When does delay not cause prejudice: Different rules applied to audit proceedings

Background

The Plaintiff, China Lumena New Materials Corp (China Lumena), is a Cayman Islands-incorporated company in provisional liquidation. The Defendant, BDO Limited (Auditor), was China Lumena’s auditor for 2010, 2011 and 2012. The underlying proceedings relate to the Auditor’s audits of China Lumena’s consolidated financial statements during those years.

The action against the Auditor was commenced in 2018 by China Lumena’s provisional liquidators with a statement of claim (SOC) filed in February 2019. In the absence of the Hong Kong court's recognition of their appointment as provisional liquidators and therefore unable to exercise liquidators' powers to obtain information and documents from the Auditor, the liquidators relied on public sources, including short-seller research reports, publicly available credit reports and financial analysis conducted by the liquidators to prepare the SOC.

The Auditor’s audit working papers for the relevant audits were disclosed during the discovery process in late 2024. Around the same time, the liquidators obtained judgments in criminal proceedings in Mainland courts involving former directors and senior management of the China Lumena group and additional Mainland tax filings of China Lumena's subsidiaries.

China Lumena's amendment application

In April 2025, China Lumena applied for leave to amend its SOC. The proposed amendments sought to incorporate matters arising from the audit working papers obtained through discovery, the Mainland judgments and other materials subsequently obtained. The amendments refined China Lumena's pleaded case on loss and damage and reduced the quantum of their claim.

The Auditor opposed the applications on three grounds:

1. The proposed amendments fell outside scope of the Writ of Summons and were misconceived
2. The amendments relied extensively on the Mainland judgments and amounted to impermissible pleading of evidence rather than material fact
3. There had been exceptional delay in bringing the amendment application, which would:
1. Prejudice the Auditor that could not be remedied by costs, including requiring the Auditor to investigate matters beyond what could reasonably have been anticipated when the claim was first advanced
2. Prejudice, embarrass or delay a fair trial of the action considering that several team members of the Auditor had long left and memories will have faded after such a long period of time

The Court of First Instance's ruling

Despite the delay, the Court of First Instance allowed China Lumena's application for leave to amend its pleadings.

First, the Court rejected the argument that certain amendments relating to the audit of a subsidiary acquired by China Lumena in 2011 were outside the scope of the action.

Secondly, the Court addressed the objection that the amended pleadings impermissibly pleaded evidence by referring extensively to findings and summaries of witness evidence in the Mainland judgments. The judge observed that the distinction between material facts and evidence is not always clear-cut, and concluded that it was not plain and obvious that the proposed amendments crossed that boundary. Therefore, the Court took the view that the Auditor would not be placed in an embarrassing position in pleading its response.

Thirdly, on the critical issue of delay and prejudice, the Court accepted that the underlying events were historic and the amendment application was made several years after the proceedings were commenced. However, the judge emphasised that the critical question was whether the specific amendments would cause prejudice that could not be addressed through costs or case management directions. In assessing this issue, the Court took into account:

1. That the complexity of the case and technicality of audit working papers, which involved multiple years of audit work relating to a listed corporate group operating in a specialised industry and voluminous evidence, meant the liquidators would need more time to consider and prepare the amendments to pleadings
2. The size of the claim and corresponding need for care and prudence on the part of the liquidators when formulating amendments
3. The timing at which the new materials resulting in the proposed amendments became available to the liquidators

The Court emphasised that auditors are professionally obliged to document their audit procedures in a manner that enables an experienced auditor with no prior involvement in the audit, to understand: (a) the nature, timing and extent of the audit procedures performed, (b) the results of the audit procedures and the audit evidence obtained; and (c) the significant matters arising during the audit and the conclusions reached. Staff departures and fading memories would therefore not cause prejudice to the Auditor's ability to defend the claim.

Takeaways and implications

This decision emphasises the higher expectations placed on professionals, particularly auditors, by the courts which in turn reflects the higher standards to which the wider public holds professionals to account.

Nevertheless, where the higher standard not only results in auditor conduct being viewed through a more critical lens but also goes further and allows prejudice to be suffered which against other types of defendant would not be tolerated, auditors may be justified in feeling that they are receiving short shrift by having to follow a different set of rules. Delays in amending pleadings cause those pleadings to become moving targets, increasing the difficulty and complexity of defending such actions. Late amendment ought therefore only be allowed in the most limited and justifiable of cases and plaintiffs should be required to get their case right the first time, using available tools to obtain necessary information.

Given the magnitude of the proceedings and the length of time that had passed since they were issued, questions may arise over why the provisional liquidators did not obtain full recognition or otherwise cause the company to be wound up by the Hong Kong courts. Had they done so it would have allowed them or others appointed to exercise Hong Kong liquidators' broad immutable powers of investigation to obtain all necessary information before launching this action.

In any event, given this is a first instance decision, it will be interesting to see whether higher courts or other judges adopt this approach in similar proceedings against auditors and other professionals.