Court File and Parties

COURT FILE NO.: CV-17-220-00 DATE: March 27, 2019 SUPERIOR COURT OF JUSTICE - ONTARIO

RE: HYDROCLAVE SYSTEMS CORP., Plaintiff AND: STEPHEN GAMMON AND SECKER ROSS & PERRY LLP, Defendants

BEFORE: Justice Patrick Hurley

COUNSEL: Michael Pretsell, for the Plaintiff Simon Bieber, for the Defendants

HEARD: March 12, 2019

Endorsement

Nature of the Motion

[1] In late November 2014, the plaintiff learned that an employee had defrauded the company of a large sum of money. On July 4, 2017 it commenced this lawsuit against the defendants for professional negligence. The plaintiff alleges that the defendants, who were its outside accountants, should have detected the fraud at an earlier date.

[2] The defendants say that the limitation period began to run upon the plaintiff’s discovery of the fraud or, alternatively, by no later than June 2015. As a result, the limitation period expired in June 2017. The plaintiff’s position is that the limitation period did not commence until it had received advice from another accountant in January 2016 that the plaintiff had been negligent. Therefore, the action was started well before the expiry of the limitation period.

[3] Both sides agree that the limitation period defence can be determined by way of summary judgment.

The Facts

[4] The plaintiff is a small company based in Kingston which specializes in the treatment of medical and infectious waste. The owner, Richard Vanderwal, is an engineering technologist. In November 2014, the Royal Bank of Canada contacted the company about suspicious transactions on a credit card that had been reported to it by the credit card issuer. One of the plaintiff’s employees, Erica Estabrooks, who was its internal accounting manager, soon confessed to defrauding the company for several years. She did so by using credit cards for personal purchases and creating fictitious entries in the accounting records, disguising payments made to third parties as legitimate corporate transactions.

[5] Her fraudulent activity spanned the years 2010 – 2014. Over that same period of time, the defendants were responsible for preparing the plaintiff’s financial statements. The individual defendant, Stephen Gammon, had a close professional relationship with Mr. Vanderwal. The two spoke soon after Mr. Vanderwal learned of the fraud and Mr. Gammon described him as devastated by it.

[6] Mr. Vanderwal contacted the police who commenced an investigation in December 2014. Although the exact date is not identified in the record, it appears that Ms. Estabrooks was charged either that month or in early 2015. By the end of 2014, the plaintiff had determined that she had embezzled approximately $640,000.

[7] As the case progressed through the criminal court system in 2015, Mr. Vanderwal and Mr. Gammon met on several occasions to discuss the company’s accounting and legal situation. At one of these meetings, Mr. Gammon explained to Mr. Vanderwal that he and his firm were not responsible for failing to detect the fraud because they had been retained only to perform what is known in accounting parlance as a “review engagement”. This position was also stated in letters which accompanied the annual financial statements in 2010, 2012 and 2013.

[8] In an email dated April 20, 2015, Mr. Vanderwal wrote, in part, to Mr. Gammon, “Hi Steve, thanks for educating me on the levels of accounting. I wish I’d known that a few years ago…”. At his cross-examination, he testified:

“Q. Okay. Did you discuss with him the possibility of suing people other than Ms. Estabrooks? A. No. No. Q. Why not? A. Because at the time I felt that – and what – as – Steve Gammon explained to me, that, you know, the accounting firm, you know, was clean. It had – it – it could not have found fraud nor is it responsible for it and I believed it at the time.”

[9] They also discussed how the plaintiff might reduce the financial impact of the fraud. On February 23, 2015 Mr. Gammon emailed Mr. Vanderwal: “Have found a CRA tax ruling about losses from theft or embezzlement. You’re going to be able to fit into those criteria, but we can discuss further tomorrow. Don’t think we’ll need Doyle to do anything just yet”. Mr. Vanderwal replied the next day: “Good news!!”

[10] The person referred to as “Doyle” was David Doyle, a local corporate lawyer, who Mr. Vanderwal had spoken to about suing Ms. Estabrooks.

[11] Although Mr. Gammon had told him about the limited scope of a review engagement, Mr. Vanderwal had lingering concerns about the failure of the Royal Bank and the defendants to discover the fraud. Mr. Gammon knew that he did. In June 2015, when the defendants were completing the company’s financial statement for the year ending January 31, 2015, he wrote to Mr. Vanderwal about his firm’s estimated bill, stating: “Here’s what I’d suggest. You decide what is fair to bill. I’ve attached a copy of your 2014 bill as a reference point. I know you were disappointed with all your business service partners when the Erika [sic] situation was revealed – and we want a long ongoing relationship with Hydroclave – so, you decide what I can bill.”

[12] Mr. Vanderwal replied the next day, June 6:

“I’m going to give this considerable thought. Also the Erica debacle I have given a lot of thought.

First of all, I must admit Hydroclave did not have the appropriate safeguards in place that would have prevented it, and Erica presented herself over the years as a hard-working, company dedicated worker, and she had us all fooled. No – one, including Connie and Marijane and myself, never suspected anything.

Bear in mind we don’t have an MBA degree, we are not accountants and/or bankers, we are in engineering, product manufacturing, marketing and sales. We relied on our service business partners, the Royal Bank, and Secker, Ross & Perry, to help fill the gap, and give us advice.

But the gap wasn't filled. That allowed Erica to get away with it for five years, to a total of $650,000. We all should have picked up on irregularities, but the books were balanced (Erica knew how to manipulate the books) and her figures were taken at face value. I would have thought that a review engagement would pick up on something over the years. And the bank never noticed any odd transactions either.

It took an employee of Can. Tire Mastercard to notice the glaring transactions and get the ball rolling."

[13] Mr. Gammon replied the same day in a short email in which he did not respond to these imputations but thanked Mr. Vanderwal "for wanting to sort out the billing issue."

[14] They agreed on $3500 for the financial statement and $300 for Mr. Vanderwal’s personal tax return. This was a substantial reduction in the potential bill which had included the time spent by Mr. Gammon in dealing with the consequences of the fraud and advising Mr.Vanderwal about it. The financial statement was sent to the plaintiff on June 8 and a final account on June 30. In the financial statement, there is an entry for “loss from employee theft”; the amount is $189,728 for the year 2015

[15] The next month Ms. Estabrooks pleaded guilty to theft over $5000 in the Ontario Court of Justice. She was sentenced on September 8, 2015 to four years in jail and, rather than a restitution order, a fine in lieu of forfeiture was imposed for the full amount of the embezzled funds. In another example of the succor he offered him and the closeness of the relationship, Mr. Gammon accompanied Mr. Vanderwal to court when Ms. Estabrooks was sentenced.

[16] In January 2016, Mr. Vanderwal consulted another accounting firm, Ivimey and Hogeboom, who he then retained as the plaintiff’s outside accountants. He deposed that it was not until he consulted them that he became aware of the defendants’ negligent acts and omissions that form the basis of this lawsuit.

[17] Mr. Vanderwal advised Mr. Gammon that the plaintiff had retained this firm in February 2016, stating in an email dated February 3:

“We have retained Ivimy [sic] & Hogeboom, specifically Bob Hogeboom, to be our accountant and he has accepted the position.

Yes, we have worked together for a long time, and I enjoyed it, but serious problems cropped up which I’m still not comfortable with. I’m still losing sleep over it.

I like you as a person, family, kids, hard-working, and I’ll have lunch with you any time!”

[18] In his cross-examination, Mr. Gammon agreed that he and his firm remained the plaintiff’s accountants until their services were terminated in February 2016.

[19] The plaintiff commenced the lawsuit by issuing a notice of action on July 4, 2017. The statement of claim identifies the following wrongful acts and omissions on the part of the defendants:

(i) they failed to recognize the substantial increase in expenses in a certain line of the accounting records of the business which were unexplained by any change in the business practice; (ii) they failed to properly consider, or consider at all, the change in the profitability of the company when there are was no change in the business to account for that; (iii) the defendants and particularly Gammon failed to make any inquiries about fluctuations in gross profit; (iv) they failed to consider work in progress, final inventory and parts inventory in order to understand inventory as part of the review process; (v) they failed to gain an understanding of the processes in place in the accounting of the plaintiff in order to properly perform their review function; (vi) they failed to review the engagement letter and the terms of their engagement with the plaintiff, or in the alternative, adequately explain the review procedure with the plaintiff; (vii) they failed to properly review the books and records to determine why expenses had increased dramatically without any increase in revenue; (viii) they failed to make inquiries with respect to how purchases and payments are handled internally as well as failing to review all sales receipts and payroll; (ix) without limiting the generality of the foregoing, they failed to conduct the review transaction and their engagement with the plaintiff in accordance with the minimum standards as contained in the CPA handbook regarding the Canadian Standard on Reviewing Engagements (CSRE); (x) the decrease in gross profits on the review from 2012 to 2013 and from 2013 to 2014 should have alerted any competent accounting professional that further investigation was required in order to determine the cause of those fluctuations and had that occurred the frauds would have been discovered.

[20] The statement of defence denies that the defendants breached their contract with the plaintiff or were negligent but does not specifically respond to the particulars included in the statement of claim. It also repeats what Mr. Gammon had informed Mr. Vanderwal – that under a review engagement, it was the plaintiff, not the defendants, who was responsible for detecting an employee fraud.

The Law and Analysis

[21] As the parties have agreed that this is a suitable case for summary judgment, I will not review the general legal principles applicable to this type of motion.

[22] The plaintiff did not deliver a reply but it relies upon the principle of discoverability in responding to the motion. The relevant statutory provisions are ss. 5 (1) and (2) of the Limitations Act, 2002, S. O. 2002, c. 24, Sch. B. They read:

“A claim is discovered on the earlier of,

(a) the day on which the person with the claim first knew,

(i) that the injury, loss or damage had occurred,

(ii) that the injury, loss or damage was caused by or contributed to by an act or omission,

(iii) that the act or omission was that of the person against whom the claim is made, and

(iv) that, having regard to the nature of the injury, loss or damage, a proceeding would be an appropriate means to seek to remedy it; and

(b) the day on which a reasonable person with the abilities and in the circumstances of the person with the claim first ought to have known of the matters referred to in clause (a).

(2) A person with a claim shall be presumed to have known of the matters referred to in clause (1) (a) on the day the act or omission on which the claim is based took place, unless the contrary is proved.”

[23] There is no question that, as of the end of November 2014, the plaintiff knew that it had suffered a loss as a result of Ms. Estabrooks’ fraud. But when did it know or ought to have known the material facts giving rise to a claim against the defendants and that a proceeding would be an appropriate means to recover this loss?

[24] This is necessarily a fact driven analysis: Chelli- Greco v. Rizk, 2016 ONCA 489 at paras. 3-4. The plaintiff need not appreciate the legal significance of the facts but must know or ought to know the constitutive elements of the cause of action: Nicholas v. McCarthy Tetrault at para. 27, aff’d 2009 ONCA 692. As stated by Rouleau, J. A. in Lawless v. Anderson, 2011 ONCA 102 at para. 23:

The question to be posed is whether the prospective plaintiff knows enough facts on which to base an allegation of negligence against the defendant. If the plaintiff does, then the claim has been “discovered”, and the limitation begins to run: Soper v. Southcott and McSween v. Louis.

[25] The threshold to displace the presumption in s. 5(2) is relatively low: Miaskowski v. Persaud, 2015 ONCA 758 at para. 28.

[26] The existence of a professional relationship requires consideration of two factors. In Presidential MSH Corp. v. Marr, Foster& Co. LLP, 2017 ONCA 325, Pardu,J.A. stated at paras. 20 and 26:

[A] legal proceeding against an expert professional may not be appropriate if the claim arose out of the professional’s alleged wrongdoing but may be resolved by the professional himself or herself without recourse to the courts, rendering the proceeding unnecessary.

Resort to legal action may be “inappropriate” in cases where the plaintiff is relying on the superior knowledge and expertise of the defendant, which often, although not exclusively, occurs in a professional relationship. Conversely, the mere existence of such a relationship may not be enough to render legal proceedings inappropriate, particularly where the defendant, to the knowledge of the plaintiff, is not engaged in good faith efforts to right the wrong it caused. The defendant’s ameliorative efforts and the plaintiff’s reasonable reliance on such efforts to remedy its loss are what may render the proceeding premature.

[27] Given that it was an employee at a credit card company who initially flagged the transactions which led to the discovery of Ms. Estabrook’s larceny, it is not surprising that Mr. Vanderwal surmised that other entities or persons privy to comparable information could have made the same deduction. But his suspicions were allayed by Mr. Gammon, a person he trusted and who he had no reason to disbelieve.

[28] Moreover, although Mr. Gammon did not accept any responsibility for what had happened, he did take steps to diminish the impact of the fraud on the plaintiff. The defendants now minimize the practical effect of those efforts but that was not what Mr. Gammon led Mr. Vanderwal to believe when he first advised him of a potentially favourable CRA ruling: indeed, he suggested that it might obviate the need to sue Ms. Estabrooks. This meliorative work by the defendants would, I find, fall within the two guiding principles enunciated in Presidential MSH Corp. that serve to postpone the running of the limitation period. See also Presley v. Van Dusen, 2019 ONCA 66.

[29] Mr. Vanderwal’s concerns about the potential responsibility of the Royal Bank and the defendants had not completely abated but his emails in June 2015 are, in my view, simply the expression of a niggling doubt and do not confirm, as the defendants assert, knowledge either of the necessary material facts or the appropriateness of a proceeding against the defendants. That he still reposed trust and confidence in Mr. Gammon is shown by the continued retainer of his firm and the cordial agreement they reached on the fees. Their professional relationship continued until February, 2016.

[30] Once he received independent accounting advice, Mr. Vanderwal gained the knowledge which triggered the commencement of the limitation period. He acted with reasonable diligence in seeking this advice. The criminal proceeding was not completed until September 2015. Although a large fine was imposed, he would have known by that time it was unlikely any significant payment would be made in the future by Ms. Estabrooks. He also knew that, despite some tax benefit in 2015, the plaintiff would not be able to recoup more of its loss through this legal route. Armed with this knowledge, he consulted another accountant in January 2016 who was able to properly advise him of the defendants’ negligent acts and omissions.

[31] I have also considered what would have likely transpired even if Mr. Vanderwal had decided in November 2014 that he should look to recover his loss from someone other than Ms. Estabrooks. Any lawyer he consulted would have told him that, before incurring the substantial expense of a lawsuit against a professional advisor, he would need to obtain an expert opinion. Without one, the plaintiff would not know whether it would be worthwhile to commence a proceeding or if it could prove its case. I agree with Mr. Pretsell’s comment made during the argument of the motion that the days of starting a lawsuit and figuring things out after the discoveries are long gone because of the decision in Hryniak v Maudlin, 2014 SCC 7. Thus, it is quite unlikely that the plaintiff would have had the requisite knowledge to commence a lawsuit before July 4, 2015, which is the legally relevant date in this case.

Conclusion

[32] The motion is dismissed. In accordance with the parties’ agreement that the limitation period could be finally determined in this motion, I find, under rule 20.05(1), that the action is not statute-barred. The plaintiff is presumptively entitled to its costs on a partial indemnity basis. Counsel provided me with their respective cost outlines at the conclusion of the hearing. The plaintiff’s claim is for $11,360 exclusive of HST and the defendants is $10,710.66 inclusive of HST. If for some reason the parties cannot reach an agreement on costs, the plaintiff can make written submissions not to exceed two pages within 15 days of the date of the release of this decision and the defendants have 7 days in which to reply. The submissions should include a copy of the email which contains the party’s final offer to settle the amount of costs.

Hurley, J Date: March 27, 2019