England and Wales High Court (Queen's Bench Division) Decisions

IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		30/01/2009

Mr Justice Jack :

1. The claimant, Mr Duncan Rushmer, asserts that in consequence of the negligent over-statement of the profit and assets of his company, Audio Visual Asset Management Limited, in its accounts for the year to 31 March 2002 by its auditor, Mr Mervyn Smith, he continued the company's trade, invested further monies into the company and in due course became liable on his guarantee, limited to £1 million, of the company's bank borrowings. It is accepted on behalf of Mr Smith that the figures were negligently over-stated, but it is denied that Mr Rushmer has suffered any recoverable loss in consequence.
2. This judgment is in three parts. First I will relate the relevant history including my findings of primary fact where there is dispute. Next I will consider the conclusions which I should draw from those facts. Third I will consider the relevant law and its application.

A. The history

3. Mr Rushmer's background is in finance, in particular in the leasing of assets. In 1990 he decided to go into business on his own account as a finance broker, and for this purpose formed a partnership with his wife, called FJ Associates. His expertise was in finding finance for companies whose credit ratings were not such that they could obtain finance unassisted, and he was aware of the substantial interest margin that such companies would pay to obtain finance over that which a finance house would charge a creditworthy borrower. He had particular experience of the media industry where small production companies needed finance for expensive equipment. It was probably in 1995 that Mr Rushmer decided to use a company as a vehicle for the business, and Avam, as I will call Audio Visual Asset Management Limited, was acquired for that purpose. The core business of Avam was straightforward. It would acquire equipment which a customer needed and would lease it to the client. The purchase would be funded by bank borrowing, or by use of 'block discounters' with which Avam would enter a separate purchase and leasing arrangement. Avam's profit on a transaction would be the interest difference. Provided a lessee honoured the leasing agreement all would be well. If it did not, Avam would have the security of the equipment which had been leased, which it might sell or lease to another customer. Avam had two employees, Mr Rushmer and Miss Georgina Roffey who worked part time dealing with the paper work. FJ Associates provided 'management services'. The accountants for the company and firm were Ledger Sparks. Mr Rushmer had a close relationship with Mr Graham Ledger. Mr Rushmer held all the shares in Avam save one, and was the sole director. The issued share capital was 300,000 one pound shares. Mrs Rushmer was the company secretary. She played no part in the day-to-day management of the company. Avam had no office outside Mr and Mrs Rushmer's home in Kingswood in Surrey. It banked with the National Westminster Bank.
4. The first accounts which I have for Avam are those for the year to 31 March 2001. They give the figures for the previous year. The profit for the year to 31 March 2000 (or 1999/2000, for example, as I will refer to the company's years) was £217,517 on a turnover of £1,636,990. The balance sheet showed assets of £2.3 million including accumulated profits of £1.9 million. The assets included £512,741 in unlisted investments and also real property valued at £1.1 million. The unlisted investments were written off in the year 2002/3, and it seems likely that they had become valueless because the companies invested in had failed before then. The real property was 1 and 3 St Peter's Street in Islington, which had been bought as an investment for £965,000 and after some refurbishment had been valued at £1.1 million. Bank borrowing was £893,646. The borrowing was secured by a debenture and by a guarantee from Mr Rushmer dated 15 March 1999 up to £1 million. The borrowing had been increased by a loan made by Avam to Mr Rushmer of £485,000 lent for the development of a property referred to at the trial as 'the cottage'.
5. The accounts of Avam for 2000/1 were again produced by Ledger Sparks but with some difficulty because in the summer of 2001 Mr Rushmer lost confidence in Mr Ledger. They showed a substantial loss on the year of £979,354. The assets were down to £1.3 million. The director's report stated that the loss was due to the writing off of a lease of equipment made with Soho Bangkok Limited. There was a close connection between Soho Bangkok and Avam because Mr Rushmer was also a director of Soho Bangkok. The report stated that the company's solicitors, Downs Solicitors, had obtained a court order on 2 October 2000 for the return of the equipment and were considering action against the directors of Soho Bangkok. Mr Rushmer had stated that he was confident that the loss would be fully recovered in the year 2002/3. I comment that was a very substantial transaction for Avam and that Avam was the victim of a fraud. The leased equipment was sold on by Soho Bangkok and went to Thailand, and was never recovered. Nothing was paid under the lease. Nor did the proceedings against the directors progress. In April 2002 a draft witness statement by Mr Rushmer was prepared for the purpose of proceedings against Downs on the ground that they had failed to pursue the directors. He there put the value of the lost equipment at £1.2 million plus vat. He said that three of Avam's long-standing funders had refused to continue with the company because of the damage done to its balance sheet.
6. The notes to the accounts for 2000/1 also referred to a loan by Avam of £174,862 to Morphos Limited, a company in which Mr Rushmer was a major shareholder. It was stated that Avam had rented offices to Morphos for 5 months for £81,250. Those offices were at 18 and 19 D'Arblay Street, London W1. Avam had itself taken a lease of the building on 20 July 2000 at a rent of £165,000 per annum. Mr Rushmer explained in evidence that the function of the building was to provide space where production companies could process their product. He said that this was the idea of Mr Mark Openshaw, and that Morphos was a joint venture between Mr Openshaw and himself. It was originally intended that Morphos should take the lease, but the landlord was not prepared to take Morphos as the tenant because it was a £100 company. So Avam became the tenant and sublet to Morphos. In fact Mr Rushmer had 70 shares in Morphos to Mr Openshaw's 10. Georgina Roffey also had 10. They subscribed for the shares on 9 May 2000. Miss Roffey resigned as a director on 18 May 2001, and Mr Openshaw resigned on 1 June 2001. No accounts were ever filed and Morphos was struck off the register on 9 April 2002. Mr Rushmer said in evidence that there were problems with damp at D'Arblay Street because of a leak in the roof, and Mr Openshaw declined to continue with the venture. Mr Rushmer said that some of the equipment at D'Arblay Street was 'lent' to Morphos, and some was leased. So the Morphos venture caused two problems for Avam. First Avam was landed with an expensive lease. Second there was the equipment at D'Arblay Street. Morphos Media Limited was incorporated on 3 November 2000 as 4 Anglers Limited and changed its name on 11 September 2001. It was probably about then that it became involved with D'Arblay Street. Mr Rushmer said the driving force behind it was Alan Goddard. But he was not one of the directors. Neither was Mr Rushmer or Miss Roffey. Morphos Media was struck off on 5 November 2002. According to a schedule drawn up by Mr Shane Moloney, the accountant instructed as an expert for Mr Rushmer as at March 2002 Morphos Media owed future rentals on equipment leased by it from Avam totalling £1,362,710. I understand that this related to equipment at D'Arblay Street.
7. I return now to 12 October 2001 when the first meeting occurred between Mr Rushmer and Mr Smith. Mr Smith had been recommended to Mr Rushmer and Mr Smith's offices in Sutton in Surrey were convenient.
8. Because there is a dispute about what was said at the meeting I must begin by saying something about Mr Rushmer and Mr Smith as witnesses. I mention that they were the only witnesses whom I heard as to the facts. There were a number of matters which arose in the course of Mr Rushmer's evidence which persuaded me that I should be cautious before accepting what he said on matters of dispute. A very clear example was his denial that he had told Mr Philippe of the Inland Revenue and Mr Smith at a meeting on 24 January 2002 that 60 to 70% of the equipment leased would have little value at the end of a lease. This was recorded in separate contemporary notes made by Mr Philippe and by Mr Smith. This was a point of importance because it was part of Mr Rushmer's case that where a customer failed to pay the equipment could be repossessed and either relet or resold at little loss. Another example was his statement that he had not been interested in selling the St Peter's Street property in 2002. The papers show that it was in fact on the market in the latter part of that year. This was important because it was his case that if the 2001/2 accounts had not misstated Avam's position, he would have sold St Peter's Street. A third matter related to two fictitious invoices, one appearing to be produced by Morphos Limited dated 1 March 2001, and one appearing to be produced by MCMXC Limited probably dated 15 September 2003. It is very difficult to see that Mr Rushmer was not involved in the production of these invoices. I have made up my own mind of the truthfulness of Mr Rushmer as a witness, but I record that in other litigation in which Mr Rushmer was a defendant the Court of Appeal referred to his 'lack of credibility' and 'obstructive dishonesty': see Dickinson v Rushmer (t/a FJ Associates) 14 February 2000.
9. On the other hand neither was Mr Smith a satisfactory witness. He fenced with counsel and often would not give a straight answer. He had difficulty in explaining passages in his own letters. Perhaps the clearest example here was his failure to appreciate that in his letter of 23 April 2003 he enclosed accounts to Mr Rushmer which he intended Mr Rushmer to use in a meeting with National Westminster, which were, as he accepted in evidence, plainly wrong. That is to say, even if, as he asserted, the figures put forward came from the company, he failed at the time to see that they were wrong, and could not now see why he was criticised. I have concluded that I should have very real reservations as to his general competence at the time in question, and secondly that I should also treat his evidence with caution. I say 'at the time in question' because it appears that he had had previously a successful career. Put more bluntly, I think that age has affected him adversely.
10. I should mention that because Avam is in liquidation, or has now been dissolved, its documents have not been available at the trial, and so determining what happened has been the more difficult.
11. The immediate problem which Avam had in October 2001 and which required Mr Smith's assistance was that the company was facing demands from the Inland Revenue for £257,854, which, according to Mr Rushmer, Mr Ledger had failed to respond to. Proceedings had been issued against Avam on 8 October. The meeting on 16 October was about 2 hours long. Mr Smith made a note which covers a page of manuscript. It is not very informative. It is plain that at the meeting Mr Rushmer introduced himself and his company. He explained in some degree how the company did its business. He referred to St Peters Street and probably also D'Arblay Street, though that name was not recorded by Mr Smith. Mr Smith recorded no reference to Avam's banking arrangements although he did note 'Finance arranged with cos. such as First National and Co-op Bank and Lombard'. I think that if the National Westminster had been mentioned Mr Smith would have noted at least the name. It follows that I reject Mr Rushmer's evidence that he explained his banking arrangements. I find that the fact that he was a guarantor of the bank account was not referred to, and there I accept Mr Smith's evidence. It emerged at the very end of the trial that Mr Rushmer was also a guarantor of Avam's indebtedness to Lombard under a guarantee dated May 2001 with a limit of £500,000. He has never suggested that he informed Mr Smith of that.
12. Mr Rushmer said that he had told Mr Smith at the meeting that he wanted him to be his business adviser. I do not accept that. In my view he was looking to Mr Smith for accountancy services only: I include in that advice as to tax. I do not think that Mr Rushmer informed Mr Smith that Avam's lenders needed regular financial information from Avam. If he had referred to that it was because Mr Smith was to be involved in providing it and Mr Rushmer would have needed to say specifically what was required, and I think that Mr Smith would have noted the requirement. In a letter to his professional Institute dated 14 April 2004 Mr Smith stated: 'I initially concentrated on tax matters, since it seemed apparent that the priority that Mr Rushmer had for Accounts to be supplied to his lenders, did not seem consistent with the type of business in which he was involved.' This is a curious statement because the type of business was consistent with lenders wanting to see accounts. It is not clear what complaint Mr Smith was seeking to answer in this paragraph, but it is most probably a complaint that he was slow in producing the 2001/2 accounts. He was not put under pressure to produce those accounts until the summer of 2002, as I will relate. I do not think that Mr Rushmer told Mr Smith that the National Westminster needed to see accounts within 90 days from the year end. Mr Rushmer may have mentioned that Avam would provide Excel spread sheets to assist with the preparation of accounts, but I do not regard this as having significance: it was just a way of giving necessary information. The same letter of 14 April 2004 refers to the provision of information for the year 2001/2 on spread sheets, and other material. It is as consistent with the provision after the year end as on an on-going basis. In paragraph 24 of Mr Smith's witness statement he refers to 'information … passed to me periodically as spreadsheets provided by AVAM … .' I therefore accept that at some point Avam began to supply spreadsheets. I do not accept that prior to the year end of 31 March 2002 Avam had provided other materials, namely purchase day books, and bank pay-ins and withdrawals. I accept that the leases which form part of the trial papers were a batch supplied to Mr Smith for testing for the purpose of the audit.
13. On 17 October 2001 Mr Smith wrote to Mr Rushmer a letter to follow up the meeting. He began 'It was a pleasure to meet you…. and to discuss what are very substantial problems in respect of the conduct of the taxation affairs of the company.' He said he was happy to act for Avam in that regard and also in future audit and accounting matters. He enclosed three letters of engagement. He recounted the progress which he had made with the Inland Revenue in the meantime. The letters of engagement were addressed to Avam, to FJ Associates and to Mr Rushmer personally. They were standard form letters of engagement as in general use at that time rather than being particularly tailored to the circumstances of each recipient. That to Mr Rushmer began 'This letter sets out the basis on which we are to act as your tax agents and advisers.' It was submitted on behalf of Mr Rushmer that 'advisers' meant advisers' in a general sense. It is clear that in the context of the letter it means advisers on tax. The letter also had a standard paragraph referring to investment advice regulated under the Financial Services Act. This case is not concerned with that.
14. On 23 October 2001 Ledger Sparks wrote to Mr Smith saying that they saw no reason why he should not act. They pointed out that the accounts for 2000/1 had not been signed by Mr Rushmer and that they could not complete the audit until their fees had been paid.
15. On 24 January 2002 the meeting occurred between Mr Rushmer, Mr Smith and Mr Philippe of the Inland Revenue which I have previously mentioned. Mr Smith had been corresponding with the Revenue and with Ledger Sparks with the object of resolving the Revenue's demands. The meeting had been preceded by a request by Mr Smith that Mr Rushmer explain further how Avam's business worked. This led to a two page note by Mr Smith dated the day before the meeting with Mr Philippe. At this time Mr Smith was trying to secure documents from either Ledger Sparks or Avam which would help him with the dispute with the Revenue.
16. On 19 February 2002 Mr Smith wrote to Mr Rushmer with the names of solicitors in Bangkok, who might help with recovering the equipment leased to Soho Bangkok. He also suggested pursuing one of the directors in England. It is clear that he was working with Mr Rushmer on the Soho Bangkok problem. His fee note of the same date refers to 'Meeting to consider matters relating to debtors, namely Pukka Group Ltd, Soho Bangkok Ltd and UBQT Media Plc. Instructing Solicitors with regard to Winding-Up Petition against UBQT.' Mr Smith's computer time record dates this meeting as being on 15 February. The leasing payments shown by Mr Moloney as outstanding from Pukka at March 2002 totalled £364,858. It appears that the equipment was repossessed by Avam and some recovery was made by selling it. The leasing was also covered by a personal guarantee from a director of Pukka. Nothing was in the end recovered under that. UBQT had leased valuable equipment which was repossessed and sold, resulting in substantial payments to Avam, in particular a payment of £149,989 on 22 May 2002. It is apparent that during March 2002 Mr Rushmer asked Mr Smith if he would become the liquidator of Soho Bangkok, two previous liquidators having resigned.
17. In a letter dated 4 April 2002 Mr Smith referred to accounts for Avam for 2001/2, and what needed to be done. The director's report on those accounts is dated 19 September 2002. The first reference in correspondence to draft accounts being provided to Mr Rushmer is in a letter from Mr Smith dated 12 July 2002. The first draft accounts which are now available are dated 18 July 2002. It is Mr Rushmer's case that in May 2002 at a meeting at Mr Smith's offices Mr Smith provided Mr Rushmer with a set of draft accounts showing among other figures an operating profit for 2001/2 of £1,553,418. He identified those accounts among the papers, but it is clear that if any accounts were presented at such a meeting they cannot have been those he referred to. Mr Rushmer's case is that he and Mr Smith had been discussing Avam's cash flow difficulties at about this time, and that he was considering winding down or re-structuring Avam. He asserts that he was surprised at the figures in the draft accounts and queried them, but Mr Smith told him that they were right, that Avam was highly profitable and that there was no need to touch the company. As a result, Mr Rushmer says he decided to continue 'to grow the company'. He says that he told Mr Smith that he was having a meeting with the National Westminster to discuss the company's progress and its requirements and that he would be showing the bank the draft accounts. This meeting is a very important though not crucial part of Mr Rushmer's case. It is denied by Mr Smith that it took place.
18. There is no documentary evidence of such a meeting. In particular none is listed in Mr Smith's computer time record, but I accept that this is not conclusive. What is wholly clear to my mind from the correspondence through the next months is that Mr Smith did not have the information at this point to have produced any meaningful accounts. Mr Smith said that he had not circulated any draft accounts before July, and that there was no meeting in May. A number of points were made as to this in paragraphs 66 and 67 of Mr Cannon's closing submissions, and, broadly, I accept them. I have concluded that I should reject Mr Rushmer's evidence as to this meeting. I find that no accounts were circulated until July.
19. It is probable that during the first half of 2002 Mr Rushmer and Mr Smith did discuss Avam's cash flow problem because they were certainly discussing the bad debts and Mr Smith was involved with unpaid demands for the D'Arblay Street rent, as I will relate. It would have been but common sense for Mr Smith to have said that it would help if Mr Rushmer repaid the £485,000 cottage loan, and I accept that he referred to that. Mr Rushmer said that Mr Smith advised that if he could extend the repayment time under the block discounting from two years to three to match the three year terms of Avam's leasing that also would help. This was denied by Mr Smith who said that he was never asked for such advice. Again it is common sense that such a step would ease the position. It is likely that it was referred to between the two men, but I do not think that this has any significance in the case. Mr Rushmer stated that at this time because of the cash flow problems he was giving serious consideration to 'winding down or looking to re-structure Avam' – witness statement paragraphs 35 and 58. The probability is that this was not discussed with Mr Smith. I am invited to hold on the basis of further information provided as part of Mr Rushmer's pleading that in March or April 2002 Mr Smith reassured Mr Rushmer as to Avam's solvency. I am satisfied that this did not occur: Mr Smith then had nothing on which to base a view as to Avam's solvency.
20. The reason why it was important for Mr Rushmer to establish his case as to a meeting in May is that he said that it was a consequence of the meeting that he obtained an increase in Avam's facilities with the National Westminster. There is no record of any meeting with the bank, or of the facilities which were agreed in May. But the banking arrangements were changed and it would seem that there must have been a meeting between Mr Rushmer and the bank. What happened has to be deduced from the bank statements. These show that on 24 May 2002 a new loan account was opened with a debit balance of £450,000. That sum was credited to Avam's current account, reducing the balance by that amount. So the balance owed to the bank overall was unchanged. On the same day £485,000 was credited to the current account. This came from the sale of the cottage, the development of which had been financed by the bank through Avam. The receipt of that enabled what had been a separate loan account in the sum of £485,000 to be paid off. As at 30 April 2002 Avam's total borrowings had been £3,029,919. As at 31 May 2002 they were £2,299,188. The difference of £730,731 is in part referable to the repayment of the £485,000 and in part due to the receipt of £149,989 on 22 May from the sale of equipment repossessed from UBQT. Thereafter bank borrowing remained fairly level up to 20 May 2004 when Avam went into administration. The highest figure was £2,627,496 at 28 February 2003, which by then included at loan of £100,000 made in July 2002 for the refurbishment of the St Peter's Street property. So contrary to what Mr Rushmer said the facilities were not increased but were re-arranged so that £450,000 was transferred to a separate loan account, which was presumably to Avam's advantage. (In fact the correct figure may be £350,000 because on 28 May 2002 £100,000 was re-transferred back from the new loan account to the current account: but this is of no importance.)
21. In order, as it appeared, to meet the point that Avam's banking facilities were not in fact increased in amount in May 2002 Mr Rushmer asserted that, if he had not thought in May 2002 that the company was doing so well he would not have gone through with a financing agreement which he had reached with a company called Arion Facilities shortly before, but would have re-arranged the transaction with another source of finance with Avam acting as the broker. However as the leasing agreements which had been provided to Mr Smith as part of the audit process were found to show when examined during the trial, the six agreements with Arion had mostly been entered into in June and July 2001, the largest by far being dated 3 July 2001 with total payments to be made by Arian under it of £465,262. I reject the suggestion that Mr Rushmer would have re-arranged these transactions.
22. On 12 June 2002 Fosters, solicitors for the D'Arblay Street landlords, served a statutory demand on Avam for £55,393 due as rent. On 13 June Mr Smith wrote to Mr Rushmer reporting on progress with Mr Philippe saying that he was hoping to provide combined accounts for Avam for the two years to 31 March 2002. Mr Smith anticipated certainly having these finalised before the end of June. The letter ends 'We also discussed the asset position and capital allowances, and of course, that we can do as soon as we get the accounts sorted out and I think Georgina [Roffey] is producing, or has produced, the information for Zelia [Mr Smith's employee].'
23. On 19 June 2002 Georgina Roffey wrote to Zelia enclosing accounting information and ending 'If you require further information on this, or any other information in an attempt to produce AVM account pages, please contact me ASAP.' This shows that both that no accounts had yet been produced and that there was urgency on the side of Avam. A further such message was sent by Georgina Roffey on 25 June.
24. On 2 July 2002 Mr Smith wrote to Fosters proposing that the amounts outstanding in respect of D'Arblay Street totalling £101,678, should be paid in four monthly tranches between that July and October. Fosters replied on 10 July with a counter-proposal, requiring 50% by the end of the week. On 11 July it was agreed there should be 4 payments, two in July, one in August, one in September.
25. On 4 July 2002 Mr Smith made a manuscript note raising 8 matters in respect of Avam's accounts, which included 'Write off bad debts.'
26. On 12 July 2002 Avam drew down a loan from National Westminster for £100,000 which was for the purpose of refurbishing the St Peter's Street Property, in particular providing it with air conditioning. This must have been arranged before Mr Rushmer had any accounts for 2001/2 to present to the bank.
27. On 12 July 2002 Mr Smith sent Mr Philippe draft accounts for 2001/2. He stated that, as they had discussed, the accounting basis differed from previous years. There was a suspense item of £68,482, which still required resolution. It is unclear whether these had been supplied first to Mr Rushmer. The letter was not copied to Mr Rushmer, and I think it likely that Mr Rushmer had not seen these accounts. On 12 July Georgina Roffey sent Mr Smith spread sheets 'as discussed last week for depreciation and capital allowances' She said that they were working sheets and that Mr Rushmer requested that they should not be shown to any third party: Mr Rushmer wished to discuss them first. On 18 July Mr Smith wrote to Mr Rushmer saying 'I enclose herewith draft Accounts for the year ended 31 March 2002. I hope that this is of assistance, but should you need to contact me, please do not hesitate to do so.' This suggests that Mr Smith had not previously supplied any draft accounts for the year. It suggests that Mr Rushmer needed them for something for which they would be 'of assistance'. It does not say what. It may have been the bank; it may have been another source or sources of finance.
28. The first draft accounts for 2001/2 in the trial papers bear that date, 18 July 2002. They show a profit of £1,495,221 on a turnover of £2,114,429. Bad debts written off are £6,478. Net assets were £2,766,780, and there was a suspense account of £68,482, the figure mentioned in Mr Smith's letter to Mr Philippe. The papers then contain a set of accounts marked in Zelia's writing 'Faxed to Duncan [Rushmer] 26/7/02.' And they bear that date. They show a profit for 2001/2 of £1,430,739 on a slightly different turn over, £2,114,432. Net assets are unchanged. The suspense account has gone. Bad debts are unchanged. On 29 July Georgina Roffey emailed Zelia referring to Mr Smith having been on holiday, saying that Zelia could not go further while he was away, and that the accounts were desperately needed. She hoped for a meeting on 5 August to sort out all problems. There is a manuscript note by Mr Smith appearing to record the important points covered at that meeting. They are points which required giving effect to in the accounts rather than any points relating to general discussion. It may well be that more general topics such as the profit shown by the accounts was discussed. The notes record: 'Anticipate finalising accounts by end Aug.' In cross-examination Mr Rushmer did not allege that the viability of Avam had been considered at the meeting.
29. On 7 August 2002 Mr Smith wrote to Mr Rushmer listing the points on which he needed information. They included bad debts and unquoted investments. He also wanted payment of fees totalling £9,400. Mr Rushmer replied on 8 August. He said that the UBQT assets were sold for £450,000 after March 2002. I record that the total debt was £610,000. He said that there were no bad debts. He asked to be advised of future costs for accounting work after the accounts for 2001/2 were finalised. On 14 August Georgina Roffey asked for confirmation that all questions had been answered satisfactorily and that they could expect the accounts by 23 August. On 27 August Mr Smith wrote to Mr Rushmer saying he could not sign a certificate for the 2000/1 accounts as he had not done the audit, and suggested they be filed without an auditor's certificate. As I had stated, the 2000/1 accounts bear a certificate signed by Ledger Sparks dated 8 October 2001. Mr Rushmer referred to this in his letter of 29 August. Mr Smith also enclosed the audit report for the 2001/2 accounts. As is apparent from Mr Rushmer's letter of 29 August this contained a proposed qualification. On 27 August Georgina Roffey sent Zelia details of Mr Rushmer's loans to Avam between 1999 and 31 March 2002 totalling £184,005. This was corrected to £148,823 by a fax later the same day. On 28 August Mr Smith wrote to Mr Rushmer referring to the test sampling that Zelia had carried on 24 rental agreements, of which 7 were incorrect. He enclosed a schedule showing the balance outstanding as calculated by Georgina and as calculated by Zelia. Mr Rushmer replied on 29 August saying that Mr Smith had been provided with the correct information. He said that he had assured his funders that the audited accounts would be with them by the end of August, and asked for confirmation that this would be met. He said that he had told Mr Smith that there must be no qualification to the accounts, and that Ledger Sparks had signed the previous accounts. I insert that it may be that the proposed qualification of the 2001/2 accounts related to the 2000/1 accounts.
30. On 30 August 2002 Mr Rushmer wrote to Mr Ledger threatening to report him to his Institute for not providing Mr Smith with necessary information. On 2 September Mr Smith wrote to Mr Rushmer referring to 'sums to be recovered in respect of' Pukka (£364,858) and UBQT (£610,072). He said that contrary to Mr Rushmer's view some provision should be made. He asked for details of the realisations which had been effected, so a note could be made in the accounts. On 4 September Mr Rushmer sent Mr Smith a copy of the accounts for 2000/1 signed by Ledger Sparks, and asked for the accounts for 2001/2 without any qualification to be provided no later than 12 September. On the same day Mr Smith wrote to Mr Ledger. The letter makes clear that Ledger Sparks had not signed the 2000/1 accounts until about this time, and asks for further information from Ledger Sparks. On 11 September Mr Smith wrote to Mr Rushmer with a number of questions. On 16 September the National Westminster replied to Mr Smith's letter of 22 August. Balances, facilities and securities were stated. The review date for the facilities was 31 October 2002. There was no reference to Mr Rushmer's guarantee. The letter is stamped 'Received 24 September 2002'. On 18 September Mr Rushmer told Mr Smith he needed signed unqualified accounts for a meeting with the National Westminster the next morning.
31. Avam's accounts for 2001/2 have a director's report and auditor's certificate both dated 19 September 2002. They are unqualified. In the table below I set out the figures in the accounts, the figures in the draft accounts of 18 July 2002 and the figures as it is said they should have been.

	Audited Accounts	18 July 2002	Per Callingham Crane
Profit before tax	£1,363,489	£1,363,489	£665,101 loss
Net assets	£2,699,531	£2,699,531	£670,941
Bad debts	nil	nil	Substantial
Investments written off	nil	nil	£387,741

Callingham Crane were the auditors who replaced Mr Smith. Unfortunately their working papers have not been made available to the accountant experts instructed in the case. They had calculated that the net profit after tax and the net assets were each over-stated by £2,028,590.

32. Mr John Grogan was instructed as an accountancy expert on behalf of Mr Smith. His report was not challenged. In paragraph 7.8 of his report he set out the elements among those identified by Callingham Crane in the 2001/2 accounts by which Mr Rushmer might have been misled and those elements by which he was not misled. The misleading elements totalled £1,418K and the non-misleading elements £611K.
33. The most important mistake that Mr Smith had made was the inclusion as assets of the cost of equipment purchased during the year and leased out. This accounted for £1,247,883 of the over-statement, leaving £2,469,575 to be accounted for. Crane Callaghan considered that rental debtors were over-stated by £3,717,458 and stock understated by £1,467,500. Mr Grogan concluded that the greater part of the remaining overstatement of rental debtors was due to the inclusion of bad debts, and the greater part or all of the under-statement of stock arose from the failure to include stock recovered or recoverable from bad debtors. He calculated that at least £1,247,572 of the £2,469,575 was due to Callingham Crane's bad debt adjustment. It is not alleged that Mr Smith was negligent in respect of bad debts. (I comment that he might have pressed Mr Rushmer further as to bad debts, but it was Mr Rushmer who knew what the bad debt position was.) Mr Smith had misapplied SSAP 21 in calculating the rental debtors in that he had included all that was due rather than what was due in 2001/2. That is admitted to have been negligent. Mr Grogon concluded that the maximum adjustment to be made in respect of the SSAP 21 error was £842,003 (£2,469,575 less £1,627,572). These two errors (£1,247,883 and £842,003) total £2,089,886.
34. It might be thought that the delivery of the finalised accounts would be the occasion of a meeting between Mr Rushmer and Mr Smith to discuss them. That did not occur. What did occur was that Mr Rushmer attended at Mr Smith's office and expressed his anger at the delay in strong and loud terms. However it seems obvious that when Mr Smith produced draft accounts showing a very large profit and a very much improved asset position that there must have at some point been comment by Mr Rushmer to Mr Smith. For Mr Rushmer cannot have been expecting such figures. He must have had an idea of how the company was doing prior to the production of accounts, and given Avam's shortage of cash as shown by its inability to pay the D'Arblay Street rent as it became due, the large profit claim by Mr Smith is at the least surprising.
35. Further light is thrown on the situation by later correspondence. In a fax to Mr Smith dated 6 May 2003 Mr Rushmer stated:

"I have spoken to Mr Philippe of the Inland Revenue …. He is arranging another meeting with you to discuss the make up of the March 2002 accounts. He is currently thinking that the 2002 accounts will have to be restated. You have stated that I have signed off the accounts as director of the company. I agree, I did sign the accounts your firm prepared. On numerous occasions I queried the profit stated with the response from you being that the rental received was pure profit after deduction of the cost of sales. I also made you aware on a number of occasions of the company cash flow position. You refused to discuss the position."

He also there said that he had contacted the Institute of Chartered Accountants for advice. This suggests that in the period leading to the finalisation and at their finalisation Mr Rushmer was doubtful that Avam had really made the profit which the accounts showed. The letter shows that 8 months later Mr Rushmer was very doubtful that the profit shown could be correct.

36. In his reply to the fax of 6 May 2003 in a long letter of 9 May 2003 Mr Smith stated :

"With regard to your comments in respect of profit shown in the accounts, I have always stated to you that the accounts prepared for your type of business are not the same as would apply for a normal retail operation. The accounts reflect the rental income which has come in, and against that, is the interest paid and overhead costs. The profit is then offset by capital allowances, but the profit and loss account does not reflect the capital repayments. Anyone looking at the accounts requires to look at those various aspects, or enquire about those various aspects. To look at the accounts without that, is to read them incorrectly and incompletely."

As this was written in response to Mr Rushmer's suggestion that the profit was over-stated, it seems to suggest that the profit was not actually as high as stated if the accounts were read correctly. However the passage was not considered in the evidence at the trial.

37. It is appropriate here to set out also to what Mr Philippe of the Inland Revenue had to say. On 12 May 2003 he wrote to Mr Smith saying :

"Although we do not agree the way the accounts are presented we were able to agree that there is no tax liability for the year ended 31 March 2002."

In the context of an apparent profit of as much as £1.36 million, it is surprising that no tax was considered due, which raises a doubt as to the reality of that profit. But again this letter was not considered in the evidence. Further light is provided by Mr Philippe's letter to Callingham Crane of 12 November 2003. Mr Philippe then said:

"I had a meeting with Mr M Smith on 15 April 03 and again on 8 May 03. We discussed widely the accounts and the figures behind the. In the light of what I found out, which was in addition to what I found out with my meeting with Mr Rushmer on 11 February 2003 I was able to be confident that whatever the correct figures for the accounts and capital allowances might turn out to be for the year to 31 March 2002 the computation would be showing a loss for tax purposes. As such there would be no tax profit for the year and so no tax liability for the year. ……. I met with Mr Rushmer and your good selves on 28 May 2003 where I explained my concerns with all the figures in the year ended 31 March 2002, … ."

Again this was not considered in the evidence and in particular it was not considered by the accountancy experts and an explanation provided. But it strongly suggests that the profit shown by Mr Smith's accounts was more of a paper profit than a real one, and that at a meeting with Mr Rushmer on 11 February 2003 there was discussion about this. However I do not have Mr Rushmer's evidence as to it.

38. It follows that there must be serious doubt (1) as to whether the profit shown by Mr Smith for 2001/2 was a real profit or a paper profit, and (2) whether Mr Rushmer believed that Avam had made a profit as the accounts purported to show. I will set out the finding which I make as to Mr Rushmer's state of mind in Part B. I refer to paragraph 62.
39. Mr Rushmer said in evidence that following the provision of the accounts by Mr Smith in September 2002 he renewed Avam's facilities with the two block discounters, the Co-operative Bank and the First National Bank, and arranged that the repayments to the discounters would run for the same period as the underlying leases, thus reducing the monthly amounts that would have to be paid by Avam, and easing its cash flow. There are no documents to support this, but it is clear that Mr Rushmer was anxious to obtain the accounts and I accept that it was for this purpose.
40. In paragraph 35 of his witness statement Mr Rushmer stated that in reliance on the accounts and what he was told by Mr Smith he 'decided to continue moving forward to grow the company.' That is not in fact what happened. According to Callingham Crane's accounts the turnover of Avam in 2001/2 was £753,557, and the turnover for 2002/3 was £948,547 but that included an exceptional item namely £495,000 coming from the sale of equipment leased to UBQT. An analysis of the receipts from leases by reference to Avam's bank statements shows the same decline. So Mr Rushmer did not 'grow' the company, but rather the contrary.
41. In September 2002 Mr and Mrs Rushmer arranged to borrow £125,000 from Birmingham Midshires Building Society on the security of their jointly owned home. The advance was paid into Mrs Rushmer's bank account and went from there to the credit of Avam's current account with National Westminster on 7 October. The total paid in was £127,066. Mr Rushmer said that he and his wife advanced £125,000 in order to alleviate Avam's cash flow. Mr Rushmer also said that a further 5 sums totalling £213,000 were loaned to Avam by Mrs Rushmer between 1 October 2002 and 1 October 2003. The only evidence of these payments is in Avam's bank statements. The first alleged payment can there be seen by the reference to be from a block discounter. The other payers cannot be identified. Different figures have been advanced by Mr Rushmer at different times in respect of these further alleged loans. I refer in this regard to paragraph 10 of Mr Cannon's closing submissions for the defendant where the history is set out. All Mr Rushmer was able to say in his evidence was the figures totalling £213,000 had been supplied to him by his wife. I am not satisfied that these further loans were made.
42. On 13 December 2002 Georgina Roffey wrote to Mr Smith enclosing a disk with information from the accounting programme 'Sage', from April 2002 to that date, saying that as she was not familiar with the programme there would be numerous errors. It appears from the letter that the information was provided to produce some half year accounts to the end of September. There is nothing to show whether such accounts were produced.
43. On 16 December 2002 the Royal Bank of Scotland as agent for National Westminster wrote to Avam setting out the terms on which Avam's main overdraft facility would be renewed. The limit was £1.5 million until the St Peter's Street Property was sold and was then to be £1 million. As I have mentioned the property was then on the market. The terms required the provision of audited accounts within 180 days of the end of Avam's financial year and quarterly management accounts within 30 days of each period. Avam's current account broadly kept within the £1.5 million limit, but St Peter's Street was not sold at this time.
44. On 27 January 2003 Mr Rushmer wrote to Mr Smith enclosing his own signed tax return. He acknowledged the requirement of Avam to settle Mr Smith's fees but said he was awaiting a breakdown. He said that there were two offers on St Peter's Street, with one party having instructed its solicitors to complete as soon as possible. Once the sale was completed Avam would be able to settle any outstanding invoices. In cross-examination Mr Rushmer said that the refurbishment was completed in October or November. He said the sale was taken out of his hands in April 2004 when Avam went into administration. When questioned how it was that he had not sold the property earlier, he said he had decided to let the property.
45. On 10 February 2003 Mr Smith wrote to Mr Rushmer giving some detail of how outstanding fees of £14,322 had accrued. He said 'You must recognize yourself the amount of time that was spent discussing and amending these accounts from the very strong views you had that you had with regard to the work that was necessary to produce accounts in the form that you required.' He asked for payment. On 15 April Mr Smith informed Mr Rushmer that he had agreed with the Revenue that nothing was due in respect of 2000/1 and 2001/2. On 23 April Mr Smith wrote again about non-payment of his account. He said that he had no desire to put Avam into liquidation. He said that management accounts to the end of March had been provided. He said work was required to them. He said no further work would be carried out without payment, and that he would resign as liquidator of Soho Bangkok unless Mr Rushmer kept his promise to meet his time costs. He ended 'I trust that the enclosed accounts, which should not be dissimilar from those already in your hands, can resolve matters with your bankers and I look forward to receiving a cheque in settlement of all monies due, whereupon I will be pleased for Zelia and my firm to continue working ... .' Mr Rushmer replied on 24 April. He asked how the accounts could show a profit of £1,630,758 on a turnover of £1,550,186. He said that if he had shown them to National Westminster, his relationship with the bank would have been damaged. (In his witness statement he said that he had shown them to the bank, and had been told he should take them back to Mr Smith. Plainly he did not do that but saw immediately that the accounts could not be correct.) He said in the letter that he had not been provided with a proper breakdown of the fees. He criticised the preparation of the 2001/2 accounts and Mr Smith's conduct as liquidator of Soho Bangkok. Mr Smith replied the same day. He said that the accounts which he had sent were from Avam's computer and were unadjusted by him: there had been no analysis of monitoring. He had not agreed to produce management accounts: that was supposed to be done by Georgina Roffey. So he was saying that what he had sent was simply a print out done in his office of the input of Georgina Roffey. That may be so, but, as I have said earlier in paragraph 9, it does not explain how he could suggest that accounts which were so obviously wrong should be presented to National Westminster. On 25 April Mr Smith sent a further invoice. There was more correspondence.
46. I have already quoted in paragraph 36 from Mr Smith's letter to Mr Rushmer of 9 May 2003. Mr Smith ended that by stating that he would not be carrying out further work without payment of his fees, and said that if he was not paid by 16 May he would have to pursue Mr Rushmer and his wife. On 12 May Mr Rushmer replied that he had no confidence in Mr Smith and had that day instructed Mr Earle of Callingham Crane.
47. On 22 May 2003 Callingham Crane wrote to Ledger Sparks saying that they had been instructed by Mr Rushmer to prepare the accounts for the year ended 31 March 2002. This further suggests that Mr Rushmer had no confidence in Mr Smith's accounts for that year. That is confirmed by Callingham Crane's letter to the Institute of Chartered Accountants in Scotland dated 16 June 2003, Mr Smith's professional body, saying that they had been instructed by Mr Rushmer in relation to the preparation and audit of Avam's accounts for 2001/2 and management accounts for the period ended 31 March 2003. The letter stated: 'When the accounts for the year ended 31 March 2002 were presented to [Mr Rushmer], … he expressed his disquiet at the level of profits disclosed by the accounts. Mr Rushmer had anticipated a profit of £150,000, whereas the reported profit per the audited financial statements was £1,363,489.' It stated that Mr Philippe of the Inland Revenue had expressed the view that the 2001/2 accounts were materially incorrect, but Mr Smith had been adamant.
48. On 19 May 2003 Mr Smith sent a statutory demand in respect of his fees from Avam in the sum of £27,130. On 19 June Mr Rushmer responded to Mr Smith's solicitors that the fees had been the subject of dispute since November 2002 by reason of the standard of work. On 4 June Mr Smith commenced an action in the Epsom County Court against Mr and Mrs Rushmer for fees of £2,490. It was not until 5 August 2003 that he commenced an action in the Epsom County Court against Avam for fees of £28,166.
49. As is shown by a letter from Manches writing as solicitors for Mr Rushmer dated 8 June 2006 addressed to the administrators and alleging negligence against them, in June 2003 Mr Rushmer was advised by an insolvency practitioner, Mr Graham Peterson 'to advise our client on his own position and that of Avam with a view to ensuring Avam was preserved as a trading company and thus our client's own financial position protected.' It was stated that from January 2004 Mr Peterson advised generally on the deteriorating position of Avam, and in March recommended liquidation. When he was asked in cross-examination about the position in June 2003 Mr Rushmer said that he did not then start to wind down Avam: Mr Peterson had said that the company was still cash positive and there was not much of a problem; Mr Rushmer decided to 'trade out' of the position.
50. On 25 June 2003 Mr Smith wrote to the Institute in large part setting out the history of his dealings with Mr Rushmer. Unfortunately the letter from the Institute to which he was replying is not available, and it would be helpful to see what he was responding to. In the course of his reply Mr Smith stated;

"On many occasions, Mr Rushmer demanded of me, as a Licensed Insolvency Practitioner, that the company be placed in liquidation, as he was not getting any finance. This was predominantly, in my opinion, as a consequence of the adverse transactions which the company had entered into, the major one being the transaction with Soho Bangkok Limited, which company [sic] I was requested to act as Liquidator. I have to say, so far as that matter is concerned, I was the third Liquidator and the Official Receiver considered it to be "a poisoned chalice", since Mr Rushmer was also a Director and Secretary of Soho Bangkok Limited. The two previous Liquidators had resigned."

When Mr Smith was asked about this in cross-examination he said that Mr Rushmer's demands to put Avam into liquidation had had to be assessed by him as to whether they were serious, for, if they were, the consequences were also serious: he had to decide whether Mr Rushmer meant what he said, and he concluded that he did not. This was a most unsatisfactory passage in Mr Smith's evidence. There is however nothing to support the idea that Mr Rushmer was wanting to wind up Avam in 2002. He was undoubtedly concerned by Avam's cash flow problems, for example, his inability to pay the rent on D'Arblay Street: any one would have been. But, in his witness statement, what he says in paragraph 35 after referring to cash flow problems is that he was considering winding down Avam, or re-structuring the company. Further, it is incorrect that Avam was having trouble in getting finance. It had lost some sources as a result of the Soho Bangkok debacle but had been able to continue satisfactorily with its remaining lenders: Mr Rushmer did not say to the contrary, but emphasised his good relations with the National Westminster and with Lombard. I do not know what Mr Smith was responding to in this paragraph. I have decided that I should take no account of it.

51. The documents then jump to 12 November 2003. On that date Mr Philippe of the Revenue wrote to Callingham Crane in terms which I have already quoted in paragraph 37. On 19 November Callingham Crane produced a report on the 2001/2 accounts concluding that shareholders' funds had been overstated by £2,028,590. Appendix 4 to the Report constituted draft accounts produced by Callingham Crane 2002/3. They showed a trading loss for that year of £202,900 offset by a property revaluation gain of £376,373 to give a gain for the year of £173,473. These accounts were never certified. The notes recorded £120,812 as owed to Avam by FJ Associates, and an interest-free loan of £125,000 by Mrs Rushmer.
52. On 3 December 2003 Mr Smith wrote to his Institute justifying the 2001/2 accounts prepared by him. He wrote a further letter on 14 April 2004 setting out what he had done on Mr Rushmer's instructions, and saying that Mr Rushmer had been a difficult client.
53. On 12 December 2003 the Royal Bank of Scotland wrote to Mr Rushmer following a meeting with him and Callingham Crane. Among other things they said:

"Our assessment is that whilst potentially there is a viable business, it depends heavily on quite ambitious assumptions contained within the projections [which were not available at the trial] and the writing of new business that will require additional funding. You have already suggested that the Bank considers this. …. The existing structure of an overdraft carrying c £1.5 m of hardcore is unacceptable and has to change. The risk profile of the company has altered significantly in the past two years culminating in the current position. If there is to be a way forward that is to allow the Company the possibility of trading through its present situation with us continuing as bankers, then there has to be a clear understanding of what is and is not possible."

A further meeting was suggested to find a way forward. But on 20 March 2004 administrators were appointed and on 25 March the National Westminster issued a demand for £1,527,176. On 29 March the bank made demand under Mr Rushmer's guarantee. On 23 March the landlords of D'Arblay Street had presented a winding-up petition in respect of £190,000 rent arrears.

54. The administrators were partners in Baker Tilley and Benedict Mackenzie respectively. The trial papers include an unsigned report from Baker Tilley recommending administration. It stated that the directors had advised that the company's losses stemmed from difficult trading conditions leading to cash flow difficulties, and that those conditions included fraudulent action by third parties [i.e. Soho Bangkok], under-utilised premises [i.e. D'Arblay Street], and cash flow difficulties. Bad debts and bad investments might have been added. St Peter's Street was given a value of £1.75 million. D'Arblay Street was referred as a lease with no premium value. It was stated that much of the equipment there could not be removed in a usable condition. I insert that this meant a substantial loss because the company's accounts reflected equipment in D'Arblay Street as having substantial value. The report recorded that the block discounters would be entitled to have all rentals paid direct to them [which happened]. The estimated statement of affairs gave a surplus before bad debts, interest and compensation for the D'Arblay Street lease disclaimer of £1,358,000. But assets totalling £1,880,000 were included, which were dubious at the best, for example assets at D'Arblay Street and in Bangkok, were included. The notes to the statement said that Avam had 'a potential claim under professional negligence against its former auditors who overstated the company accounts.' This claim was enlarged on by Mr Rushmer in his witness statement made for the purpose of the administration on 10 May 2004.
55. Emails of 8 September and 8 October 2004 show disagreements between Mr Rushmer and the administrators. Following a review, by letter of 5 November Mr Rushmer received an apology from Baker Tilley in respect of some aspects. The relationship was not a happy one, and in his evidence Mr Rushmer stated that the administrators did not realise the assets as they might have done. I express no view whether that is correct or not.
56. On 9 November 2004 National Westminster wrote to Mr Rushmer demanding that the £1 million due under his guarantee be paid immediately. Proceedings were issued on 26 January 2005, Summary judgment was obtained for £987,480 with £9,000 costs on 25 April 2005.
57. On 19 May 2005 the Institute of Chartered Accountants of Scotland wrote to Mr Smith informing him that the Discipline Committee had found made out the complaint that he had signed an unqualified audit report to the Avam accounts for 2001/2 when he knew or ought to have known that they were materially misstated. It was recommended that he be ineligible to hold registration for audit work.
58. On 19 September 2005 Benedict Mackenzie wrote to solicitors suggesting investigation of a number of matters 'in respect of antecedent transactions and suspicious activities'. These were:

(1) Soho Bangkok – loss of £979,354.

(2) Trading losses, in particular falling turnover.

(3) D'Arblay Street rent, £165,000 pa.

(4) A loan from Lombard Finance ostensibly for a purchase from Morphos Ltd in the sum of £564,000. I insert that this involved a false invoice from Morphos, which Mr Rushmer could not explain. Mr Rushmer said in evidence that Morphos had no equipment to sell: he said the loan related to equipment in D'Arblay Street.

(5) A further dubious transaction whereby Morphos purported to sell Avam equipment, the sale being financed by a loan from Lombard of £500,000

(6) A transaction whereby Avam received £97,200 in respect of a supposed purchase of equipment from MCMXC Ltd for letting to a company named D'Arblay Street Post which never paid any rental. I add that this was supported by a false invoice from MCMXC.

(7) Transactions where Avam purported to purchase the same equipment from Mayfair Recording Studios for £100,000 and from Timera Ltd for £130,000.

(8) The debt due to FY Associates, which had increased from £80,185 as at 31/3/01 to £126,191.

(9) Directors' current accounts.

(10) An investment purportedly made in the year to 31 March 2003 in an unquoted company, Altered Images Ltd, in the sum of £125,000, of which the directors of Altered Images had no knowledge.

These matters were not investigated in depth at the trial but I am satisfied that the strong probability is that in respect of items (4) to (7) and (10) the paperwork were fraudulent. The phrase 'a can of worms' comes to mind.

59. The St Peter's Street property was sold for £1,625,000 in April 2005. Following surrender of the D'Arblay Street lease some of the D'Arblay Street stock was sold to the new tenant for £17,000. It had been put in the original estimated statement of affairs at £200,000. The administrators decided on legal advice not to pursue Avam's claim against Mr Smith. In May 2005 the administrators applied for orders that the administration order should cease to have effect and Avam should be placed in compulsory liquidation. £1,573,649 had been distributed to the National Westminster.
60. The subsequent history of the actions commenced by Mr Smith in the Epsom County Court which I have mentioned in paragraph 48 is as follows. On 16 June 2003 Mr and Mrs Rushmer filed a manuscript defence to the claim against them for fees, filled in on the form, saying that the accounts for the year to 30 April 2002 were not a true and fair view and that their tax returns and those of F J Associates were incorrect. I assume that the reference to accounts is to Avam's accounts and that 30 April 2002 is a mistake for 31 March 2002. The space for a counterclaim was left blank. Mr Smith made a witness statement dated 5 September 2003 setting out some of the history and saying the accounts and returns had been properly prepared. Mr Rushmer made a witness statement dated 3 March 2004. Paragraph13 read :

"13. At the time of writing this statement, Callingham Crane, due to the non cooperation of ME Smith are unable to be specific about the total amount of damages. However, indentifiable damages to date include the cost of the work carried out by Callingham Crane to remedy the defaults of ME Smith. This figure is in excess of £20,000.

13.1. Continued negotiation of tax position with Inland Revenue (awaiting response from HMIT)

Loss of amenity for having to instruct third firm of accountants in work that should have been carried out correctly.

Potential loss of investment of £125,000 by Fiona Rushmer into AVAM following receipt of audited accounts prepared by ME Smith & Co in October 2002. Mr Smith has now admitted to his Institute that the accounts are materially incorrect.."

In August 2004 Mr Smith discontinued his claim having received a payment of £1,240 which he had accepted in settlement. There was no order as to costs.

61. Mr Rushmer filed a defence to the claim against Avam for £28,385 on 19 August 2003. He stated that the professional services in question were the subject of complaint to Mr Smith's professional body. The space for a counterclaim was left blank. Mr Smith applied to have the defence struck out and for summary judgment, and supported the application with a witness statement dated 23 September 2003. I refer in paragraph 64 below to Mr Rushmer's witness statement prepared in answer. On 5 January 2004 Mr Rushmer served a typed amended defence and counterclaim of 6 pages. This included 12 allegations of negligence in relation to the 2001/2 accounts. The counterclaim claimed as damages, inter alia, the cost of preparing correct accounts and damages for loss of business following the withdrawal of the National Westminster's credit facility. Directions were given on 6 April 2004 including that a full schedule of special damage should be served by 28 April. On 31 August 2004 a notice of discontinuance was filed signed by solicitors for Mr Smith and Avam on the basis that Mr Smith should submit his claim for proof against Avam in the administration and there should be no claims for costs.

B. Conclusions from the facts

62. Mr Rushmer's primary case, that he received draft accounts from Mr Smith in May 2002 and received advice from him at a meeting, fails because I have found that there were then no draft accounts, and there was no meeting and no advice.
63. Mr Rushmer has a fall-back position that he did on any view receive negligently overstated accounts which showed the company to be in a very much better position than it actually was, and had he not received those accounts, first in draft in mid July 2002 and in final form in September 2002, he would have taken a different course with Avam: he would not have 'grown' the company but would have wound it down with the outcome that liability on his guarantee would have been avoided or much reduced.
64. It is clear that Mr Rushmer did not believe that Avam had made the profits which Mr Smith showed in the 2001/2 accounts. They were very large, and if the figures were right, where were the profits? Instead the company was struggling to pay its debts. I have referred in paragraph 35 to what Mr Rushmer stated in his fax to Mr Smith of 6 May 2003. I have quoted from Mr Philippe's letters of 12 May and 12 November 2003 in paragraph 37. Mr Rushmer also knew as Mr Smith did not that Avam's investments included in the accounts at £387,741 were of no value. He also knew that Avam had sustained substantial bad debts, which were not taken into account. In Callingham Crane's letter of 16 June 2003 it was stated that he had expected a profit of £150,000. In an undated and unsigned witness statement prepared by Mr Rushmer to resist an application for summary judgment in the county court proceedings brought by Mr Smith against Avam Mr Rushmer stated in paragraph 10 :

10 When we came into the 2002 accounts, I was very unhappy at the figures that the Claimant put before me.

10.1 As I say, I am not an accountant, but the figures seemed grossly wrong to me. I have estimated closely that our profit would be in the region of £150,000 whereas the Claimant insisted that the correct figure was £1,363,489.

10.1.1 Indeed, the accounts actually show profit as being greater than turnover.

10.2 I repeatedly as the Claimant to explain these figures, but he just told me that I have no position to question his authority. As we have seen, Callingham Crane have expressed considerable reservations about these accounts.

10.2.1 I repeatedly asked the Claimant to explain how he calculated these figures. He told me that preparing the accounts was a 'paper exercise' rather than actually auditing the money that had actually passed through the business. I said that this could not possibly be correct – if we had made such an enormous profit, where was it? – I could not find it in my bank account or anywhere else and I certainly could have done with those sorts of reserves.

10.2.2 On this point, it is worth noting that in their report, Callingham Crane observe that at no time had anyone from the Claimant's business come to our offices to look at our papers, nor had we been asked to let them have any of the papers that were necessary to carry out an audit.

10.3 It is not true, therefore (paragraph 8 of the Claimant's Statement) to say that I never raised any queries about these accounts. I questioned them repeatedly. I accept that I signed the accounts, but pragmatically I had no choice. I was not an accountant: he was. He had certified the accounts and my Bank was pressing me urgently for the paperwork. I had little choice but to sign, but it was reluctantly, and with considerable reservations.

65. If Mr Rushmer expected a profit of £150,000 on the basis of the information he had supplied to Mr Smith, he expected that the reality was a substantial loss for the year. For the figures Mr Smith was using made no allowance for bad debts and valueless investments and Mr Rushmer knew that. It is as well also to remember that Mr Rushmer was an intelligent businessman with long experience of Avam's business and a close knowledge of its trading. The outcome is that I find that Mr Rushmer did not believe in September 2002, or the preceding months, that Avam had made a profit of £1,363,489 or any really substantial profit. He knew that the company was struggling and he knew or at least strongly suspected that, if the correct figures were used, the accounts would show a loss.
66. I therefore conclude that Mr Rushmer did not rely on the figures produced by Mr Smith in the 2001/2 accounts to decide what he should do with Avam. I have already pointed out that, contrary to his evidence, he did not grow the company. There was the investment of £125,000 in September 2002. That was not an investment made on the strength of Mr Smith's accounts.
67. Mr Rushmer's subsequent conduct also shows that he had not relied on the 2001/2 accounts. Even disregarding the matters I have mentioned, by June 2003 Mr Rushmer knew that Mr Smith's accounts for 2001/2 were of no value: I refer to Callingham Crane's letters dated 22 May 2003 and 16 June 2003 referred to above in paragraph 47. He knew that even on the basis of Mr Smith's figures no tax was due, and that Mr Philippe considered that the 2001/2 accounts would have to be restated. So he was then in a position to take the action which he now says he would have taken and so have protected his position under the guarantee. But he took no action: he did not change course. This is consistent with him having known much earlier that he should not rely on the accounts. But, were that to be wrong, it would be inconsistent with the allegation that, if he had known the true position, he would have taken a different course, because by June 2003 he did know and did not change course. The obvious step to take to reduce Avam's indebtedness to the National Westminster was to sell the St Peter's Street property. That was not done, despite – as it appears - it being arranged with the bank that it should be sold – see the terms of the banking facilities dated 16 December 2002.
68. The claim against Mr Smith therefore fails because I find that Mr Rushmer did not rely on Mr Smith's accounts as he says that he did. I have also found that no representations going beyond that constituted by the provision of the accounts was made.

The law

69. As I have found that Mr Rushmer has failed to establish a fact, namely reliance, essential to his claim, I will take this part of the judgment more shortly than I otherwise would. For the legal questions on which I was addressed do not on that basis arise.
70. The auditor's report on the 2001/2 accounts made the usual statement that the accounts gave a true and fair view. That was the representation that was made by the provision of the accounts. I do not consider that Mr Smith added to it by anything that he said.
71. The primary question is whether Mr Smith owed any duty to Mr Rushmer personally in respect of the making of that representation. He clearly owed a duty to Avam as its auditor. Mr Smith undertook no contractual duty to Mr Rushmer in respect of Avam's accounts. That follows from the findings I have already made. The question is whether he owed a duty in tort.
72. The facts that can be relied upon to support a duty in tort are that this was a small private company of which Mr Rushmer was the sole director and shareholder. It had been formed to carry on his business, and it was his livelihood. The evidence established that it was very probable that with such a company, if it had substantial bank borrowings, a guarantee of the borrowings would be required by the lending bank. Mr Smith did not know that Mr Rushmer had provided a guarantee and so of course he did not know the size of the guarantee. A claim by Mr Rushmer as the shareholder cannot succeed, and is not made. The claim has to be made on the basis that a duty was owed to him as guarantor, and that he has suffered loss because he is liable on his guarantee without the prospect of being reimbursed by Avam.
73. The modern law relating to the duty of accountants in relation to statements made by them and the provision of accounts starts with Caparo Industries plc v Dickman [1990] 2 AC 605 and has since been developed in a number of subsequent cases. The law is analysed in Jackson & Powell on Professional Liability, 6^th edition, chapter 31. At paragraphs 17-031 a number of factors are considered, which are relevant to whether the particular situation has given rise to a duty in respect of the loss which is claimed. These are: (1) the purpose for which the statement was made; (2) the purpose for which the statement was communicated; (3) the relationship between the advisee and any relevant third party; (4) the size of any class to which the advisee belongs; (5) the state of knowledge of the adviser; (6) reliance by the advisee. I have already held that factor (6) is not established. However putting that aside, and having considered the authorities to which I was referred and the discussion in Jackson & Powell, I have concluded that Mr Smith did not owe Mr Rushmer a duty in respect of Mr Rushmer's liability as the guarantor of Avam's overdraft. I have found that Mr Rushmer did not tell Mr Smith that he was a guarantor. Further, I am satisfied that the guarantee was never discussed, and that in particular Mr Rushmer never asked Mr Smith for advice relating to his position as guarantor. In these circumstances it would not be reasonable to regard Mr Smith as having assumed such a duty of care.
74. There is, however, a second and more clear cut reason why there can be here no such duty of care. There can only be such a duty in respect of damage which falls within the scope of the duty: Banque Bruxelles Lambert v Eagle Star Insurance Co Ltd [1997] AC 191. Loss which is irrecoverable under the principle of reflective loss considered by the House of Lords in Johnson v Gore Wood [2002] 2 AC 1 therefore falls outside the scope of the duty. Mr Rushmer's liability under the guarantee is caught by the reflective loss principle: Humberclyde Finance Group Ltd v Hicks Neuberger J, 14 November 2001, paragraphs 97-99. I refer also to Gardner v Parker [2004] EWCA Civ 781, [2004] 2 BCLC 554 where in paragraphs 67 to 75 Neuberger LJ considered the position of a shareholder/creditor: Mr Rushmer is a shareholder/creditor. But even if the principle of reflective loss is not considered as part of the consideration of whether there was a duty, it will nonetheless apply to prevent Mr Rushmer recovering.
75. Mr Peter Knox QC submitted that the reflective loss principle did not apply here, because Avam would not have been able to recover the alleged reduction in its assets which followed from Mr Smith's negligence and its continuing to trade as it did. He submitted that this followed from the application of the decision of the Court of Appeal in Galoo Ltd v Bright Grahame Murray [1994] 1 WLR 1360. The facts there, much abbreviated, were as follows. The defendant accountants were required by an agreement for the purchase of shares in a company to calculate the profits of the company for a year. The accountants failed to uncover that the company records included fictitious stock to the value of £15 million. The claims against the accountants included claims for subsequent trading losses, which was said would not have occurred because if the accountants had not been negligent the company would have been caused to cease to trade. It was held that the negligence of the accountants could not be said to have caused the trading losses but had simply provided the opportunity for them to occur: the losses followed from the trading not from the negligence relating to the fictitious stock. In short the company might have trading profitably or it might have traded at a loss. The claim for the trading losses was struck out. Mr Mark Cannon QC submitted that Galoo was to be distinguished because here Mr Rushmer asserted that Mr Smith had negligently represented that the company was profitable when it was not, and that if the representation had not been made he would have wound down the trading and protected his position as Avam's guarantor.
76. This situation was to be contrasted with that in Galoo where there was no allegation that the company's trading was unprofitable. I consider that the distinction made by Mr Cannon is a valid one. Accordingly, in my judgment Mr Knox's attempt to avoid the application of the principle as to the recoverability of reflective loss cannot succeed.
77. The last matter of law is whether the settlement of Mr Smith's action against Mr Rushmer is a bar to Mr Rushmer's claim because in the circumstance it is an abuse of the court's process to raise the claim in these separate proceedings. I have set out in paragraph 60 the history of the action and quoted from Mr Rushmer's witness statement made in it. The principle to be applied is that classically stated in Henderson v Henderson (1843) 3 Hare 100 at 114. The principle was considered by Lord Bingham in Johnson v Gore Wood & Co [2002] 2 AC 1 at 31. To pick two dicta only from the passage : "there will rarely be a finding of abuse unless the later proceeding involves what the court regards as unjust harassment of a party"; "a broad merits based judgment …. focussing on the crucial question whether, in all the circumstances, a party is misusing or abusing the process of the court by seeking to raise before it the issue which could have been raised before." Applying those tests I do not consider that the county court proceedings and their settlement should in the circumstances bar Mr Rushmer's present claim. That would be unjust to him, and to let the claim proceed is certainly not to permit an unjust harassment of Mr Smith.

D. Conclusion

78. The action fails.