VI. ADVANTAGES AND DISADVANTAGES OF JOINT AND SEVERAL LIABILITY

VI. ADVANTAGES AND DISADVANTAGES OF JOINT AND SEVERAL LIABILITY2017-03-03T18:33:23+00:00

In the broad framework of the policy factors above, this part of the report presents the arguments for reform to proportionate liability and statutory caps on damages, as well as the arguments for maintaining the status quo.

 

A.   Reform to Proportionate Liability and Legislative Caps

 

Many arguments are made for reform away from joint and several liability to some variant of proportionate liability and/or statutory caps. Submissions supporting reform of Ontario’s joint and several liability system came primarily from the audit and engineering professions. Seven key arguments are set out below.

 

1.                 Fairness

 

Stakeholders, particularly from the audit industry, argue it is unfair to make defendants liable for one hundred percent of a plaintiff’s loss.

 

Just as proponents of joint and several liability frame their arguments around fairness, supporters of liability reform likewise stress the inherent unfairness of the joint and several liability system with respect to the defendant. It is argued that it is unfair for a defendant, whose degree of fault is minor when compared to that of other defendants, to have to fully compensate a plaintiff should the other defendants be insolvent or unavailable. The ICAO stressed that auditors should only be liable for what they actually did or did not do:

 

The audit profession accepts that it should be responsible for its fair share of a loss to the extent it is responsible for the loss. However, we are strongly of the view that it should only be responsible for what it did or did not do, rather than for the acts or omissions of others. In the context of joint and several liability, the burden of satisfying judgments and settlements falls on those who can pay. The profession is not and should not be seen as the guarantor of issuers whose financial statements it audits, or of other parties who are unable or unavailable to pay their share of the losses.[75]

 

In theory, the less blameworthy defendants can recover contribution from the more blameworthy defendants; however, in practice the former, particularly where they are insured professionals, are left to bear the majority share of liability when other defendants are insolvent or unavailable.

 

Fairness arguments formed the bulk of concerns expressed in one submission,[76] were explicitly identified as one of the advantages of a proportionate liability system by the ICAO,[77] and remain prevalent in the background of several others.[78]

 

A proportionate liability regime would ensure that defendants are not liable for more than their individual share of the fault, as determined during court proceedings. Stakeholders argue that this is inherently more fair to defendants, particularly specific groups of professionals who regularly only play a small role in the proceedings but, for reasons such as the availability of insurance or the non-availability of other co-defendants, are liable for more than their “fair share” of the damages.

 

2.                 Deep Pocket Syndrome

 

A second argument for reform away from the current regime concerns strategic litigation. Proponents of proportionate liability contend that joint and several liability encourages plaintiffs to unfairly target defendants who are known or perceived to be insured or solvent. These “deep pocket” defendants may be able to fully compensate a plaintiff – far beyond that which is owed by them– in the event of a co-defendant’s insolvency.

 

For example, the accounting industry argues that, because auditors are known to be insured, plaintiffs seek them out as defendants. The same can be said for lawyers and other professionals. Given that plaintiffs decide when, where and whom to sue, it is argued that plaintiffs will sue persons they believe afford the best opportunity for recovery.

 

This unfair targeting was identified as a particular problem in submissions by Richard Hardingham and the Association of Municipalities of Ontario (AMO). Mr. Hardingham notes that fraud committed by a CFO or CEO may be very difficult to detect and even beyond an auditor’s means of control, thus it would be unfair for the auditor to face increased liability and the potential for 100% payment.[79] Moreover, this risk puts increased pressure on “deep pocket” defendants such as auditors, other professionals or municipalities to avoid protracted, expensive litigation by settling for amounts that may be excessive. The ICAO suggests that auditors are uniquely situated: compared to other professions, whose work product passes directly to another party, auditors’ works are widely disseminated among numerous parties, increasing their exposure to liability.[80]

 

It is argued that proportionate liability would prevent these well-placed defendants from being unfairly targeted for undue compensation by aggrieved plaintiffs.

 

3.                 Rising Costs of Litigation, Insurance and Damage Awards

 

Opponents of the joint and several liability regime are concerned about the rising costs of litigation, insurance and damage awards.

 

The current system involves two sets of proceedings: one to determine the liability for the loss and one to establish the measure of contribution among co-defendants. The argument is that with proportionate liability, both issues would be settled in one trial, potentially saving time and money.

 

The ICAO recently conducted a survey of just over 1,700 small to mid-sized firms and sole practitioners. Among the findings, 73% of respondents stated that they have faced a moderate to significant increase in liability insurance costs over the last five years, while 64% of respondents said they are being deterred from taking on assurance engagements. Fifty-eight percent said that the liability crisis is creating difficulty for clients to access assurance services.[81]

 

The ICAO makes the argument that “[t]he current system of joint and several liability makes audit firms in Canada today the de facto insurers of our capital markets.”[82] The ICAO estimates that the number of suits claiming damages of over $100 million filed in the last 10 years in Canada is 12 and that the estimated number of those suits claiming damages of over $1 billion is 3.[83] The ICAO expresses the concern that lawsuits in such large quantums “[have] the potential to do serious damage to the audit industry or to cause the failure of an audit firm.”[84]

 

The ICAO also indicates that the dollar value of “incurred claims” against five of the biggest six audit firms in Canada increased from $190.96 million, as at December 1995, to $673.11 million as at December 2005. Incurred claims are not the total of damages sought but instead reflect the amounts firms must set aside in anticipation of prospective case settlements, plus amounts paid up to that point and related defence costs. They also highlight that the trend line for the dollar value of amounts actually paid by those audit firms was even “more ominous”: the amounts paid out increased from $12.65 million as at December 1995 to $298.67 million as at December 2005.[85]

 

The argument is that these rising litigation costs are making it more difficult for audit firms to access insurance. Moreover, the difficulty in quantifying expected loss makes some insurance companies unwilling to engage with auditing firms. Proportionate liability would introduce a solution:

 

Bringing this problem under control through proportionate liability will see insurance companies re-enter the market, which would enable them to ‘price’ that risk and create a source of recovery for shareholders.[86]

 

The ICAO argues that while all firms carry insurance, none is able to insure against the sort of “catastrophic exposure which can arise from joint and several liability.”[87] A further submission on behalf of the ICAO and the large accounting firms states that “in the past twenty five years, no insurance market has developed to provide the large audit firms with catastrophic loss insurance for professional liability”. The result is that “each of the large global accounting firm networks has had to form a captive insurer” to create self-insurance “with layers of reinsurance at certain upper levels when available and supplied at commercially reasonable rates”. Consequently, it is “virtually certain” that an audit firm facing catastrophic loss that required reinsurance “would no longer have access to the reinsurance markets….”.[88]    

 

4.                 Competitiveness

 

Opponents of joint and several liability often point to the system’s alleged negative effects on Canadian competitiveness.

 

Mr. Hardingham posits that by introducing some form of a proportionate system, the costs of liability insurance would decrease and more insurers would enter the market due to a reduced risk of catastrophic damage claims against audit firms, making Ontario a more attractive market for auditors and accountants.[89]

 

The ICAO also notes that Canada must remain competitive with other jurisdictions, particularly the jurisdictions in the United States that have abandoned joint and several liability.[90]

 

5.                 Provision of Services

 

Supporters of liability reform frequently argue that joint and several liability is responsible for reducing the amount of talent entering and remaining within the professions. This is due to the exposure to liability created by joint and several liability that discourages entry into the profession or subsequent retention.  Data are presented to support these fears. For example, in 2001 there were 400 public company audit firms in Canada. In 2008, that number had been reduced to 230.[91] While this argument is generally made in relation to the audit profession, the Ontario Society of Professional Engineers fears that the burden of indeterminate liability is squeezing engineering firms out of the marketplace.[92] The argument is that a move to proportionate liability would increase the supply of talent by reducing risk and attracting young professionals.

 

Concerned about the effects of this loss on the public, the ICAO argues that:

 

Firms, both large and small, are being driven out of the audit and assurance services market because of skyrocketing insurance costs and exposure to disproportionate liability. Access to vital audit and assurance services for enterprises of all sizes is becoming more expensive or unavailable, and as a result, companies cannot access investment capital needed to grow and create jobs.[93]

 

Thus the reduction in the number of auditing professionals does not just harm the auditing industry, but prevents companies from accessing professional audit services. Moreover, joint and several liability actively inhibits the quality of auditing services provided to members of the public:

 

We do not believe that joint and several liability enhances audit quality. On the contrary, we believe that it, in fact, inhibits audit quality. In this regard, the public interest is best served by a competitive environment of high-calibre professionals as auditors, combined with a willingness of audit firms to audit Ontario corporations. Joint and several liability works against the needs of capital markets to the detriment of the public at large.[94]

 

Similarly, the deterrence effects presumed to be inherently higher in a system of joint and several liability do nothing to heighten the quality of work performed by auditors. Auditing professionals are already in a highly regulated industry, and further deterrence is unnecessary.[95]

 

The AMO identifies another negative externality of joint and several liability: municipalities are having to delay or otherwise cut back services to limit exposure to liability.[96]

 

6.                 Statutory Caps on Liability

 

A statutory cap on liability is frequently advocated together with proportionate liability because proportionate liability on its own does not protect against catastrophic loss: “[a]fter all, when faced with a multi-billion dollar lawsuit, a 20 per cent liability apportionment will still be more than enough to destroy an audit firm.”[97]

 

It is argued that a cap would limit exposure to risk, increasing certainty for insurers to predict their potential exposure, reduce costs for professionals and clients, and alleviate some concerns about presumed unfairness inherent in joint and several liability.[98]

 

The ICAO would prefer to see a statutory cap based on a formula, but has in the interim suggested a cap of $75 million, similar to that in Australia.[99]

 

7.                 Contractual Limitations on Liability

 

The ICAO argued that contractual limitations are not as effective as statutory caps because a) third parties to the contract will still be able to sue in tort, and b) many jurisdictions, such as the U.S. Securities and Exchange Commission, consider non-statutory contractual limitations an interference of auditor independence.[100]

 

B.   Maintaining the Status Quo: Joint and Several Liability

 

There are seven key rationales and arguments for maintaining the joint and several liability scheme, as discussed below.

 

1.                 Fairness and Compensation

 

The first argument in favour of maintaining joint and several liability is that it is the most fair.  Interestingly, the concept of fairness forms the central argument for proponents as well as opponents of the joint and several liability regime. Proponents of maintaining the joint and several liability regime argue that if two or more persons are the cause of a financial or economic loss suffered by another, it is fair that they should be liable for the full extent of those consequences.

 

In other words, it would be unfair to shift to the plaintiff the risk of a co-defendant’s inability to pay damages. That risk ought to be borne by the other defendant(s) because they have caused the financial or economic loss. Conversely, it would not be fair to require a plaintiff to seek individual recovery from each defendant in a lawsuit based on the proportion of which the court determined they were at fault. In the words of William Sasso:

 

[Full compensation to injured persons] is a goal that the OLRC regarded as just. Abolition of the rule would mean that injured persons, including those who are completely innocent, would remain undercompensated for their losses. In the view of the OLRC, and in our view, the burden of justifying change clearly lies with those who propose reforms that would give rise to such a result.[101]

 

It should be noted that some submissions were further concerned with the “fairness” debate in and of itself, and whether it is a truly appropriate policy measure in this context. One submission noted that discussions of fairness “to” a plaintiff or defendant in their respective capacities as opposing parties are unhelpful, and one must look to the fairness of the system as a whole.[102]

 

2.                 Common Law Protections

 

The second argument for maintaining the joint and several liability regime is that the common law has sufficient safeguards that prevent defendants from being exposed to enormous and undue liability. Common law principles of tort law, particularly as expressed in Hercules, [103] ensure that plaintiffs must prove that each defendant owed him or her a duty of care, which in turn will require determinations of proximity and foreseeability. Even if a prima facie duty of care is established, policy considerations protecting the interests of defendants may convince a court to refuse a finding of liability against any particular co-defendant. Thus, supporters of joint and several liability argue that the common law protects defendants:

 

[Professionals]…are not responsible for a plaintiff’s losses unless there is the triumvirate of foreseeability, proximity and no persuasive public policy reason to negate the duty of care. This triple layer of protection…provides all the protection needed to avoid inequitable or undue exposure to liability. There is no need to turn to the complex and difficult to understand provisions in the CBCA.[104]

 

A further argument recognizes that this common law test is an onerous challenge for the plaintiff to meet. As a result, there are some concerns that since the duty of care analysis post-Hercules already limits a party’s liability, further statutory reforms limiting liability will place defendants in an unfairly advantageous position relative to a plaintiff.[105] If changes are made to the liability system, changes should also be made to the common law in order to keep the system fair and balanced for both plaintiffs and defendants. Otherwise, having to meet both an onerous standard and facing the potential of incomplete recovery, the system would be “stacked” against the plaintiff. This argument is not strictly against reform towards proportionate liability, but recognizes that earlier reforms of liability systems, particularly under the OSA, involved a balancing of benefits received by both plaintiffs as well as defendants.

 

 

 

3.                 Deterrence and Risk

 

The third argument in favour of joint and several liability is that it acts as a deterrent for misconduct by professionals. Knowing that they will be held fully accountable, the argument is that professional advisors are more likely to implement measures to avoid liability. 

 

It has been suggested that replacing joint and several liability with a proportionate liability regime might adversely affect the risk management behaviour of potential defendants. If defendants are only liable for a known portion of a total damages award, the future incentive to develop, adhere to and improve professional standards may decline. The submission of the bcIMC in particular argues that proportionate liability is less effective for purposes of accountability and corporate governance (and thus, deterrence of wrongdoing) than the joint and several liability alternative.[106]

 

Similarly, caps on liability create greater certainty for firms and professionals. This certainty allows parties to incorporate maximum potential liability into their business plan. Thus, by ensuring perfect information, caps potentially eliminate risk from future liability, and as a result professionals have less incentive to develop and maintain the highest professional standards.

 

4.                 Simplicity

 

The fourth argument in favour of joint and several liability is its simplicity. Proponents of joint and several liability argue that it is less complex than an alternate system of proportionate liability or a capped hybrid system of liability. Under joint and several liability, a plaintiff can pursue a legal action without worrying about how to apportion fault at the trial stage. Full compensation is ensured and the legal arguments may focus purely on establishing liability for each co-defendant. Apportionment of fault is an ex-post-facto exercise performed in order for co-defendants to compensate each other, if necessary.

 

The argument is that a proportionate liability system would introduce unnecessary complexity into Ontario’s legal system. Lawsuits would be lengthened and made more complex as plaintiffs would search to add more parties than may be necessary to serve their goal of obtaining full recovery.[107]

 

5.                 Lack of Evidence

 

The fifth argument in favour of the joint and several liability scheme is the lack of empirical evidence or data indicating that a change in this context would be beneficial overall. Several submissions highlighted this issue. The “lack of evidence” argument can further be divided into three groups: i) rising insurance costs, ii) potentially catastrophic damage awards, and iii) effects on the profession.

 

The first concern relating to lack of evidence is about rising insurance premiums and insurance coverage. Arguments have been presented that rising insurance costs are having deleterious effects on professionals, clients and markets in general; in some cases businesses are not undergoing audits due to the underlying costs.[108] The most extreme form of this argument is that of an “insurance crisis”: a situation in which, because of the disproportionate costs for auditors, insurance is not available in sufficient amounts.

 

As several submissions pointed out, no substantial evidence has been presented demonstrating these effects.[109] While the ICAO mentions surveys of auditors that allegedly demonstrate the effects, such anecdotal studies may not be persuasive evidence demonstrating a clear need for reform:

           

[T]he lack of data supporting a claim must be very concerning to anyone seeking to implement a new protocol or procedure. Anecdotal evidence is inherently unreliable, and, unfortunately, contaminated with bias because it can only ever truly relate to the small picture, rather than the big picture.[110]

 

The second concern is about the rising costs of damage awards and/or settlements. These arguments can be ones of steadily increasing costs, or simply of the potential for “catastrophic loss” as a result of joint and several liability. A related claim is that a party 1% at fault can be found liable for 100% of the plaintiff’s damages.

 

Available data fail to support these claims (for example, that a party found 1% at fault has been held liable for 100% of damages) or to substantiate that joint and several liability is primarily responsible for increasing costs or instances of patently unfair damage awards.

 

Siskinds LLP’s submission noted that one particular case of empirical evidence being presented by the accounting profession (reproduced in part above) did not, in fact, point to “catastrophic loss”, and no evidence was forwarded to explain how any losses were potentially inflated as a result of joint and several liability.[111] Moreover, it is unclear what numbers in the data pertained to auditors in particular. The ICAO itself concedes that it “does not have a figure for the total amount of damages claimed in all actions that include auditors, as this kind of information is not always made public.”[112]

 

The OBA’s submission points out that auditors pointed to an “insurance crisis” emerging from the principles in Hedley Byrne, long before the decision in Hercules that shifted the debate to joint and several liability.[113]

 

The OBA also shows that statistics showing a decline in the number of accounting firms in Ontario do not seem to take into account factors such as the recent economic slump or the effects of notable accounting scandals.[114] The OTLA notes:

 

No one has pointed to a single case, reported, settled or otherwise, where an accountant or auditor, who is 1% responsible for a loss, ended up paying 100% of the claim or anything even close to 100% of the claim…Such a scenario, in the words of commentator David Debenham, is ‘an urban legend.’[115]

 

The third concern relates to arguments about the current liability system discouraging young individuals from entering the accounting profession, the pricing of audit services and the impact of the liability scheme on competitiveness.

 

These claims take on two general forms: (i) massive increased personal risk under joint and several liability deters individuals either from entering or continuing their chosen profession, and (ii) joint and several liability has deterrent effects on the national and international markets, as a result of which Ontario-based firms suffer a distinct competitive disadvantage relative to other Canadian or international jurisdictions.[116]

 

Submissions from parties such as the OBA noted the absence of empirical evidence that auditing firms are locating elsewhere, that domestic businesses are not undergoing audits due to their costs or that insurance premiums are skyrocketing.

 

It is alleged that this phenomenon is the result, in some measure, because of unrestricted joint & several liability. There was no evidence to support this statement. Even if the statement is true, there was no evidence that the move out of audit functions by mid and small accounting firms was due to unrestricted joint & several liability, as opposed to other factors such as the post September 2008 economic slump or changes in the audit/accounting world after the Enron/Arthur Anderson fiasco.[117]

 

Referencing David Debenham, the OTLA adds:

 

[T]here is no empirical evidence to support these arguments – firstly, in that the cost of audit engagements has been decreasing, not increasing, as a result of computerization and increased competitiveness of the audit market. Secondly, he observes that there is no evidence that the cost of malpractice insurance is being passed on to clients.[118]

 

6.                 Competitiveness and Comparisons with Other Jurisdictions

 

Several of the submissions note the inappropriateness of comparing the current joint and several liability provisions of the OBCA to foreign jurisdictions, particularly the US, which have instituted proportionate liability schemes. As several stakeholders have noted, there are fundamental differences between many jurisdictions that have instituted proportionate liability and the Canadian experience. US jurisdictions that have implemented proportionate liability schemes have opted for stricter liability rules and increased government regulation of auditors to counterbalance the move from a joint and several scheme.

 

Several characteristics of the American litigation model point to a more suitable climate for a proportionate liability system. As the OTLA argues, there are at least five differences between the Canadian and American litigation models that highlight some of the reasons why proportionate liability systems are more amenable to American jurisdictions. First, punitive damages tend to be much higher in the US relative to Canada. Second, costs sanctions are part of the law of Canada but not the US in the vast majority of cases involving auditors. Third, in the US, unsuccessful plaintiffs often incur no costs as opposed to Canada. Fourth, the current regulatory environment is less aggressive towards auditors in Canada than in the US. Fifth, class action law suits against auditors are far less common in Canada. These differences, far from an exhaustive list, suggest that the implementation of joint and several liability in Ontario could have consequences significantly different from those experienced in the United States.[119]

 

7.                 Statutory Caps are Inappropriate

 

Despite their potential benefits for certainty, the argument is that caps would diminish deterrence effect; reduce incentive to settle; be unfair to plaintiffs and also to defendants who might remain liable for their full amount, if under the cap; introduce more bureaucracy to frequently monitor and review the caps; and would be arbitrary.[120] In sum, statutorily capped liability reform would address the problems caused by exposure to catastrophic loss, but would not necessarily be fair.  The residual unfairness was particularly highlighted in Wayne Gray’s submission.[121] Liability caps are not truly a way of increasing certainty, as supporters of reform contend, but a way of limiting legal liability. Certainty could also be achieved by an extremely high statutorily fixed damage amount, one that would be applied in all contexts whether actual damages are higher or lower, yet insurance would remain expensive and limited.[122]

 

 

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