Rushmer v Smith (t/a Mervyn E Smith & Co)

An auditor’s negligent accounts do not create a personal duty of care to a company director and shareholder in respect of liability under a personal guarantee where the auditor was unaware of the guarantee and was not asked to advise on it. Reliance is an essential element of the claim. Further, loss suffered by a shareholder or creditor which reflects loss suffered by the company is outside the scope of the duty and is irrecoverable under the reflective loss principle. A causation argument based on the company’s continued trading must be distinguished where the allegation is that the negligent accounts represented an unprofitable company as profitable. Separate proceedings are not abusive merely because a related claim could previously have been advanced.

The claimant was the sole director and principal shareholder of a company whose auditor negligently overstated its profits and assets in the accounts for the year ended 31 March 2002. He alleged that he relied on the accounts, continued trading, invested further money and incurred liability under a personal guarantee of the company’s bank borrowing.

The defendant accepted negligence in preparing the accounts but denied that the claimant had suffered recoverable loss. The court considered reliance, the existence and scope of any personal duty of care, reflective loss, causation and whether earlier county court proceedings and their settlement barred the claim.

1. Claim dismissed. The claimant failed to establish reliance on the overstated accounts. The evidence showed that he knew the company was experiencing cash-flow difficulties and did not believe that it had made the substantial profit shown. His later conduct was also inconsistent with the course of action he alleged he would have taken.
2. The accounts made a representation that they gave a true and fair view. Applying the factors identified in Caparo Industries plc v Dickman [1990] 2 AC 605, the defendant did not owe the claimant a personal duty of care in respect of his liability as guarantor. The defendant did not know of the guarantee, it had never been discussed, and the claimant had not sought advice about his position as guarantor.
3. There was an additional and decisive reason for rejecting the claim. Under Banque Bruxelles Lambert v Eagle Star Insurance Co Ltd [1997] AC 191, loss must fall within the scope of the relevant duty. The claimant’s liability under the guarantee was reflective of loss suffered by the company and was therefore irrecoverable under the principle explained in Johnson v Gore Wood [2002] 2 AC 1. The same conclusion followed from Humberclyde Finance Group Ltd v Hicks (Neuberger J, 14 November 2001) and Gardner v Parker [2004] EWCA Civ 781, [2004] 2 BCLC 554.
4. The claimant’s attempt to avoid reflective loss by relying on Galoo Ltd v Bright Grahame Murray [1994] 1 WLR 1360 failed. That case concerned losses following trading where there was no allegation that the company’s trading was itself unprofitable. The present allegation was materially different: the accounts allegedly represented an unprofitable company as profitable.
5. The settlement of the defendant’s earlier county court claim did not bar the present proceedings. Applying the principles in Henderson v Henderson (1843) 3 Hare 100 and Johnson v Gore Wood [2002] 2 AC 1, allowing the claim to proceed was not unjust harassment or an abuse of process.

First instance decision. No appellate history is stated in the judgment.