Guardian Insurance Co. of Canada v. Sharp

dUARDIAN INSURANCE COMPANY'

* Nov. 4,5,6.

OF CANADA

(PLAINTIFF) ............

APPELLANT; AND

F. W. SHARP

OTHERS

(DEFEND- R

N ANTS)

..

...........................

R

ON APPEAL FROM THE KING'S BENCH, APPEAL SIDE, PROVINCE QUEBEC

Insurance - Fidelity - Companies - Auditors' duties - Statutory audit - When a firm of accountants has merely been appointed to act as auditors of an advertising company, without any special terms or conditions as may have been contained in a by-law or a special contract and, thus, where the definition of their duties must be found entirely within the language of section 120 of the Dominion Companies Act, their duties are those, and only those, imposed upon them by the statute.

A contract imposing upon them the duty of making the statutory audit therein referred to and of issuing a certificate to the effect that the balance sheet was "properly drawn up so as to exhibit a true "and correct view of the state of the company's affairs * * * as "shown by the books of the company " does not call for a more complete and detailed audit, unless some circumstances would give rise to suspicion of dishonesty or irregularities.

In the absence of any suspicion as to the honesty of a cashier, who as a fact had been guilty of defalcations for a period of nearly six years before they were discovered, the auditors were not obliged, as in this case, to compare the details of the bank daily deposit slips with the entries in the cash book: they were bound only to exercise a reasonable amount of care and skill in order to ascertain that the books were showing the company's true position; or, adopting the words used by Lopes LJ. in In re Kingston Cotton Mill Co. (1896 2 Ch. 279), "it is the duty of an auditor to bring to bear on the work he has to perform, that skill, care and caution which a reasonably competent, careful and cautious auditor would use "; and, using a term of the Quebec law system, auditors must act " en bons phres de famille ".

Upon an action brought by an insurance company, which had issued a fidelity bond on the employees of the advertising company and which had been subrogated in that company's rights, if any, against the auditors, held, applying the principles enunciated in the decisions below-mentioned to the particular facts of this case, that there was no such neglect or default on the part of the auditors as would entitle the advertising company, were it the plaintiff, to succeed in the action.

Crocket, Davis, Hudson and Taschereau JJ. Bench, appeal.side, province of Quebec (1), reversing the judgment of the Superior Court, L. Cousineau J. and dismissing the appellant's action.

The appellant company, having by its policy of insurance guaranteed to the Claude N6on General Advertising, Limited the honesty of its cashier, A. 0. Cl6ment, was, since the cashier turned out to be a defaulter, obliged to pay the Non Company $5,000, and, having received subrogation of that company's rights, instituted an action against the respondents, alleging that the theft, misappropriation or fraudulent conversion by Cl6ment, were rendered possible and caused through the neglect and want of professional skill of the respondents, in particular because they failed to check the bad accounts of the company and to compare, check and verify the moneys received, as shown by the general cash book and the certified bank deposit slips, in which were entered the names of the makers of cheques which did not appear in the cash book itself. The respondents alleged that they exercised reasonable care and skill in the performance of their duty; that Cl6ment was never subject to their discipline or control, and that he succeeded in deluding his employers, the officers of the N6on Company, into extraordinary practices, by which were created possibilities for dishonesty which were beyond the scope of investigation and inquiry of an ordinary audit; that any loss sustained by the Neon Company is attributable to the dishonesty of Cl6ment and the gross negligence and incompetence of the assistant-secretary of the N6on Company, whose duty it was to supervise Cl6ment.

J.-La Guardian Insurance Company, l'appelante, avait 6mis une police d'assurance destin6e h indemniser la Claude N6on General Advertising Limited jusqu'A concurrence de $5,000 contre les d6falcations de ses employds.

Comme r6sultat de la manipulation de certains comptes, le caissier de cette dernibre compagnie a d6tourn6 durant une p6riode de pr~s de cinq ans une somme de $6,756.41, et l'appelante a dfi payer a son assur6e, en vertu de sa police, la somme de $5,000. Elle poursuit maintenant pour ce montant les intim6sauditeurs de la Claude Non, et ayant 6t6 subrog~e dans les droits de cette dernibre, elle alligue qu'ils ont 6t6 n6gligents dans l'exercice de leurs fonctions et qu'ils n'ont pas, comme ils auraient dfi le faire, d6couvert le syst6me employ6 par Climent pour frauder son employeur. En Cour Sup6rieure, lFaction a t maintenue, mais la Cour du Bane du Roi, l'honorable juge-en-chef et l'honorable juge Gibsone dissidents, en est venue A la conclusion que la responsabilit6 des intim6s n'avait pas 6td 6tablie, et a rejet6 Faction.

Le systime employ6 par Climent pour convertir h son usage personnel les fonds dont il avait la garde 4tait assez ingenieux.

Lorsqu'un client de Claude Non se pr6valait de la Loi des Faillites, ou lorsqu'on faisait avec lui un compromis pour la paiement de son compte, ou bien encore lorsque l'on conflait la reclamation contre lui aux avocats de la Compagnie, on inscrivait son nom dans un r6gistre special avec tous les autres mauvais comptes. L'assistantsecr6taire-tr6sorier, M. Tulloch, apposait ses initiales visa-vis le nom de celui qui ainsi 6tait consid6r6 comme incapable de remplir son obligation. Depuis ce moment, aucune facture n'6tait adress6e A ce d6biteur et il fallait attendre la remise de 1'avocat de la Compagnie ou les dividendes du syndic A la faillite. Le syst~me imagin6 par Cl6ment consistait h s'emparer de ces remises, a ne les entrer nulle part dans les livres, et A garder ces cheques en sa possession jusqu'au moment oii des clients dont les comptes 6taient actifs venaient au comptoir payer en argent ce qu'ils devaient.

Cl6ment s'appropriait alors cet argent, jusqu'h concurrence du montant des ch6ques des mauvais comptes, entrait dans le livre de caisse les noms de ceux qui payaient Taschereau J. en argent, et, pour balancer, d6posait en banque les chbques qu'il avait en sa possession. Ce systime dont les auditeurs ne s'apergurent pas dura au-delh de quatre ans et permit au caissier de d6tourner la somme de $6,756.41.

A cause d'un changement dans le systime de perception des comptes, on dicouvrit qu'un montant de $13.50 qui avait t6 pay6 n'6tail cr6dit6 nulle part. La Compagnie en avertit aussitit les auditeurs qui firent une enquite spciale avec les r6sultats que cette fraude fut mise A jour et le montant de la d~falcation d6finitivement 6tabli.

La faute des auditeurs r6side, pr6tend 1'appelante, dans le fait qu'ils n'ont pas compar6 les entr6es quotidiennes du livre de caisse avec les copies des bordereaux de d6pots.

On aurait pu s'apercevoir ainsi, parce que les noms des signataires des chiques apparaissaient sur les bordereaux, qu'il y avait sur ceux-ci des noms ne figurant pas au livre de caisse et ces dissemblances auraient imm6diatement fait naitre des soupgons.

Il est n6cessaire, pour bien d6terminer les responsabilitis, s'il en existe, d'examiner la nature et 1'6tendue des services que les intimbs 6taient appel6s A rendre a Claude Neon.

Aucun contrat 6crit n'a 6t produit, mais on trouve cependant un r~glement des actionnaires pass6 conformiment aux dispositions de la Loi F6d6rale des Compagnies, nommant les intim6s auditeurs, et rien dans le dossier ne d6termine les devoirs qu'ils doivent remplir.

Il n'y a aucune restriction qui limite, et aucun engagement qui augmente leurs obligations.

I s'ensuit done qu'ils ont A remplir les devoirs impos6s par la loi telle qu'interpr6t6e par les auteurs et la jurisprudence.

L'article 120 de la Loi F6d6rale des Compagnies se lit de la fagon suivante:- A Comme il est facile de s'en rendre compte, oet article ne d6termine pas tous les devoirs des auditeurs. II dit bien que ceux-ci doivent faire un rapport aux actionnaires, qu'il est de leur devoir de reviler si le bilan, dans leur opinion, repr6sente 1'6tat v6ritable des affaires de la Compagnie d'apris les informations obtenues et les livres de la Compagnie. Mais, jusqu'o va leur r8le d'investigateurs, et oii s'arrate leur obligation de chercher dans les livres pour trouver des irr6gularitibs, voire m~me des fraudes? Cette cause qui a pris naissance dans la province de Qubbec, doit n6cessairement 6tre jug6e suivant les lois de cette province.

II ne s'agit nullement d'une r6clamation dilictuelle ou quasi-d6lictuelle fondie sur l'article 1053 C.C., mais bien d'une r6clamation bas~e sur le d6faut d'accomplir certaines obligations r6sultant d'un contrat d'engagement.

II n'y a pas dans la province de Qubbec d'arr~ts qui ont 6t6 rendus et qui puissent nous aider A solutionner le problime de la responsabilit6 des auditeurs. Ayant en vue toujours qu'il s'agit de l'inex~cution d'une obligation contractuelle, je crois qu'il est difficile de mieux d6finir les devoirs r~sultant d'un semblable contrat, que ne l'a fait l'honorable juge L6tourneau qui s'exprime de la fagon suivante:- Ce principe qui doit nous guider est bien semblable A la doctrine maintes fois appliquie en Angleterre, et oii les juges des plus hautes cours ont maintenu que les auditeurs doivent dans l'exercice de leurs fonctions, faire preuve d'un degr6 raisonnable d'habilet6 et d'attention. Et nous devons d'autant plus nous inspirer de cette jurisprudence, si l'on considbre que Particle 120 de la Loi F6d6rale des Compagnies que je viens de citer est semblable au texte de la loi anglaise.

Quelques extraits des causes les plus importantes nous font voir l'uniformit6 de la jurisprudence anglaise, et F. ceux-ci, dans les limites d6termin6es par cette Cour dans The King v. Desrosiers (1), et Latreille v. Curley (2), peuvent sans doute nous servir de guides.

Dans In re

London and General Bank (No. 2) (3), Lindley L.J.

s'exprime de la fagon suivante:- Dans In re Kingston Cotton Mill Company (No. 2) (4):

Et plus loin, Lopes L.J. dit:- Et plus loin, h la page 288 de la m~me cause:- Les auditeurs, comme dans le cas actuel, A qui on n'a pas confi6 la tAche d'ex6cuter un travail sp6cial, doivent done remplir leurs devoirs avec la prudence, 1'attention et

'habilet6 qu'un autre auditeur comp6tent montrerait dans des conditions identiques. C'est en "bons phres de famille "

qu'ils doivent agir.

Leur thche consiste h v6rifier si le bilan repr6sente bien la position financi~re de la Compagnie, d'apris les livres et les informations obtenues. Ils ne sont pas des d6tectives et ils ne sont done pas tenus de pr6venir et de retracer toutes les fraudes que des employ6s malhonn~tes et ing6nieux peuvent commettre au pr6judice de leur employeur.

Ils sont justifiables de croire h 1'honn~tet6 de certains employ6s qui jouissent de la confiance des directeurs de la

Compagnie depuis de nombreuses ann6es de service, et il leur est 6galement permis, lorsque les livres ne donnent naissance A aucun soupgon, de s'abstenir de faire certaines recherches et investigations, qui pourraient 6tre n~cessaires dans des cas d'auditions particulibres des instructions sp6ciales leur sont donn6es.

C'est d'ailleurs la jurisprudence constante telle qu'6tablie et par les arrits cit6s antirieurement et aussi par les suivants:- Dans la cause de In re London and General Bank (2) F.w.SHARP d6jh cit6e (1), Lindley L.J. dit:- An auditor has nothing to do with the prudence or imprudence of Taschereau J. making loans with or without security. It is nothing to him whether the business of a Company is being conducted prudently or imprudently, profitably or unprofitably. * * * his business is to ascertain and state the true financial position of the Company at the time of the audit, and his duty is confined to that.

Dans la m~me cause, h la page 683:- Where there is nothing to excite suspicion, very little inquiry will be reasonably sufficient * * * where suspicion is aroused, more care is obviously necessary; but still an auditor is not bound to exercise more than reasonable care and skill even in a case of suspicion, and is perfectly justified in acting upon the opinion of an expert where special knowledge is required.

Dans In re Kingston Cotton Mill Company (2) (2),, il a 6t6 d6cid6:that, it being no part of the duty of the auditors to take stock, they were justified in relying on the certificates of the manager, a person of acknowledged competence and high reputation, and were not bound to check his certificates in the absence of anything to raise suspicion and that they were not liable for the dividends wrongfully paid.

An auditor is not bound to be suspicious where there are no circumstances to arouse suspicion; he is only bound to exercise a reasonable amount of care and skill.

Lopes L.J., dans la m~me cause, nous dit:- An auditor is not bound to be a detective, or as was said, to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watch-dog, but not a bloodhound. He is justified in believing tried servants of the Company in whom confidence is placed by the Company. He is entitled to assume that they are honest, and to rely upon their representations, provided he takes reasonable care. If there is anything calculated to excite suspicion he should prove it to the bottom; but in the absence of anything of that kind he is only bound to be reasonably cautious and careful.

Et plus loin,

Auditors must not be made liable for not tracking out ingenious and carefully laid schemes of fraud when there is nothing to arouse their suspicion, and when those frauds are perpetrated by tried servants of the company, and are undetected for years by the directors. So to hold would make the position of an auditor intolerable.

Aller au-delh de cela serait crder pour les auditeurs, comme il est dit dans les arrts ci-dessus, une situation (2) [18961 2 Ch. 279.

intol6rable, et signifierait qu'ils assurent contre la fraude, et qu'ils sont responsables des habiles manipulations d'employ6s peu scrupuleux qui r6ussissent A tromper la surveillance de leurs employeurs.

Dans le cas actuellement soumis h la Cour, on reproche F.W.s aux intim6s, et c'est le seul grief s6rieux invoqu6 contre eux, de ne pas avoir compar6 les bordereaux de d6pit avec les entries au livre de caisse. Il est utile de se rappeler ici que tous les mauvais comptes de la Compagnie 6taient initial6s par l'assistant-secr6taire-tr6sorier, M. Tulloch, et, en consiquence, soustraits du compte des profits et pertes.

M. Turner, le vice-pr6sident, le tr6sorier et le g6rant g6n6ral de la Compagnie nous dit:job it

Lorsque Cl6ment r6ussissait h, percevoir le montant de certains de ces comptes, il d6posait, comme nous l'avons vu, ces chbques au compte de banque de la Compagnie sans faire d'entrie au livre de caisse, et s'appropriait d'autres montants 6gaux pay~s en argent. Il est possible que la v6rification des bordereaux efit r6v616 certaines de ces malversations, mais les experts entendus, sauf M. Parent et

M. Grant, nous disent qu'on ne peut se fier h une pareille comparaison.

M. Gordon Scott nous affirme que l'examen d6taill6 des bordereaux de d6p6t n'est d'aucune utilitA. M.

Young, un des associds de Price, Waterhouse & Co., nous dit que l'examen des copies de bordereaux de dip8t a peu de valeur comme moyen de v6rifier 1'exactitude des recettes en argent.

affirme que ces bordereaux ne sont pas une preuve de r6ception d'argent, mais bien une preuve que de l'argent a ti donni h la banque. M. L. E. Potvin jure que le bordereau de d6pit peut faire mention d'entries qui n'ont aucune relation avec le commerce du client, qu'il peut y avoir eu 6change de chiques avec ce client et autres accommodations, et il nous dit qu'il ne pourrait pas se fier h ces copies de bordereaux de d6p6t. C'est aussi l'opinion de M. Maurice Chartr6 et de M. K. W. Dalglish qui tous deux croient que cette fagon de v6rifier n'est pas certaine et qu'elle n'est pas g6n6ralement employee.

La raison se devine facilement. II peut se pr6senter des cas nombreux un caissier honnite ne pourra jamais faire concorder les entr6es d'un jour inscrites au livre de caisse avec le bordereau de d6p6t. Si, ainsi, il regoit au w. comptoir d'un client d6biteur de $25, un chique de $50, et lui remet $25 en change, le livre de caisse comportera J.une recette de $25 et le bordereau un dipot de $50. Si un autre client paye le mgme montant au moyen de trois chiques diff6rents signis par des tiers, et endoss6s par lui il y aura encore une entr6e de $25 au livre de caisse, et sur le bordereau, le d6p6t de trois ch&ques qui n'ont aucune relation avec les affaires de la Compagnie. Le caissier peut changer le cheque d'un officier de la Compagnie, qui apparaitra au bordereau mais nullement au livre de caisse. peut aussi recevoir des ch~ques postdat6s qui ne seront pas sur le bordereau A la date qui correspond A celle inscrite au livre de caisse.

L'on voit donc par ces timoignages des experts et les exemples cit6s que cette faute reproch6e aux intim6s n'en est pas une en r6alit6. Ils se sont contents de v6rifier le total des dip6ts, oomme le font tous les auditeurss prudents et ayant un degr6 raisonnable d'habilet6 professionnelle. Les intimis ont agi comme les autres auditeurs agissent dans des conditions identiques, et parce qu'ils ont omis de faire cette v6rification qui ne se fait pas habituellement, on ne peut pas dire qu'ils n'ont pas agi en " bons phres de famille ".

Devaient-ils surveiller davantage des comptes consid6r6s comme mauvais comptes?

Il ne faut pas oublier que 1'appelante a 6t6 subrog6e aux droits de Claude Non Limited. Elle a tous les droits de celle-.i, mais elle n'en a pas davantage. Les auditeurs ont suggir6 A M. Turner, vice-pr6sident et g6rant g6n6ral, d'adresser une circulaire A tous les d~biteurs de la Compagnie pour v6rifier l'exactitude des montants dus, mais celui-ci a refuse cette suggestion en disant que le contr8le interne de la Compagnie 6tait suffisant.

II y avait donc lieu d'assumer que ces comptes disparus des livres l'6taient r6gulibrement. On sait que des auditeurs, qui louent leurs services A une corporation employant de nombreux commis, sont tenus de donner moins d'attention A certains d6tails pr6cis6ment A cause du contr6le interne exerc6 par les employds. Les tribunaux ne doivent pas 6tre plus s6v&res vis-&-vis les auditeurs qu'ils ne le sont vis-h-vis les autres profeasionnels. Du moment qu'ils agissent suivant les prineies que j'ai mentionnis d6jh, ils sont A l'abri de responsabilit6 civile, et ne peuvent pas 6tre recherch6s en domnages si l'on d~couvre des vols dont l'examen raisonnable des livres ne faisait pas soupgonner 'existence.

I est vrai, comme J on 'a dit, qu'ils ne sont pas employds seulement pour additionner, soustraire ou diviser, et qu'on a droit d'attendre d'eux un degr6 d'habilet6 qui permette A la Compagnie de se rendre compte de sa situation financibre. Mais il est 6galement vrai qu'on ne peut pas exiger d'eux que le bilan qu'ils contresignent comporte une garantie d'honn~tet6 de tous les employ6s, et qu'il est une assurance que leur vigilance n'a pas 6t6 tromp6e.

Le certificat qu'ils donnent aux actionnaires indique la situation de la Compagnie, telle que r6v616e par les livres qui n'ont pas 6veill6 de soupgons, et d'apris les informa- 'tions fournies par des employ6s responsables qui ont la confiance des directeurs. Ils sont des auditeurs, et non des enquiteurs sp6ciaux qui, eux, souvent doivent pr6sumer, a cause de soupgons pr6existants, la malversation et le d6tournement.

Pour ces raisons, je crois que le jugement de la Cour du Banc du Roi, qui a rejet6 1'action, est bien fond6, et je suis d'opinion de le confirmer avec depens.

DAVIs J.-Claude Neon General Advertising Limited

(hereinafter for convenience called " the company "), with head office in the city of Montreal in the province of

Quebec, carries on the business of manufacturing and leasing advertising signs. The company was incorporated in

1929 for the purpose of consolidating the activities of several advertising businesses theretofore carried on separately and became one of a group of nine companies whose consolidated balance sheet shows total assets to the amount of approximately four million dollars. That indicates in a general way the nature and extent of the business of the

In November, 1935, shortly after a collector of accounts in the employ of the company had introduced for his own its protection the use of a counterfoil receipt book, the auditors discovered that the company's cashier, Cl6ment, had stolen some money from the company.

He had been a trusted employee against whom there had never been any suspicion of wrongdoing but when the defalcation was discovered an investigation was at once commenced to ascer- Davis J. tain if there had been any other defalcations by this man. A thorough investigation of all customers' accounts, deposit slips, bankruptcy dividends and agreements with customers was made, with the result that this special investigation disclosed that comparatively small sums of cash had been taken by Cl6ment from time to time from as early as January 29th, 1931 (when $13.50 was taken) over a period of nearly six years, the total amounting to $6,756.41. Each of the items going to make up this total was a comparatively small sum, such, for instance, as $11.50, $7, $21.25, $18.65, $2, $14.44, $6.20, $1.74, $83.25, $10.31, $27.50, $19. I have picked out these items at random throughout the long list. In only a few instances was more than .9100 taken at one time; the defalcations were usually of small amounts at a time.

One at once asks how this sort of thing was done in that it was not discovered for nearly six years.

The obvious answer on the evidence is that Cl6ment was fully trusted by his superior officers in the large business, that there was no suspicion that anything like this was going on. And one naturally asks then: How did Cl6ment do this so as to evade discovery?

Like most consistent practices of fraud, the system when explained seems very simple, though perhaps ingenious at its inception in the mind of the guilty person. What happened was this: Cl6ment from time to time induced Tulloch, the assistant treasurer of the company whose duty it was to supervise Cl6ment and who was specifically entrusted with credits and bad debts, to write off some comparatively small accounts as bad debts, though apparently C16ment himself regarded them as accounts from which the company might well receive some further payments. These accounts, I should think negligently by Tulloch, were closed and written off on the books of the company and became dead accounts. No further monthly or other statements of account went out to these customers and therefore if any of them subsequently paid in anything on their accounts they did not thereafter receive statements of account which would have indicated at once that their payments had not been properly credited to their accounts on the books of the Further, there were accounts of persons or firms which went into bankruptcy; when notice of bankruptcy was received the company filed its claim with the trustee in bankruptcy and these accounts were then closed out on the books of the company.

Other accounts from time to time were given over to the solicitors of the company for collection and when that was done these accounts were closed on the books of the company and no further statement of account was sent by the company to the customer; the matter was left in the hands of the solicitor. Those three named classes of accounts, I take it from the evidence, represent the basis of the system upon which Climent, the cashier, worked in taking moneys from the company. He did it this way: the company had an ordinary cash ledger in which he daily recorded or was supposed to have recorded all the incoming moneys which in most cases were by cheques but in some cases by small cash payments. Every day the cashier sent, or was supposed to send, all the moneys taken in that day, whether represented by cash or by cheque, to the company's bank for deposit.

On the whole this was done faithfully day after day during the six years in question. But from time to time in order to take some money to himself Cl6ment did this: having received a cheque from a bankrupt estate or from the company's solicitor on a collection or in respect of one of the accounts that had been written off as a "bad debt," he would hold the particular cheque and not enter it in the cash ledger.

And then, when sufficient cash was in to amount to or exceed the amount of the cheque, he deposited the cheque at the bank to the company's credit but would take to himself the equivalent amount out of the cash in hand. It is plain that each day Cl6ment deposited or caused to be deposited in the company's bank the exact amount of money, represented by cheques or cash, which was shown in the cash ledger of the company as having been received that day by the The amount of the daily deposits as shown on the original bank statements to the company agreed exactly with the amount of the daily receipts as shown in the company's cash ledger.

1o

The company carried a fidelity bond on its employees which had been issued to it by the appellant, Guardian Insurance Company of Canada, and the appellant paid the company in respect of Cl6ment's defalcations $5,000, F. w.sHARP being the full amount of the bond. Upon payment the appellant took from the company a document headed Davis J. "Subrogation Receipt," in which the company acknowledged receipt of the $5,000 from the appellant in full settlement of all claims and demands under the bond in respect of defalcations on the part of Cl6ment and, in consideration of such payment, the company hereby assign and transfer to (the Guardian Insurance Company of Canada) each and all claims and demands against any other party, person, persons, property or corporation, arising from or connected with such loss and the said (the Guardian Insurance Company) is hereby subrogated in the place of and to the claims and demands of the undersigned (Claude Non General Advertising Limited) against said party, person, persons, property or corporation in the premises to the extent of the amount above named, and the said (Guardian Insurance Company) is hereby authorized and empowered to sue, compromise or settle in its name or otherwise to the extent of the money paid as aforesaid. The document is dated July 10th, 1936.

Neither the appellant nor the company itself took any proceedings against Cl6ment to recover the amount of his defalcations, or any part of them, but the appellant commenced this action on November 10th, 1936, in its own name, against the auditors of the company (who are the respondents in this appeal) to recover $5,000, the amount it had paid on its bond, alleging that the "theft or misappropriation or fraudulent conversion " by Cl6ment was rendered possible by and was caused through the neglect, want of professional skill of the defendants; that such conversion would have been impossible if the defendants had done what they were bound to do, and what they had agreed to do towards the said company, Claude Non General Advertising Limited, and its directors, and that the said loss was caused immediately by the said negligence, want of profesional skill of the defendants.

The appellant put its case on the alleged neglect of the auditors in failing to check what are called the "deposit slips." Cl6ment had made out day by day the usual form of bank deposit slip in connection with the daily deposit of company's moneys at the bank. The original deposit slip was retained by the bank. The amount of the daily deposit would vary considerably but on some days would be several thousand dollars. But on any day that Cl6ment intended to misappropriate some of the cash on hand, he would deposit the particular cheque which he had been GuwTx holding back with the other cheques received that day but the amount of cash he would deposit would be the amount actually received less the amount of the cheque F. Sm which he had been holding back until that day. Climent kept a carbon copy of each of these daily bank deposit slips. They appear to have been kept by him openly on a file on his desk; he must have known that it was not customary for auditors to check these carbon deposit slips or else he would not have adopted the system he did.

While the bank stamped each of these carbon copies, it merely acknowledged that it had received "the total amount" as shown on the slip.

The original deposit slips, which were left with the bank, do not appear to have been produced but I understand it is admitted that they were the same as the carbon copies. Strange as it may appear, on the days when misappropriations took place Clement made marginal notes on the copy of the deposit slip for the day which he retained which would give him the information, if he ever wanted the information, as to what cheque was added in the deposit of that day that had not been shown in the cash ledger, and in some cases a notation of the difference in the cash. There was no explanation for the making or for the keeping of these annotated copies but I suspect that Cl6ment, at least at the inception of the defalcations, hoped to make good later on and wanted a record of exactly what he had taken.

However that may be, the appellant says that if the auditors had checked not only the books of the company but these copies of bank deposit slips in Clement's possession, his system would have failed and the company would not have lost the money. What the auditors say is that it is not customary in the practice of auditors to check copies of bank deposit slips because they are not original documents and that the bank's stamp on them is expressly limited to an acknowledgment that "the total amount"

shown on the slip has been received and deposited to the credit of the company's account. The auditors say that they entirely shared the confidence of the superior officers of the company in Clement's honesty and had no ground for suspicion and that as a matter of auditing practice a stamp by the bank on a carbon copy of a deposit slip that the total amount shown thereon had been received by the bank was not something which in the ordinary course they would examine because they had before them the company's original cash ledger with its details of the F. w.sHARP daily receipts and they checked and examined the original statements received by the company from the bank, show- J. ing the total daily deposits, against the daily receipts as shown by the company's cash ledger.

The appellant's factum contains the admission:

The auditors had been appointed at the time of the incorporation and organization of the company in 1929. They then made out a programme or chart of their work which was known and accepted by the company and to which they adhered. They are admitted to be an old Montreal firm with an excellent reputation.

It is indeed a striking fact that Turner (himself a chartered accountant), who was the senior officer in charge of the company's office (being vice-president and secretarytreasurer for some years), testified that the company had foreseen "something like this " and had sought to cover it by internal checks and controls which he described. He said he did not criticize the auditors after the investigations had revealed the losses. Further, the Hon. Gordon W. Scott, who is acknowledged to have been one of the outstanding chartered accountants in this country and who was himself a director of the company, testified that had the audit of the company been under his supervision he would not have thought it an essential part of his duty to check the deposit slips. " In a large public corporation," he said,

Mr. Scott said there was and and he thought the checking of the daily deposit slips by the auditors would be " superfluous " and " useless " work in the circumstances. Dempster, one of the partners in the auditing firm, testified that he had at one time suggested to the company that a communication be sent to each customer to ascertain if the customer admitted that his indebtedness to the company was exactly as shown on his card or ledger sheet but that his suggestion had not been carried out; Mr. Turner felt that the system of internal control was a sufficient safeguard against defalcations.

Cl6ment's misappropriations. The liability of the auditors was put as coterminous with the liability of Cl6ment himself to the company.

In the view I take of the case it is unnecessary to determine the question whether or not under Quebec law the so-called subrogation receipt is sufficient to entitle the appellant in its own name to maintain this action against the auditors.

I turn now to the consideration of the nature and extent of the duty of the auditors to the company. It was admitted that they had merely been appointed by resolution of the company "to be the auditors of the company," without any special terms or conditions by by-law or agreement, and that the definition of their duty was to be found entirely within the language of sec. 120 of the Dominion Companies Act, 1934, ch. 33, which reads as follows:

the state of the company's affairs according to the best of their informa- G tion and the explanations given to them, and as shown by the books of the company.

(2) Every auditor of a company shall have a right of access at all times to all records, documents, books, accounts and vouchers of the F. W. 8AR company, and shall be entitled to require from the directors and officers the company such information and explanation as may be necessary for the performance of the duties of auditor.

(3) The auditors of a company shall be entitled to attend any meeting of shareholders of the company at which any accounts which have been examined or reported on by them are to be laid before the shareholders for the purpose of making any statement or explanation they desire with respect to the accounts.

The respondents were engaged then to make what is called a statutory audit for the company and their duties were those and only those imposed by the statute. A distinction was very properly made in the argument between a statutory audit and a special investigation that may be undertaken by auditors under terms of a special contract. The language of the statutory duty here is substantially the same as the language in the Companies Act, 1879, which was under consideration in In re London and General Bank (2) (1).

In that case Lindley L.J. said at p. 683:

An auditor, however, is not bound to do more than exercise reasonable care and skill in making inquiries and investigations. He is not an insurer; he does not guarantee that the books do correctly shew the true position of the company's affairs; he does not even guarantee that his balance-sheet is accurate according to the books of the company. If he did he would be responsible for error on his part, even if he were himself deceived without any want of reasonable care on his part, say, for the fraudulent concealment of a book from him. His obligation is not so onerous as this. Such I take to be the duty of the auditor: he must be honest-i.e., he must not certify what he does not believe to be true, and he must take reasonable care and skill before he believes that what he certifies is true. What is reasonable care in any particular case must depend upon the circumstances of that case. Where there is nothing to excite suspicion very little inquiry will be reasonably sufficient, and in practice I believe business men select a few cases at haphazard, see that they are right, and assume that others like them are correct also. Where suspicion is aroused more care is obviously necessary; but, still, an auditor is not bound to exercise more than reasonable care and skill, even in a case of suspicion, and he is perfectly justified in acting on the opinion of an expert where special knowledge is required.

Lopes L.J., who concurred in the judgment of Lindley L.J., said in another case that came up the following year, In re Kingston Cotton Mill Company (2) (2):

(2) [1896] 2 Ch. 279, at 288, 289. (1) [ 1895] 2 Ch. 673.

But in determining whether any misfeasance or breach of duty has been committed, it is essential to consider what the duties of an auditor Go are. They are very fully described in In re London and General Bank to which judgment I was a party. Shortly they may be stated thus: It is the duty of an auditor to bring to bear on the work he has to perform that skill, care, and caution which a reasonably competent, careful, and F. W. cautious auditor would use. What is reasonable skill, care, and caution OTERS. must depend on the particular circumstances of each case. An auditor is not bound to be a detective, or, as was said, to approach his work Davis J. with suspicion or with a foregone conclusion that there is something wrong. He is a watch-dog, but not a bloodhound.

He is justified in believing tried servants of the company in whom confidence is placed by the company. He is entitled to assume that they are honest, and to rely upon their representations, provided he takes reasonable care. If there is anything calculated to excite suspicion he should probe it to the bottom; but in the absence of anything of that kind he is only bound to be reasonably cautious and careful.

Lord Alverstone C.J., in summing up to a special jury in a case in the King's Bench Division on June 1st, 1904, said (London Oil Storage Company Limited v. Seear, Hasluck and Co. reported in Dicksee on Auditing, 11th ed., p. 783, at pp. 785 and 786):

I will not adopt any fanciful expression which may be quoted from any particular judgment, but he (the auditor) has got to bring to bear upon those duties reasonable and watchful care, he has got to discharge those duties remembering that the company look to him to protect their interests. He is not, however, supposed to be a man constantly going about suspecting other people of doing wrong, and that is the only respect in which, I think, Mr. Bankes in his most able speech pressed the matter a little too high.

While Mr. Hasluck has by the exercise of due and reasonable care to see that all the officials of the company are doing their duty properly in so far as the accounts are concerned, he is not bound to assume when he comes to do his duty that he is dealing with fraudulent and dishonest people; and there comes in the most important consideration from one point of view-perhaps more important than the other, though I do not think of such substantial weight in this matterif circumstances of suspicion arise, it is the duty of the auditor, in so far as those circumstances relate to the financial position of the company, to probe them to the bottom.

And further on at p. 787:

Mr. Isaacs is quite right in saying to you, as I have already indicated, that the auditor is not bound to assume that people are dishonest. On the contrary, he is entitled to think that they are honest.

Lord Alverstone later on said, p. 787:

* * * I think the best concluding direction I can give to you for which I am responsible is, that he must exercise such reasonable care as would satisfy a man that the accounts are genuine, assuming that there is nothing to arouse his suspicion of honesty, and if he does that 'he fulfills his duty; if his suspicion is aroused, his duty is to "probe the thing to the bottom," and tell the directors of it, and get what information he can. (1) [18951 2 Ch. 673.

In re City Equitable Fire Insurance Company Limited affords an exhaustive discussion, by Romer J. (as he IURAN"

then was) and on appeal by Pollock M.R., Warrington L.J., and Sargant L.J., of the duties of auditors. The F. W. report of the case extends to 125 pages.

I shall quote only one passage from the judgment of Pollock M.R., at Davis J.

p. 509:

What is the standard of duty which is to be applied to the auditors? That is to be found, and is sufficiently stated, I think, in In re Kingston Cotton Mill Co. (No. 2) (2).

As I have already said it is quite easy to have discovered something which, if you had discovered it, would have saved us and many others from many sorrows."

But it 'has been well said that an auditor is not bound to be a detective or -to approach his work with suspicion or with a foregone conclusion that there is something wrong. " He is a watchdog, but not a bloodhound." That metaphor was used by Lopes LJ., in In re Kingston Cotton Mill Co. (No. 2) (2). Perhaps, casting metaphor aside, the position is more happily expressed in the phrase used by my brother Sargant LJ., who said that the duty of an auditor is verification and not detection. The Kingston Cotton Mill case (2) is important, because expansion is given to those rather epigrammatic phrases. Lindley LJ. says: "It is not sufficient to say that the frauds must have been detected if the entries in the books had been put together in a way which never occurred to anyone before suspicion was aroused. The question is whether, no suspicion of anything wrong being entertained, there was a want of reasonable care on the part of the auditors in relying on the returns made by a competent and trusted expert relating to matters on which information from such a person was essential." The judgment of Lopes LJ., as well as that of Kay L.J., may be looked at in support of the words of Lindley L.J., and also in support of what I have called the epigrammatic way of putting the auditors' duty. The legal standard of duty of auditors (to adopt a phrase of Lindley L.J.), in the absence as here of any special by-law or stipulation of the terms of employment, is plainly defined in the decisions to which I have referred, and applying the principles of those decisions to the particular facts of this case I am unable to hold that there was any such neglect or default on the part of the auditors as would entitle the company, were it the plaintiff, to succeed in the action. The question is whether before the discovery of the thefts, in the then existing state of experience, failure of knowledge or foresight is to be imputed to the auditors for a breach of duty. Conduct pursued in the light of experience derived from the present knowledge of the system of defalcations can hardly be taken as a sufficient basis for a charge of want of care. There was nothing to indicate that the accounting methods and con- (2) [1896] 2 Ch. 279.

trol of the company were so lax and inadequate that reliance could not properly be placed upon the books.

But assuming that there was some breach of duty on the part of the auditors to the company, there would be two answers, I should think: firstly, a claim based on such a breach of duty may not be covered by the subrogation document in favour of the appellant; and, secondly, assuming it were covered by the subrogation, what is the measure of damages for such a breach of duty? The auditors did not steal the money; they were not the direct cause of the loss.

As Lord Alverstone told the jury in the London

Oil Storage Company case above mentioned (Dicksee on

Auditing, 11th ed., at p. 797):

The loss of the plaintiff amounted to £760; the jury awarded five guineas against the auditors.

Canadian Woodmen of the World v. Hooper et al. (1), was a somewhat recent Ontario case.

The auditors were held liable for breach of their duties to the plaintiff corporation.

The trial judge, Raney J., awarded the corporation the full amount of its loss, $8,840.32, against the auditors as well as against an official of the corporation, but after the case had been twice before the Ontario Court of Appeal (1) the protracted litigation ended, so far as the auditors were concerned, with a judgment against them of only $1 as nominal damages.

I do not pursue the difficult question of the measure of damages because, in my view of the case, it is unnecessary to do so. Nor do

I find it necessary to consider the question of prescription raised by the respondents.

I would dismiss the appeal with costs.

Appeal dismissed with costs.