The first shot across the bow: Hong Kong court allows Evergrande claim against PwC International to proceed

The case against PwC International

The liquidators allege that PwC International was responsible for the PwC global brand and for maintaining consistent standards across the network, including the standards, resources, competence, independence, and quality control of the audits. The claim also relies on a number of pleaded facts, including:

• PwC International's constitutional documents give it a wide-ranging role to oversee the network, including developing, monitoring, and promoting common standards and practices across member firms
• PwC International's power to place member firms under "supervised remediation" and impose leadership changes
• Alleged review activities involving personnel from across the PwC network in the Evergrande audits
• Public statements made following Mainland regulatory findings concerning the Evergrande-related Hengda Real Estate audits

The liquidators contend that PwC International owed Evergrande a duty to exercise reasonable care and skill in monitoring and reviewing the audits and audit functions of the local member firms and ought to answer the allegations against it despite not having a contractual relationship with Evergrande or having carried out the audits.

Why PwC International sought a strike-out

PwC International argued that there had never been any contract, communications, or direct dealings between it and Evergrande. It also maintained that it did not perform the audits, was not qualified to conduct audits in Hong Kong, and received no remuneration for the audit engagements.

PwC International further relied on provisions in the engagement letters where Evergrande agreed not to bring claims against other PwC entities in connection with the audit services.

PwC's position was therefore that PwC International was not a party to the engagement and no duty of care was owed by it. The claim against it should therefore be struck out.

Court: the claim is arguable

The Court rejected PwC International's arguments.

Deputy High Court Judge Patrick Fung SC considered a line of authorities emphasising that a strike-out application is a drastic remedy and that a claim should only be struck out where it is unarguable or almost incontestably bad. All the facts pleaded in the subject pleading must also be assumed to be true.

After reviewing the pleadings, the Court held that the liquidators had pleaded all the essential elements of a negligence claim against PwC International, including:

• Its governance and oversight role within the PwC network
• Its participation in audit review processes
• Reliance by Evergrande
• Knowledge, breach, and causation
• Resulting loss

The Court concluded that it was at least arguable that PwC International owed the Group a duty of care. It further observed that not all the relevant facts were known and that discovery and interrogatories would likely throw more light on the case. In those circumstances, the issues should be explored through disclosure and determined at trial rather than on a preliminary strike-out application.

One of PwC International's strongest arguments was the engagement letter provided that Evergrande agreed not to pursue claims against other PwC entities for claims relating to the audit services. However, the Court considered that a number of issues remained to be determined, including whether PwC International falls within the relevant contractual definitions and is entitled to rely on the contractual protection. The Court also noted the liquidator's argument that any exclusion of liability would need to satisfy the statutory requirement of reasonableness under the Control of Exemption Clauses Ordinance (Cap 71). Despite the relative strength of those arguments, they did not overcome the high threshold of making the claim unarguable or almost incontestably bad.

Key takeaways

1. Whether PwC International owes duties is still unresolved

The judgment does not determine that PwC International owed Evergrande a duty of care, nor that it is liable for any losses allegedly suffered by Evergrande. The decision only means that the claim met the relevant sufficiently arguable threshold to justify the continuation of proceedings.

PwC International relied on provisions in the engagement terms designed to prevent claims against other PwC entities. The Court did not decide whether those protections are effective which remain to be resolved.

2. Network firms remain in focus

The claim is notable because the audits were carried out by local PwC firms, but the liquidators have also sued PwC International. The case therefore raises important questions about when a global network entity may be exposed to claims arising from the work of member firms.

The liquidators rely heavily on allegations that PwC International set standards, monitored audit quality, carried out reviews, and had powers to intervene in member firms' affairs. The case illustrates how well intentioned network-wide quality control and oversight arrangements are increasingly being relied upon by claimants seeking to establish a duty of care.

3. Discovery may be pivotal

The judgment highlights the importance of discovery in complex network-firm disputes. Parties will now have an opportunity to examine the documentary evidence relating to PwC International's oversight and review functions and gain an insight into the operations of the global firm.

4. A reminder of the challenge facing global networks

Well intentioned strong oversight and quality assurance processes help improve audit quality and protect a firm's reputation. At the same time, claimants are increasingly seeking to rely on those same arrangements as evidence that the network entity assumed responsibility for the work of member firms.

5. Implications for Swiss Verein and similar network structures

The judgment will attract attention across the professional services sector, particularly among the Big Four accounting networks and other global organisations that operate through an umbrella with legally separate member firms but brand themselves as being one firm.

Conclusion

The judgment suggests that the practical operation of such structures may take precedence over formal corporate, contractual, and professional separation. This is despite the good intentions and necessity of such structures for corporate governance and ultimately the benefit they bring to the industry by coordinating the raising and maintaining of standards across disparate member firms. The sound of this warning shot across the bows of professional firms is reverberating around the world but only time (and evidence) will tell whether this claim has any real substance to it.