, no warning bells were heard, if they were in fact sounded. 200 Indeed, it is no wonder that Russo did not pick up on the nuances of the past activities and concerns of some of his partners since he, if not Power, was scrambling to catch up after being thrust on to the Livent file in late September. The Firm had to provide a comfort letter on the statements prepared by management to the end of Q2, and up to October 7th, all of which was prepared to accompany the Offering Memorandum released on October 10th in respect of the U.S. $125 million debenture un-

128Letter from Power to Emerson, 11 November 1997, JBD 10764, at p. 2. 129Transcript, Barrington Cross-Examination, 11 July 2013, at p. 158. 130John Kligman, Enquiry Documentation Sheet, 13 November 1997, JBD 11395. 276 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

derwriting.131 Logic suggests the work he and his team did thereafter could not have been sufficient to bring them up to speed on all the issues that were then outstanding.

ii. Conclusion — Q3 — 1997 201 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 earli- est, but no later than the end of Q3, or September 30th, at the latest. The red flags were certainly aflutter by that time. While the Firm, even with the change of audit teams, was clearly aware that Livent’s management was more than merely pushing the envelope from a GAAP perspective, it seemed to turn a blind eye to the warning signs, which I attribute to the fact that it was only too amenable to a line-up change, which it thought was the panacea. I shudder to think it was all about the $50,000 fee they received for the Review Engagement undertaken as a pre-cursor to the October Underwriting or the $95,000 fee charged in respect of the 1997 Audit. 202 In my view, there was a complete break-down in the relationship when Gottlieb purposefully placed the Q2 statements before the Audit Committee in early August when he and the rest of his toadies knew that they contained information which Deloitte presaged amounted to material misstatements. To place the statements before the Committee in that form was bad enough. But not to tell the Audit Committee that Deloitte had warned Gottlieb, if not Messina, against this course of conduct, was inexcusable. This action was not simply one which could be negotiated away, particularly since Gottlieb prohibited Deloitte from attending Au- dit Committee meetings when the quarterly statements were tabled and reviewed. I would also venture to say that Gottlieb did not think Deloitte had the backbone to force the issue by insisting on their statutory right to require a meeting with the Audit Committee as such was an extreme measure not undertaken lightly by auditors. 203 Furthermore, while Wardell, and no doubt Chant, were clearly upset by this turn of events when they first learned about the proposed statements in early August, I did not get the sense that they expressed their level of concern about Gottlieb’s integrity with Emerson and the only

131Letter from Deloitte to the Directors of Livent Inc., CIBC Wood Gundy Se- curities Corp., Furman Selz LLC, and PaineWebber Incorporated, 10 October 1997, JBD 7348. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 277

other remaining “independent” member, Goldfarb, during the three meetings at the end of August. 204 Deloitte knew the management of both Dundee and Livent and would have understood that the original Air Rights letter agreement had been product of “intense business negotiations”.132 I therefore cannot understand why no one at Deloitte questioned either Seyffert or Michael Cooper, the president of Dundee Realty, about the fact that the Put was apparently “intentionally deleted”, if not to accommodate the revenue recognition issue. Surely, their collective professional skepticism should have been elevated at this point when they had reason to question the integrity of Gottlieb with or without knowledge of the other Revenue Transactions at the time! 205 The situation, in my view, deteriorated even further when Deloitte agreed to the September 2nd Press Release, when it knew or ought to have known that it contained a misstatement in and of itself. And why Barrington did not realize that he was or might be being played when he was asked to remove Wardell and basically his entire audit team even for the Review Engagement leaves me wondering whether he occupied too exalted a position in the Deloitte ranks to remember what professional skepticism was all about. 206 To make matters worse, Gottlieb soon sought to include the present value of a new revenue transaction in the Q3 results. In mid-September, Gottlieb entered into a handshake deal with AT&T for the naming rights of the Pantages, the payments in respect of which were to be spread out over 10 years. Power, who had not witnessed first-hand the 1996 Reve- nue Transaction debates, and had not debriefed Wardell, initially took the position that the transaction could not be recognized in Q3 because there was no signed agreement and the cash paid on signing would not reach 3% of the total payments. 207 The ever irrepressible Gottlieb obtained another opinion from Seyf- fert in early November that the September oral negotiations between Livent and AT&T amounted to an enforceable agreement. Still faced with opposition from Deloitte, Gottlieb negotiated an amendment to the deal which by then — now in November — had AT&T increasing its down-payment from $300,000 to $1 million, which was still less than 10% of the total contract price, in an agreement that was dated “as of

132Letter from Seyffert to Gottlieb, 26 August 1997, JBD 9852. 278 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

September 10th”. Finally, in support of this position, Gottlieb obtained an opinion from E&Y that the transaction “could” be recorded in Q3, without opining on the manner in which it should be recorded. 208 Deloitte, with its back to the wall, in the most unusual of circumstances, obtained their own opinion from PwC, which was to the same effect as E&Y’s. When push came to shove, Deloitte modified its tough stance of the previous month and basically offered no opinion on the issue: It continues to be our opinion, taking into account all aspects of this transaction, that the preferred treatment is to record the revenue in the Company’s fourth quarter results. Furthermore, it is our opinion that under U.S. generally accepted accounting principles, this revenue would not be recognized in the third quarter. If in the opinion of management and the Board it is appropriate to reflect the transaction in the Company’s third-quarter results, we will not object but would suggest that the appropriate disclosure for this transaction would be similar to that set out in the offering document with respect to similar transactions.133 209 Finally, although it takes me somewhat out of the Q3 time frame, I have more than modest difficulty accepting the accounting treatment of the Air Rights transaction in November, when Power and Russo signed off on the numbers without revisiting the operation of the U.S. GAAP strictures and the information that would have been available to them if continuity of audit team personnel had been maintained. This to me was but another example of Deloitte accommodating the needs of the client while casting professional skepticism, if not GAAS, aside.

iii. The Infamous Put, Part Deux 210 The 1997 audit was beset with problems right from the get-go.134 First, it was staffed by new team members who, but for Chant, had little

133Letter from Power to Livent Audit Committee, 17 November 1997, JBD 10765. 134I note that subsequent to the preparation of the penultimate draft of these reasons, I was referred to — but not by either set of counsel — a recent decision of the Court of Appeal which would arguably permit me to reference some or all of the ICAO Proceedings, supra note 1, including the decisions of the Discipline and Appeal Committees, since the prosecutions of Messrs. Barrington, Power and Russo took place under the Chartered Accountants Act, 1956, S.O. 1956, c. 7, the predecessor legislation to the Chartered Accountants Act, 2010, S.O. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 279

or no history with the client and senior management. Secondly, the team that was parachuted into the audit was still reeling from the quickly-undertaken Review Engagement. Thirdly, Livent had entered into five more Revenue Transactions which required renewed and increased attention to detail. Fourth, and by no means least, the issues surrounding PPC took on an added dimension before audit sign-off when Ovitz and Furman asked for about a 20% reduction in the capitalized PPC as a condition of their share purchase. I have concluded, with some mixed emotions or misgivings, with Power and Russo splitting its over-all supervision, and with Barrington acting as the field marshal from the rear, that the team was not up to the task.135 211 First, the 1997 Audit Plan (“Plan”) conveys the impression that the Team did not engage in much independent thought when drafting it. The Plan tracks the language of the 1996 Audit Plan in most material respects, but eliminates certain cautionary tasks or descriptions which would have been of benefit to an audit staff charged with the responsibility of auditing a “greater than normal” risk audit client that had more than a modest history of aggressive, if not questionable, accounting practices.136 212 Secondly, and before the audit was completed, Deloitte uncovered evidence that suggested that the Put they had been told had been “intentionally deleted” was alive and well and living in the Dundee copy of the Air Rights sale closing book. Because this part of the story is stranger than fiction, I will endeavour to set it out in detail.

2010, c. 6, Sch. C. See Canadian Imperial Bank of Commerce v. Deloitte & Touche, 2014 ONCA 89, 118 O.R. (3d) 508 (Ont. C.A.), rev’g 2013 ONSC 2166, 361 D.L.R. (4th) 549 (Ont. S.C.J.). That said, my analysis and conclusions in respect of the 1997 audit are not in any respect rooted in any of the decisions of the ICAO Proceedings. 135I use the phrase “mixed emotions or misgivings” not to suggest that there is not sufficient evidence to come to this conclusion, but because these three gentlemen, whose integrity is unquestioned, have been the subject matter of multiple “prosecutions” and have spent untold numbers of days defending their work product, if not their previous stellar reputations. I am particularly concerned for Claudio Russo, who was dragooned into this engagement and is still tolling in the trenches. 1361997 Audit Planning Memorandum, JBD 7579 & JBD 5640. 280 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

iv. The Put Uncovered 213 On or about April 2nd, Bob Savaria, the Deloitte Engagement Partner on the Dundee audit, was told by Cooper that Dundee Realty took the position that the Put was still operative and, hence, Dundee Realty did not have to consolidate its statements with those of the Pantages Newco. As a result of this conversation, Savaria asked Cressatti to attend at the Dundee offices to review the closing book, at which time he retrieved a copy of the Put that was then memorialized in a separate lawyer-crafted three page agreement.137 Savaria communicated the existence of the Put to Wardell, who then brought it to the attention of Chant. Chant advised Russo who then told Power, after which all hell broke loose. Power called a reluctant Savaria and demanded to be sent a copy of the document just recovered, which was then faxed to him. Power was concerned that this discovery had very serious implications as it basically contradicted what Deloitte had been told the previous August. In fact, Power conceded under cross-examination that it was possible that Gottlieb had “lied” to Deloitte back in August — a fact which he downplayed in the course of his evidence.138 214 A meeting of senior partners was convened on the 3rd at the Deloitte offices. In attendance were Chant, Barrington, Power, Russo, Calpin, Bruce Richmond (Senior Partner in charge of Client Relations), Paul Cobb (LCSP-Dundee), internal counsel and external counsel, J.L. Mc- Dougall.139 There was conflicting evidence and a modest dispute among counsel as to whether or not Savaria was in attendance at the meeting. All the partners who testified before me acknowledged, however, that their collective professional skepticism would have been at the highest level. 215 Chant, who did not testify at the trial, but whose evidence on discovery was excerpted and filed as an exhibit, does not recall whether or not a copy of the Put had been tabled at the meeting at that moment in time. He said, however, that he had not been asked to put together a brief of the relevant documents sent and received the previous summer in ad-

137Side Agreement, 15 August 1997, JBD 14945, at p. 2. 138Transcript, Power Cross-Examination, 8 July 2013, at pp. 134-35. 139Mr. McDougall had no recollection of being at this meeting and did not have any notes. In fact, I was not furnished with any notes of the meeting, which I found to be interesting if not unusual having regard to what was being discussed. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 281

vance of the meeting. He was adamant, which almost everyone in attendance confirmed, that he made three critical statements to his partners: (1) Gottlieb had misled them on three separate occasions. (2) If this were Deloitte U.S., they “would have been out of there by then”, i.e. the relationship with Livent would have been terminated. (3) He, Chant, thought that the Firm should be out of “here” and he took his leave, somewhat in a huff.140 216 Chant was firmly of the view that Deloitte had been lied to and that the Put had been removed from the Master Agreement to intentionally deceive Deloitte back in August.141 217 After Chant left the meeting, the remaining partners fashioned a plan to investigate the matter further. They decided that Barrington and Power would immediately meet with Drabinsky, Richmond would meet with Emerson to fill him in and Cobb would meet with Cooper. 218 Chant, the one member of the team who had any continuity with the client on this and other issues, was for all intents and purposes excluded from any further discussions over the next few critical days. He was not asked for any further input or for copies of his desk file, which I was told was a shadow file kept by individual technical and audit partners on matters for which continuity and instant access were important, if not essential. Similarly, no one contacted Wardell for his take on this recent revelation or for copies of his desk file. 219 Barrington and Power’s meeting with Drabinsky proved, in my view, less than fruitful, if not unsatisfactory. First, as one might have expected, Drabinsky expressed, if not feigned, ignorance of the entire matter. Got- tlieb was then summoned to the meeting where he provided the following explanation, which raised more questions than it answered: Myron agreed that there was a side agreement but it was only temporary, a bridging situation. He said that when he talked to Cooper about removing the put, Cooper agreed that they didn’t need it but that he couldn’t make the decision on his own, that it would have to go to his CEO for clearance. Therefore he suggested the temporary side agreement to protect himself.

140Defendant’s Discovery Read-Ins, Exhibit 27, Chant Discovery, 2 September 2009, at pp. 344, 354-356. 141Ibid., at p. 356. 282 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Myron said that Cooper came back to him later and said that he had received clearance and said “the agreement doesn’t exist; it was never there; so tear it up”. So Marvin [sic] tore it up “it was as simple as that, I swear to God”. We will now get documentation of this position from both sides. Tony advised Bruce Richmond before he met with Gar Emerson, the chairman of the audit committee, later that evening. Apparently on the Dundee side, they unloaded on Bob Savaria for disclosing the confidential agreement.142 220 I was told, as well, that Emerson met with Richmond that night, after Barrington and Power had met with Drabinsky and Gottlieb. While there is some confusion in Emerson’s evidence about that meeting,143 it would appear that Richmond provided him with the “Gottlieb explanation”, which could only have come from a recitation of the above excerpted phone message. (In a subsequent phone conversation between Gottlieb and Emerson, the same tale was repeated yet again.) Emerson was told by Richmond that Deloitte hoped to receive a confirmation letter from Goodman that the Put was no longer operative. Pending receipt of that letter, Deloitte was content with the explanation that Gottlieb had given to Barrington and Power. Emerson recommended that Smith Lyons prepare an agreement stating that the Put was no longer operative from that date forward. I reserve comment about the value of such a suggestion and how it might impact the fact that the Air Rights revenue had already been recognized and announced publically in Q3. 221 I was also told, as a wee bit of hearsay evidence — presumably as part of the narrative — that Cobb heard from Cooper that the Put was no longer operative, notwithstanding what Cooper had told Savaria a scant two days before. I would hasten to observe that it made little sense to me why Savaria was not at the Cobb-Cooper meeting on the night of the 3rd simply to confront him with the elements of their previous discussion, which, from any reckoning, had to give lie to what Cobb was being told that night. 222 I also note that Savaria appears to have been upbraided by someone at Dundee, presumably Cooper, for breaching a confidence by disclosing a copy of the Put to the Livent auditors, which started this whole chain of events. This action again underscores the Vince Lombardi adage about

142Memo to File by Calpin re: Power Voicemail, 6 April 1998, JBD 11355. 143Transcript, Emerson Examination-in-Chief, 24 May 2013, at pp. 59-73. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 283

the “best defence”, but more to the point, demonstrates the symbiotic relationship between Dundee and Livent and the fear Chant articulated on his discovery that such a relationship would drive the agenda on the supposed investigation of the newly discovered Put. 223 Returning now to the Deloitte “plan”, apparently and incredibly, Bar- rington and Power were satisfied with Gottlieb’s explanation. Barrington went back to the office and either that night or the next morning, Satur- day the 4th, crafted six pages of talking points for his next meeting with Drabinsky and Gottlieb. He also planned a meeting with Russo and Mes- sina to finalize certain remaining audit issues.144 224 I have reviewed the Barrington Memo and Barrington’s evidence several times. I am more than satisfied that this memo was prepared as a “go-forward” memo. In other words, I am not persuaded that it was prepared simply as an outline for a further review of the Put issue and to but receive confirmation or further confirmation that the Put was “finally” dead — for at least the second time. The memo is divided into several parts: First, a discussion of Deloitte’s business philosophy and how Livent’s business practices and financial reporting did not live up to the standard that Deloitte expected of its clients; second, a list of the terms on which Deloitte was prepared to continue its relationship with Livent; third, a list of the steps that had to be taken for Deloitte to accept that the Put had been eliminated; fourth, finalization of various 1997 year-end accounting issues; and fifth, a review of the previous year’s debate about whether revenue from the Air Rights sale could be recognized in Q2. 225 My conclusion that Barrington’s memo reflected the terms on which Deloitte would continue working with Livent, rather than a plan to seriously investigate management’s past misconduct to determine whether it warranted ending the relationship, is supported by the meetings with management that subsequently occurred. The first meeting was between Barrington and Power and Drabinsky. Drabinsky told Barrington and Power that Gottlieb was going to be marginalized once a new investor came on board. The next meeting was attended by the rest of the senior team, including Russo and Messina, to close the loop on some of the outstanding 1997 issues. In my view, the plan for the elimination of the Put — which was just that: a plan to eliminate rather than investigate — did not dispel any suspicion of bad faith on the part of Gottlieb, in partic-

144Barrington Talking Points Memo, 3-4 April 1998, JBD 9536. 284 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

ular, and Livent, in general, which Deloitte was obliged to do under s. 5135 of the Handbook, set out above. The plan, such as it was, provided as follows: In order to have us accept the verbal explanation we must: 1. Be provided a copy of the “put” agreement signed on August 15th, 1997. 2. Receive directly a confirmation in writing that the “Put” agreement was canceled by the parties in the third quarter and a copy of this must be provided to Dundee’s auditor. 3. Receive an opinion from the company’s legal counsel that this document does in fact constitute an effective cancellation of the “Put” agreement in the third quarter. Counsel may want to re-issue its letter to you, and provided to us, as part of the 2nd quarter debate. 4. Have full disclosure of all these facts to the Audit Committee in our presence.145 226 Deloitte took the position that the following events provided it with a satisfactory explanation in accordance with the plan: 1. Barrington and Power were told by Gottlieb that he had ripped up his copy of the Put when Cooper told him it was no longer needed, at an unspecified time and date. 2. Goodman wrote Gottlieb a letter dated April 4th that said the Put agreement had been cancelled sometime in August, a fact which he had not communicated to Cooper because of the “pace of business and travel”. 3. On April 7th, Seyffert drafted an agreement, at Emerson’s request, which effectively said that if the Put (which I conclude he prepared or caused to be prepared on or about Au- gust 15th, 1997) were alive, it was now “officially” dead.146 227 As a further demonstration of the problems with which Deloitte was faced in accepting the word of either of these two clients, the following is the text of a letter Gottlieb sent Cooper on April 7th — the same date as the agreement apparently eliminating the Put: I understand from Ned that you are upset about the agreement that Ned and I had achieved regarding the cancellation of our PUT agree-

145Ibid., at p. 4. 146Draft Agreement Eliminating the Put, 7 April 1998, JBD 10745. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 285

ment. Please be assured that we are positive about the project and wish to retain the good spirit of cooperation between Livent and Dundee. Accordingly, we wish to confirm that notwithstanding Ned’s letter of April 4, 1998, and the agreement of today, a copy of which is attached hereto, the PUT agreement referred to in Ned’s letter is binding and effective and remains so in favour of Dundee Realty Corpo- ration as if it has never been cancelled.147 228 For reasons that were never explained in evidence, the Put was memorialized in what appears to be yet another lawyer-drafted agreement, dated the 27th of May, 1998, with but modest word changes from the August 15th version. What is of some moment, though, is the nature and tone of the covering letter enclosing an executed version of the agreement that Gottlieb sent to Goodman: As discussed last night, I met this afternoon with Michael Cooper and he and I reviewed together the enclosed PUT agreement which is in the exact format as the original. I am forwarding herewith the original agreement as executed by both Michael and myself and I ask that you put this agreement in a sealed envelope in your safe or safety deposit box.148 229 Finally, and again, for reasons which were never forthcoming, counsel jointly filed one last document that only confounds matters, namely, a letter from Cooper to the late L. David Roebuck, then Drabinsky’s civil litigation lawyer, after the frauds had been discovered, Drabinsky had been terminated and he and Gottlieb had started actions for wrongful dismissal: This is in response to your letter dated October 19, 1998 (a copy of which is enclosed) concerning the history and current status of what you describe as certain put arrangements between Dundee Realty Corporation (“Dundee Realty”) and Livent, Inc. (“Livent”). This letter will confirm, as Mr. Ned Goodman did in his letter to Myron Gottlieb dated April 4, 1998, that both (i) “Dundee’s Put” to Dundee Realty (Victoria-Shuter) Corporation (“Victoria-Shuter”) referenced in the Term Sheet dated May 22, 1997 between Dundee Realty and Livent and (ii) the executed Put Agreement dated August 15, 1997 among Dundee Realty, Livent and Victoria-Shuter (which is included in Dundee Realty’s closing binder for the Pantages Thea-

147Letter from Gottlieb to Cooper, 7 April 1998, JBD 15053. 148Letter from Gottlieb to Goodman, 28 May 1998, JBD 15056. 286 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

tre at Tab 20) were cancelled pursuant to an oral agreement made in August 1997 following the Pantages Theatre Project closing on Au- gust 15, 1997. This letter will also confirm that, notwithstanding both (i) an April 6, 1998 letter from Livent to me regarding these put arrangements and (ii) a Put Agreement dated as of May 27, 1998 among Dundee Re- alty, Livent and Victoria-Shuter (referenced in my letter to David Maisel of Livent dated August 18, 1998), there is not now, nor has there been since the cancellation referred to in the preceding paragraph, any legally binding or effective put or agreement with similar effect between Dundee Realty and Livent or Victoria-Shuter regarding the Pantages Theatre Project.149 230 While it is not necessary for me to speculate about the legal status of the on-again, off-again Put, at least in October 1998, particularly since neither Drabinsky nor Gottlieb was prosecuted in respect of this transaction, the revenue was backed out completely on the re-audit because of the “uncertainty of the status of the put”.150

v. Conclusion on the Put Investigation 231 As I daresay is evident from my narration of the events from April 2 to April 7, I have concluded that the Deloitte plan to deal with the “elimination” of the Put fell well short of reasonable, both in terms of its design and its execution. During argument, Mr. Fleming tried to persuade me that so long as a plan was “reasonable”, it need not meet perfection in order for an auditor to discharge its obligation under GAAS. That proposition is, in itself, unexceptionable. I cannot, however, accept that an auditor discharges its obligation simply by identifying the risk and making what it considers are appropriate plans to deal with the identified issues. In my view, minimally, more is required under ss. 5135.12 -.14 of the CICA Handbook. Furthermore, the plan in itself must be reasonable in the circumstances — which I find the Deloitte plan was not. 232 As well, once the Put was uncovered and it led to the suggestion, if not implication, if not conclusion, that Deloitte had been lied to the previous August, then Deloitte was under an obligation to obtain adequate audit evidence to dispel the suspicion that a fraudulent act had occurred. In that respect, Deloitte was obliged to assess all the evidence available

149Letter from Cooper to Roebuck, 20 October 1998, JBD 10731. 150Deloitte & Touche, Report to the Audit Committee, supra note 13, at p. 26. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 287

to it at the time and to determine whether or not there was “completeness and truthfulness of representations made and about the genuineness of accounting records and documentation”.151 233 On April 3, Deloitte knew that management, at its highest level, was involved in a fraud, and therefore the assumption of management’s good faith was, by definition, contradicted. Indeed, it might very well have been that the integrity of another client was called into question and therefore, notwithstanding the close relationship of Dundee with Deloitte, the latter had to be mindful that the former might have been complicit in the activities and actions of Gottlieb. I am persuaded that Deloitte, save for Chant, paid only lip service to the fact that its professional skepticism should have been at the highest level. 234 In summary, I would note the following points which lead me to conclude that Deloitte’s investigation of this issue fell well short of generally accepted auditing standards and its legal standard of care: (1) At no time did anyone at Deloitte collect all the paper touching on the matters in issue for purposes of reviewing the same from start to finish. These documents were readily available to several of the Deloitte partners and no one assumed or was directed to assume the initiative to do a bare- bones analysis of the paper itself. (2) Had the August 15, 1997 Put agreement been reviewed by an auditor with a modicum of professional skepticism, he or she would have seen that the document itself gave lie to everything that had preceded its creation. In the first place, it incorporated by reference the Master Agreement, which suggests that it was prepared by a lawyer at or about the time that the Master Agreement was executed, most probably someone from Smith Lyons. This fact supports Chant’s suspicion that the Put was not “intentionally deleted” but was put into a separate confidential agreement to deceive Deloitte. (3) In addition, the fact that the side agreement contained a confidentiality provision would underscore that the parties intended to keep it away from the eyes of the auditor to further the deception. So why did Deloitte not ask for a

151CICA Handbook, s. 5135.12, JBD 15993. 288 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

copy of the closing book that Livent received in September 1997 for purposes of comparing it to the one seen by Cres- satti? Deloitte would have uncovered the fact that the Put was not in the closing book but formed part of a separate attachment sent to Livent by one of Seyffert’s staff.152 (4) I did not receive a valid explanation as to why Savaria was excluded from the meeting with Cobb and Cooper on the 3rd. Savaria was the partner who had been given an explanation from Cooper as to why the put was “alive and well” and being relied on by Dundee Realty from a GAAP point of view. Cooper’s explanation to Cobb during that meeting, therefore, would have made little or no sense since it was at odds with what he had previously told Savaria. (5) Gottlieb’s explanation to Barrington and Power made no sense, whatsoever. First, as I indicated above, it raised a series of other questions, including, when and where the suggested conversations with Cooper took place, why Cooper then took the position he did on the 2nd, and when, for how long and why the Put had to remain secret, and in a separate agreement. (6) Deloitte never determined when the Put was allegedly ripped up. In my view, as a minimum, even if Deloitte believed this tale they were obliged to assess the timing of its destruction, if only to determine whether or not the revenue recognition should have taken place in Q3 or Q4, or in 1998. This issue was never analyzed. The only evidence I heard was from Barrington that the revelation of the Put meant that Deloitte had wasted a good deal of time debat- ing the Q2-Q3 issue, in the first place, which was an issue which paled in comparison to the “big lie”. (7) The best that can be said about Deloitte’s investigation is that it appeared to have been an audit by conversation, which gives rise to all manner of GAAS deficiencies. Un- fortunately, the conversations were held with people whose veracity was seriously in question. Therefore, better audit evidence was mandated in the circumstances. Had there

152Letter from Brown to Gottlieb, 17 September 1997, JBD 15102. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 289

been continuity in the team, with even Chant being part of the investigation, he or Barrington should have remembered that either or both of them had been misled, if not lied to in conversations they had with Cooper and/or Seyffert on or about the 26th and 27th of August, 1997. (8) The letter from Goodman on April 4th did not dovetail at all with what had transpired in late August. Nor with Cooper’s stated position with Savaria on the 2nd as it related to a consolidation of Dundee Realty statements with those of Pantages Newco. It seemed, again, as Chant suggested, that Deloitte was prepared to accommodate, if not Livent, then another of its major clients, Dundee Bancorp. 235 In my view, if s. 5135 of the Handbook were not enough to require greater diligence in the planning and execution of an investigation into the newly discovered Put, the Deloitte Manual set a standard which the Firm’s actions in the first week of April 1998 did not measure up to: 23.15 If a representation by management is contradicted by other audit evidence, we should investigate the circumstances and, when necessary, reconsider the reliability of other representations made by management. We need to ensure that our reliance on management’s representations relating to other aspects of the financial statements is appropriate and justified. 23.16 We should also consider the implications of fraud and significant error in relation to management’s representations. The implications of particular instances of fraud or error that we have discovered will depend on the nature, concealment (if any), and level of management or employee involved.153

vi. Other Matters — 1997 Audit 236 If I am wrong in concluding that Deloitte’s conduct fell below the applicable standard as of April 4th, 1998, if not in Fall 1997, as previously concluded, I am at a loss to understand how Deloitte could have signed a clean audit opinion for 1997 as it did in the weeks subsequent to revisiting the “transaction from hell”, as Barrington labelled the Air Rights revenue recognition fiasco.

153Deloitte Manual, supra note 72, at p. 306, ss. 23.15-23.16. 290 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

vii. PPC 237 The same concerns I raised with respect of the audit work in 1996 were repeated in 1997. First, Russo acknowledged that the audit only tested the first three quarters of 1997, which from all accounts amounted to an inadequate review. Secondly, while little would be accomplished drilling down to the core as was done by Mr. O’Kelly in his cross examination of Russo and in his written argument, I think the matter can be distilled to one unassailable fact: Deloitte was prepared to accept and sign off on the final numbers put forward by management for PPC prior to the Audit Committee meeting of April 9th, 1998, some few days after the Put fiasco. At that meeting and for the first time, Gottlieb tabled a list of proposed PPC write-downs, all being put forward in exactly the manner objected to in the previous week’s Barrington Memo, namely, disclosure by ambush. 238 Simply put, management was recommending, at the request of the Furman-Ovitz group as a pre-condition to their share purchase, that PPC be written down by $27.5 million, or by roughly by 29%. How Deloitte could have reasonably concluded that the inclusion of the $27.5 million was accounted for in accordance with GAAP and that the statements before the proposed write down would “present fairly, in all material respects, the financial position of” Livent as at December 31, 1997 left me breathless. Put otherwise, Deloitte was prepared to sign off on the statements before and after the write down, even though Power told me, the write down was a “step in the right direction”.154 In fact, Emerson must have found the whole process a little unsettling since he deferred approval of the statements by the Audit Committee pending a further review by Deloitte.155 Russo thereupon went back to Toronto and re- worked the numbers by applying them on a show by show basis, a step which had not been undertaken at first instance. 239 How this last minute adjustment, which created a huge loss for the year, in respect of a hot-button item such as PPC, coming on the heels of the Put fiasco did not cause Deloitte to put the brakes on the entire audit process is beyond my comprehension. Why these issues alone, together with the fact that management insisted yet again on bringing five other

154Transcript, Power Examination-in-Chief, 28 June 2013, at pp. 70-71; Tran- script, Power Cross-Examination, 8 July 2013, at pp. 215-17. 155Minutes of a Meeting of the Audit Committee of Livent Inc., 9 April 1998, JBD 15760. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 291

“unusual” Revenue Transactions into income, did not cause Deloitte to rethink every representation made by management, causes more than modest concern about the entire audit for year-end 1997, if not before. In arriving at this conclusion, I have not thrown the other matters into the mix which, as O’Kelly argued, should have raised more red flags, in which category I include additions to fixed assets and their testing, accounts payables testing and sampling and unrecorded liabilities. And in that regard, I have not expressed my concerns about the fact that the representation letter provided Deloitte for the year was signed by Gottlieb and Drabinsky and not by Banks and Messina, which would have been more normal and expected. 240 Putting the matter otherwise, even if Deloitte somehow escaped an adverse finding in respect of the Put issue in April 1998, I am satisfied that it would have been obliged to withhold a clean audit opinion for year-end 1997 in respect of PPC, the Revenue Transactions, and the ancillary issues described above. Simply put, the Firm’s professional skepticism, while at an acknowledged all-time high, would have mandated a wholesale investigation, and not simply an audit on those matters, which would have placed them on a collision course with Gottlieb and Drabinsky.

9. Tort Claim — Conclusion/Distillation 241 Where am I, now that I have canvassed the Livent-Deloitte water- front? I have first concluded that Deloitte should have pulled the plug on its relationship with Livent at the end of August or, at the very latest, September 1997. In my view, had matters come to a head on either of those two dates, then Deloitte would have been obliged to make “full and frank” disclosure not only to the Audit Committee but to the regulators, the results of which would have put Livent in the position it found itself in 11 months hence. 242 In the alternative, if I am wrong in that conclusion, based upon the matters distilled in the judgment to that point, I am of the opinion that Deloitte should not have signed off on the 1997 Audit in early April 1998. The events of that month and the weeks leading up to the Put rediscovery, if not the massive proposed PPC write-down illuminated by the foot-lights of the New York Audit Committee meeting gave new meaning to the adage “once burned, twice shy”. 292 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

10. Breach of Contract — Conclusion 243 Returning but briefly to the commencement of these reasons, because of the manner in which this case was presented on both sides of the aisle, I indicated that the review would focus on the tort aspect of the claim as opposed to the fact that the action is also founded in contract. I am satisfied that the action in contract succeeds similarly and for the reasons expressed above. No distinction will therefore be made on the elements of the contract and its breaches, all of which are incorporated by reference to the finding of “negligence” described above. Not that it was argued in that vein, but I do not believe that it is necessary for me to find that the caveat found in the standard engagement letter set out at footnote 76 above acts in any way as a limiting or exclusionary clause relieving Deloitte of its contractual duty in respect of the detection and resolution of intentional misstatements.

Part II: Corporate Identification Doctrine 1. Introduction 244 Deloitte takes the position that even if I were to find negligence or breach of contract on the part of the Firm, Livent’s losses are not recoverable because such were caused by its own illegal acts. This proposition, otherwise described as the “corporate identification doctrine”, arises out of what Professor MacPherson observed is rather “unsettled law”, which he also argues is “in need of rationalization”.156 245 This doctrine, and the principle of ex turpi causa non oritur actio, achieved more than some prominence during the course of argument. I think it is also fair to say that the ultimate conclusions expressed below in respect of the application of the two doctrines to the facts of this case were not arrived at lightly, but only after repeated reflections on the parties’ respective arguments and the case law cited. I am also not na¨ıve enough to think that the issue will not receive further consideration by other courts in this continuing saga.

156Darcy L. MacPherson, Annotation, Hart Building Supplies Ltd. v. Deloitte & Touche, 2004 BCSC 55, 41 C.C.L.T. (3d) 240 (B.C. S.C. [In Chambers]). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 293

2. Genesis of Corporate Identification 246 Professor MacPherson, who has written on the doctrine,157 notes that the “identification doctrine was created as a device to ascribe or attribute a mental state to a corporate body for the purposes of civil or criminal liability. The original application of the identification doctrine was as a means to hold a corporation liable.”158 247 He made a similar, if not clearer, observation about the genesis of the doctrine in an article in the Canadian Business Law Journal: Identification theory is the manner in which a corporation is held liable for actions that are not amenable to vicarious liability. This in- cludes crimes requiring proof of mental fault - mens rea or negligence -... or torts requiring actual fault or privity of the corporation.... Once the application of the theory is established, then the actions and mental states of the human individual who is “identified” with the corporation become those of the corporation. As one judge has put it, the human being becomes the “embodiment” of the corporation.... Even though the individual and the corporation “become one” when the identification theory is applied, the individual can generally be convicted in addition to the corporation.... 248 The two seminal cases which provide the underpinning for the doctrine of corporate identification, he suggests, are Asiatic Petroleum Co. v. Lennard’s Carrying Co.159 in the civil context, and R. v. McNamara (No. 1)160 in the criminal law arena. Both cases arise in circumstances where the Court created fact-specific criteria to determine when and under what conditions a company should be responsible at law for the acts of its directing mind. 249 Neither case dealt with a situation where the doctrine was sought to be applied in an action by the “aggrieved” company against a third party who allegedly missed or failed to uncover the wrong doings of the company’s directing mind. The first Canadian case that seems to have dealt with an action against a third party and the applicability of the identifica-

157Darcy L. MacPherson, “Emaciating the Statutory Audit — A Comment on Hart Building Supplies Ltd. v. Deloitte & Touche” (2005) 41 Can. Bus. L.J. 471; Darcy L. MacPherson, “The Civil and Criminal Applications of the Identifica- tion Doctrine: Arguments for Harmonization” (2007) 45:1 Alta. L. Rev. 171. 158MacPherson, Annotation, supra note 156. 159[1915] A.C. 705 (U.K. H.L.). 160[1985] 1 S.C.R. 662 (S.C.C.). 294 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

tion doctrine was Hart Building Supplies Ltd. v. Deloitte & Touche,161 a case which I will discuss below.

3. Deloitte’s Position 250 Deloitte’s position is that the frauds of Gottlieb and Drabinsky must be attributed to Livent under the identification doctrine developed by Es- tey J. in Canadian Dredge, which is succinctly stated in that judgment as follows: [T]he identification doctrine only operates where the Crown demonstrates that the action taken by the directing mind (a) was within the field of operation assigned to him; (b) was not totally in fraud of the corporation; and (c) was by design or result partly for the benefit of the company.162 251 The defendant submits that Drabinsky and Gottlieb were the directing minds of Livent, that they were acting within the scope of their authority and assigned functions, and that they undertook the frauds discussed above to maintain, among other things, Livent’s access to the capital markets and ensure a continuous flow of money to the company. Deloitte agues, as it did in Hart Building, that once the criteria set forth by Estey J. are met, then attribution to the corporation is established and the defence prevails. 252 While I do not take issue with the proposition that the formula has been met in the instant case, I am not sure that Estey J. intended that it be applied in circumstances other than as “a court-adopted principle put in place for the purpose of including the corporation in the pattern of criminal law in a rational relationship to that of the natural person”.163 If that statement were not sufficient to limit or clarify the application of the doctrine, Estey J. made this further observation: The identification theory was inspired in the common law in order to find some pragmatic, acceptable middle ground which would see a corporation under the umbrella of the criminal law of the community but which would not saddle the corporation with the criminal wrongs of all of its employees and agents.164

1612004 BCSC 55, 41 C.C.L.T. (3d) 240 (B.C. S.C. [In Chambers]). 162Canadian Dredge, supra note 159, at pp. 713-14. 163Ibid., at p. 693. 164Ibid., at p. 701. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 295

253 Indeed, I believe it is now well accepted that cases like Canadian Dredge were not intended to create universal attribution rules that can and should be applied mechanically, as Deloitte postulates, regardless of the context. Such a view runs counter to the excerpt from Estey J.’s decision, as well as the oft-quoted decision of Lord Hoffmann in Meridian Global Funds Management Asia Ltd. v. The Securities Commission: The company’s primary rules of attribution together with the general principles of agency, vicarious liability and so forth are usually sufficient to enable one to determine its rights and obligations. In excep- tional cases, however, they will not provide an answer. This will be the case when a rule of law, either expressly or by implication, excludes attribution on the basis of the general principles of agency or vicarious liability. For example, a rule may be stated in language primarily applicable to a natural person and require some act or state of mind on the part of that person “himself,” as opposed to his servants or agents. This is generally true of rules of the criminal law, which ordinarily impose liability only for the actus reus and mens rea of the defendant himself. How is such a rule to be applied to a company? One possibility is that the court may come to the conclusion that the rule was not intended to apply to companies at all; for example, a law which created an offence for which the only penalty was community service. Another possibility is that the court might interpret the law as meaning that it could apply to a company only on the basis of its primary rules of attribution, i.e. if the act giving rise to liability was specifically authorised by a resolution of the board or an unanimous agreement of the shareholders. But there will be many cases in which neither of these solutions is satisfactory; in which the court considers that the law was intended to apply to companies and that, although it excludes ordinary vicarious liability, insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc. of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy.165

165[1995] 2 A.C. 500 (New Zealand P.C.), at p. 507 (emphasis added). 296 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

254 The analysis in Lennard’s — the case in which Viscount Haldane L.C. coined the phrase “directing mind and will” — is consistent with the methodology described by Lord Hoffmann. Like Estey J. in Canadian Dredge, Viscount Haldane L.C. was addressing an attribution problem in a particular context, not laying down a universal rule. The question in Lennard’s was in fact far narrower than that in Canadian Dredge: Sec- tion 502 of the Merchant Shipping Act relieved ship owners of liability for “any loss or damage happening without [their] actual fault or privity”, and the House of Lords was called on to determine whose “fault or privity” would count as the fault or privity of a corporate ship owner for the purposes of s. 502.

4. Hart Building 255 The facts in Hart Building, which I find are almost on all fours with the instant case, can be best summarized as follows: 256 Larson, the fraudster, was the general manager and chief operating officer of the company. He was also a 15% shareholder. The balance of the shares was owned by another, who took no role in the management of the day-to-day affairs of the company. Larson fraudulently overstated the value of Hart’s inventory for a number of years and provided representation letters to Deloitte that the financial statements were prepared in accordance with GAAP and were otherwise free from any material errors and omissions. 257 While he did not profit personally from his actions, his intention in overstating the value of the inventory was to keep Hart’s bankers at bay and permit the company to access financing until the economy turned around and the books of account could be revised to reflect reality. When the fraud was uncovered, Hart went into receivership and an action was commenced in the name of the company against Deloitte for negligence in not uncovering the fraud during the course of its audits. 258 Deloitte brought a summary judgment motion in which it argued that Larson’s fraud ought to be attributed to Hart in accordance with the corporate identification doctrine. Baker J. first determined to apply the Ca- nadian Dredge formula, it having been conceded by the plaintiff that “there is no dispute... that the enunciation of the central concepts of the doctrine apply equally in the civil context”.166 Once it was established

166Hart Building, supra note 161, at para. 30. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 297

that Larson’s fraud was, at law, that of Hart, Hart’s action was dismissed on the ground that it could not be allowed to profit from its own fraud. 259 The receiver only argued that the Estey criteria had not been met because on the facts of the case the company did not realize a benefit from the fraud. He further argued that there were limited policy reasons which militated against the application of the doctrine to the facts of the case. Baker J. rejected both arguments and dismissed the action by concluding as follows: Larson was Hart’s directing mind and its alter ego. Hart may not benefit from its own fraud. Hart, in the person of Larson, deliberately misrepresented the true state of its financial affairs to Deloitte, in contravention of the agreement it entered into with Deloitte by virtue of the representation letters Larson, acting on behalf of Hart, signed. Hart knew that the audited financial statements were incorrect, because Hart provided false information with the knowledge and intention that the auditors would rely on that false information in preparation of the statements. Hart did not rely on the audited statements because Hart’s directing mind knew those statements were incorrect.167

167Ibid., at para. 63 (emphasis added). In applying the Canadian Dredge criteria to the facts in Hart, Baker J. seemed to find comfort in two other decisions in which she said the corporate identification doctrine was applied in the civil context, namely 373409 Alberta Ltd. (Receiver of) v. Bank of Montreal, 2002 SCC 81, [2002] 4 S.C.R. 312 (S.C.C.), and Dixon v. Deacon Morgan McEwen Eas- son (1993), 102 D.L.R. (4th) 1 (B.C. C.A.). Neither of these two cases involved an action by the “affected” company against a third party for a breach of duty or contract and in my opinion are of limited assistance to an understanding of the application of the corporate identification doctrine. Properly understood, 373409 Alberta Ltd. did not involve corporate identification doctrine at all. The attribution of the sole shareholder and director’s action to the corporation depended only on the primary rules of attribution in corporate law. Canadian Dredge was referred to only in the context of explaining why the wrongfulness of his actions with respect to the creditors of the corporation did not prevent those actions from being attributed to the corporation. In any event, the case is of no assistance here, since it involved the interpretation and application of the tort of conversion, not the illegality defence. Dixon v. Deacon Morgan McEwen Easson, meanwhile, is not helpful because it concerned the liability of a company to victims of frauds committed by its president and chief financial officer. In the case at bar, there is no dispute about whether Livent is liable to the victims of Gottlieb and Drabinsky’s frauds. 298 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

260 As indicated above, the decision of Baker J. has been commented upon, albeit adversely, by Professor MacPherson first in the article above cited and in an annotation to the report of judgment. While he questioned the applicability of the docine to actions against third parties, although conceding that the law on this issue was unsettled, he suggested that there were policy reasons why the doctrine should not be applied in actions against auditors. His thesis can be best captured in the following excerpt: I have argued that the application of the identification theory to deny a corporation the right to sue its auditor for negligence in the preparation of the statutorily mandated audit is problematic for several reasons. First, it is proper and in fact necessary to consider policy arguments in determining whether attribution to the corporation is warranted, and this article has attempted to discuss a number of policy factors that could be considered relevant to this determination. It may be that there are other countervailing policy arguments that have not been considered. Second, Canadian Dredge & Dock Co. is a key part of the identification theory, but it should not be used to foreclose any debate as to the proper scope of the theory. Third, there are serious policy flaws with the application of the theory in Hart, and it would require substantial opposing policy arguments to make the result in Hart acceptable at a policy level. It is hoped that this article will stimulate debate about these policy issues.168

5. Ex Turpi Causa 261 Leaving aside the MacPherson policy considerations upon which I did not hear argument, I am of the view for the reasons expressed above that the corporate identification doctrine was not intended to and does not apply to an action commenced by an aggrieved company against a third party for negligence or breach of contract.169 Notwithstanding,

168MacPherson, “Emaciating the Statutory Audit”, supra note 157, at p. 491. 169The two cases cited by Deloitte which were decided subsequent to Hart Building, namely B & Y Holdings Ltd. v. Best, 2008 NLTD 78, 45 B.L.R. (4th) 143 (N.L. T.D.) and Cosmetology Industry Assn. of British Columbia v. Nguyen, 2010 BCSC 1051, 84 C.C.E.L. (3d) 257 (B.C. S.C.), do not analyze whether the doctrine applies to actions against third parties since each deals with whether the Canadian Dredge formula has been satisfied. In my view, these two cases are similarly of limited assistance since the threshold question was not addressed and the policy considerations do not appear to have been canvassed. In B & Y Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 299

however, the concession made by Deloitte in its written final argument that it was not seeking to rely on the maxim ex turpi causa to defeat Livent’s claim,170 I have concluded that such forms, without acknowl- edgment, a fundamental underpinning to the decision of Baker J. in Hart Building and was, in fact, the position which Deloitte advanced in that case to persuade the motion judge that Hart should not be permitted to benefit from its own fraud. I have also concluded that notwithstanding Deloitte’s concession in respect of its applicability, I am obliged to consider whether the maxim should be applied to the circumstances of this case. 262 The doctrine of ex turpi causa non oritur actio literally means “from a dishonourable cause an action does not arise”. The leading case on this rule of law is Hall v. Hebert and the decision of McLachlin J., as she then was, writing for the majority.171 The principles to be derived from that case were summarized more recently by the SCC in British Columbia v. Zastowny as follows: 1. Application of the ex turpi doctrine in the tort context in- validates otherwise valid and enforceable actions in tort (p. 169). 2. Therefore, its application must be based on a firm doctrinal foundation and be made subject to clear limits and should occur “in very limited circumstances” (p. 169). 3. The only justification for its application is the preservation of the integrity of the legal system. This concern is only in issue where a damage award in a civil suit would allow a person to profit from illegal or wrongful conduct or would

Holdings, the outcome of the case did not turn on the court’s brief and uncritical adoption of Hart Building, but on the plaintiff’s failure to establish any wrongdoing, causation or loss. In Cosmetology Industry Assn., the outcome turned on the plaintiff corporation’s inability to establish the requisite elements of the tort of deceit because no natural person involved with the corporation was actually deceived by or actually relied on any false representation by the defendant. See Closing Argument of Deloitte & Touche LLP, vol. 1, at paras. 392-97. 170Ibid., vol. 1, at para. 428. 171[1993] 2 S.C.R. 159 (S.C.C.). 300 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

permit evasion or rebate of a penalty prescribed by the criminal law (p. 169). It would, in short, introduce an inconsistency in the law. It is particularly important in this context that we bear in mind that the law must aspire to be a unified institution, the parts of which • contract, tort, the criminal law • must be in essential harmony. For the courts to punish conduct with one hand while rewarding it with the other, would be to “create an intolerable fis- sure in the law’s conceptually seamless web”: Weinrib, supra, at p. 42. We thus see that the concern, put at its most fundamental, is with the integrity of the legal system. [p. 176] 4. The ex turpi doctrine generally does not preclude an award of damages in tort because such awards tend to compensate the plaintiff rather than amount to “profit”: Such damages accomplish nothing more than to put the plaintiff in the position he or she would have been in had the tort not occurred.... [A plaintiff should get] only the value of, or a substitute for, the injuries he or she has suffered by the fault of another. He or she gets nothing for or by reason of the fact he or she was engaged in illegal conduct. [pp. 176-77] 5. The ex turpi doctrine is a defence in a tort action. The plaintiff’s illegal conduct does not give rise to a judicial discretion to negate or refuse to consider the duty of care which goes to the relationship between a plaintiff and a defendant. It is independent of that relationship. The defendant may have caused harm by acting wrongly or negligently, but the “responsibility for this wrong is suspended only because concern for the integrity of the legal system trumps the concern that the defendant be responsible” (pp. 181-82). 6. Treating the ex turpi doctrine as a defence places the onus on the defendant to prove the illegal or immoral conduct that precludes the plaintiff’s action. And as a defence, it allows for segregation between claims for personal injury and claims that would constitute profit from illegal or immoral Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 301

conduct or the evasion of or a rebate of a penalty provided by the criminal law.172 263 It seems to me, from a review of the above principles, that I am obliged to determine whether this defence of public policy, as it has been described, is a bar to the corporation’s claim on the facts of this case. To that end, in my view, the question to be posed is not whether Gottlieb and Drabinsky’s fraud should be attributed to the corporation for all purposes but whether their fraud should be attributed to Livent for purposes of applying the ex turpi causa doctrine. As part of this inquiry, I believe I must decide whether the company will profit from its own fraud. Further- more, and perhaps as a threshold consideration, I am obliged to determine whether or not to decline to apply the doctrine would, in the circumstances of this case, undermine the justice system. 264 The recent judgments of the House of Lords in Stone & Rolls Ltd. v. Moore Stephens Ltd. are of assistance to this inquiry.173 As in the instant case, that case also involved a claim brought by an insolvent corporation against its auditor. The plaintiff Stone & Rolls was a “one-man company”, meaning that it was entirely owned and controlled by one Stojevic. “S & R” was a sham company; it had no legitimate business. Its sole purpose was to enable Stojevic to defraud its bankers. The defendant firm of auditors, Moore Stephens, was hired by S & R to audit its books. It failed to detect the fraud in the course of its audits and by the time the fraud was detected, the money spirited out of the banks had disappeared. The victims sued S & R for deceit and were awarded substantial damages, but S & R did not have the funds to pay and went into liquidation. The liquidator then caused S & R to sue Moore Stephens in negligence, in an attempt to recover damages for the benefit of S & R’s judgment creditors. The allegation was that, but for Moore Stephens’s carelessness in conducting the audits, Stojevic’s fraud would have been detected earlier. Moore Stephens moved to strike out the claim on the basis that S & R’s claim was founded on its own fraud and therefore barred by the doctrine of ex turpi causa. 265 At the House of Lords, a 3-2 majority held that S & R’s claim was barred by the ex turpi causa rule. The majority view turned on the fact

1722008 SCC 4, [2008] 1 S.C.R. 27 (S.C.C.), at para 20. The page numbers in this quotation are references to Hall v. Hebert, supra note 171. 173[2009] UKHL 39, [2009] 3 W.L.R. 455 (U.K. H.L.). 302 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

that S & R was a one-man company, a fact that was significant because everyone for whose benefit the auditor owed a duty was a wrongdoer. Lord Phillips put the point as follows: [A]ll whose interests formed the subject of any duty of care owed by Moore Stephens to S & R, namely the company’s sole will and mind and beneficial owner Mr Stojevic, were party to the illegal conduct that forms the basis of the company’s claim. In these circumstances... ex turpi causa provides a defence.174 266 Even though the liquidator’s action was, in reality, an action for the benefit of S & R’s creditors, as innocent victims of the fraud, Lord Bridge’s decision in Caparo established that the auditor’s duty of care did not extend to them as stakeholders and hence, their claim as a group did not form part of the mix. 267 However, the House of Lords appears to have been unanimous in suggesting by way of obiter, or at least leaving open for further consideration, the notion that S & R’s claim would not have been barred had there been innocent shareholders.175 268 Lord Phillips put the proposition in this fashion: I would not think it right to hold as a matter of general principle that ex turpi causa does not apply to a claim by a company against its auditors for failing to detect that the company has been operating fraudulently unless it were demonstrated how the difficulties to which I have referred could be resolved.... At the same time, I have not been persuaded by Mr. Sumption’s primary case that the reliance test, or the principle of public policy that underlies it, would necessarily defeat S&R’s claim if S&R were a company with independent shareholders that had been “high-jacked” by Mr. Stojevic. In that, at least, I believe that I share common ground with all your Lordships.176 269 Indeed, Lord Mance went further and said that it was “clear beyond doubt that the company has a remedy against its auditor for negligent failure to detect and report fraud by a company’s directing mind where (at the very least) the company has innocent shareholders”.177 In my

174Ibid., at para. 86. 175Ibid., at paras. 32, 174, 201. 176Ibid., at para. 63. 177Ibid., at para. 225. As I alluded to above, Hart Building, supra note 161, and its progeny are at odds with this proposition and the obiter of the House of Lords Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 303

view, the underlying rationale would be, as Lord Phillips explained, “[i]f ex turpi causa is not to apply..., the reason should simply be that the public policy underlying it does not require its application”.178 270 In the case at bar, the plaintiff corporation had innocent shareholders and directors who were not party to the fraudulent schemes of Gottlieb and Drabinsky. Hence, if Livent were to recover damages from Deloitte, none of that money would provide any benefit, direct or indirect, to anyone who participated in the fraud. No wrongdoer would therefore be allowed to profit from his wrong or to evade a criminal sanction, and therefore the integrity of the legal system would not be called into question. In these circumstances, therefore, I am not persuaded that the purpose of the ex turpi causa doctrine would be served by attributing the fraud to the company. 271 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 high-level management. That proposition is, in my opinion, part of the underlying rationale of the leading auditors’ negligence cases in Canada and the U.K. As was discussed in the prior section of this judgement, the leading decisions in both jurisdictions con- template a corporation bringing an action against its auditor for failure to detect wrongdoing by directors.179 272 In Stone & Rolls, Lord Mance, albeit in his dissenting opinion, which I find to be very persuasive, made short work of the argument that an auditor could be absolved of liability for negligently failing to detect fraud so long as the fraudster could be described as a “directing mind”: Leaving aside situations in which the directing mind(s) is or are the sole beneficial shareholder(s), it is obvious... that an auditor cannot, by reference to the maxim ex turpi causa, defeat a claim for breach of duty in failing to detect managerial fraud at the company’s highest level by attributing to the company the very fraud which the auditor should have detected. It would lame the very concept of an audit — a

in Stone & Rolls. Because of the focus of the case that was presented to Baker J., the issue was not addressed and she did not have to grapple with the fact that the fraudster in that case was but a 15% shareholder in the corporation. 178Stone & Rolls, supra note 173, at para. 60. 179Hercules, supra note 18, at para. 48; Caparo, supra note 42, at pp. 626, 630. 304 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

check on management for the benefit of shareholders — if the higher the level of managerial fraud, the lower the auditor’s responsibility. When Lord Bridge noted in Caparo Industries plc v Dickman [1990] 2 AC 605, 626e that shareholders’ remedy in the case of negligent failure by an auditor to discover and expose misappropriation of funds by a director consisted in a claim against the auditors in the name of the company, he cannot conceivably have had in mind that it would make all the difference to the availability of such a claim whether the director was or was not the company’s directing mind. The fact that [the] “very thing” that an auditor undertakes is the exercise of reasonable care in relation to the possibility of financial im- propriety at the highest level makes it impossible for the auditor to treat the company itself as personally involved in such fraud, or to invoke the maxim ex turpi causa in such a case.180 273 In the final analysis, I am not persuaded that either the corporate identification or ex turpi causa doctrines should be applied to the instant case for legal or policy reasons. I decline, therefore, to follow the decision of Baker J. in Hart Building.

Part III: Damages 1. Introduction 274 The assessment of damages is as often as not a mug’s game. First, the trial judge must set the parameters for the exercise, defining and then applying the appropriate first principles. Next, he or she is called upon to determine whether the acts of the defendant caused or contributed to the damages complained of, regardless of whether they are founded in contract or tort or both. At this stage the trial judge has to engage, as well, in the confounding exercise of determining whether or not the damages sought must be limited by remoteness or proximate causation. Finally, as if the other tasks were not enough of a challenge, the trial judge must determine whether there are any delimiting factors which apply to the calculus, such as contributory negligence, contingencies for which the defendant should not be held accountable or the application of full or partial releases. 275 As an intended aid to all of this mysterious crystal ball gazing is the much trumpeted assistance trial judges receive — or should receive — from the expert witnesses who line up on either side of the dispute. Re-

180Stone & Rolls, supra note 173, at para. 241. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 305

grettably, in the instant case, the evidence I heard from the two experts spanning some six days left me somewhat at sea. Mercifully, however, as a result of the concessions made by counsel during the waning days of argument, the issues which I was left to resolve in this area were significantly reduced. 276 I digress to observe that the complexity and confusion erupting from the banker’s box of damage reports could have been more readily avoided had counsel directed their respective experts to engage in some early “hot tubbing”, a concept which has not been met with favour from the Ontario bar181 though it has on occasion been ordered by this court.182 The resolution of certain evidentiary problems and factual dis- putes that disappeared during the course of the trial through the court- assisted conclusion of agreed statements of fact underscores why counsel should insist on more trial management, earlier and more often than a scant few weeks before trial.

2. First Principles 277 Initially I thought there was little to separate the parties in respect of the general theoretical principles that apply to the assessment damages sustained as a result of the commission of a tort or breach of a contract. That separation, regrettably, looked smaller at thirty thousand feet than it did at ground level. 278 The parties do agree, however, that in a tort action a successful plaintiff must be put into the position he would have been in had the tort not been committed; in a breach of contract action, a successful plaintiff should be put into the position he would have been in had the contract not been broken or been performed. Professor McGregor amplified these basic principles in this fashion in his oft-cited text: The general rule is, however, only a starting point, for upon it a number of important limits are engrafted which may result in the claimant recovering less than an amount which would put him in the position he would have been in had the tort or breach of contract never been

181See the comments of the Court of Appeal on this issue in Suwary (Litigation Guardian of) v. Women’s College Hospital, 2011 ONCA 676, 285 O.A.C. 199 (Ont. C.A.), at paras. 110-14. 182Glass v. 618717 Ontario Inc., 2011 ONSC 2926 (Ont. S.C.J. [Commercial List]) (CanLII), at para. 26; Karrys Bros. Ltd. v. Ruffa, 2014 ONSC 713 (Ont. S.C.J. [Commercial List]) (CanLII), at para. 19. 306 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

committed. Rigorously to insist upon such full compensation would be too harsh upon defendants. The loss for which the claimant will be compensated is cut down by a variety of factors: thus he cannot recover damages for that part of the loss due to his contributory negligence, nor for such loss of which the defendant’s conduct is not the cause, nor for such loss which is not within the scope of the protection of the particular tort or contract, nor for loss which he should have avoided, nor for loss which is too uncertain, nor for some past and prospective losses. These factors are all given extended consideration: many of them are frequently grouped under the compendious term “remoteness of damage”. The width of meaning commonly given to this term can easily lead to muddled and telescoped thinking by grouping diverse factors under the same name, and separate analysis is therefore important. At the same time this umbrella use of “remoteness of damage” can serve to point to the common denominator of these various factors: they all delimit the consequences and losses for which the claimant can recover compensation. In this way the term “remoteness of damage” can be distinguished from the term “measure of damages”, the former referring to the consequences and losses for which the claimant can recover compensation, and the latter referring to the method of calculating the compensation for the particular consequence or loss.183 279 I do not believe this is a case where the maxim omnia praesumuntur contra spoliatorem (all is presumed against a wrongdoer or despoiler) should apply as the plaintiff urged upon me. This is not a situation where (a) the nature of the wrong itself makes it difficult for the plaintiff to establish loss or (b) the critical facts are peculiarly within the defendant’s knowledge.184 Even if the assessment of damages is difficult, I am obliged to struggle with it, as were the parties. 280 I do, however, agree with the plaintiff that Deloitte knew at all material times that Gottlieb and Drabinsky were using the financial statements to assist them in convincing third parties to invest money in or extend credit to Livent. 281 Finally, I accept that the “but for” test has to be applied to the causation issue. The “but for” test requires me to determine whether the dam-

183Harvey McGregor, McGregor on Damages, 18th ed., (London, U.K.: Sweet & Maxwell, 2009), at pp. 16-17. 184Ticketnet Corp. v. Air Canada (1997), 154 D.L.R. (4th) 271 (Ont. C.A.), at para. 85. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 307

ages that Livent seeks to recover would have been suffered but for the negligence or breach of contract committed by Deloitte. As previously indicated, I am not persuaded on a balance of probabilities that Livent would have been deprived of its access to the capital markets, but for the negligence of Deloitte for the years prior to year-end 1995. In fact, the same conclusion could be drawn from the balance sheet deterioration theory, one of the plaintiff’s early theories of damages that was aban- doned on closing. I am therefore left to assess damages for the years subsequent.

3. Applying the “But For” Test 282 The plaintiff’s position is that Deloitte ought to have discovered material misstatements, whether caused by error or done intentionally, in each of its Livent audits. Had it done so in any of the years in question, the plaintiff argues that Deloitte would have been obliged to withhold its clean opinion of the financial statements for that year. The lack of audited financial statements would, in turn, have meant that Livent could not have accessed the capital markets and no further losses could have been incurred past that point. 283 In the first place, I am not persuaded that, short of any finding or suspicion of fraud, Deloitte would have refused to issue a clean opinion in any of the years prior to year-end 1995 without first attempting to persuade Livent’s management to correct the errors that had been detected. 284 Alternatively, even if Deloitte had uncovered inadvertent errors in the years prior to year-end 1996, I am persuaded that Livent would likely still have been able to access the capital markets for share underwritings and debt placement. This proposition is underscored by the events of the spring of 1998, when Ovitz and Furman insisted on a massive PPC write down, throwing Livent into a huge loss position. Regardless of this swing in fortunes, it was still able to complete the underwriting. Indeed, the situation repeated itself in the months following the Ovitz-Furman closing and after a further write down of PPC and a further anticipated Q2 loss. Messrs. Black and Pattison seemingly beat a path to Drabin- sky’s door to dump additional millions into Livent’s lap. The fraud to that point had not been uncovered and access to the capital markets had not been denied, accordingly. Regardless of the newly recorded losses, Drabinsky’s star was still shining brightly on the horizon. 308 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

285 Mr. Howard suggested during argument that if I were to adopt the above analysis, I would be falling into error by “assuming away the breach” of providing a clean opinion. However, I am of the view that Mr. Howard has himself drawn a false distinction between a breach of duty and a breach of the standard of care. When one is said to owe another a duty of care, it means simply that one is obliged to exercise a reasonable standard of care to avoid injury to the other. That is to say, the content of the duty of care is an obligation to meet the standard of care. In my view, the ultimate issuance or withholding of a clean opinion is but one aspect of conducting an audit in accordance with GAAS. It is not close to being the complete embodiment of the duty of care. Indeed, if his argument were accepted, it would preclude the applicability of the “but for” test. Instead of asking whether damages would have been sustained but for the negligent failure to detect certain errors or fraud, one would be restricted to asking whether or not damages would have been sustained but for the provision of a clean opinion. 286 The following excerpt from Professor Osborne’s text illustrates that the actionable breaches that must be taken into account in the causation analysis include every breach of the standard of care: [T]he application of the but for test involves a number of discrete steps. First, the harm that is alleged to have been caused by the defendant must be identified. Second, the specific act or acts of negligence by the defendant must be isolated. Third, the trier of fact must mentally adjust the facts so that the defendant’s conduct satisfies the standard of care of the reasonable person, being sure to leave all other facts the same. Fourth, it must be asked if the plaintiff’s harm would have occurred if the defendants had been acting with reasonable care.185 287 Finally, not that it is dispositive of the issue, a review of the paragraphs of the Statement of Claim paraphrased towards the start of these reasons demonstrates that the plaintiff described the breaches more broadly than it did during the course of closing arguments. Indeed, from my observation, the over 200 pages of written argument devoted to these issues conflates the concepts repeatedly.

185Philip H. Osborne, The Law of Torts, 4th ed. (Toronto: Irwin Law, 2011), at p. 53 (emphasis added). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 309

4. The Experts 288 Business valuation and appraisal evidence has fallen within the almost exclusive domain of accountants who realized early on in their ca- reers that there were alternatives to merely doing audits and tax planning. They have, as a consequence, created a growth industry such that no complex litigation can be pursued without their assistance. At the risk of seeming a tad cynical, and because few of the litigation support specialists who have testified before me adopt the KISS principle, much trial time, and judicial time prior to trial, is spent sifting through complex theories that either never see the light of day or fall away upon critical examination. 289 In this case, I heard from Ian Ratner, for Livent, and Stephen Cole, on behalf of Deloitte. They came from the same mold, although a few years apart, and progressed through similar career paths, leading ultimately to their present positions as full-time forensic investigation and valuation specialists cum professional witnesses. Each has a r´esum´e adorned by a wealth of credentials, publications and honours, of varying kinds. And, alas, each prepared reports, cross reports and reply reports that were too complex by half, and replete with charts, tables and graphs that confused matters, rather than simplified them. 290 After much handwringing on my part in trying to understand their unnecessarily complex presentations, when all the dust settled, which included their respective cross examinations, they each settled upon the same equation to encapsulate the plaintiff’s theory of damages with some, admittedly significant, differences. That said, I do not find it necessary to revisit the other theories that were discarded in the trial trash heap.

5. The Equation and the Math 291 The plaintiff’s theory of damages can best be expressed in the following sentence: the measure of damage equals the change or increase in the losses sustained by Livent between the time of Deloitte’s breach and the time of Livent’s eventual CCAA filing, if not its insolvency. This proposition was translated by each of Messrs. Ratner and Cole into the following equation (“Equation”): Loss (L) = Actual Liquidation Deficit (ALD) - Estimated Liquidation Deficit (ELD) or L = ALD - ELD. 292 The estimated liquidation deficit is calculated as at the measurement date, which is the date when (a) Deloitte breached its standard of care, 310 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

(b) the fraud would have been discovered but for the breach, (c) if the fraud had been uncovered, Livent would have been unable to access the capital markets, and (d) this would, in turn, have led to a formal insolvency (“Measurement Date”). 293 The first step in dealing with this equation is to understand that the ALD was a given or constant, which the parties agreed was $418.83 million. That number was established by calculating the loss sustained in the sale of Livent’s assets to SFX Entertainment Inc. in August 1999, a year after the first disclosure of the frauds. It is the result obtained by subtracting the sum of the share capital and debt from the net cash received on the sale of the Livent assets. 294 The next step in the order of operation, to employ a high school math term, is to perform the same exercise by subtracting the sum of the share capital and debt from the estimated value of the Livent assets as of the Measurement Date. This last calculation is at the heart of one of the major differences between the approaches of Messrs. Cole and Ratner. 295 To borrow liberally from the plaintiff’s written submissions on damages, Ratner’s approach to the valuation of Livent’s assets at each potential Measurement Date was to utilize a ratio that resulted from a comparison of the actual amount realized from the sale of the Livent assets measured against the adjusted book value of the same assets. The resulting ratio was then applied to the ELD calculation portion of the Equa- tion. Cole, on the other hand estimated the fair market value (“FMV”) of Livent’s assets on each of the suggested Measurement Dates to arrive at an estimate of what he thought the assets would have netted had they been disposed of at that precise moment in time. 296 The moving target in respect of the two approaches is the estimated versus the mathematical value of the bundle of assets of Livent on any date set as the Measurement Date. What I did not fully grasp until well into Cole’s evidence was the fact that a higher value ascribed to the assets at each of the suggested measurement dates would yield a lower ELD, which would result in a greater overall economic loss or greater damages. This somewhat counterintuitive proposition meant that it was in Deloitte’s interest to have a lower value ascribed to the assets or a lower FMV at the Measurement Dates established in the liability section of these reasons. 297 Both Ratner and Cole’s methods of asset valuation were subject to criticism. Cole suggested that Ratner’s approach, in being wedded to what he characterized as Accounting Book Values (“ABV”), flies in the Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 311

face of acceptable valuation and damage quantification practice. He suggested that one of the inherent difficulties with the ABV method was that it would result in an overstatement of Livent’s losses. In particular, he testified that because assets under this method were recorded on an his- toric basis, they would not have a value on any given Measurement Date, which was reflective of any change in their value associated simply with the passage of time or, in the case of the several theatres under construction, as a result of their restoration and refurbishment. 298 Basically, he hypothesized — if not argued, at times — such a dispar- ity from FMV would be amplified the closer one moved towards construction completion. 299 The plaintiff’s complaints about the Cole analysis can be boiled down to a few basic propositions: Cole’s approach employs more than a few assumptions, relies on a subjective approach to value and has to accept, in some instances, as part of the assumptions the hearsay information and estimates provided by others that remained untested. In other instances, such as his valuation of the Pantages, Cole was evidently not provided with contemporaneously-prepared appraisals and excluded the value of the Air Rights, which had an intrinsic value of some significance and which the plaintiff argued Cole ignored. The net effect of these and other omissions meant that Cole’s asset values were lower than the ABV numbers relied on by Ratner. 300 Ratner, to be fair, did not discount PPC as much as it was discounted by Cole, for reasons that were lost on me, which resulted in a roughly $23 million differential, or about 2/3 of the difference between their two calculations for March 1997. While the rationale for Cole’s number for the carrying value of PPC makes some sense to me and perhaps more than the number fastened upon by Ratner, there are still issues in respect of Cole’s number, which were brought to light during his cross- examination. 301 Interestingly enough, and somewhat at odds with Cole’s thesis, was the fact that as the Measurement Date moved closer to the actual liquida- 312 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

tion date, the difference in in the economic loss calculation put forward by either expert was narrowed to almost insignificant values: March 1997 March 1998 Ratner $174 million $53.8 million Cole $136.8 million $54 million186 Difference $37.2 million (0.2 million) 302 Regrettably, the issue in terms of deductions and additions to the overall loss calculation proposed by either expert was not made any clearer after the entire matter was canvassed by counsel. I was basically left to my own devices to sort through this mess.

a. The “Raw” Number 303 As I just observed, neither of the approaches is unassailable, and, therefore, neither produced numbers that could be accepted without mod- ification. And but for choosing a mid-point between the two — the approach recommended by the plaintiff187 — I am at a loss to settle upon a principled approach for preferring one set of numbers over another. I am of the view that the economic loss number for March 1997, which would be at about the time of the audit completion for the year-end 1996, should be set at $155 million. The number for March 1998, which comes within days of the discovery of the secreted Put, will be $53.9 million.

b. The Sliding Number 304 At my request, Mr. Cole re-worked his numbers and provided me with an estimate of the economic loss assuming a Measurement Date of August 31st, 1997. He did this analysis and provided me with an “estimated” loss number moving the loss down from his original March 1997 number of $136 million to just over $100 million. He indicated that while this calculation, which was undertaken primarily on his behalf by one of his colleagues, did not completely comport with the guidelines prescribed by the Canadian Institute of Chartered Business Valuators, it comprised more than a back-of-the-envelope analysis.

186Simple Summary of Differences between Cole and Ratner, Exhibit 48. 187Supplementary Closing Submissions of the Plaintiff: Part V - Submission on the Measure and Quantification of Damages, at para. 92. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 313

305 He further told me that it did not entail simply a straight-line arithme- tic reduction of the previous loss number, but called for a principled reduction of the over-all loss calculation by massaging certain previously- accounted-for losses such as the Show Boat and Ragtime touring productions, among other deductions. I would hasten to observe that I found this explanation reasonably compelling since a simple straight-line reduction of the economic loss numbers would render the analysis that each of Ratner and Cole did for March 1998 meaningless. 306 I therefore determined to convert the reduction assessed by Cole as a function of his original raw loss number, which yielded a ratio of 73.5%, which I multiplied by the mid-way point number of $155 million. The net economic loss number for August 31st chosen as the Measurement Date in the wake of the first Put issue would yield an economic loss number of $113 million.188

6. Limiting Principles 307 Counsel for the defendant argued that the establishment of an economic loss number does not necessarily equate to an assessment of damages. In other words, they argued that I am obliged to consider certain other issues and factors which they suggested would reduce, if not eliminate, any raw number that I might ascribe to economic loss. Included in this argument are factors such as: (1) the proximate cause of loss or remoteness of damages; (2) contributory negligence; (3) deepening insolvency and (4) the effect of the Bar Orders. I will deal with each of these arguments in series.

a. Remoteness/Proximate Cause 308 Defendant’s counsel argues that Deloitte’s negligence or breach of contract was not the proximate cause of the damages complained of or, in other words, that the damages are too remote a consequence of Deloitte’s breach to be recoverable from Deloitte.

188Similarly, and without purporting to have nearly the same aptitude or training that either Cole or Ratner possess, I would fix the economic loss number at $105 million if the Measurement Date was set at September 30th and $53.9 million if it were moved to March 31, 1998. 314 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

309 Professor Klar described the role of the remoteness analysis as follows: As with the question of duty of care, the remoteness or proximate cause aspect of the negligence action allows judges to control the use of the negligence action and to limit a defendant’s responsibility to compensate injured victims. Duty asks the question: is this defendant obligated to take reasonable care for the protection of this plaintiff? Remoteness asks the question: even if there is an obligation to take reasonable care and it was breached, how far will the legal liability of the defendant stretch?189 310 Putting the matter otherwise, it is Deloitte’s position that any audit failures on its part did not cause loss to Livent — an argument which in the early days of the trial I found fairly compelling. In that respect, Deloitte relied on a decision of the Court of Appeal of England and Wales (“Galoo”) in support of the proposition that merely providing an opportunity for losses to be sustained by a company, by not uncovering fraudulent statements, for example, does not necessarily cause those losses.190 Furthermore, so the argument goes, the losses that Livent sustained are trading losses which were either incurred in the normal course of Livent’s business, arose out of a failed business strategy or in the wake of Livent’s subsequent insolvency. 311 The facts in Galoo parallel the facts in the instant case. The company in liquidation brought action against its former auditors in respect of alleged negligence spanning a ten-year period. During that time period Galoo’s accounts were falsely overstated as a result of frauds being carried out by the company’s managing director and another officer. The financial statements portrayed a picture of corporate profitability and a substantial net worth when, in fact, the company was singularly unprofitable, if not virtually worthless. Once the fraud was discovered, the company was put into liquidation and an action was commenced against the auditors. 312 The auditors brought a motion to strike out portions of the statement of claim under the English equivalent of our Rule 21, which permits

189Lewis N. Klar, Tort Law, 5th ed. (Toronto: Carswell, 2012), at p. 487. See also Mustapha v. Culligan of Canada Ltd., 2008 SCC 27, [2008] 2 S.C.R. 114 (S.C.C.), at para. 12. 190Galoo Ltd. v. Bright Grahame Murray (1993), [1994] 1 W.L.R. 1360 (Eng. C.A.). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 315

pleadings that disclose no reasonable cause of action to be struck. The plaintiff’s argument in Galoo was that had the auditors not breached their duty and discovered the fraud as they should have in a timely fashion, the company would have been put into liquidation earlier than occurred, would not have sustained any further losses, nor declared any further div- idends. Hence, all trading losses that occurred could and would have been avoided. 313 When the matter made its way to the Court of Appeal, Lord Glidewell stated that for the argument to succeed, it would be necessary for the plaintiff to show that the auditors’ breaches caused the trading loss, as opposed to merely providing an occasion for the losses to occur. Lord Glidewell made the following observation, in reliance on an Australian case to the same effect: It is necessary, to determine whether there is a causal relationship, to look more closely at the breach and what (to use a neutral term) flowed from it. In the present case, the company’s loss resulted from the defendants’ breach in the sense that the course of events vis-a-vis the company would have gone in a different direction had it not been for that breach. But that, I think, is not, or is not necessarily, sufficient. Thus, the breach allowed the company to continue in business. If its net worth had fallen because, for example, the main buildings it owned had been destroyed by an earthquake, I do not think that the loss would have been causally related to the breach which let the company continue in business.191 314 In Galoo, because it was a pleadings motion, no evidence was introduced on how the trading losses flowed from or were connected to the auditor’s breach.192 Indeed, it would appear that there were a number of factors which might have given rise to the trading losses sustained by the company in liquidation.

191Ibid., at p. 1372, quoting Alexander v. Cambridge Credit Corporation Ltd. (1987), 9 N.S.W.L.R. 310, at pp. 333-34. 192Deloitte cited two other cases that it suggested followed Galoo, namely Bank of Credit and Commerce International (Overseas) Ltd. v. Price Waterhouse, [1999] B.C.C. 351 (Ch. Div.), and Continental Assurance Co of London Plc (In Liquidation), Re [(2001), [2007] 2 B.C.L.C. 287 (Eng. Ch. Div.)], 2001 WL 720239. I agree with Livent’s counsel that these cases do not support the proposition for which they are cited. 316 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

315 Some years later, the Court of Appeal for England and Wales revis- ited the issue on another pleadings motion. In Sasea Finance Ltd. v. KPMG,193 on facts similar to those found in each of Galoo and the instant case, that court came to a different conclusion. Lord Justice Ken- nedy, in distinguishing Galoo, stated as follows: One of the Australian decisions referred to [in Galoo] was Alexander v. Cambridge Credit Corp Ltd. (1987) 9 NSWLR 310. In that case it had been pointed out that to allow a company to continue in existence did not, without more, cause losses occasioned by the ordinary risks associated with carrying on business. So it will be seen that a distinction may be made between the present case and the Galoo case. We are concerned with losses brought about by fraud or irregularities the risk of which KPMG ought to have apprehended and reported. Albeit in the Galoo case the auditors had failed to detect a fraudulent overstatement of assets going back several years and by continuing to trade the companies were acting fraudulently in that they were insolvent, the auditors were not under a duty to warn against the possibility of losses of the type incurred.194 316 Galoo and Sasea each provide valuable guidance on which losses will be recoverable against an auditor, and which will not. At one end of the spectrum, there are cases like Galoo in which the only connection between the auditor’s breach and the consequential loss is that the breach allowed the company to stay in business. It is safe to say that an auditor cannot fairly be held liable for every risk that materialized merely because it allowed the company to continue in existence. Otherwise an auditor might find himself liable for the destruction of the company’s buildings in an earthquake or trading losses incurred in the course of the company’s legitimate business. Even though the earthquake losses or trading losses would not have occurred but for the auditor’s negligence, they are nonetheless too remote to be recoverable. A breach by an auditor that allows a company to stay in business does not make the auditor an insurer against every post-breach risk that becomes a reality. 317 At the other end of the spectrum are cases like Sasea in which the company’s losses were directly caused by the very fraud that the auditor negligently failed to detect. Thus, an auditor who negligently fails to detect that an employee is embezzling company funds may fairly be held

193(1999), [2000] 1 All E.R. 676 (Eng. C.A.), at pp. 678-79. 194Ibid., at p. 682 (emphasis added). Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 317

liable for the funds lost due to the embezzlement. That is the very type of risk that an auditor is paid to take reasonable care to prevent from materi- alizing. The loss occasioned by such a negligently-undetected fraud is therefore one for which an auditor ought to be taken to have accepted responsibility. 318 The case at bar does not fall squarely into either category. On the one hand, Livent’s losses after the Measurement Date are largely attributable to the very fraud which Deloitte should have detected. The fraudsters may not have been directly stealing from the company, but they did directly cause the company to improperly incur greater liabilities than it would otherwise have incurred. The use of fraudulently misstated financial statements to induce people to invest in a company is entirely pre- dictable. Livent’s losses — to the extent they are attributable to this improper increase in liabilities — cannot be said to be too remote. 319 On the other hand, Livent was also engaged in a legitimate business at all material times. As I will elaborate, that business fared poorly in its last years. For the reasons given in Galoo, Deloitte ought not to be liable for the losses attributable to Livent’s legitimate but unsuccessful ventures. The trouble is that the basic measure of damages in this case — the increase in liquidation deficit that would not have occurred but for Deloitte’s negligence — does not permit me to readily ascertain how much of the damage ought to be seen as a result of the normal vagaries of Livent’s business, and therefore too remote to be recoverable. Mr. Cole sought to assist me with this matter. 320 Cole opined that Livent engaged in a very risky business, which was fraught with perils right from the start of the enterprise.195 He suggested that the following factors contributed to Livent’s total economic loss: (a) the inherent risks of the Broadway theater and musical productions industry; (b) the pursuit of a high-risk integrated operating strategy (i.e. all aspects of the production and distribution of a show were carried out by Livent); (c) the financial failure of several large-scale productions, which were not backstopped by successful productions; (d) the investment in and construction of multiple theaters, which was lost when the theatres were liquidated; and (e) the carrying and financing charges associated with the aforesaid activities.

195Stephen Cole Report: Loss Suffered by Livent, 13 August 2010, Exhibit 23, Appendix D. 318 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

321 While no doubt Cole is not a theater maven, and in some respects was compelled to rely upon information obtained from interviews with industry sources or trade publications, I am prepared to accept his assessment of the vagaries of the industry, even though such has a hearsay element to it. I am satisfied that much of the information upon which he commented is generally accessible through accepted industry literature, if not online. If he had been completely off base in his general articulation of the vagaries of the industry, I dare say Howard and company would have taken him to task. As it turned out, the plaintiff was able to nibble away around the edges, forcing me to view this type of evidence with modest skepticism. That said, the principled approach to the acceptance of hearsay evidence based on necessity and reliability is engaged in this situation, at least insofar as Cole’s evidence provides me with an acceptable backdrop to the industry, in general, and Livent’s business, in particular. 322 Howard argued, however, that I should not place any weight on these contingencies, if I can call them that, not because the information was wanting, but because the same variables existed at all material times during Livent’s operation. As such, so his theory proceeds, the risk factors about which Cole was concerned remained constant throughout Livent’s existence after the IPO and therefore during the “delta period” between the ELD and the ALD, “the application of the formula is not skewed by the introduction of new causes and risks and... the methodology isolates the number attributable to the loss caused by the Defendant’s breach”.196 323 Like many of Mr. Howard’s arguments, particularly those found in his facta, which are unparalleled in their turn of phrase and which were anything but prosaic, there is something compelling about the simplicity and cogency of his thesis. Regrettably, I am persuaded that the evidence undercuts the accuracy of his suggestion. As best as I have been able to distill the welter of material thrown my way, there was a change in Livent’s game plan from about the middle of 1995 to the day of reckoning in August 1998. Unfortunately for Livent, this change in game plan was coupled with a change in its operating fortunes during this period, driven by internal and external forces. While the general business strategy remained essentially the same throughout, namely the establishment of a vertically-integrated theatre and production company, the growth in expenditures in both productions and theatre construction was exponen-

196Supplementary Closing Submissions of the Plaintiff: Part V - Submission on the Measure and Quantification of Damages, at para. 48. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 319

tial, and not incremental. That increase might have been manageable ex- cept for the fact that Livent suffered significant losses from several of its own productions, which, had things rolled out as anticipated, it might have self-financed some or a larger portion of the enterprise, without relying on the capital markets or its creditors as a primary source of funds. 324 In my opinion, it would not be fair and reasonable to visit the entire delta at Deloitte’s door. There must be some reduction in the raw number if only to give recognition to the impact of these contingencies. Regretta- bly, the assistance I received from Cole in this regard posed as many questions as it answered. First, I was provided with a table that suggested, without comprehensible explanation, that the economic loss suffered by Livent from March 1997 was attributable solely to the operation of the contingencies, particularly those related to “investments in productions”, which reduced down to 54% as of March 1998. Secondly, I was not provided with an explanation on how each of the constituent elements functioned and what principles were at play to drive the conclusion. Finally, in my view, since this was a defence that was being put forward by Deloitte, counsel had an evidentiary burden to insure that the matter was “dished-up” to me in manageable form. 325 As in many cases over which trial judges preside, assistance with the application of “contingencies”, which do not admit of precise calculation, is given through the use of ranges. It is not, in my experience, an all or nothing proposition because the concepts are more than a little “soft” and difficult if not impossible to pin down. That said, and to repeat, I accept, conceptually, the notion that the consequences of certain of the “trading losses” should not be borne by Deloitte. 326 I have struggled through this area, with some misgivings. It is my assessment of the evidence, heard throughout the course of the entire trial, including the evidence of Cole, that the raw number should be reduced by 25%. In my opinion, the percentage chosen reflects the change in the environment in which Livent was functioning after year-end 1995, and would account for the “trading losses” that would be generated from the unprofitable but legitimate theatre business.

b. Contributory Negligence 327 It is Deloitte’s position, as well, that it is “always open to a trial judge to reduce, or eliminate, a plaintiff’s damages award if his or her own 320 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

negligence has contributed to that loss”.197 When pressed in argument, Mr. Leonard, who argued this point on Deloitte’s behalf, advised me that he was suggesting that Deloitte was entitled to a reduction of any amount found against it by a maximum of 50%. Again, he did not provide me with a principled approach for choosing that percentage, as opposed to any other, nor did he attempt to justify it by reference to any argument or evidence. 328 Deloitte’s position was based on s. 3 of the Negligence Act, which provides as follows: In any action for damages that is founded upon the fault or negligence of the defendant if fault or negligence is found on the part of the plaintiff that contributed to the damages, the court shall apportion the damages in proportion to the degree of fault or negligence found against the parties respectively.198 329 When I first considered this argument, I was of the preliminary view that there was a simple answer to the whether or not Deloitte could seek contribution from Livent since the acts for which contribution was sought, namely the actions of Drabinsky and Gottlieb and their co-actors, did not sound in negligence, but were founded in fraud. 330 I was quickly disabused of this facile approach to the issue, first because it was never raised by the plaintiff in argument, but, more importantly, because s. 3 of the Negligence Act uses the phrase “fault or negligence”, which phrase suggests that the section was designed to capture not only the inadvertent acts of a tortfeasor, but also those which were purposeful. In that respect, I have reluctantly concluded that acts of deceit, such as the fraudulent misrepresentations of Messrs. Drabinsky and Gottlieb, would be caught by the wording of the section. 331 The plaintiff first argued that the doctrine of contributory negligence has no place in the post-Hercules era since its application makes “abso- lutely no sense and would be wrong as a matter of law with respect to a public company”.199 It relies on two decisions of the New South Wales jurist, Justice Moffitt, as he then was, in Vischer & Co. v. Holt & Thomp-

197Closing Argument of Deloitte & Touche LLP, vol. 1, at para. 677. 198R.S.O. 1990, c. N.1, s. 3. 199Initial Closing Submissions of the Plaintiff, vol. 1, at para. 245. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 321

son200 and Pacific Acceptance Corp. v. Forsyth.201 The following statement appears in the former case: Where the action for professional negligence is against an auditor, it is difficult to see how a finding of contributory negligence, according to usual concepts, could be made. If, as where the audit is of a public company, the audit contract or the undertaking of an audit is found to impose a duty to be exercised so as to safeguard the interest of shareholders, it is difficult to see how the conduct of any servant or director could constitute the relevant negligence, so as to defeat the claim against the auditor, whose duty is to check the conduct of such persons and, where appropriate, report it to the shareholders. 332 The plaintiff next suggested that the concept was picked up and adopted in Canada in Coopers & Lybrand Ltd. v. H.E. Kane Agencies Ltd., where the trial judge observed: While these remarks [i.e. Justice Moffitt’s] may be appropriate in situations involving public companies and or in the case of third party actions such as investors or purchasers who rely on these statements I must think that contributory negligence is appropriate in circumstances like this.202 333 One problem with relying on the decisions of Moffitt J. for the proposition that there is no room to advance a claim for contributory negligence in a public company auditors’ negligence case is that the New South Wales Court of Appeal cast doubt on the validity of those conclusions some two decades after the Moffitt decisions were first pronounced.203 334 Further, the decisions of Moffitt J. have not been met with favour in Canada either. Indeed, even before decision of the NSWCA, McEachern C.J.S.C., in Revelstoke declined to apply the principles set out in Justice Moffitt’s decisions.204 Most recently, McKinnon J. of this court made the following observation when asked to decline to apply the contributory negligence doctrine in an auditor’s negligence case unless he found

200[1979] 2 N.S.W.L.R. 322 (Australia C.A.), at pp. 329-30. 201Supra note 57, at pp. 124-25. 202(1983), 44 N.B.R. (2d) 374 (N.B. Q.B.), at para. 38. 203Daniels v. Anderson (1995), 118 F.L.R. 248 (N.S.W.C.A.). There is discussion in this case of the U.S. position on this issue. The best that can be said is that there were two conflicting streams of authority. 204Supra note 54, at pp. 330-32. 322 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

that the “client’s negligence contributed to the auditor’s inability to discharge its professional responsibility to the client”: The facts of this case are very different, and in any event, I would not be attracted to the theory advanced for the simple reason that in a regime of tort law, where the factual enquiry relates to the assessment and weighing of fault, the excusing of fault upon the philo- sophic basis that the defendant’s job was to discover fault, is, in my view, inimical to the provisions of the Negligence Act. As stated earlier, on the facts before me, the plaintiff contributed to its own loss and cannot in law, nor should it on the basis of public policy, escape apportionment of liability for their own negligence.205 335 In order to decide the threshold issue of the applicability of the doctrine, it is necessary to consider certain first principles, which were again discussed by McKinnon J. in Capital Credit. He made the following reference to a decision of the Privy Council that bears repeating: In Nance v. British Columbia Electric Railway, [1951] 3 D.L.R. 705 (British Columbia P.C.), Viscount Simon, on behalf of the Judicial Committee of the Privy Council of England stated as follows, at p. 711: ... When negligence is alleged as the basis of an actionable wrong, a necessary ingredient in the conception is the existence of a duty owed by the defendants to the plaintiff to take due care, is, of course, indubitably correct. But when contributory negligence is set up as a defence, its existence does not depend on any duty owed by the injured party to the party sued and all that is necessary to establish such a defence is to prove to the satisfaction of the jury that the injured party did not in his own interest take reasonable care of himself and contributed, by this want of care, to his own injury. For when contributory negligence is set up as a shield against the obligation to satisfy the whole of the plaintiff’s claim, the principle involved is that, where a man is part author of his own injury, he cannot call upon the other party to compensate him in full...206

205Capital Community Credit Union, supra note 55, at para. 260. 206Ibid., at para. 255. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 323

336 He also quoted a decision of Trainor J., which I similarly find to be instructive in the circumstances: In Grand Restaurants of Canada Ltd. v. Toronto (City) (1981), 32 O.R. (2d) 757 (Ont. H.C.), Trainor, J. stated at p. 775: In the case of fault that contributes to the damage suffered, reliance that is “unreasonable” simply goes to reducing damages otherwise recoverable by the plaintiff; it does not go to cancelling the prima facie liability of the defendant. I find some analogy in case law which holds that even where the defendant is solely responsible for the damage suffered by the plaintiff, the plaintiff’s damages will nevertheless be reduced on the grounds of contributory negligence where the plaintiff could have taken steps to avert or mitigate the damages flowing from the defendant’s tortious act: See O’Connell v. Jackson, [1972] 1 Q.B. 270.207 337 I draw at least two points from the references noted above that I believe apply to the instant case: first, the fault or negligence in respect of which a reduction in an award is warranted must be the responsibility of or attributable to Livent; secondly, if the actions of Drabinsky and Got- tlieb and their merry men are not determined to be the actions of Com- pany, was there some innocent person who failed to take steps to mini- mize, if not avert, the harm done, whose want of care could be attributed to the Company? 338 I do not intend to repeat the discussion above in the Corporate Identi- fication section of this judgement. I do believe, however, that some of the policy and philosophical underpinnings expressed above are equally applicable to militate against the application of the contributory negligence doctrine to the instant case. To that end, I am not prepared to find that the fraud of the various officers, directors and employees of Livent should be attributed to the corporation for purposes of applying the contributory negligence defence. 339 While no doubt a corporation would be found vicariously liable to victims of the frauds perpetrated by its management and employees, the policy underpinning such a conclusion does not apply when the frauds of

207Ibid., at para. 257. 324 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

management are being put forward as a shield and not as a sword. This point was well put in Fleming’s The Law of Torts: Identification in this context has little to commend it.... Vicarious liability is based primarily on the economic policy of assuring effective redress for tortious harm by allowing recourse against the employer who profits from the employee’s activity and is best able to absorb the loss. There is no corresponding reason for protecting a culpable tortfeasor to the prejudice of his or her victim.208 340 Without completely adopting the rule advocated by Justice Moffitt, I believe the purpose of an audited statement, namely to insure that the interests of shareholders are safeguarded by giving them the means to supervise management, would be undermined if an auditor’s responsibility were reduced in proportion to the egregiousness of the misconduct which it failed to detect. 341 Secondly, I believe that the honest directors and innocent shareholders in this case were entitled to rely on Deloitte’s audits to discharge their supervisory task without the corporation suffering a diminution in the amount of its recovery. As a corollary to this proposition, I did not hear any evidence to suggest that the innocent members of the Board or the Company’s shareholders knew or ought to have known, or were warned, that something was amiss at any time relevant to the audits in question. Based on the Canadian case law, this is the approach that would have been preferable for Deloitte to have followed had it sought to establish a contributory negligence defence. In cases in which an auditor negligently failed to detect fraud, our courts have often considered whether the corporate plaintiff was contributorily negligent by asking whether there was a failure of supervision by honest management.209 342 Finally, I am at a loss to understand why Deloitte chose not to pursue others to trial by way of third party actions for contribution. This last point may not be dispositive but it is nevertheless of some moment because it reduces the force of any complaint by Deloitte that it is not fair

208Carolyn Sappideen & Prue Vines, eds., Fleming’s The Law of Torts, 10th ed. (Pyrmont, N.S.W.: Lawbook, 2011), at p. 333. 209See Revelstoke, supra note 54, at p. 328; Connor v. Shaparrall Ltd. (1998), 34 C.C.E.L. (2d) 208 (Ont. Gen. Div.), at paras. 145-46; Sydney Cooperative Society, supra note 45, at paras. 160-215. In Revelstoke, the proposition that the fault of the fraudulent manager himself should be attributed to the corporation was summarily rejected, at p. 331. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 325

to hold it solely responsible for the damages suffered by Livent when various other parties associated with Livent might also be said to be responsible. Actions had been started against, for example, Smith Lyons, Dundee Realty Corporation and CIBC Wood Gundy, that were never pursued after the issuance of Notices of Action.210 They died on the vine for reasons that were never developed in evidence. Indeed, as was noted by Lord Mance in Stone & Rolls, it is the usual practice of auditor-defendants to “join fraudulent directors and others as third party defendants”.211 343 I have therefore concluded that s. 3 of the Negligence Act is not applicable to the circumstances of this case and no reduction of the amount of damages will be taken in respect of this defence.

c. Deepening Insolvency 344 A significant amount of time was devoted by both sides in their respective written and oral arguments to the concept of “deepening insolvency”, an argument that has generated some academic comment on both sides of the border. While there is limited U.S. jurisprudence on the subject, I was not directed to any Canadian cases. The term has been used to refer to both an independent cause of action and a measure of damages. While Deloitte’s written argument was directed to the damages issue, the articles with which I was furnished were of marginal assistance since they spoke, primarily, to the cause of action, a matter with which, mercifully, I was not compelled to grapple. 345 As previously discussed, the plaintiff’s theory of damages attempted to quantify the loss to the Company by reference to an increase in the total liquidation deficit that would not have occurred but for Livent’s continuing ability to access the capital markets. Deloitte objected to this measure of damages because it suggested that the accumulation of fur-

210Notice of Action: Deloitte & Touche LLP v. Canadian Imperial Bank of Commerce and CIBC Wood Gundy Securities, Inc., 6 August 2004, JBD 15971; Notice of Action: Deloitte & Touche LLP v. Dundee Realty Corporation, 6 Au- gust 2004, JBD 15977; Notice of Action: Deloitte & Touche LLP v. H. Garfield Emerson, Martin Goldfarb and A. Alfred Taubman, 6 August 2004, JBD 15972; Notice of Action: Deloitte & Touche LLP v. The Estate of Andrew Sarlos and Dewlim Investments Ltd., 6 August 2004, JBD 15979; Notice of Action: Deloitte & Touche LLP v. Smith Lyons, 6 August 2004, JBD 15978. 211Stone & Rolls, supra note 173, at para. 251. 326 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

ther liabilities by an insolvent company does not result in a loss to the company, but only to its creditors. 346 Curiously, I did not hear or see any evidence that established that Livent was insolvent on any of the Measurement Dates that I have suggested applies. The Bankruptcy and Insolvency Act defines an “insolvent person” as follows: [A] person who is not bankrupt and who resides, carries on business or has property in Canada, whose liabilities to creditors provable as claims under this Act amount to one thousand dollars, and (a) who is for any reason unable to meet his obligations as they generally become due, (b) who has ceased paying his current obligations in the ordinary course of business as they generally become due, or (c) the aggregate of whose property is not, at a fair valuation, sufficient, or, if disposed of at a fairly conducted sale under legal process, would not be sufficient to enable payment of all his obligations, due and accruing due.212 347 Black’s Law Dictionary, 7th ed., employs the following definitions: insolvency, n. 1. The condition of being unable to pay debts as they fall due or in the usual course of business. 2. The inability to pay debts as they mature.... balance-sheet insolvency. Insolvency created when the debtor’s liabilities exceed its assets.... equity insolvency. Insolvency created when the debtor cannot meet its obligations as they fall due.... insolvent, adj. (Of a debtor) having liabilities that exceed the value of assets; having stopped paying debts in the ordinary course of business or being unable to pay them as they fall due. 348 First, no evidence was lead that the creditors of Livent were beating a path to its door and asking to be repaid before the fraud was discovered and revealed to the world. Indeed, as I indicated, sophisticated businessmen were still prepared to invest in the Company right to the end of June 1998. Secondly, the Restated Consolidated Balance Sheets indicate that Livent’s assets, which had undergone a deep discount from an account-

212R.S.C. 1985, c. B-3, s. 2. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 327

ing point of view, still exceeded liabilities in each of year-end 1996 and 1997, albeit marginally as at December 31st, 1997.213 The fact that Re- tained Earnings had been eroded significantly in that time period, on restatement, and were in a deficit position as at the two year-ends, does not amount to insolvency. Having regard to the time spent on the issue, I am going to assume for purposes of this discussion that Livent, because of the undiscovered fraud, was on the precipice of insolvency and would have been a likely candidate for CCAA protection had the frauds been uncovered, as happened in August 1998, in the two years before that date. 349 In his paper, “The Shallows of Deepening Insolvency”, Sabin Willett put forward the proposition that deepening insolvency formed an aspect of a traditional damages claim: [I]njury to solvency is an incident to the harm, not the harm itself. If the debtor lost asset value through defendant’s conversion of property, the law measures damage; if through breach of contract, commission of tort, breach of fiduciary duty, or fraudulent transfer, the law already measures damage. The damages may include the insult to asset values (for example, a corporate waste claim against a director), or the accumulation of a liability (breach of fiduciary duty of care). Depending on the underlying law, the damage may or may not also include lost profits (a measure of damage that captures the economic injury to an operating business of its reduced liquidity). Sol- vency analysis will be incidental to all of these damage analyses. It may so happen that the diminished asset value, new liability, or lost profits that measures the damage also measures precisely the deepening of the firm’s insolvency. The point is that insolvency analysis adds nothing to the measure of damages the law already allows. ... Compensable injuries may have the indirect effect of deepening insolvency, but this indirect impact adds nothing to a direct impact (loss in asset value, increase in liabilities, or lost profits) that itself will be compensable — or not — under familiar common law and statutory remedies.214

213Press Release, 18 November 1998, JBD 16204, Exhibit 1: Audited Consoli- dated Financial Statements of Livent Inc., December 31, 1997 and 1996 (as restated), at p. 1. 214(2005) 60 Bus. Law. 549, at pp. 571-72. 328 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Willet summarized the point as follows: The deepening of a firm’s insolvency is not an independent form of corporate damage. Where an independent cause of action gives a firm a remedy for the increase in its liabilities, the decrease in fair asset value, or its lost profits, then the firm may recover, without reference to the incidental impact upon the solvency calculation.215 350 Again, the essence of Livent’s claim is that Deloitte’s negligence allowed Livent’s fraudulent management to continue operating for longer than it otherwise would have. The kind of damage occasioned by the fraudulent activities of management and the negligence of Deloitte was a wrongful increase in the liabilities of the corporation, which Willett recognizes as a genuine form of damage to the corporation. 351 This issue bears some resemblance to the analysis that is employed in assessing damages in a “crumbling skull” personal injury case. Triers of fact are called upon to assess the incremental damage which has been suffered by a plaintiff no matter how dire his or her condition was at time the tort was committed. The fact that Livent might have been on the road to ruin as at either Measurement Date does not absolve Deloitte from liability for the additional damages it might have caused. Indeed, assuming that there was no spectre of insolvency on those dates, it is clear that Livent could recover damages if there was but a negative impact on its balance sheet that created, simply, an economic loss between the two points along the damages spectrum. 352 That said, I am not persuaded that this special defence assists the defendant in reducing the damages.

d. Prolonged Corporate Life 353 The defendant mounted one other argument in a similar vein by which it sought to reduce or eliminate the amount of damages to be meted out in this case — and it was one which gave me pause right from the start. It suggests that Livent actually benefitted from the negligence because the failure to discover the fraud effectively prolonged the corporation’s life. This theory, which more often than not is found in the deep-

215Ibid., at p. 575. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 329

ening insolvency line of cases, was discussed by the U.S. 7th Circuit Court of Appeals in Schacht v. Brown as follows: [T]o the extent that the cited cases suggest that a corporation may not sue to recover damages resulting from the fraudulent prolongation of its life past insolvency, we decline to speculate that the Illinois courts would accept this restriction on the Director’s freedom of action. For each of these cases rests upon a seriously flawed assumption, i.e., that the fraudulent prolongation of a corporation’s life beyond insolvency is automatically to be considered a benefit to the corporation’s interests.... This premise collides with common sense, for the corporate body is ineluctably damaged by the deepening of its insolvency, through increased exposure to creditor liability.... Indeed, in most cases, it would be crucial that the insolvency of the corporation be disclosed, so that shareholders may exercise their right to dissolve the corporation in order to cut their losses.... Thus, acceptance of a rule which would bar a corporation from recovering damages due to the hiding of information concerning its insolvency would create perverse incentives for wrong-doing officers and directors to conceal the true financial condition of the corporation from the corporate body as long as possible. We are not prepared to conclude that the Illinois courts would adopt such a regime.216 354 I find the logic and rationale of that excerpt compelling. I note, as well, that the ratio of that case was cited with approval in at least two other U.S. jurisdictions, although I hasten to add that it does not appear to have been applied in Canada.217

e. U.S. Bar Orders 355 At the commencement of these reasons, I described certain consolidated class actions filed on behalf of the Livent Shareholders and the Livent Noteholders, respectively. To flesh that out a bit, the Livent Shareholders’ actions were launched on behalf of common shareholders who purchased shares between March 1996 and August 1998. The Livent Noteholders’ actions covered two classes of noteholders: those who purchased Livent’s 1997 9 3/8 % senior unsecured notes between

216711 F.2d 1343 (U.S. C.A. 7th Cir. 1983), at p. 1350. 217See Thabault v. Chait, 541 F.3d 512 (U.S. C.A. 3rd Cir. 2008), at p. 529; NCP Litigation Trust v. KPMG LLP, 901 A.2d 871 (U.S. N.J. Sup. Ct. 2006), at p. 888. 330 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

October 1997 and August 1998 and those who purchased Livent notes from October 1997 and thereafter. 356 The U.S. Actions were settled by way of two final orders and judgments in November (Noteholders) and December 2003 (Sharehold- ers).218 Both orders contained a Bar Order, as well as a release, which Deloitte argues prevents certain claimants in the US actions from asserting individual claims against Deloitte, “either directly or indirectly, and in any forum”. 357 It is the defendant’s position that the plaintiffs in the U.S. Actions, or anyone claiming under them, have agreed that: (i) Deloitte is discharged from all of its obligations to any and all members of the plaintiff classes; (ii) Deloitte is released from all claims of the members of the plaintiff classes and those claiming through them “however denominated or wherever arising” that relate to the subject matter of the US Class Actions; (iii) All claims against Deloitte raised in the US Class Actions are dismissed with prejudice; and (iv) All members of the plaintiff classes and “anyone purporting to claim on their behalf” are barred and enjoined from pur- suing directly or indirectly any of the plaintiff classes’ claims against Deloitte in any forum.219 358 Putting the matter otherwise, it is Deloitte’s argument that because the Special Receiver in the instant action is making a claim on behalf of certain of the Livent stakeholders (noteholders and shareholders) covered by the U.S. Actions, he is bound by the Bar Orders of Judge Marrero. As a result of the settlement of the U.S. Actions, Deloitte paid US$1.75 million and US$5.5 million in the Shareholder and Noteholder actions respectively. The total payments made in each of the actions by certain of the defendants, including Deloitte, were US$6.45 million and US$17.25

218Final Order and Judgment, In Re Livent, Inc. Noteholders Securities Litiga- tion, United States District Court, Southern District of New York, Judge Mar- rero, 7 November 2003, JBD 16006 (“Noteholder Order”); Final Order and Judgment, In Re Livent, Inc. Securities Litigation, United States District Court, Southern District of New York, Judge Marrero, 19 December 2003, JBD 16005 (“Shareholder Order”). 219Closing Argument of Deloitte & Touche LLP, vol. 1, at para. 630. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 331

million, respectively, or US$23.7 million (Cdn$24.2 million) in the aggregate. 359 In his report, Cole, on instructions of counsel, prepared a calculation which embodied the notion that the Special Receiver could only recover amounts not covered by the Bar Orders. He suggested that I must deduct the following amounts from an award as of the following Measurement Dates: (1) March 31, 1997- $76.20 million (2) August 31,1997- $55.89 million (3) March 31, 1998- $30.06 million220 360 Without going into the complexities of the analysis and the math, which was only made clearer to me in a post-trial conference call with counsel, I understand that Deloitte takes the position that any amount awarded to the plaintiff in this action should be reduced by 55.7%. In other words, regardless of the amount of the award in this action, but 44.3% will be distributed to the unsecured creditors, if I give effect to the Bar Orders. As an aside, it should be noted that the Livent shareholders will not recover any amount, regardless of the effect of the Orders, unless the amount of the award exceeds $189 million. 361 Livent advances several arguments in response to the Bar Orders defence: (1) the US orders do not apply to an action commenced by and on behalf of the Corporation, Livent; (2) the cause of action in the instant litigation is that of the Company whereas the cause of action in the US actions was that of the individual stakeholders; (3) Deloitte seeks to make an in personam foreign order binding upon non-parties; (4) Livent’s obligations under the court-approved Plan are not in respect of the parties covered by the US orders and the Plan takes precedence; (5) even if the claims of the classes involved in the US orders were said to be compromised as against Livent, the claims

220Ibid., at paras. 550, 568-69. 332 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

of the non-barred classes exceed the quantum of losses that Livent has established.221 362 The U.S. actions, more particularly described in the Marrero Deci- sion, were launched pursuant to certain provisions of the U.S. Securities Act of 1933 where, subject to applicable statutory defences, auditors and others may be held liable to investors (debt and equity) for material misstatements or omissions in audited statements. 363 The applicable section of the U.S. securities law has been reviewed Justice Winkler, as he then was, in Carom v. Bre-X Minerals Ltd., which provides a helpful primer: In accordance with the securities fraud prevention purpose of the provisions, the civil right of action that has developed through judicial interpretation has certain essential elements. To succeed in an action based on an S.E.C. rule 10b-5 breach, a plaintiff must establish that the defendant had a degree of scienter, which is intentional or wilful conduct intended to deceive or defraud investors; there was a purchase or sale of securities involved; the misrepresentation was material; and there was detrimental reliance on the misrepresentation. Aside from the essential elements of the cause of action which has been developed in the case-law, there is a statutory limitation period. Neither s. 10(b) or Rule 10b-5 provide for punitive damages and no authority has been provided to this court in which such damages have been awarded in the private right of action.222 As the plaintiff noted in its Initial Closing Submissions: The claims underlying the U.S. Actions were brought under this statutory regime, which allowed the respective Livent stakeholders qua individual stakeholders to advance direct claims against Deloitte to recover for their personal market losses. No claims were advanced by Livent in any of the U.S. Actions, nor could there have been given that the actions were all based on the acquisition of Livent’s securities.223 364 In my view, since the plaintiff and the causes of action in the instant case differ from those in the U.S. Actions in which the Bar Orders were made, I agree with plaintiff’s counsel that the Bar Orders are not applicable to any award in this case and need not be accounted for.

221Initial Closing Submissions of the Plaintiff, vol. 1, at para. 278. 222(1998), 41 O.R. (3d) 780 (Ont. Gen. Div.), at p. 787. 223Initial Closing Submissions of the Plaintiff, vol.1, at para. 283. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 333

365 To cycle back to the SCC decision in Hercules, it is clear and beyond doubt that Livent cannot advance a claim on behalf of stakeholders, such as shareholders and noteholders. The claim for breach of contract and for negligence is that of the corporation and no such cause of action rests with the shareholders or creditors. The fact that some stakeholders might benefit from any recovery in this action does not, in my view, alter this conclusion. For what it is worth as part of this analysis, the same conclusion, as the plaintiff has argued, can be drawn from recent U.S. jurisprudence that has examined similar causes of action.224 366 In the alternative and without going into the details of this argument with great particularity, since it is very much case specific, I agree with plaintiff’s counsel that the defendant’s argument on the effect of the Bar Orders is inconsistent with the Fourth Amended Livent Plan of Reorgani- zation, dated October 10, 2003 (“Plan”).225 I incorporate by reference, without further repetition, the argument set out in paragraphs 302-311 of the Initial Closing, paragraphs 224-231 of the Reply Submissions, and the sections of the Plan to which references are made. 367 Furthermore, I agree with plaintiff’s counsel that if Deloitte were of the view that the Bar Orders were applicable to the instant litigation, particularly those referable to the Noteholders Action, they should have taken issue with the operation or application of the Plan and its relationship to the Bar Orders when the CCAA Sanction Order was made some weeks after the Noteholder Order was signed by Judge Marrero. The Plan, to which Deloitte is deemed to have consented, specifically provided that it shall take precedence over any other agreements, which in my view covers the Bar Orders.226 368 Having come to the conclusions I have reached on the plaintiff’s first two arguments in respect of the Bar Orders, I do not think it necessary to parse the balance of the plaintiff’s arguments on this issue. At the risk of doing a disservice to the arguments of counsel, I specifically decline to comment on the applicability of the decision of Justice Sharpe in

224Official Committee v. RF Lafferty & Co., 267 F.3d 340 (U.S. C.A. 3rd Cir. 2001); Bondi v. Citigroup, Inc. [(February 28, 2005), Doc. BER-L-10902-04 (U.S. N.J. Super. L.)], 2005 WL 975856. 225Debtors’ Modified Fourth Amended Joint Consolidated Liquidating Plan of Reorganization, 10 October 2003, JBD 15932. 226CCAA Sanction Order, 21 November 2003, JBD 15990, at para. 12(b). 334 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Parsons v. McDonald’s Restaurants of Canada Ltd.,227 tempting as it is to weigh in on this debate in the unending line of arguments on both sides of the aisle.

7. The Final Number 369 Before embarking upon a review of the Limiting Principles, I established the “raw” damage number with a Measurement Date of August 31, 1997 at $113 million.228 Again, for the reasons described above, I would reduce that number by 25% to account for the “contingencies” which I have concluded should not be Deloitte’s responsibility. That reduction yields a net damage number of $84,750,000. Judgment will therefore issue in favour of Livent in that amount.

8. Interest and Costs 370 Neither party addressed pre and postjudgment interest in oral argument, presumably as a result of battle fatigue and time constraints. The plaintiff’s written Supplemental Submission on Damages did contain a section dealing with the interest rate and start date applicable to any judgment obtained. However, the defendant requested that it be permitted to make submissions on interest after this court’s determination of liability. 371 Therefore, if the parties are not able to settle this issue, I will receive written submissions on the same schedule as that set for costs submissions, below. In light of the written submissions that the plaintiff has already made, it is not required to provide any further submissions, though it may do so if it wishes. 372 While I would encourage the parties to attempt to settle the costs of the trial without prejudice to any rights of appeal, in the event that such cannot be achieved, I will receive written submissions from the parties thereafter. The plaintiff will have 4 weeks from the date of this judgment to provide me with its submissions, in hyperlinked form, to which the defendant will respond in similar fashion a further 3 weeks beyond that

227(2005), 74 O.R. (3d) 321 (Ont. C.A.). 228I have postulated, as well, that there might have been “alternative” Measure- ment Dates, for reasons expressed in this judgment, of September 30th, 1997, and early April 1998. Based upon the available evidence, I have assessed the “raw” number applicable for each of the two dates at $105 million and $53.9 million, respectively. Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 335

date of receipt of the plaintiff’s argument. I will decide the issues of interest and costs on the written material and will only hear argument in the event that such becomes necessary. I would ask counsel to provide me with their argument and a “form of bill of costs” setting out the constituent elements in much the same fashion as would have been undertaken by counsel before the High Court of Justice, after trial. I would not welcome the receipt of computerized dockets although such should be shared with the party opposite if so demanded. If this directive needs further clarification, I can be contacted to discuss the same by way of conference call.

Acknowledgements 373 I would like to take this opportunity to thank all counsel for the manner in which this case was presented. Counsel were first and foremost courteous to the Court and each other throughout. They comported themselves in the best traditions of the skilled barristers that they are. I would also like to thank them for undertaking the trial from start to finish electronically. There is no doubt the administration of justice was well served both in terms of the hearing itself and the judgment-writing process because of the manner in which the evidence and argument were presented. 374 In this regard, I would like to acknowledge the never-ending and ex- cellent assistance, if not e-trial guidance, I received from Carolyn Anger and Margaret-Anne MacKinnon, the law clerks associated with each of the combatants, without whom I dare say the trial would never have got- ten off the ground, or would have faltered on countless occasions thereafter. A trial of this complexity could not have been undertaken without the assistance of skilled support staff. Action allowed. 336 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Appendix A

DEBT AND EQUITY FINANCING

LIVENT — MAY 1993 TO JUNE 1998 Deloitte Unqualified Financial Debt or Equity Document Audit Opinion Date Statements Event Type Included with Included Deloitte’s Consent 5/20/93 1993 Canada IPO - Prospectus December 31, 1991 ✓ $30 million and 1992 9/30/93 Private Placement Prospectus December 31, 1991 ✓ of Special Warrants and 1992 - $20 million 4/2/96 1996 U.S. IPO - Prospectus & December 31, 1994 ✓ C$43 mil- Registration and 1995, and cer- lion/US$31.4 mil- Statement tain information lion from December 31, 1991, 1992 and 1993 5/8/97 Common Shares - Prospectus December 31, 1995 ✓ Canada - $27.5 and 1996 10/16/97 9 • % Senior Un- Confidential December 31, 1995 ✓ secured Deben- Offering Mem- and 1996, 3-mos tures — C$172.6 orandum, Ex- ended March 31, million/US$125 change Offer 1996 and 1997 million Registration (unaudited), 6-mos and Prospectus ended June 30, 1996 and 1997 (unaudited), and certain information from December 31, 1992, 1993, and 1994 6/12/98 Lynx Ven- Investment December 31, 1996 ✓ tures/Furman Equi- Agreement and 1997 and Sep- ty Investments - tember 30, 1997 US$22 million (unaudited) 6/26/98 Southam Inc. In- Investment December 31, 1997 ✓ vestment - US$12.2 Agreement and March 31, million 1998 (unaudited) Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 337

Appendix B

1994 Audit Net income (JBD 11206, p. 29) $ 5,835,077 Effective tax rate (JBD 11206 p. 36, Note 10) 26.0% Overstatement of Income Description of Current Year Pre-tax After-tax % of Net Error Income Deloitte’s 1994 SUD (JBD 1661) $ 484,879 $ 358,810 6.1% Phantom Tour original preproduc- 1,447,253 1,070,967 18.4% tion costs amortization Joseph Tour original preproduction 1,201,894 889,402 15.2% costs amortization Sponsorship revenue 247,246 182,962 3.1% Total Current Year Error 3,381,272 2,502,141 42.9% Planning Materiality (JBD 1693 1,150,000 851,000 14.6% p. 2) Errors in excess of Planning $ 2,231,272 1,651,141 28.3% Materiality Summary: Net income as originally reported $ 5,835,077 1994 tax-adjusted errors (2,502,141) Net income (loss) as adjusted 3,332,936

1995 Audit Net income (JBD 10157, p. 32) $11,766,969 Effective tax rate (JBD 10157 p. 39, Note 11) 36.0% Overstatement of Income Description of Current Year Pre-tax After-tax % of Net Error Income Deloitte’s 1995 SUD ($142,400 - $ 99,538 $ 63,704 0.5% 42,862) (JBD 2818) Retroactive reversal of previously 7,121,138 4,557,528 38.7% reported amortization of Show Boat original preproduction costs Phantom Tour original preproduc- 1,123,389 718,969 6.1% tion costs amortization Phantom Israel touring preproduc- 881,616 564,234 4.8% tion costs amortization 338 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Overstatement of Income Description of Current Year Pre-tax After-tax % of Net Error Income Joseph Tour original preproduction 1,201,014 768,649 6.5% costs amortization Joseph Montreal touring preproduc- 234,437 150,040 1.3% tion costs amortization Sponsorship revenue 1,083,913 693,704 5.9% MOTN Guarantee 335,500 214,720 1.8% Musician’s Pension Surplus 1,151,568 737,004 6.3% Westsun revenue 859,320 549,965 4.7% Total Current Year Error 14,091,433 9,018,517 76.6% Planning Materiality (JBD 1,875,000 1,200,000 10.2% 2876) Errors in excess of Planning $12,216,433 7,818,517 66.4% Materiality Summary: Net income as originally reported $11,766,969 1995 tax-adjusted errors (9,018,517) Net income as adjusted 2,748,452

1996 Audit Net income (JBD 9461, p. 45) $11,053,702 Effective tax rate (JBD 9461 p. 53, Note 12) 22.0% Overstatement of Income Description of Current Year Pre-tax After-tax % of Net Error Income Deloitte’s 1996 SUD ($804,100 - $ 671,000 $ 523,458 4.7% 133,000) (JBD 4795) Ragtime 1 original preproduction 318,861 248,712 2.3% costs amortization Show Boat 1 Los Angeles Touring 878,825 685,484 6.2% preproduction costs amortization Show Boat 1 original preproduction 3,042,504 2,373,153 21.5% costs amortization Show Boat 2 original preproduction 1,419,594 1,107,283 10.0% costs amortization Show Boat 3 original preproduction 2,294,086 1,789,387 16.2% costs amortization MOTN Guarantee amortization 1,006,275 784,895 7.1% Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 339

Overstatement of Income Description of Current Year Pre-tax After-tax % of Net Error Income MOTN original preproduction costs 342,004 266,763 2.4% amortization Phantom Tour original preproduc- 2,646,947 2,064,619 18.7% tion costs amortization Phantom Israel touring preproduc- 948,078 739,501 6.7% tion costs amortization Joseph Tour original preproduction 1,059,812 826,653 7.5% costs amortization Joseph Montreal touring preproduc- 254,177 198,258 1.8% tion costs amortization PREPRODUCTION COSTS 14,882,263 11,608,165 105.0% Subtotal Sponsorship revenue 1,173,158 915,063 8.3% Westsun revenue 685,300 534,534 4.8% Ticketmaster 2,048,250 1,597,635 14.5% Pace Show Boat 6,231,549 4,860,608 44.0% Pace Ragtime 5,965,016 4,652,712 42.1% Dewlim 4,231,015 3,300,192 29.9% Kiss Japan 372,409 290,479 2.6% REVENUE TRANSACTIONS 20,706,697 16,151,224 146.1% Subtotal Musicians Pension Surplus 1,583,889 1,235,433 11.2% Show Boat Box Office Fixed Asset 248,261 193,644 1.8% Write Off Likely unrecorded liabilities - 1,368,025 1,067,060 9.7% Deloitte’s Accounts Payable confirmation testing Actual Unrecorded Liabilities - 149,586 116,677 1.1% Deloitte’s Search for Unrecorded Liabilities Likely cutoff errors based on not quantified not quantified Deloitte’s Search for Unrecorded Liabilities Total Current Year Error 38,938,721 30,372,202 274.8% Planning Materiality (JBD 5635 1,670,000 1,302,600 11.8% and JBD 5441) 340 CANADIAN CASES ON THE LAW OF TORTS 10 C.C.L.T. (4th)

Overstatement of Income Description of Current Year Pre-tax After-tax % of Net Error Income Errors in excess of Planning $37,268,721 29,069,602 263.0% Materiality Summary: Net income as originally reported $ 11,053,702 1996 tax-adjusted errors (30,372,202) Net income (loss) as adjusted (19,318,500)

1997 Audit Net Loss (JBD 11208, p. 48) $ 44,130,869 Applicable Tax rate (see “Notes” below) 0.0% Description of Current Year Error Overstatement of % of Net Income Income Deloitte’s 1997 SUD ($1,139,692 - 677,032) (JBD $ 462,660 1.0% 7621) Ragtime original preproduction costs amortiza- 2,201,757 5.0% tion/write down Show Boat 1 preproduction costs amortization/write 1,765,536 4.0% down Show Boat 2 preproduction costs amortization/write 5,885,771 13.3% down Show Boat 3 preproduction costs amortization/write 2,602,730 5.9% down Phantom Tour Extension PPC 3,044,237 6.9% MOTN Guarantee 2,012,550 4.6% Phantom Touring Loss Recovery 931,686 2.1% Joseph Touring Loss Recovery 1,423,903 3.2% Actual error based on Deloitte’s Preproduction 3,491 0.0% Costs additions testing Likely errors based on Deloitte’s Preproduction 221,202 0.5% Costs additions testing PREPRODUCTION COSTS Subtotal 20,555,523 46.6% Sponsorship revenue 1,251,924 2.8% Amex Exclusivity 2,190,476 5.0% Dundee Air Rights Sale 5,575,779 12.6% AT&T Namint 5,000,000 11.3% Pace Show Boat Extension 537,786 1.2% Pace Ragtime Extension 1,088,970 2.5% Livent Inc. (Receiver of) v. Deloitte & Touche Gans J. 341

Description of Current Year Error Overstatement of % of Net Income Income American Artists 5,815,015 13.2% REVENUE TRANSACTIONS Subtotal 21,459,950 48.6% Musician’s Pension Surplus 1,592,027 3.6% Show Boat box office fixed asset write off 248,261 0.6% Errors based on Deloitte’s Fixed Assets additions 585,725 1.3% testing Likely errors based on Deloitte’s Fixed Assets addi- not quantified tions testing Likely unrecorded liabilities - Deloitte’s Accounts 1,241,735 2.8% Payable confirmation testing Likely cutoff errors based on Deloitte’s Search for not quantified Unrecorded Liabilities Total Current Year Error 45,683,221 103.5% Planning Materiality (JBD 7576) 2,000,000 4.5% Errors in excess of Planning Materiality $ 43,683,221 99.0% Summary: Net loss as originally reported $ (44,130,869) 1997 errors (45,683,221) Net loss as adjusted (89,814,090)