Auditor negligence requires reasonable care plus causally proved loss; hindsight and weak red flags do not establish liability.

An auditor must exercise reasonable skill and care, but is not required to begin with suspicion or act as a detective. On the facts presented, selective verification, confirmation of debts, and scrutiny of documents were treated as proper audit methods, and the alleged warning signs were not enough to put the auditors on inquiry. The plaintiffs also failed to prove that any breach caused recoverable loss: alleged damage to reputation, goodwill, business, and tax-related loss was not shown to flow from the audit, and the tax settlement was unconnected to the auditors' conduct. The commentary therefore states that liability depends on both negligent breach and causally proved loss.

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Issues: (i) Whether the auditors failed to exercise reasonable care and skill in the conduct of the audit and were negligent in not detecting the manipulation of the company's accounts; (ii) Whether the plaintiffs proved that any such negligence caused recoverable damages.

Issue (i): Whether the auditors failed to exercise reasonable care and skill in the conduct of the audit and were negligent in not detecting the manipulation of the company's accounts.

Analysis: The Court held that an auditor is required to exercise reasonable skill and care, but is not bound to begin with suspicion or to act as a detective. Where the company had an apparently effective internal control system, a long-standing audit relationship, and no circumstances then available that would reasonably have excited suspicion, the use of selective verification and in-depth checking on representative transactions was a recognised and proper audit method. The alleged red flags, including the public issue, increased sales in the last quarter, and higher gross profit ratio, were not treated as sufficient to put the auditors on inquiry on the facts as they then stood. The Court also found that the challenged audit procedures, including selection of invoices, confirmation of debts, and scrutiny of documents, did not establish a failure to apply accepted auditing standards.

Conclusion: The issue was answered against the plaintiffs. The auditors were not held negligent.

Issue (ii): Whether the plaintiffs proved that any such negligence caused recoverable damages.

Analysis: The Court held that the plaintiffs failed to prove actual damage flowing from any breach by the auditors. The evidence was insufficient to establish loss of reputation, goodwill, or business dislocation, and the claims for tax-related loss were not shown to be causally attributable to the alleged negligence. The settlement with the tax authorities was found to have been entered into for reasons unconnected with the auditors' conduct. In the absence of proof of breach and causal loss, damages could not be awarded.

Conclusion: The issue was answered against the plaintiffs. No recoverable damages were proved.

Final Conclusion: The suit failed because the plaintiffs did not establish either actionable negligence on the part of the auditors or a legally recoverable loss arising from the audit.

Ratio Decidendi: An auditor is liable only for failure to exercise the reasonable care and skill of a competent auditor on the facts then available, and negligence is not established by hindsight or by circumstances that would not reasonably have excited suspicion; damages must also be proved as causally flowing from the breach.

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