Question

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. EcoPak’s 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 EcoPak’s 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 EcoPak’s 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&Q’s audit and could have been avoided if the audit had been done properly. After a thorough discussion, EcoPak’s 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?

Answer 1

1. the dictionary gives meaning to the term due diligence as the investigation done before purchasing another company in order to a avoid harmful effects. so here Ecopack assigned G&Q audits to investigate and to give due diligence to avoid harmful effect in future. Here we can treat the relationship of Ecpark with G&Q as an investigation assigner and investigator. Investigators have to be truthful on the investigation and he has to follow the code of conduct ore ethics in his investigation as per the law prevailing in the country and of course of the professional to which he is associated.
2. As I said in above paragraph the relationship between Ecopark with G&Q as an investigation assigner and investigator.Investigators have to be truthful on the investigation and he has to follow the code of conduct ore ethics in his investigation as per the law prevailing in the country and of course the professional to which he is associated. As an auditor G&Q is not allowed to act as an agent of Waterfalls for sale of its subsidiary because he performing an investigation against the waterfalls for another company. It is a breach of ethics.even there is material fact that waterfalls having a cleanup liability the auditor given a qualifying report which is not ethical. So Ecopark can sue against the auditor.
3. The auditor can defend only saying that he made audit based the on material fact presented to him or up to the material facts known to him So he can defend the suit by saying waterfalls does not provide material information and mislead him. According to facts and documents provided to him, the financial statement provided a fair value.