Findlay v DSHE Holdings Limited (Receivers and Managers Appointed) (In Liquidation); Mastoris v DSHE Holdings Limited (Receivers and Managers Appointed) (In Liquidation)

By notices of motion filed on 25 March 2019 in each of proceedings 2017/294069 and 2018/52431 (together, the Representative Proceedings) the fourth to four hundred and fifty seventh defendants (Deloitte) seek to strike out those parts of the plaintiffs’ Amended Joint Statement of Claim (AJSC) that plead a claim against Deloitte.

The two proceedings are brought on behalf of investors in DSHE Holdings Limited (Receivers and Managers Appointed)(In Liquidation) (DSH). DSH traded as “Dick Smith”, a well-known electronics retailer. It was floated on the Australian Securities Exchange (ASX) in December 2013. It was placed into voluntary administration by its directors on 4 January 2016 and was placed into liquidation on 25 July 2016. Deloitte was retained by Dick Smith Sub-Holdings Pty Limited (DSSH), an intermediate holding company in the DSH Group, and later DSH to audit the financial statements of DSSH for the financial year ending 30 June 2013 (FY13) and the financial statements for DSH for the financial years ending 30 June 2014 (FY14) and 30 June 2015 (FY15).

In broad terms, the plaintiffs allege that the practices and decisions made by DSSH concerning the provisioning of inventory and by DSH concerning both rebates and the provision of inventory meant that the financial statements of DSSH for FY13 and the financial statements for DSH for FY14 and FY15 were not prepared in accordance with Australian Accounting Standards. That led to the financial statements of DSSH for FY13 and of DSH for FY14 and FY15 not giving a true and fair view of DSH’s financial position and performance. It is alleged that Deloitte’s failure to identify those matters, and representations by Deloitte contained in its audit reports that the financial statements did present a true and fair view of DSSH’s and DSH’s financial position, meant that Deloitte failed to conduct its audits in accordance with applicable auditing standards, failed to exercise reasonable care and skill, and engaged in misleading and deceptive conduct in contravention of various statutory provisions.

Deloitte contends that the pleading against it is defective because it fails to plead the case against it with sufficient specificity. In making that submission, it relies heavily on the judgments given by Ward CJ in Eq in Hastie Group Ltd (In Liq) v Bourne [2017] NSWSC 709 and Smith v Australian Executor Trustees Ltd [2017] NSWSC 1406, where her Honour set out in some detail what needed to be included in the pleadings considered in those cases.

In my opinion, the decisions in Hastie and Smith are not of great assistance in resolving the issues in this case, turning as they did on the particular facts and pleadings in those cases.

The critical issue in cases such as the present one where a strike out application is brought is whether the pleading gives fair notice of the case to be made against the other party at trial so as to minimise the risk of injustice resulting from surprise. As Ward CJ in Eq pointed out in Smith at [73], the pleadings have a critical role to play in ensuring that that requirement is satisfied. However, it also needs to be borne in mind that these proceedings are being managed together with proceedings in the Commercial List and that other techniques are available and used by the Court to ensure that no party is caught by surprise. They include, where appropriate, orders for the provision of particulars, orders for the service of evidence in chief, including expert evidence well in advance of a hearing and orders for the exchange of lists of issues.

Against that background, it is possible to turn to the pleading in this case. The claim against Deloitte occupies approximately 100 pages of a pleading which in all comprises approximately 300 pages (including annexures). It is divided into eight Parts. Part F.1 sets out some background. Part F.2 pleads the relevant accounting and auditing framework, including the obligation on Deloitte under s 307A of the Corporations Act 2001 (Cth) (the CA) to conduct its audits in accordance with the Auditing Standards in force under s 336 of the CA. It also identifies the relevant Auditing Standards. Part F.3 pleads the contents of the relevant Auditing Standards and the obligations imposed on Deloitte by those standards in undertaking the audits for FY13, FY14 and FY15. Part F.4 provides a definition of the term “Reasonable Auditor” used in the pleading. Part F.5 pleads the representations said to have been made by Deloitte in its audit reports. Part F.6 pleads Deloitte’s conduct in relation to the audit in each relevant year. Part F.7 pleads the various contraventions said to arise from that conduct. Part F.8 pleads causation, loss and damage. In essence, it is pleaded that but for Deloitte’s conduct the relevant financial statements would either have been corrected or Deloitte would have issued qualified audit opinions in respect of them. It is pleaded that had the FY13 financial statements been corrected or a qualified audit opinion issued in respect of them, DSH would not have floated and been listed on the ASX and Group Members in the Representative Proceedings would not have acquired their shares.

Deloitte’s attack on the pleading is primarily focussed on Parts F.6 and F.8. It contends that both Parts fail to identify with sufficient particularity what Deloitte ought to have done but did not do. It is sufficient to consider the pleading in relation to FY13. The pleading in respect of other years raises similar issues. It is also convenient to start with Part F.6.

The plaintiffs allege that Deloitte failed to act as a “Reasonable Auditor” (as defined in the pleading) in three respects. First, it failed to obtain sufficient appropriate audit evidence in respect of the assumptions and methodology applied by management in determining inventory provisions. Second, it failed to properly determine materiality. Third, it failed to adjust the warranty sign on liability to zero. It is pleaded in para 444 of the AJSC that each of those failures meant that Deloitte:

Deloitte’s criticism of the pleading focuses on the pleading in relation to inventory.

In para 427 of the AJSC, the plaintiffs plead that Deloitte knew or ought to have known of DSH’s failure to write down or to make a provision against the carrying value of inventory and of DSSH’s inventory management and accounting policies. Paragraphs 427(a), (b) and (c) give particulars of why it is said Deloitte knew the relevant facts. Paragraph 427(d) pleads why it is alleged that Deloitte ought to have known the relevant facts. In substance that paragraph pleads that a Reasonable Auditor:

Paragraphs 428 of the AJSC pleads in effect the FY13 audit report did not express the opinion that the inventory practices adopted by management needed to be disclosed in the FY13 financial statements or that those practices caused the FY13 financial statements to be materially misstated. Paragraph 429 pleads that the practices needed to be disclosed, and that adoption of the practices meant that the FY13 financial statements did not give a true and fair view of the financial position and performance of DSSH and the DSH Group, were not prepared in accordance with the Australian Accounting Standards and were materially misstated.

Paragraph 430 pleads that Deloitte failed to take various steps it should have taken. Those steps include:

A number of other failings are pleaded in para 430 to be derivative from the failings pleaded in paras (a) to (d). They include:

Paragraph 431 pleads that:

I accept that the pleading is not entirely satisfactory. The difficulty with it is that the pleading of knowledge and constructive knowledge are confused with the pleading of conduct that is said to involve a breach of duty. The case against Deloitte has as its starting point the allegation that the FY13 financial statements did not comply with the Australian Accounting Standards because of the failure to write down or make provision against the carrying value of inventory. Details of why that is said to be so are set out in Section C of the pleading. No issue is taken with the pleading of that Section. The case against Deloitte is then put in two ways.

First, it is alleged that Deloitte knew of the practices adopted by management. If that is right and if those practices did not comply with Australian Accounting Standards and if that non-compliance was material (which is pleaded to be the case in para 429), it seems to follow that Deloitte breached its duties as auditor either by failing to require the financial statements to be corrected or by qualifying its audit opinion.

Second, if Deloitte did not know the actual position, it is alleged that that is because it failed to carry out appropriate audit enquiries. Some particulars of what enquiries Deloitte ought to have carried out are to be found in the pleading of constructive knowledge (para 427(d)) and the particulars to that paragraph. However, the principal allegations are to be found in para 430. The critical paragraphs appear to be paras 430(b) and (c). What is alleged is that:

As I have said, a number of plainly derivative breaches are pleaded. The only exception is the breach pleaded in para 430(h). The failure to perform “adequate audit procedures” referred to in that paragraph appears to be a reference back to the failures previously pleaded. But that is not plain from what is said in the paragraph. On its face, the reference to a failure “to perform adequate audit procedures to evaluate whether the overall presentation of the financial report was in accordance with the applicable financial reporting framework” could be a reference to any type of failure unconnected with provisioning in respect of inventory. However, that cannot be what is intended; and it seems to me that any lingering ambiguity could be resolved by an appropriate request for particulars.

Deloitte’s complaint with this pleading is that it does not identify what it is Deloitte ought to have done. For example, it does not identify the type of testing Deloitte should have undertaken. Nor, for example, does it identify the extent of the misstatement in the accounts that Deloitte ought to have identified.

I do not accept that criticism. In my opinion, the case that Deloitte must meet emerges sufficiently from the pleading so that it will not be caught by surprise. To take the examples just referred to, Deloitte knows that it needs to consider the requirements of the Auditing Standards that have been identified by the plaintiffs and consider the question whether any testing it did in relation to provisioning met those standards. Similarly, for the purposes of understanding the case it must meet, it is not necessary for Deloitte to know what provision the plaintiffs say ought to have been made. It is sufficient that they know (which is obvious from the pleading) that the provision would have been sufficiently large to cause the accounts to be corrected or qualified because the misstatement was material.

The likelihood is that, assuming that the plaintiffs are correct and the Auditing Standards required Deloitte to make enquiries or conduct testing concerning DSSH’s policies in relation to provisioning to determine whether those policies were appropriate, there were a number of different types of enquiry or testing that Deloitte could have undertaken. In my opinion, it is not necessary for the plaintiffs to specify precisely what enquiries and testing Deloitte ought to have undertaken; and indeed such a requirement runs the risk of unreasonably narrowing the plaintiffs’ case. It would be sufficient for the plaintiffs to prove that Deloitte did not undertake any enquiries or testing of the type required by the Auditing Standards. In those circumstances, their case should not fail because they were required to identify the precise enquiries and testing that Deloitte should have undertaken, but were unable to prove that enquiries and testing of those specific types were necessary to comply with the relevant Auditing Standards.

The timetable in the case makes provision for both the plaintiffs and Deloitte to serve expert evidence in relation to the claims against Deloitte, and there is every reason to think that both will do so. Following the service of expert evidence, the experts will be required to meet to attempt to narrow the issues between them. They will be required to prepare a joint report setting out the matters on which they agree and disagree and brief reasons for their disagreement. The likelihood is that the experts will give evidence concurrently and that for the purpose of their concurrent evidence the parties will be required to prepare an agenda for their evidence. Through that process, the issues between the parties will be narrowed further. That is not to suggest that that process is a substitute for adequate pleadings. However, it needs to be borne in mind in determining what is required of the pleading.

As I have said, Deloitte also takes issue with the pleading of causation because it is said not to contain a proper articulation of what Deloitte would have done in the counterfactual. I do not accept that submission. The claim is that the matter would have been raised with management, that either the accounts would have been corrected or Deloitte would have qualified its audit report, and that in either case DSH would not have been floated. In my opinion, it is not necessary for the pleading to be more precise than that. Deloitte is put on notice clearly that the case it must meet is that it would have raised the matter in a way with management that would either have led to changes in the accounts or a qualified audit report. I do not see why the pleading needs to be any more precise than that.

As I have said, it is not suggested that different issues are raised by the pleading in respect of other years. The pleading perhaps is not as clear as it might be. But, for the reasons I have given, I have concluded that the case that Deloitte must meet emerges sufficiently from it, and for that reason I do not think that it should be struck out.

It follows that the notices of motion filed on 25 March 2019 in each of proceedings 2017/294069 and 2018/52431 should be dismissed.

I will hear any application for costs at a time fixed with my Associate.