Abound Catering, Conventions & Receptions Pty Ltd v Bizane Pty Ltd [1999] VSCA 53

"9.1 The Vendor, and separately the Covenantors, jointly or [sic] severally hereby warrant:-

(a) that the copies of the financial statements attached to this Agreement were prepared in accordance with general [sic] accepted accounting principals [sic] consistently applied and that they represent the financial position of the Business and the results of its operation [sic] on the respective dates or periods mentioned therein.

(b) that the contents of the other documents attached to this Agreement are, to their best information and belief, true and correct.

14 The parties hereby acknowledge and declare that this Agreement embodies the whole of their agreement in relation to the sale and purchase of the Business sold hereunder and all other express or implied conditions warranties statements assurances or representations verbal or written whether imposed by statute common law or otherwise are hereby expressly negated and excluded to the extent permissible at law."

14. The financial statements referred to in clause 9.1(a) included an Interim Trading and Profit and Loss Statement for the period ended 31st December 1992 ("the interim statement"). The interim statement was in the following terms:

"ABOUND CATERING, CONVENTIONS & RECEPTIONS PTY.LTD.

45. After a trial occupying 12 days in the Commercial List Hansen, J. found that both the gross profit from trading and the net profit were overstated. The gross profit should have been $120,061 and the net profit should have been $79,588. As the interim statement did not accurately represent the results of the operations of the business for the period to which it related, there was a breach of the warranty in clause 9.1(a). The learned judge rejected Bizane's other claims, leaving the parties to calculate the quantum of damages in the light of his findings concerning the net profit that should have been shown in the interim statement. No criticism is made of the reasons for judgment which his Honour published on 3rd October 1997. They have been overtaken in one immaterial respect by the recent decision of the High Court in Astley v. Austrust Ltd. (1999) 161 A.L.R. 155.

48. On 31st October 1997 the learned judge heard submissions as to the amount of damages, interest and costs. He published further reasons for judgment on 4th December 1997. No challenge is made to his Honour's decision on the question of costs. The appeal relates to the amount of damages and a cross-appeal by Bizane relates to interest.

52. Hansen, J. calculated the damages for breach of warranty as $375,552 on the basis that the true value of the goodwill, for which Bizane had paid $500,000, was $124,448. The true value of the goodwill was calculated in three steps:

(a) The net profit for the period of six months ended 31st December 1992 was $79,588. To double that figure in order to produce a figure for the whole year would ignore seasonal factors. Accordingly an annualization factor of .57 was applied. The net profit divided by the annualization factor was $139,628.

(b) If the net profit shown in the interim statement is divided by the same annualization factor the result is $243,812. One generally accepted method of valuing a business based on earnings is to apply a multiplier to the earnings before interest and tax. If those earnings had been $243,812 and the purchase price of $892,175 represented the value of the business based on earnings, the implied multiplier to one decimal place is 3.7.

(c) The earnings before interest and tax calculated in accordance with step (a) were $139,628. (There was no relevant interest to be added back.) Applying the same multiplier, the result is $516,623. The value of the goodwill is ascertained by subtracting debtors and stock ($392,175) from that figure.

58. Mr. O'Callaghan, Q.C, who appeared with Mr. Peters for Abound, advanced three contentions. The first was that there was no evidence from which his Honour could calculate the true value of the goodwill and accordingly Bizane was entitled only to nominal damages. The second and the third contentions were advanced in the event that the first was rejected. The second contention assumed that the methodology explained above was appropriate. In that event it was said that the correct multiplier was 4.54. The third contention was that that methodology was not appropriate and the damages should have been calculated by reference to gross profit alone.

61. The starting point for those contentions was that the interim statement related only to past profits. Indeed it related only to the profits earned in the period of six months ended 31st December 1992. The appellants had in fact refused to give a warranty about future earnings. I doubt that that can be taken into account in construing the agreement, except perhaps to negate an implied term: see Codelfa Construction Pty. Ltd. v. State Rail Authority of N.S.W. [1982] HCA 24; (1982) 149 C.L.R. 337 at 352-353. The doubt does not matter because the interim statement and the associated warranty plainly do relate only to the past.

64. Counsel submitted that, even if the adjusted interim statement established the profits earned in the period of six months ended 31st December 1992, it was not evidence of the profits for the whole financial year or evidence of future earnings. It was wrong even to annualize. Bizane was in the same position as the respondents in J.L.W. (Vic.) Pty. Ltd. v. Tsiloglou [1994] VicRp 16; [1994] 1 V.R. 237 or, more charitably, the plaintiff in Hall v. Queensland Truck Centre Pty. Ltd. [1970] Qd.R. 231: see especially 241-246, 248-249 and 251 in the former case and 236-237 in the latter.

67. I do not accept that the profits earned in a period of six months afford no evidence of the profits for the whole financial year or of future earnings. There might be cases in which that was so and, more often, cases where there was other countervailing evidence. In the present case, however, the learned judge made no finding about the profits of the business after 30th June 1993. The annualization factor of .57 is no longer challenged as such and was open on the evidence. In my opinion his Honour was entitled to find that the earnings before interest and tax for the year ended 30th June 1993 were $139,628.

70. The methodology Hansen, J. adopted to calculate the true value of the goodwill had been advanced by Mr. Wight of Ernst & Young, an accountant called by Bizane. (The appellants' accounting witness was Mr. Marsh of Pannell Kerr Forster.) In paragraph 5.2 of a report dated 18th February 1997 Mr. Wight said that that was how he would value the goodwill of the business if its adjusted earnings for the period of six months ended 31st December 1992 were positive, as his Honour found them to be. It would not be correct to say that Mr. Marsh accepted Mr. Wight's methodology, but he did not question it. He adopted it for comparative purposes and advanced no alternative methodology: see page 1 of the reasons of judgment published on 4th December 1997. I do not decide whether, in those circumstances, it was open to the appellants to argue, on 31st October 1997 or before us, that the only methodology of which there was expert evidence, or the multiplier which formed part of it, was inappropriate to value the goodwill: cf. Fry v. Oddy [1998] VSCA 26 at [31], [46]-[47] and [74]. It is preferable to deal with Mr. O'Callaghan's second and third contentions on their merits.

73. In paragraph 5.2 of his report Mr. Wight said that Bizane was prepared to pay $892,175 for the business "based on the earnings before interest and tax ... of $138,973 of the business for the six months ended 31 December 1992". The "required rate of return of Bizane", he continued, might be derived by annualizing the sum of $138,973 and dividing it into the agreed purchase price. That resulted in a multiplier of 3.7, being a rate of return of 27 per cent. None of the foregoing implies that the warranted figures were being taken as anything other than what they were, namely figures relating only to a past period, or that the multiplier was based on a false premise. (That it was based on a false premise was the lynchpin of counsel's second contention.) Mr. Wight was not referring to the rate of return subjectively expected by Bizane, or factored into its own decisions, but to the rate of return implied by the terms of the agreement. As he said in answer to the third question he was asked in cross-examination, 27 per cent was "the implicit rate of return that was built into the original contract based on goodwill of 500,000 and annualised earnings of about ... $240,000".

76. Goodwill reflects the capacity of a business to generate future profits, but to derive a multiplier from the agreement in that way is not to imply a warranty about future earnings of the kind that the appellants expressly refused to give. Bizane could not, for example, have sued Abound for breach of an implied term of the agreement if the rate of return on its investment proved to be less than 27 per cent.

79. Mr. O'Callaghan's multiplier of 4.54 was based on Bizane's actual expectations in July 1993. In a forecast prepared for its bankers it estimated profit before tax in the year ended 30th June 1994 at $196,470. The multiplier of 4.54 is the result of dividing that figure into the purchase price. There was some debate as to whether $196,470 was truly an approximation of earnings before interest and tax, but that need only be noticed in passing. The real issue is whether it is appropriate to have regard to Bizane's actual expectations as evidenced by the forecast prepared in July 1993 or at all. In my opinion it is not appropriate.

82. Bizane conducted a due diligence inquiry in June 1993 in the course of which, in his Honour's words, it became aware, to a greater or lesser extent, of the inaccuracies in the interim statement. There was insufficient information to complete the inquiry to Bizane's satisfaction. At a meeting held at the offices of Abound's solicitors on 26th June 1993 its representatives therefore required the deletion of a clause 14.1 which his Honour found to be in the following terms:

"14.1 The Purchaser hereby acknowledges and declares that the Purchaser is entering into this Agreement as the result of the Purchaser's own enquiries and investigations and upon its independent assessment of the Business and not in reliance on any representation statement assurance warranty or promise made or given by the Vendor or the Directors of the Vendor or the Vendor's servants contractors agents or any person or corporation on behalf of the Vendor to the Purchaser and/or the Guarantors in respect of the subject matter of this Agreement."

That does not correspond with the clause referred to in the agreed summary of facts (F259). It is similar to, although not identical with, the clauses at F207 and F227.

87. Bizane's representatives also insisted that the warranty in clause 9.1(a) remain. It would not be correct to say that that was notwithstanding the due diligence inquiry. It was because of that inquiry. As the learned judge said, Bizane's insistence was founded on the fact that the appellants had given Bizane only limited information concerning the business. He continued:

"If emphasis of the significance of the presence of cl.9.1(a) and the removal of cl.14.1 is required it is found in the evidence which I accept that at the meeting Kotler, when faced with Martin's requirements, asked Kratzer if the interim statement was correct to which he replied that it was and that he was willing to warrant it. According to Parker, Kotler also said to Kratzer that he recommended that cl.9 not be included unless he was satisfied that the financial documents are true and correct. When Kratzer said he was satisfied, Kotler queried whether he was sure to which Kratzer responded he was. This evidence was not challenged and Kotler was not called. I accept the evidence."

Mr. Kotler was Mr. Kratzer's solicitor. A little later his Honour characterized the information that had been given to Bizane in the course of the due diligence inquiry as inadequate or incomplete.

92. In his reasons for judgment published on 4th December 1997 Hansen, J. referred to his earlier findings and characterized clause 9.1(a) as a "contractual warranty in respect of the accuracy of which [the appellants] undertook the risk". I agree. It does not matter that the due diligence inquiry was sufficient to prevent Bizane from being misled by the warranty. It relied on the warranty not as being accurate but as a term of the contract. The bargain struck by the parties was that Abound, and the second and third appellants as the Covenantors, would accept the risk to which his Honour referred. Damages are not assessed in limbo; they are determined in accordance with, and must reflect, the contract. To calculate them in this case as the learned judge did was not to give Bizane an uncovenanted advantage, thereby placing it in a superior position to that which it would have been in had the warranty not been breached: cf. The Commonwealth v. Amann Aviation Pty. Ltd. [1991] HCA 54; (1991) 174 C.L.R. 64 at 82, 99, 116, 136 and 152. There is no suggestion that Bizane deceived any of the appellants or acted unconscionably.

95. When the matter is approached in that way, it will be seen that Bizane's subjective expectations are irrelevant. It did not contract on the basis of the rate of return that it thought it could achieve.

98. Mr. O'Callaghan's third contention was that damages should have been calculated by reference to gross profit alone. In September 1994 Bizane's solicitors asked Messrs Ernst & Young to comment on the price paid for the business if, in their opinion, Abound had overstated achievable gross profit. They were asked to take into account, among other things, the return on investment reasonably expected by Bizane and the effect of valuation errors on the value of stock acquired. In those circumstances it is not surprising that, in a letter of advice dated 9th November 1994, they included calculations based on gross profit, including a multiplier of 4.57. Mr. Wight denied in cross-examination that that was a valuation of goodwill. The letter was based on the information available at the time. He gave uncontradicted evidence that it was not appropriate to value goodwill on the basis of gross profit. This contention, too, should be rejected.

102. It was common ground that Bizane was entitled to damages in the nature of interest, at the rate fixed under s.2 of the Penalty Interest Rates Act 1983, from the date of commencement of the proceeding to the date of judgment. At the hearing on 31st October 1997 Bizane also sought damages calculated as interest from the date of settlement under the agreement to the date of commencement of the proceeding, those damages being sought on the basis explained in Hungerfords v. Walker [1989] HCA 8; (1989) 171 C.L.R. 125. Junior counsel for Bizane said that his client had borrowed money to finance the acquisition of the business and that financial statements were in evidence, but he did not identify or rely upon any particular piece of evidence to show what had happened or what the appropriate rate should be. He merely sought interest on the sum of $375,552 at the statutory rate. In those circumstances his Honour concluded that the claim had not been established.

105. I agree with that conclusion and do not think it should be disturbed. Proceedings in the Commercial List are not a preliminary skirmish, the real battle being fought in the Court of Appeal: cf. Saffron v. Société Minière Cafrika [1958] HCA 50; (1958) 100 C.L.R. 231 at 240; Coulton v. Holcombe [1986] HCA 33; (1986) 162 C.L.R. 1 at 7 and the cases referred to in Fry v. Oddy at [75]. The statutory rate was not appropriate. At the hearing of the cross-appeal Mr. Young, Q.C., who appeared with Mr. Sifris for Bizane, contended instead for 10 per cent, which was the default interest rate under the agreement, or an estimate of the actual interest paid on shareholders' loans. An alternative head of loss was also proffered, on the assumption that the cost of vendor finance would not have been incurred but for the overpayment to Abound. I express no opinion as to whether any of those claims might may be established by the evidence. The only basis on which the claim was made below was rightly rejected.

108. For these reasons I would dismiss both the appeal and the cross-appeal.

118. I agree that the appeal and cross-appeal should be dismissed for the reasons stated by Callaway, J.A.