AIM-listed AssetCo had contracts to provide and maintain London and Lincolnshire’s fire engine equipment. It had to adjust its 2010 accounts to reflect a gap of more than £235m in its balance sheet, and the UK business was subsequently sold for just £2 in 2012 following a shareholder backlash over losses resulting from accounting irregularities. The company went on to secure refinancing and restructured to focus on operations in the United Arab Emirates (UAE) and elsewhere in the Middle East.

Grant Thornton acted as the company’s auditor for the financial years ended 31 March 2009 and 31 March 2010.

In 2017 the firm’s work was investigated by the Financial Reporting Council (FRC), which fined Grant Thornton £2.275m and gave retired partner Robert Napper a three-year ban and a £130,000 fine after it identified a range of ‘widespread and significant’ failings.

AssetCo then took Grant Thornton to court alleging the firm’s negligence meant that the financial problems and fraudulent reporting at the company were not identified when they should have been, meaning that AssetCo was denied the opportunity to take action earlier. [AssetCo plc and Grant Thornton UK LLP, 2019] EWHC 150].

The court examined Grant Thornton’s actions during the two audits in detail, with the judge saying the firm had shown ‘negligent conduct of the highest order (short of recklessness) amounting to flagrant breach of professional standards’.

The court was told it was common ground that in those years the senior management team at AssetCo behaved in a way that was fundamentally dishonest. During the audit process management made dishonest statements to Grant Thornton, providing the firm with fabricated and massaged evidence and dishonestly misstated reported profits, and flawed and dishonest forecasts and cash flow projections.

Outside of the audit process, management were engaged in dishonestly 'overfunding' assets (ie, misleading banks as to the costs of new purchases etc, so as to borrow more than was permitted), misappropriating monies, dishonestly under-reporting tax liabilities to HMRC, concluding fraudulent related party transactions and forging and backdating documents.

It was also common ground that at the dates of the 2009 and 2010 Audits, AssetCo's business was ostensibly sustainable only on the basis of the dishonest representations or unreasonable decisions made and taken by management.

In evidence to the court, Grant Thornton said it accepted it was negligent in a number of respects as the company's auditor in failing to detect these matters and in giving the company clean bills of health, and agreed that if it had acted competently, many if not all of the misrepresentations by AssetCo management would have been discovered.

Counterfactual

The bulk of the trial centred on AssetCo claims that if Grant Thornton had acted competently, a series of events would have been triggered with the result that the business of the company would have been revealed as ostensibly sustainable only on the basis of dishonest representations made, and/or the unreasonable positions taken by, management.  It argued that new management would have been brought in, and a substantively similar scheme of arrangement would have been agreed as was reached with AssetCo plc's creditors in 2011.

Moreover, AssetCo claimed it would have ceased incurring expenditure on its loss-making and unsustainable subsidiaries (which would have been revealed as such) and would have focused on the profitable elements of and opportunities for its business, as it has done since March 2011.

Instead, however, the executive directors were permitted to continue to operate the business in a dishonest and unsustainable way, and to incur expenditure in the failing aspects of the AssetCo Group's operations which would not otherwise have been made.

For its part Grant Thornton resisted AssetCo's claim. Although the firm admitted the majority of the alleged breaches of duty, it denied that any of the alleged breaches caused any loss or any recoverable loss to AssetCo.

AssetCo provided the court with a counterfactual, listing actions it would have taken and losses which would have been prevented if Grant Thornton had identified problems, giving the company the opportunity to reach agreement with its lenders and trade creditors and changing its business model.

The company put forward a claim for £31,461,807 in total for loss and damage. This sum included £1.5m paid under a fraudulent related party transaction; £1.65m paid by way of dividends in FY09 and FY10; £23.35m representing the sums expended by AssetCo plc in and/or on behalf of its subsidiaries increasing its loans to them from 31 March 2009 until 29 September 2011; and £15m of investments in the UK business which would otherwise have been ringfenced for the UAE.

Breaches of duty

The judge said: ‘As the breaches of duty were admitted it is easy to lose sight of just how serious those breaches of duty were.

‘They consisted of a catalogue of failures over two audit years that were of the utmost gravity and that went to the very heart of an auditor's duties and the “very thing” Grant Thornton admits it was responsible for but failed to do.’

He went on to state: ‘Those breaches of duty included a failure to exercise proper scepticism which would have led to the detection of dishonesty and prevention of fraud including representations and assumptions made by management during the course of the audit.

’These were the very matters that were allowing AssetCo to continue to trade in a dishonest manner.

‘In such circumstances I consider and find that (leaving aside dividends which are in a category of their own) Grant Thornton’s breaches were of very high relative causal potency in relation to the losses and they also bear the lion's share of relative blameworthiness.’

As a result, Grant Thornton is required to pay £23m in damages to AssetCo. 

A Grant Thornton UK LLP spokesperson said: ‘We are disappointed by today’s judgment on AssetCo plc’s claim and intend to appeal. The work in question was done around 10 years ago. We are working hard to deliver the highest quality standard of work that our clients expect and are continually evolving and improving what we do.’

AssetCo plc and Grant Thornton UK LLP, 2019] EWHC 150 is here.

Report by Pat Sweet