Breaking Fraud Cases from Canadian Courts
At Canadian Fraud News, we report on decisions issued by Canadian Courts related to fraud, that are not reported in the mainstream media, and that contain legal issues the Canadian public and fraud recovery experts should be aware of. The following is one such story.
On December 20, 2017, the Supreme Court of Canada released a decision in a complex auditor negligence case resulting from the failure of Deloitte LLP failing to uncover the fraud of some of Livent’s management. Where Livent’s shareholders, through their receiver, could not recover is losses against those directly involved in the fraud, they sought to recover their losses through the auditor which could have prevented the fraud losses from continuing.
The decision, under the title of Livent Inc. (through its receiver) ats Deloitte & Touche (now Deloitte LLP), 2017 SCC 63, has created a new standard for recovery for victim shareholders against auditors where the management of a company had engaged in fraud.
This story begins with a summary of the criminal case, and its evolution to a civil fraud recover case.
The Criminal Case
The Reasons for Conviction of Garth Drabinsky and Myron Gottlieb against Livent’s shareholders is set out in (2009), 242 CCC (3d) 449. The introduction of Justice Benotto sets out a chronological background for what happened at Livent and is relevant to the civil case. It reads as follows:
Garth Drabinsky was described as a creative genius. With his long-time partner Myron Gottlieb, he built a live entertainment empire that spanned North America and was expanding to England and Australia. “Livent” was a leading producer of musicals, plays and concerts.
From 1993 to 1998 Livent raised over $500 million dollars through share offerings, special warrants, notes, bond issues, debentures and bank credit.
By early 1998 it had launched 15 productions, won 14 prestigious Tony awards and was nominated for dozens more. Its productions included the famous titles Phantom of the Opera, Ragtime, Showboat, Joseph and the Amazing Technicolor Dreamcoat, Fosse and Kiss of the Spider Woman.
They played in historic theatres that Livent renovated, owned and managed
including The Pantages in Toronto, The Apollo and the Ford Center for Performing Arts in New York and The Oriental in Chicago.
Livent, through its founders, made important contributions to the entertainment industry, to tourism and to the lives many who are involved in or who enjoy live theatre. Mr. Drabinsky was admired as “one of the most innovative forces in the theatre.” Together with Mr. Gottlieb, he ran the company.
On April 13, 1998, Mr. Drabinsky announced a change in management of Livent that would allow him to devote his time exclusively to the artistic and creative work of the company. It was part of a deal that included Michael Ovitz, who was well known in Hollywood, and who had worked with the Walt Disney Corporation.
The notice of change of management resulted in investors were putting a further $30 million into the company. Mr. Drabinsky was to become Vice-Chairman and Chief Creative Director. Mr. Gottlieb was to become Executive Vice-President, Canadian Administration. The day-to-day accounting would be done by new management.
There was a sense of excitement and enthusiasm. It was anticipated that the management experience of the investors and the creative talent at Livent would continue to build the company and create shareholder value.
At the end of April 1998, Mr. Drabinsky attended a luncheon in Washington D.C. with President Clinton. It was a celebration weekend for the 150th anniversary of the Democratic National Committee. Ragtime was the theme of the convention and was being honoured.
In June 1998, the Ovitz deal closed. The shares of Livent were trading at $11.40. All was well in Livent, or so thought its investors.
In August 1998, however, Mr. Drabinsky and Mr. Gottlieb were locked out of their offices. New management learned of the allegations that gave rise to the charges before the Court.
Five months later, the Toronto Stock Exchange suspended trading of Livent shares and the company declared bankruptcy in the United States and Canada. A year after that the shares were de-listed from the Toronto Stock Exchange.
Mr. Drabinsky and Mr. Gottlieb were charged with two counts of fraud and one count of forgery. It was alleged that they directed a large scale accounting fraud by misstating the financial information in the books of Livent and its predecessor MyGar. The particulars on the Indictment were:
1. fraud relating to a kick-back scheme involving MyGar which resulted in a misstatement of the assets in the prospectus filed for the initial public offering;
2. fraud relating to accounting practices at Livent; and
3. forgery in connection with the filing of false financial statements while at Livent.
The Reasons for Sentence for the fraud of Drabinsky and Gottlieb against Livent’s shareholders are set out in (2009), 246 CCC (3d) 214. Justice Benotto held:
The contributions that Mr. Drabinsky and Mr. Gottlieb have made to society must be and are taken into account. But no one is above the law. No one gets to write his own rules.
Mr. Drabinsky and Mr. Gottlieb presided over a corporation whose corporate culture was one of dishonesty.
Corporate fraud such as this results in tangible losses to employees, creditors and investors. It also results in less tangible, but equally significant loss to society. It fosters cynicism. It erodes public confidence in the financial markets.
The Court has a duty to strongly denounce such conduct. Those in business must know and the community must know that this will be the Court’s response to corporate fraud.
In 2009, Drabinksy was sentenced to seven years prison. Gottlieb was sentenced to six years prison. On appeal, the sentences were reduced to five years jail for Drabinsky and four years jail for Gottlieb – see 2011 ONCA 582.
In 2017, over 8 years after the convictions of Drabinsky and Gottlieb, and almost 20 years of their acts of negligence, Deloitte, the auditor of Livent, has been ordered to pay Livent’s shareholders approximately $40 million.
No restitution orders were issued against Drabinsky and Gottlieb in their criminal case, and they were long released from prison by the time a final decision in the Deloitte case was made. Civil and class actions, however, were brought against them, the results of which are unknown.
The Livent Shareholder Case against Deloitte
The Livent shareholder case against Deloitte was brought as a breach of contract and negligence action.
It was alleged that in 1997, Deloitte signed off on a comfort letter and a press release. The comfort letter pertained was for Dundee Realty Corp., who sought to purchase air rights above Livent’s Pantages Theatre and adjacent properties. The press release was issued on the eve of a public offering, which was to take place at the time of the issuing of the comfort letter.
August 31, 2017, is the date which the SCC held that Deloitte, had it been acting reasonably, would have resigned from its audit of, and providing services to, Livent. The SCC held that this date was critical to the damage assessment as well.
In April 1998 Deloitte signed off on Livent’s financial statements giving it a clean bill of financial health / audit opinion. The SCC held that this audit lacked “independent thought” and “essentially tracked the statutory audit for 1996.”
The trial judge awarded damages payable by Deloitte LLP of approximately $80M to the Livent shareholders. This award was upheld by the Ontario Court of Appeal. The Supreme Court of Canada reduced the damages to approximately $40M.
The SCC decision is complex (this is an understatement). The essence of the decision is that the rights of shareholders, like the duties of auditors, is not limitless.
But into common parlance, the SCC held that the purpose of Deloitte providing Livent the 1997 comfort letter and the press release were for the purpose of assisting Livent solicit investment. Given this undertaking, the Livent shareholders were entitled to rely on Deloitte using reasonable care to detect the fraud being perpetrated by Drabinsky, Gottlieb and others in Livent’s management.
Further, the SCC ruled that the risk of injury flowing from undetected fraud is precisely the type of injury that statutory audits (audits on companies offering shares to the public) seek to avoid. In other words, statutory audits are conducted in part to provide shareholders with reliable intelligence for the purpose of enabling them to oversee management.
To restrict indeterminate liability to an auditor, the SCC held that claims for auditor negligence can only be brought by way of a derivative action by the company on behalf of its shareholders.
Further, a claim can only be made where the company replaces its dishonest management upon discovering their dishonesty. In the Livent case, the dishonest management, including Drabinsky and Gottlieb, were removed almost immediately upon their fraud coming to light.
To further restrict indeterminate liability to an auditor, the SCC held that the claim can only be for a one year period for which the audit was issued. In this case the limiting of the time period over which damages were incurred reduced the award from $80M+ to approximately $40M.
One could say that after all of this litigation, counsel for the Livent shareholders obtained a significant recover, and the appeal of counsel for the auditor’s resulted in a significant reduction from that award. At this holiday season, it remains to be seen what funds actually flow back to the shareholders, and what is claimed by Livent’s receiver and its counsel.
Full Reasons for Judgment
For the full reasons for judgment for this case, see Deloitte & Touche v. Livent Inc. (Receiver of), 2017 SCC 63 – https://www.canlii.org/en/ca/scc/doc/2017/2017scc63/2017scc63.html?searchUrlHash=AAAAAQAPZ2FydGggZHJhYmluc2t5AAAAAAE&resultIndex=1
Inquiries
For further information on this case or any other fraud recovery inquiry, contact Canadian Fraud News Inc. at Devin@Canadianfraudnews.com .
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