15 April 2015

Supreme Court rules in favour of chairman of the board and auditors 

The almost 12-year old claim for damages concerning Memory Card Technology has finally ended. The long-term proceedings before the Supreme Court concerned auditors' and directors' liability, and it is especially interesting that the court ruled in favour of the auditors even though errors had been made.

The proceedings concerned the question whether Memory Card Technology's former chairman of the board, the executive officer and two audit firms were liable in damages to the bankruptcy estate which claimed that the company's operation continued after it should have been suspended or adjusted. 

In 1997, Memory Card Technology was listed on the Copenhagen Stock Exchange as a high-risk company. The company's strategy was to build up major stocks as the executive board expected a price increase on the products and, over time, the company was to be listed on NASDAQ in New York at the beginning of 2000. 

Due to the so-called dot.com bubble in 2000, the NASDAQ listing did not result in the expected capital injection, the prices of the most important raw materials dropped 1/4 and the dollar rate increased substantially resulting in bankruptcy proceedings being commenced against the company in 2001 with a total loss of approx. DKK 500 million. 

THE HIGH COURT ORDERED THE EXECUTIVE OFFICER AND THE AUDITORS TO PAY DAMAGES OF DKK 100 MILLION, BUT RULED IN FAVOUR OF THE BOARD OF DIRECTORS

 The Western High Court found that the two audit firms and the former executive officer were jointly and severally liable in damages ordering them to pay damages of DKK 100 million to the bankruptcy estate. 

The High Court attached importance to the fact that the audit firms had acted in a way giving rise to liability by not making an independent valuation of the stocks' value. It later turned out that this value had been manipulated fraudulently, and the executive officer had fiddled the turnover stating fictive receivables. Notwithstanding this, the auditors approved the financial statements which, according to the court, resulted in the banks lending money to the company which was subsequently lost in the bankruptcy proceedings. 

The High Court also found that there was no basis for directors' liability referring to the board's composition, rules of procedure, organisation and the information provided to the board by way of audit reports. 

The auditors' and the chairman's liability was appealed against to the Supreme Court.

DESPITE ERRORS, THE CHAIRMAN HAD NOT ACTED IN A WAY GIVING RISE TO LIABILITY

The Supreme Court ruled in favour of the chairman as the court found that the chairman had fulfilled his obligations. 

The Supreme Court did emphasise, however, that the chairman had failed to pass the CFO's criticism of the financial statement on to the other board members and the auditors, but the nature of this one-time error could not result in liability in damages. 

AUDITORS HAD ACTED IN A WAY GIVING RISE TO LIABILITY, BUT THE SUPREME COURT RULED IN FAVOUR OF THE AUDITORS DUE TO A LACK OF CONNECTION BETWEEN LIABILITY AND LOSS

The Supreme Court agreed with the High Court that the auditors had acted in a way giving rise to liability as they should have made reservations as to the valuation of the stock and made write downs and provisions in relation to receivables. 

Notwithstanding the above, the Supreme Court found that it had not been substantiated that this in itself would have led to the board suspending the company's operation. The Supreme Court also found that it had not been substantiated that the banks would not have provided loans to the company if the auditors had not made any errors. 

Consequently, the bankruptcy estate had not met the burden of proving that there was a causal connection between the errors giving rise to liability and the loss. The Supreme Court therefore ruled in favour of the audit firms. 

COMMENTS

The result concerning directors' and auditors' liability will always depend on a specific assessment of the factual circumstances and whether the conditions for damages have been fulfilled. This was also the situation in this case, which seems to be very specifically reasoned.

As regards the auditors' liability, the ruling confirms the general condition that a causal connection must exist between the action giving rise to liability and the loss and, in this case, the court found that there was no causal connection. It cannot be ruled out that the result of this ruling is a strengthening of the requirements for proof of a causal connection in questions concerning auditors' liability compared to previous case law, but it is difficult to assess in the light of the very specific reason.

As regards the chairman's liability, it is interesting that the Supreme Court finds that the chairman had not acted in a way giving rise to liability even though he had committed a one-time error. The meaning of the comment on one-time error may be discussed, but it can obviously not be cited in support of liability being imposed for errors in general if the error is merely a one-time offence.

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