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Scant consolation for Patisserie Valerie shareholders

The accounting scandal at Patisserie Valerie fed into the controversy over UK audit, but it also highlighted the issue of personal liability at board level
September 27, 2021

The Financial Reporting Council (FRC) has fined Grant Thornton £2.3m for audit failures relating to the collapse of Patisserie Valerie at the end of 2018.

The regulator has also slapped sanctions on David Newstead, audit engagement partner, in relation to the firm’s audit of the café chain for the financial years ended 30 September 2015, 2016 and 2017. These include an £87,750 fine and a three-year prohibition from carrying out statutory audits.

Grant Thornton is now required to report to the FRC annually for three years on the impact of remedial actions, as well as the signing of an effective ‘mea culpa’ document, relating to “a pattern of serious lapses in professional judgement, failures to exercise professional scepticism, failures to obtain sufficient appropriate audit evidence and / or to prepare sufficient audit documentation”. Claudia Mortimore, deputy executive counsel to the FRC, highlighted “missed red flags” on sales and cash generation and insufficient scrutiny on the part of the auditor.

You could argue that the auditor got off lightly when you compare fines levied on some of its rivals for audit failures, along with the call for more punitive fines brought about by the Clarke review. Even in 2018/19, the year prior to the pandemic, the FRC levied fines amounting to £42.9m, a threefold increase on the prior 12-month period.

Separately, however, Grant Thornton confirmed that it had no intention of rolling over in a legal case brought by Patisserie Valerie’s liquidators, pointing to failures on the part of the chain’s management to detect fraudulent practice. This stance is understandable given the Serious Fraud Office (SFO) is investigating Patisserie Valerie, having arrested its former finance director and a handful of other bosses in 2019.

The black hole in the chain’s accounts not only added to the sense of frustration over the UK audit complex, but it also raised questions over the extent to which directors should be able to shelter behind the protection of their company’s status even if it is part of a publicly listed enterprise.

Direct lawsuits brought by shareholders are limited in scope from a practical perspective, enabling recourse in a shareholder’s right to vote, or due to a violation of pre-emptive rights. It also applies when shareholders have been denied access to certain records, or if distributions that were promised have not been fulfilled.

However, it is possible for shareholders, with the permission of the court, to bring a claim against a director in the name of the company, assuming there has been a breach of duty, fiduciary or otherwise, or even negligence on the part of a director. This is called a 'derivative' action. 

A court will only grant permission for a formal legal action to proceed if it considers it to be in the best interests of the company, a somewhat subjective appraisal, though a critical safeguard against frivolous claims or those clearly not in the company’s best interests.

In the age of the activist investor, it is probably just as well that the courts have the final say, as these types of actions could be used to put pressure on directors to, say, give way on a merger proposal, or some other corporate action, particularly if they feared they were faced with the prospect of personal liability over a corporate governance issue.

So, it remains an unlikely route for shareholders to seek any form of restitution. Earlier this year, the SFO contacted Patisserie Valerie shareholders asking them to complete a questionnaire to assist them with their enquiries, but unfortunately the horse had already bolted by that stage.