Case 4

EcoPak Inc.

The time has come for EcoPak to expand its main factory onto the adjacent land that was contaminated by the operations of its prior owner, Waterfalls Inc. EcoPaks current use of the land was permitted to be continued from the previous owners without additional environmental remediation. However, if EcoPak wants to expand onto the adjacent land, it will be required to do extensive remediation work to comply with environmental laws. Development approvals will require complete restoration of the land by removal and replacement of all the contaminated soil before any new construction can be started.

Mike and Kam had obtained audited financial statements as part of their due diligence before purchasing the property, and the audited financial statements said nothing about the problem even though Waterfalls was aware of it.

EcoPak has engaged Rachel Roy, a lawyer who specializes in environmental law, to advise on this matter. Rachel advises EcoPaks board that it may have a claim against Waterfalls and the auditors of the financial statements they had relied on. Rachel outlines the following case EcoPak could make against Waterfalls auditor, G&Q.

G&Q had a legal duty of care to Kam and Mike as prospective purchasers of the property, since Waterfalls had specifically engaged the auditor for the StyreneTech subsidiary to facilitate its sale to a new investor. There was a breach in that duty because the financial statements had omitted a material, known liability for site cleanup, so they did not comply with generally accepted accounting principles (GAAP) in this regard. Instead, G&Q provided an unmodified audit opinion stating that the financial statements were fairly presented in accordance with GAAP. Either their audit was deficient in not turning up this omitted liability, or they were negligent and complicit with the company in covering up the material information. In the latter case, they have associated themselves with misleading information, clearly a breach of their duty to users of the information as well as a violation of the standards of auditing and the rules of professional ethics.

EcoPak will easily be able to prove they suffered damage by showing the amount that must be spent on the site restoration to proceed with their planned expansion onto land they had purchased with the understanding it was suitable for any reasonable use their business would have for it in the future. The claim should be for the full amount of the cleanup plus EcoPaks legal costs of obtaining a fair remedy for Waterfalls wrong. EcoPak can also easily show a connection between the breach of duty and the resulting damage, as the losses occurred subsequent to G&Qs audit and could have been avoided if the audit had been done properly. After a thorough discussion, EcoPaks board votes in favour of pursuing the lawsuit against both Waterfalls and its auditor.

1- How would you consider EcoPak in its relationship with the auditor?

2- How would EcoPak support its case against the auditor? (What approves or support should EcoPak show against the auditor?

3- How the auditor will defend himself?