8 | Breach is just the beginning: the significance of counterfactuals, causation and contributory fault in establishing and quantifying liability

WEIS: Auditors culpable, or just a case of sour grapes?

The Wine Enterprise Investment Scheme Limited (WEIS) was marketed to investors as a tax-efficient wine investment fund. In fact, it was a Ponzi scheme operated by its directors. Crowe was WEIS' auditor for the financial years 31 December 2012 to 31 December 2018. Following its inevitable liquidation, WEIS (acting by its liquidators) sued Crowe seeking recovery of £4.2m subscribed by the shareholders.

Crowe accepted that it breached its duties in each audit year. However, Crowe denied that these breaches caused the losses claimed, given that the only individuals in a position to take any action on behalf of WEIS during the period Crowe acted as auditor were the two directors perpetrating the fraud.

The Court rejected WEIS' argument that Crowe had a duty to report certain findings directly to the shareholders. There was no English law authority, statute, or regulatory standard justifying the proposition that auditors owed a duty to report fraud directly to shareholders, even where the auditors knew or suspected that management or the directors might be implicated in or condoning that fraud.

The Court also rejected the company's argument that the shareholders would have been informed of the fraud by Crowe's resignation statement. Even if Crowe should have resigned, there were various legal constraints on an auditor's ability to publicise any fraud it may have discovered at the company via its resignation statement, including the risk of criminal liability under Proceeds of Crime Act 2002 if it was found to have prejudiced an investigation.

Whilst WEIS' case on causation did not fail entirely, the Court held that the relevant framework for determining the extent of Crowe's liability required an assessment of a range of factors, including the shareholders' evidence as to what they would have learned, how they would have reacted, and what steps they would have considered taking in the event that Crowe had declined to submit auditor's reports.

The Court held that the highest that the company could put their case was on the basis of the shareholders taking action in June 2018, in relation to the year-end 2016 accounts. The Court found that, at that stage, wine totalling approximately £2.85m could have been preserved for recovery in the event of corrective action by the shareholders.

However, steep deductions were then applied to this total recoverable amount:

• A 90% deduction was applied to reflect the Judge's finding that there was only a 10% chance that shareholders would have taken steps in June 2018 to preserve the assets of WEIS, reducing the maximum value of the claim to £285,000;
• A 2.5% reduction was then applied to reflect the costs of sale of the wine that action from the shareholders may have preserved, reducing the maximum value to £277,875.90;
• This figure was reduced by £73,944 to give credit for the benefits received by WEIS while being able to continue its business – applying AssetCo v Grant Thornton3 and Afan Valley Ltd & Ords v Lupton Fawcett LLP4; and
• A further 50% reduction was applied to reflect the contributory fault of WEIS, through the attribution of its directors' fraudulent conduct and the absence of any corporate governance or any other internal controls that were separate from the dominance of its fraudulent directors.

The result

Crowe were held liable for £101,965.95, plus approximately £30,000 in interest. This recovery, of approximately 1.6% of the total damages claimed, was expressly described in a consequentials judgment as a "Pyrrhic victory" such that WEIS could not be regarded as the successful party for costs purposes.

WEIS was accordingly ordered to pay: (i) 85% of Crowe's costs of the proceedings up to the date of the expiry of Crowe's Part 36 Offer (of £3.175m plus costs, that was made approximately 8 months before the beginning of trial); and (ii) 100% of its costs on the standard basis from the date on which the period for acceptance of Crowe's Part 36 offer expired, and interest on those costs.

WEIS' application for permission to appeal various points of the substantive judgment, including the 50% reduction for contributory negligence, was also refused by the High Court.