Court File and Parties

COURT FILE NO.: 15-CV-533238 Motion heard: May 16, 2017 SUPERIOR COURT OF JUSTICE - ONTARIO

RE: TRANSPHARM CANADA INC., Plaintiff AND MS PARTNERS LLP, Defendant

BEFORE: Master Lou Ann M. Pope

COUNSEL: Counsel for plaintiff: Ted R. Laan Fax: 416-361-0248 Counsel for defendant: Michael E. Girard Fax: 416-913-1886

Reasons for Endorsement

[1] The plaintiff’s motion is for an order that the defendant serve a further and better affidavit of documents, which shall include working papers for audits prepared by the defendant auditor respecting a number of audit engagements that the plaintiff retained the defendant to perform. However, since learning that the defendant had destroyed its working paper file for the plaintiff, the plaintiff seeks an order that the defendant produce for inspection its computer hard drive to allow the plaintiff to determine whether all relevant documents have been produced by the defendant.

Background

[2] The plaintiff carries on business as the Toronto Institute of Pharmaceutical Technology, which is a registered private career college licenced by the Ontario Ministry of Training, Colleges and Universities (“Ministry”).

[3] The defendant is a firm of chartered accountants which was retained to perform a number of audits as required by the Ministry under the provisions of the Private Career Colleges Act, 2005, S.O. 2005, c. 28, Sched L.

[4] The president and directing mind of the plaintiff is Alexander MacGregor (“MacGregor”). McGregor is also the principal of ORx Pharmaceutical Corporation (“ORx”), a corporation incorporated pursuant to the laws of Canada and carries on business in Toronto and elsewhere as an advanced drug delivery speciality pharmaceutical company. ORx is wholly owned by the plaintiff. Although not a party to this action, ORx’s involvement in the facts giving rise to this action are important to understand.

[5] In October 2012, the plaintiff retained the defendant to perform certain auditing services in accordance with the requirements of the Private Career Colleges Act, 2005. The said services included an audit of the financial statements of the plaintiff for the fiscal year ending August 31, 2012 (“2012 financial statements”).

[6] The plaintiff required the audit for several reasons; namely, as a condition of the plaintiff’s renewal of registration under the Private Careers College Act, 2005; a requirement of the Ministry to determine the appropriate level of consumer protection for fee-paying students; a condition of the plaintiff to refinance its debt; and a condition of the plaintiff receiving its scientific research and experimental development tax incentive/refund (“SR&ED”), the proceeds of which were to be applied against operating loans of the plaintiff.

[7] The parties signed engagement letters and in January 2013, the defendant delivered the audited financial statements.

[8] In addition, in January 2013, ORx retained the defendant to issue Notice to Reader financial statements which were compiled by management of ORx.

[9] On February 11, 2013, McGregor provided the ORx financial statements to TD Commercial Banking for the purposes of securing financing. The ORx financial statements that MacGregor gave to the bank were on the defendant’s letterhead, attached an outdated Notice to Reader and purported to be signed by the defendant. The following day, the bank contacted the defendant to enquire about the ORx financial statements and the defendant advised that it had not prepared the financial statements. The bank provided the defendant with copies of the financial statements that MacGregor had provided. Upon review of the financial statements, it was the defendant’s position that someone at ORx created the financial statements and fraudulently affixed the defendant’s letterhead, Notice to Reader and signature and sent them to the bank for the purpose of obtaining financing.

[10] Following discussions with MacGregor and cautioning him against the practice, the defendant issued a new Notice to Reader as approved by the Institute of Chartered Professional Accountants of Ontario (“Institute”).

[11] Thereafter, the defendant contacted the Institute to determine its options. The Institute advised the defendant that where the accountant lost trust in the client, the engagement could be terminated.

[12] Therefore, on or about February 19, 2013, the defendant pleads that it advised MacGregor by telephone that it was recalling the plaintiff’s audit and ORx’s Notice to Reader financial statements due to its loss of trust in management. There is conflicting evidence on this point. The plaintiff pleads that on February 19, 2013, the defendant emailed the plaintiff advising that it was withdrawing its services to only ORx in the future. The plaintiff pleads that the defendant did not withdraw from future financial services to the plaintiff.

[13] In fact, some seven months later on September 12, 2013, the plaintiff advised the defendant by letter that it had retained new auditors for the 2013 fiscal year and requested that the defendant transfer its files and all associated working papers to the new auditors. The defendants responded stating that the 2012 audited financial statements were recalled as the defendant had lost trust in the client. In addition, the defendant advised that the working papers are the property of the defendant.

[14] The successor auditor completed its engagement of the audit of the plaintiff’s 2012 financial statements which it confirmed without changes.

[15] The plaintiff claims that it was unable to refinance its debt obligations, it was unable to access the SR&ED incentive refund, and was in temporary breach of its obligations respecting registration with the Private Careers College Act, 2005. Ultimately, the plaintiff was able to receive its SR&ED incentive refund and was able to achieve a renewal of its registration with the Private Careers College Act, 2005.

The Pleadings

[16] The plaintiff seeks general damages in the amount of $200,000 for negligence, breach of contract and breach of fiduciary duty and punitive damages of $250,000 for breach of fiduciary duty.

[17] The primary bases for the plaintiff’s claims are that the defendant breached its fiduciary duties to the plaintiff and it was in contravention of Canadian auditing standards, the details of which are as follows:

(a) the defendant had no right to withdraw or recall the plaintiff’s audited financial statements; (b) the defendant breached its duty to investigate the risk of misrepresentation and fraud in preparing the audited financial statements; (c) the defendant discovered no misrepresentation or fraud; (d) the defendant breached its duty to discuss any suspicions of misrepresentation or fraud with MacGregor and the plaintiff on a timely basis; (e) the defendant failed to re-examine its audit.

[18] In paragraph 13 of the statement of defence, the defendant pleads that it relied on MacGregor’s representations in coming to their audit opinion. It is further pled that as a result of ORx’s fraudulent financial statements that MacGregor provided to the bank, the defendant lost trust in MacGregor and it could no longer rely on management’s integrity and could not support the audit opinion “which rested in part on management representations and relied on management’s integrity.”

[19] The defendant relies on a term of the engagement letter signed by the parties which provides that as part of the audit process, the defendant will request from management written confirmation concerning representations made to the defendant in connection with the audit. In addition, the defendant relies on another term of the engagement letter which states that the working papers, files, other materials, reports and work created, developed or performed by the defendant during the course of the engagement are the property of the defendant and will be retained by the defendant in accordance with the defendant’s policies and procedures. The defendant’s policies and procedures are not before this court, nor are they in issue on this motion.

[20] Lastly, the defendant alleges that MacGregor fraudulently forged the defendant’s letterhead, signature, and Notice to Reader report when submitting the financial statements of ORx to the bank. As a result, the defendant pleads that it lost trust in MacGregor and felt that it could no longer rely on management’s integrity and could not support their audit opinion, thus it recalled the plaintiff’s audit and the ORx Notice to Reader financial statements.

Defendant’s Evidence

[21] Nick Miseros (“Miseros”) was examined for discovery on behalf of the defendant and cross-examined on his affidavit of documents on November 3, 2016. Miseros is a chartered accountant and a partner of the defendant. On November 29, 2016, Miseros corrected portions of his discovery evidence with respect to the defendant’s working paper file for the plaintiff’s audit.

[22] In addition, Miseros swore an affidavit on May 11, 2017 which was filed on this motion.

[23] Miseros’ evidence is that he shredded the working paper file for the plaintiff’s audit in April or May 2013 after the defendant learned from the bank that MacGregor allegedly forged the signature of the defendant on the Notice to Reader report and financial statements of ORx and after the defendant recalled the plaintiff’s audit opinion. The working paper file was contained in a binder in hard copy only.

[24] Although not filed in evidence on this motion, it is not disputed that the defendant has produced voluminous documents, mainly emails, which are included in Schedule A to its affidavit of documents. The main issue is the working paper file that Miseros states he shredded.

[25] It is Miseros’ examination evidence that there would have been documents related to his working paper file on the hard drive before they were deleted.

[26] Miseros also stated on examination that he might have further handwritten documents or notes that were not shredded and were scanned onto the hard drive. He stated that the “odd time” he would scan his handwritten notes onto the hard drive. Some of those handwritten notes may have been relevant to the plaintiff’s audit and as part of the working paper file. Further, he stated that some or all of his handwritten notes relating to discussions with management would have been input on the hard drive if they were relevant to the audit and if he felt it needed to be in the working paper file. (Transcript, page 28, Question 147-151, 157)

[27] Miseros corrected his answer to question 137 where he stated that he shredded the planning checklist and deleted them from the hard drive as they were word documents. His corrected answer is that he would email Dina, MacGegor’s assistant, word documents from the PEM checklist, provided on CD from the Institute. If he did not receive the word document response from Dina, Miseros would then print the word documents from the CD and handwrite his responses on the document and place it in the hard copy working paper file. Those documents were not scanned and there are no deleted checklists in electronic form. He stated that “all other checklists” that he used were handwritten and not typed.

[28] In correcting his answer to question 146 where he stated that the “odd time” he might have scanned his handwritten notes onto the hard drive, he states that he reviewed his emails and found no emails attaching scanned notes. However, he goes on to state that “If notes had been scanned, it would only be for the purpose of sending them to Dina.”

Positions of the Parties

[29] The plaintiff’s position is that it is entitled to inspect the defendant’s hard drive as its request is not a fishing expedition, there is specific evidence of non-disclosure and destruction of material documents, there is real likelihood that documents which were not produced by the defendant exist or may have once existed on the firm’s computers, and these documents are relevant to the issues in this action.

[30] The defendant submits that he has reviewed his computer hard drive and confirmed that he does not have any other documents relating to the plaintiff that have not already been produced and that all relevant documents have been produced.

[31] In addition, the defendant filed case law that sets out the requirements and principles of professional scepticism governing all audits in Canada including the resignation of auditors. (Barrington v. The Institute of Chartered Accountants of Ontario; Power and Russo v. The Institute of Chartered Accountants of Ontario, 2010 ONSC 338 (Div. Ct.), at paras. 170-178, (overturned on appeal on different issues); Livent Inc. v. Deloitte & Touche, 2016 ONCA 11, at para. 206-213, 224)

[32] The requirements and principles are derived from the CICA Handbook and they involve dual roles, firstly the importance of the good faith of management and, secondly, the professional scepticism of the auditor. The auditor’s role is to perform the audit with an “attitude of professional scepticism, and seeks high, though not absolute assurance, referred to as reasonable assurance whether the financial statements are free of material misstatement. The auditor may encounter circumstances which make him or her suspect that the financial statements are materially misstated. In that event, the auditor should perform procedures to confirm or dispel that suspicion. Conversely, the assumption of management’s good faith is a fundamental auditing postulate. This assumption means, in the absence of evidence to the contrary, the auditor can accept accounting records and documentation as genuine and representations as complete and truthful. (Barrington and Power and Russo, at para. 172)

Law

[33] Rule 30.06 of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194 (“Rules”), provides that if the court is satisfied “by any evidence” that a relevant document in a party’s possession, control or power may have been omitted from the party’s affidavit of documents, the court may order the disclosure or production for inspection of the document.

[34] Rule 1.03 defines “document” as including “data and information in electronic form”. The definition of “document” is further defined in Rule 30.01(1)(a) to include “data and information recorded or stored by means of any device.”

[35] Section 31.9 of the Canada Evidence Act, R.S.C., 1985, c. C.5, defines an “electronic document or record” as “data that is recorded or stored on any medium in or by a computer system or other similar device, that can be read or perceived by a person or a computer system or other similar device.”

[36] The courts have accepted that these definitions include documents stored on a computer’s hard drive. (Warman v. National Post Co., 2010 ONSC 3670, at para. 90)

[37] When considering disclosure requests and standards for disclosure, the court should balance a variety of factors including the rule of proportionality which is now enshrined in rule 29.2.03. It provides:

29.2.03(1) In making a determination as to whether a party or other person must answer a question or produce a document, the court shall consider whether,

(a) the time required for the party or other person to answer the question or produce the document would be unreasonable; (b) the expense associated with answering the question or producing the document would be unjustified; (c) requiring the party or other person to answer the question or produce the document would cause him or her undue prejudice; (d) requiring the party or other person to answer the question or produce the document would unduly interfere with the orderly progress of the action; and (e) the information or the document is readily available to the party requesting it from another source.

[38] Subrule 29.2.03(2) provides that a court must also consider whether such an order would result in an excessive volume of documents required to be produced by the party or other person.

[39] In Warman at paragraph 92, Master Short referred to Master Dash’s decision in Nicolardi v. Daley [2002] O.J. No. 595, where Master Dash held with respect to the evidentiary requirement under rule 30.06 that it is not sufficient for a client to say that he believes there are more documents or it appears that documents are being hidden. If that were the situation, Master Dash found that evidence would be no more than a fishing expedition. Rather, he held that there must be specific evidence of non-disclosure.

Conclusion

[40] There is no allegation that the defendant intentionally destroyed its working paper file after this action was commenced. Miseros’ evidence is that he shredded the file in April or May 2013 shortly after the defendant withdrew its audit opinion to the plaintiff. This action was not commenced until July 27, 2015, more than two years later.

[41] It is the defendant’s evidence that the working papers consist of the planning checklist, the risk checklists, supports for balance sheet items, analytics, completeness document checklists, discussion with management and internal controls. (Transcript, Question 64, page 13).

[42] Regarding the documents that comprised the working paper file, it is my view that the documents in that file would very likely have been relevant to the issues in this action. In particular, any documents relating to representations made by the plaintiff with respect to the financial statements would be relevant given that both parties’ pleadings raise the issue of representations and misrepresentations by management in the process of giving the audit opinion. Further, the plaintiff pleads that the defendant breached several of its duties to the plaintiff including breach of fiduciary duty in failing to investigate the risk of misrepresentation and fraud in preparing the audited financial statements. Furthermore, the defendant pleads that it relied on MacGregor’s representations in coming to its audit opinion.

[43] Miseros admitted on examination that some of the shredded documents are printouts of documents from the Caseware program and that the Caseware documents could still be on the computer. (Transcript, Questions 133-134) In addition, Miseros testified that he could have scanned in his handwritten notes on the hard drive and that if the plaintiff had access to the hard drive, that would be determined. (Transcript, Questions 140, 143, 146, 151)

[44] However, in correcting some of his answers given on examination, Miseros stated in his affidavit sworn May 11, 2017 that any responses that he handwrote on a checklist was placed in the working paper file and not scanned. He stated further that there are no deleted checklists in electronic form and all other checklists that he used were handwritten and not typed. He stated further that there are no handwritten notes that were scanned in this file because he reviewed his emails to Dina and there were no emails attaching scanned notes.

[45] His corrected evidence is also that following the examination, he reviewed his computer hard drive and confirmed that he did not have any other documents relating to the plaintiff that had not already been produced.

[46] In comparing Miseros’ examination evidence with his corrected answers, it is clear in my view that he has changed his evidence with respect to what documents may have been saved on the hard drive. His evidence changed from “could still be on the computer” and “he could have scanned in his handwritten notes on the hard drive” to any handwritten notes on a checklist were placed in the working paper file and not scanned, there are no deleted checklists in electronic form, and there are no handwritten notes that were scanned in this file.

[47] To be clear, Miseros is not to be criticized for correcting his answers as he is entitled and required to do under the Rules; however, in my view the nature of his answers and corrected answers and the relevancy of the answers to the issues in this action give rise to some question as to the accuracy of his evidence.

[48] I think the facts in this action give rise to some suspicion as to the reason why the defendant shredded its working paper file and its evidence that there are no relevant documents saved electronically other than those produced which are primarily in the form of email communications. I come to that conclusion considering several facts; namely, the defendant’s position that it recalled the plaintiff’s audit because it had lost all trust in MacGregor, the defendant recalled the audit sometime after it was issued which, it is reasonable to conclude, was not a commonplace occurrence, and where the defendant destroyed its working paper file in the face of accusations or, at a minimum, suggestions that MacGregor had forged the signature of the defendant and falsely placed the defendant’s letterhead and Notice to Reader on its financial statements and provided it to its bank for financing purposes. Simply put, the defendant’s actions of destroying its working paper file in the face of its allegations of fraud against MacGreogor is unusual and suspicious.

[49] I am required to consider also the principle of proportionality under rule 29.1.03.

[50] There is no evidence regarding the cost of retaining a data recovery expert to examine the defendant’s hard drive. The plaintiff states that it will bear the cost; however, the defendant states that the plaintiff will undoubtedly seek to recover those costs in the future if successful at trial. This may very well be the case; however, I must deal with the issues at hand, not speculate on what may happen in the future.

[51] Further, there is no evidence that if the motion is granted it will cause delay in this action. In my view, it is reasonable to take judicial notice of the fact that there are plenty of experts in the field of forensic technology who can be retained and perform an inspection within a relatively short period of time.

[52] However, the defendant raises an issue regarding concerns over confidential documents on its hard drive for its clients such as financial, tax and accounting information. The defendant states that disclosure of this information would be highly prejudicial to its clients and notice ought to be provided to those persons who will be affected by a production order.

[53] There is a low threshold under rule 30.06 where the plaintiff is required to show “any evidence” that a relevant document in a party’s possession, control or power may have been omitted from the party’s affidavit of documents.

[54] I am satisfied based on the unusual facts of this case where the defendant destroyed likely relevant evidence in the face of serious allegations of fraud against the plaintiff’s representative, withdrawing an audit after it was issued, and the inconsistent evidence of the defendant that it justifies allowing the plaintiff to inspect the defendant’s hard drive to determine whether all relevant documents have been produced by the defendant. Further, it is important to remember this this action is at the discovery stage where the parties are entitled to know all of the relevant evidence in order to fairly and properly put forth its best case. It is common at this discovery stage for a party to discover evidence that ultimately is not relevant to the issues and not offered as evidence at trial. The point is that considering the facts and the evidence herein and the issues of relevancy and proportionality, it is most important that the plaintiff know with certainty that it has all the relevant evidence in order for it to put its best case forth to the trier of fact.

[55] Further, I am satisfied on the evidence that in granting the order, the time required to do so will not be unreasonable, the expense of retaining an expert is reasonable and the defendant’s hard drive is readily available. The defendant’s evidence is that it has not changed its hard drive since it represented the plaintiff in 2012 and 2013.

[56] I concur with the terms of Master Short’s order in Warman, at paragraphs 161 to 163; namely, the inspection should be restricted to very limited areas on the hard drive where documents relating to the defendant’s retainer with the plaintiff are located, be made on a mirror image of the defendant’s hard drive, and be made by an independent mutually acceptable expert. Further, the cost of the expert shall be borne by the plaintiff with the ultimate responsibility for that expense being in the discretion of the trial judge. Additionally, the expert shall execute a mutually agreed-upon form of nondisclosure agreement with respect to any information obtained by the expert concerning this case. Lastly, the expert shall execute an Acknowledgment of Experts Duty to the court in Form 53.

[57] I expect that the parties will be able to reach an agreement on an appropriate expert to perform the forensic inspection. I will not set a timeline to have the inspection completed; however, if the parties cannot agree on an expert within 30 days, then within 14 days thereafter, they may submit to me the names of up to two proposed experts, their resumes and quotations of fees to perform the inspection and I will determine the expert to be used.

Disposition

[58] The plaintiff’s motion is hereby granted and the defendant shall disclose and produce for inspection its hard drive in order for the plaintiff to obtain copies of any and all documents relating to the audit engagements that the plaintiff retained the defendant to perform as set out in paragraph 2 of the notice of motion.

[59] The plaintiff’s motion for a further and better affidavit of documents from the defendant is dismissed which may be brought at a later date if the results of the hard drive inspection reveals further relevant documents.

Costs of this Motion

[60] The plaintiff shall be entitled to its costs of this motion which shall be fixed in the amount of $4,300, inclusive, payable within 30 days.

May 18, 2017 _ (original signed) _ Master Lou Ann M. Pope