Limited Auditors' Liability: Economic Analysis and the Theory of Tort Law

Abstract

In Caparo Industries Ptc. v. Dickman, the House of Lords turned its attention again to the age-old problem of determining the liability that is appropriate for a defendant that has caused pure economic loss to a plaintiff by way of a negligent misrepresentation. While the Court of Appeal agreed that the defendant auditing company was liable because it had breached a duty of care that it owed to the plaintiff as a shareholder, the House of Lords reversed this decision, arguing that information and advice in general, and auditing services in particular, are provided with a specific purpose in mind, and that liability for negligence must be restricted to losses following upon uses of the information for that particular purpose. The House of Lords was of the view that the Companies Act indicated that the financial statements in this case had been prepared for the use of the target company's shareholders at their annual meeting and not for the purpose of an investor launching a takeover, no matter how foreseeable that takeover might be. Thus, since the plaintiff had not used the negligently audited financial statements for their intended purpose, there was no liability.

What cases like Palsgraf and Caparo show is that it is not enough for a finding of liability that the plaintiff was injured, even if foreseeably so, by the defendant's wrongful conduct. Instead what matters is that the plaintiff be wrongfully injured by the defendant, that is, that the plaintiff's injury fall within the ambit of the defendant's wrongdoing rather than just be a cause-in-fact result of it. This is a subtle distinction to be sure. But it is an important distinction which preserves the intellectual integrity of tort law as something that can properly be the subject of adjudication - that is, legal argument and reasoned judgment - in a way that a pure public policy, or economic, analysis of tort law cannot.