Auditor's Legal Liability: Case Studies of Centro and Esanda Cases

This report examines the legal liability of auditors through the lens of two significant case studies: Centro Properties Group (2011-12) and Esanda Finance Corporation Limited (1997). The analysis delves into the case law history of each, detailing the accusations, legal proceedings, and court decisio...Read More

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Legal Liability of Auditors-Case Laws
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Legal Liability of Auditor
Just like any other professional, the auditors have the legal liability in relation to both
civil and criminal obligations. There are various elements upon which the common law liability
originates from and this includes, fraud, breach of contract and negligence. In the past and
currently, there have been a variety of rising concerns on the legal liability of auditors and this
has been due to the fact that auditors are vital in regards to improving the reliability of financial
statements. The absence of competent and independent auditors often results in numerous fraud
cases. According to the professional code of conduct, it is expected of the auditors to exercise
their duties with due care and diligence and this implies being a prudent person. There are a
variety of sources of legal liability of auditors and this includes, a government which could be a
result of fraud often referred to as the gross negligence. The other source is a client which could
be due to a violation of the contract. Lastly, there is a third party as a source which is often as a
result of negligence.
(1) Centro Properties Group (2011-12)
The Centro Properties Group is one of the leading real estate firms located in the United
States of America. It mainly focuses on the management and ownership of neighborhood
shopping centers and the community. Its headquarter is located in New York with a number of
offices all over the US (Murphy & McGrath, 2016). It is estimated that the company runs a
portfolio of about 580 properties which is found in 39 states.
Case Law History
The directors of Centro Properties Group were being accused of having breached their
duties and this was in relation to the approval of the financial statements for 2006-2007. The
financial statement for that year failed to indicate that the company had been required to pay for

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debts amounting to billions of dollars. Additionally, the company was being accused by the
Australian Security and Investment Commission for not complying with the accounting
standards and corporations act (O’Donnell, Hicks, Streeter & Shantapriyan, 2015).
Also, in their argument, the ASIC said that the accounts of the company were not
classified correctly and this was on the basis that the borrowings were classified as non-current
liabilities instead of being classified as current. Further, the board of the firm failed to ensure that
the CFO and CEO gave a declaration of compliance as expected by section 295A (Westermann,
Niblock & Kortt, 2017). Another accusation leveled against the company by the Australian
Securities and Investment Commission on Centro was that there are certain guarantees as part of
the transaction in the 2007 financial year and this was considered as a material post balance date
event thus should have been displayed in the annual reports.
On the basis of misclassification of current liabilities as non-current, the arguments by the
company were dismissed by the court on reasons such as accounting standards meaning of non-
current liability as being straightforward. Also, the level of complexity of documentation was
considered irrelevant and this was because the borrowings were expected to mature in short term
which was known by the directors of the company.
Current Situation
Based on the fact that the company was found guilty of non-compliance with the
accounting standards, currently, the company has employed certain competent and reliable
auditors who have in the past been adhering to the various accounting standards (Dimovski &
O’Neill, 2015). Most of the company’s auditors exercise their core duties with care and due
diligence to avoid a repeat of the same situation which had been witnessed earlier in the 2006-
2007 financial year.

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Implications for Client/Public/Auditor
Based on the case of Centro, there were legal proceedings leveled against the directors
and this typically resulted in an increased understanding of the duties of directors and those of
the auditors in relation to approval, audit, and preparation of financial reports (Brown & Davis,
2015). It also led to the sacking of some of the auditors of the company due to failure to comply
with the accounting standards. The case also had an implication of the attitudes of the clients on
the company such that they all developed a negative attitude towards the company leading to a
loss of clients.
(2) Esanda (1997) 15 ACLC 483
History of Case Law
According to Barnett & Harder (2014), the case was between Peat Marwick Hungerfords
and Esanda Finance Corporation Limited and it was in relation to the liability of auditors to the
third parties. A decision on the case was made in 1997. In the case, the Esanda Finance
Corporation company had given out a certain sum of money to another corporation and this was
in regards to a report which had been made by a certain particular company. However, Peat
Hungerford had failed to pay the money it had borrowed from the company. The company,
therefore, claimed that the auditors had acted based on the reliance of audited accounts and
therefore they were expected to recover that amount of money (Robertson & Tilbury, 2016).
Such an action was considered as a violation of the accounting standards in regards to the
preparation of financial accounts. The Esanda Finance Corporation Limited, therefore, suffered a
loss based on the failure of paying the amount of money they had loaned out and this was due to

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the fact that the auditors had not relied on the Excel's audited accounts. Such accounts had been
prepared on the basis of a violation of the accounting standards.
Current Situation
A ruling was made against the company and this was on the basis that Esanda Finance
Corporation had failed to prove that Peats had owed it the duty of care so as to audit the financial
accounts with due care and skill. Also, it was found out that the information which had been
provided not resulted in an economic loss by the company and hence there was no need to
compensate it for the loss since they had not relied on it while preparing the financial accounts
(McKendrick & Liu, 2015). Based on that, Esanda was forced to compensate Peat for the time
and resources he had wasted for the court proceedings. Currently, the Esanda Finance
Corporation has recruited certain competent auditors who have been seen to be performing their
duties with due diligence and care. Such auditors offer advice and information in relation to
financial decisions and other decisions relating to auditing of accounts which are considered
reliable since it will be relied upon by the other third parties such as investors and clients of the
company (Bridge, 2015). Also, currently the company complies with the existing accounting
standards to help guide it during the auditing process by the auditors both external and internal.
Implications for Client/Public/Auditor
The main implication of the case on the auditors was that auditors had failed to conduct
their duties with due care and diligence to the third parties and therefore they were sacked. In

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relation to the third parties, the implication of the case was that any particular individual who is
tasked with the provision of information which could be relied upon by the third party should
one entail a disclaimer which has to be in effect that such an information will be relied upon to
use the information (Ahmadu & Hughes, 2017). Also, an individual who offers advice cannot be
considered as liable for being negligent of any particular misstatement to a third party. However
when the third party understands the information provided a particular person is considered to be
liable for the negligence of a misstatement to a third party.
Conclusion
In summary, the auditors have the responsibility in the company to carry out their duties
with due care and dillgence.Such a responsibility will help in preventing some of issues related
to misstatement of financial reports and also cases of fraud as was displayed in some of the case
laws discussed in the paper. There are also certain implications on the client, auditor and the
public which arises due to the carelessness of the particular auditor such as lack of public
confidence and also sacking of the auditors.

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References
Ahmadu, M. L., & Hughes, R. (2017). Commercial Law and Practice in the South Pacific.
Routledge-Cavendish.
Barnett, K., & Harder, S. (2014). Remedies in Australian private law. Cambridge University
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Bridge, M. G. (2015). Principles of English Commercial Law. Oxford University Press, USA.
Brown, C. A., & Davis, K. T. (2015). The sub-prime crisis down under.
Dimovski, B., & O’Neill, L. (2015). Sustainability, A-REITs and the global financial
crisis. Pacific Rim Property Research Journal, 21(1), 51-59.
McKendrick, E., & Liu, Q. (2015). Contract Law: Australian Edition. Macmillan International
Higher Education.
Murphy, D., & McGrath, D. (2016). Australian class actions as a potential motivator for
environmental, social and governance (ESG) reporting.
O’Donnell, K., Hicks, B., Streeter, J., & Shantapriyan, P. (2015). Getting it right: directors’
assessment of information. Managerial Auditing Journal, 30(2), 117-131.
Robertson, A., & Tilbury, M. (Eds.). (2016). The Common Law of Obligations: Divergence and
Unity. Bloomsbury Publishing.
Westermann, S., Niblock, S. J., & Kortt, M. (2017). Does it pay to be responsible? An empirical
investigation of corporate social responsibility and REITs in Australia.