LM Investment Management Limited (in liq) v EY (also known as Ernst & Young) & Ors

In this significant case, Jackson J was asked to grant leave to the defendants to commence proceedings by way of third party notice against a company in liquidation. After establishing the relevant principles, his Honour addressed several claims against the third party to determine whether there was a serious question to be tried. Most notable among these are whether the defendants could seek compensation under s 1325 of the Corporations Act 2001 (Cth) for breach of s 601FC(1) of that Act, and whether a claim for breach of fiduciary duty can fall within s 6(c) of the Law Reform Act 1995.

Jackson J

4 October 2019

LM Investment Management Ltd (“LMIM”) was the responsible entity for several registered managed investment schemes, materially including the LM First Mortgage Income Fund (“FMIF”). [2]. It went into liquidation. [2]. LMIM as trustee for the FMIF engaged the first defendant, EY, to audit the compliance plan of the FMIF in, materially, the financial years ending 30 June 2008 through to the year ending 30 June 2012. [3]–[4]. The plaintiff is currently suing EY for damages or compensation for breaches of EY’s obligations as auditors in the relevant years. [4]. On 1 March 2019, EY filed a third party notice against, inter alia, LMIM in its own right. [7]. As LMIM is in liquidation, EY required leave of the court to join LMIM in its own right as a third party; the question before Jackson J was whether such leave should be granted. [8]. Although there were some procedural irregularities in terms of filing a third party notice rather than a counterclaim, they were disregarded for present purposes. [12].

Jackson J started by noting that “a person applying for leave must show some reason to depart from the ordinary procedure of lodgment of a proof of debt and must establish that its claim raises a serious question to be tried”. [16]. Further, in his Honour’s view, there were two immediate consequences of the third party notice being issued to LMIM in its own right: first, it should be represented by its liquidators in defending that claim; and secondly, LMIM in its own right is “hopelessly insolvent”. [25]. His Honour noted that the second of these consequences, where there is no indication of relevant insurance by LMIM, “is a powerful discretionary factor against granting leave”. [25]. His Honour then turned to each of the claims made by EY against LMIM in its own right to determine if there is a sufficiently good reason for leave to be granted.

The first claim was for breaches by LMIM of s 601FC(1) and consequently for compensation under s 1325 Corporations Act 2001 (Cth). [28]. Section 1325(5) empowers the court to make orders directing a person who engaged in conduct in contravention of Ch 5C to pay the amount of loss or damage caused by that contravention to the person who suffered it. [29]. The plaintiff submitted that such an order could not be made “because s 1325 does not authorise an order for indemnity or contribution against the liability of a person under another provision of the” Corporations Act. [30]. In support of this proposition, it cited Selig v Wealthsure Pty Ltd (2013) 94 ACSR 308, a Federal Court case which EY sought to distinguish. [30], [32]. On this point, Jackson J noted that contrary to EY’s submission, the reference in s 1325 to orders that “will compensate” refers to the purpose of the orders, not to their form. [36]. Ultimately, “the distinction” EY sought “to make between the order refused in Selig and the present case is not one of substance”. [37]. Jackson J considered that, while not binding, Selig – at least on this point – should be followed. [37]–[39]. His Honour was not satisfied that Selig was wrong on this point for the following reasons:

(1)  Section 1325(1) “must be read as subject to the operation of other provisions in the Act, even though it is not expressly provided that it is so subject.” [43].

(2) The legislative history of s 1325 supports the proposition that it is analogous to s 87 of the Trade Practices Act 1974 (Cth), which was interpreted as not conferring “a right of indemnity or contribution by one contravenor against another.” [46].

(3) It is hard to reconcile the provisions which restrict the persons who may apply for compensation orders in this case to ASIC or LMIM with the availability of compensatory orders being made to EY under s 1325. [47]–[49].

Accordingly, EY’s claim for compensation under s 1325 did not give rise to a serious question to be tried.

Next, EY alleged that, if it was liable for breach of equitable duties owed to the plaintiff, LMIM was likewise liable for breach of its duties as trustee, and that the “‘losses’ … are common and coordinate and [EY is] entitled to ‘equitable compensation’ from LMIM in respect of any amounts which they may be ordered to pay to the plaintiff”. [52]. However, as these duties were not owed to EY, it had no right to equitable compensation for breach of them. [53]. As against this, EY argued that the liabilities “are coordinate liabilities”. [55]. However, Jackson J disagreed, and equitable contribution was not available between them. [55].

EY’s next claim was that, by reason of LMIM’s breach of its equitable duties, it and EY “are both ‘tortfeasors’ liable to the plaintiff in respect of the same damage within the meaning of s 6(c) of the Law Reform Act 1995”. [56]. For the purposes of this argument, EY were the first tortfeasor. [61]. The question, therefore, was whether “LMIM was a tortfeasor in respect of its alleged breaches of the equitable duties”. [61]. Following “formidable authority”, Jackson J held that it was not. [62]. In Pilmer v Duke Group Ltd (in liq) (2001) 207 CLR 165, [86], the High Court noted that contributory negligence would not operate to “diminish awards of equitable compensation for breach of fiduciary duty”. [63]. It followed that LMIM was not a tortfeasor within the meaning of s 6(c). [65].

EY subsequently raised claims relating to an implied term as to reasonable representations, a duty of care in tort to the defendants, misleading or deceptive conduct, unpaid audit fees and set off, none of which were held to give rise to a serious question to be tried. [76], [85], [93], [96], [101].

In the event, Jackson J dismissed the application for leave to proceed and struck out the third party statement of claim in its entirety, although his Honour granted leave to the defendants to re-plead against the individual third parties. [102]–[103].

M Paterson