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[2012] NSWSC 420
Supreme Court of NSW
2012-04-19
Ward J, Macready J
Original judgment source is linked above.
Judgment 1HIS HONOUR: This is the hearing of a reference to me to determine the amount to be paid for the purchase of the shares in accordance with orders made by consent by Ward J on 14 March 2011. The orders were amended on 21 April 2011 in some minor respects.
Background facts. 2The first defendant is a company ("the Company"), which carries on a business of hiring security fencing used on construction sites and venues. It also does some minor amount of sales of such fencing. Normally it purchases fencing for the purpose of both aspects of its business from its Australian supplier. Recently during the burst of construction activity during the governments recovery boost it has sourced some of its supplies from China. Although the Chinese stock has a cheaper purchase price the terms of trade add additional costs to the purchase price. 3The two plaintiffs between them own 47.2% of the shares in the company, the second defendant, Mr John Callaghan also owns 47.2% and the third defendant Mr Grant owns the remaining 5.6%. 4The two plaintiffs were formally married but are now divorced and there are orders of the Family Court which deal with the ownership of the shares which effectively are now owned by the first plaintiff. 5The Second Defendant and his son have been operating the Company in recent years and the business relies upon them as key individuals. The Plaintiffs have made no significant recent capital or other contribution to the business. The initial capital contributions were originally in the order of $200,000 each. The capital contributions in recent years in order to expand its business have been the Second Defendant and his family's loans of $1.3 million to the Company. 6The Plaintiffs were unhappy as to the operation of the Company. Pursuant to consent Short Minutes of Order dated 14 March 2011 the parties agreed that the affairs of the Company had been conducted in breach of the Corporations Act 2001 (Cth), which then gave the Court jurisdiction to make orders for the acquisition of the shares in the Company. The shareholders of the Company consented to a regime whereby the Court was to value the shares in the Company and in default of the parties electing to buy the shares in the Company for that stated valuation the Company would be placed into liquidation. 7A copy of the short minutes of order is annexure A to this judgement. 8The parties in substance agreed in the Amended Short Minutes of Order to what is known as a "Savoy" or "Shotgun" type process. That is, the Court's valuation can firstly be taken advantage of by the Second Defendant to (within 60 days) purchase the shares of the Plaintiffs in the Company at the Court's valuation. If the Second Defendant elects not to purchase the shares within that period, then the Plaintiffs have the opportunity to (within a further 60 days) purchase the shares of the Second Defendant in the Company at the same valuation. 9Upon either party electing to purchase the shares in the Company of the other party, they must also as part of the sale process, discharge the obligations of the Company to repay the loans to the Company associated with the party selling its shares. In the case of the Second Defendant buying the Plaintiffs shares, that means that even if the shares are assessed to be of no or some value, the Second Defendant will have to cause repayment of the loan to the Company by the Plaintiffs in the amount of $194, 771 within 60 days of a determination of value by the Court plus whatever monetary sum (if any) the Court assesses is the value of the shares. 10In the case of the Plaintiffs buying the Second Defendant's shares, that means that even if the shares are assessed to be of no or some value, the Plaintiffs will have to cause repayment of the loan to the Company by the Second Defendant and his family associates in the amount of about $1.5 million within a further 60 days plus whatever monetary sum the Court assesses is the value of the shares.
The valuation evidence 11The plaintiffs called Mr Thompson to give valuation evidence. Mr Thompson valued the shares in his first report in the range of $1,296, 652 to $1,817,672. Unfortunately Mr Thompson made a gross error in his first report by valuing the business instead of the shares imputing a value for the shares based upon the business value. His first valuation failed to take into account the significant debt in the Company. It resulted in an over valuation on his methodology. Mr Thompson, recognising his error when identified by Ms Exner, the valuer called by the defendant, then valued the shares in the range of $293 348 and $811 604. The first report by Mr Thompson therefore significantly over valued the shares.
Ms Exner's Evidence 12As I have mentioned Ms Exner gave evidence for the defendant and she concluded that the value of the company as a whole was a negative figure of $24,635. 13Because of the part her valuation plays in the resolution of this matters it is useful to set out the basis of her conclusions. In paragraph 3.28 of her report which is Exhibit 2 in the proceedings she set out her assumptions including the following: "(a) The financial documents referred to in this report and listed in Appendix B hereto can be relied upon (b) Trade debtors, as disclosed in the Company's financial statements are fully recoverable at the Valuation Date (c) In the absence of a formal market valuation of fencing product that is held by the Company for its sale activities (and classified as trading stock), the carrying value of these assets, as disclosed in the Company's financial statements, is assumed to be valued at the lower of cost and net realisable value at 30 June 2011 (d) In the absence of a formal market valuation of any fixed assets held by the Company at 30 June 2011 (including the fencing hire assets), such assets are assumed to be recorded at fair market value (e) The remuneration paid to or for the benefit of Brendon and John Callaghan for their respective roles and responsibilities in the Business is set at commercial rates." 14She adopted a methodology which was the capitalisation of Future Maintainable Earnings ("FME") of the business. 15She described the steps for determining the valuation in clause 4.5 as follows: 4.5 Adopting the capitalisation of FME methodology, it is necessary to undertake the following steps: (a) Assess the 'normal' level of earnings of the business in the years immediately prior to the date of valuation. In the case of privately owned businesses, the historic reported operating profit (or loss) of the entity housing the business (e.g. the company or trust) can be considerably different to what the historic operating profit (or loss) of the core business would have been, had the business been operating in isolation of other activities that are outside the business and operating on a stand alone basis (i.e. paying commercial rates for all expenses, including the remuneration of the owners) under normal trading conditions (i.e. without any abnormal or non-recurring items of revenue or expense). This process of 'normalisation' of earnings of the core business is also discussed in Appendix C, at paragraph 5. (b) Assess the FME of the business. The normalised historic earnings of the business (as assessed above) is an indicator of the maintainable earnings that the business can generate each year into the future (otherwise known as the FME). The FME of the business should also have regard to the expected future earnings of the business, as set out in any budgets or forecasts in existence at the date of valuation, if such documents have been prepared (and if such documents can be relied upon). Earnings can be measured on several different bases. In the present case, I have measured earnings with reference to earnings before interest and tax (EBIT) for the reasons set out in paragraph 7.14 below (c) Select an appropriate earnings multiple (or capitalisation rate) for the particular business at the date of the valuation. The earnings multiple chosen is a matter of professional judgment of the valuer. The multiple (or capitalisation rate) should complement the measure of earnings determined in (b) above and should also reflect the risk and growth potential of the business itself and the industry and economy in which it operates. The capitalisation rate is the mathematical inverse of an earnings multiple. For example, a capitalisation rate of 20% is the equivalent of an earnings multiple of 5. (d) The FME of the business (assessed in (b) above) is multiplied by the selected earnings multiple (in (c) above). Alternatively, the FME of the business is divided by the equivalent capitalisation rate. Either method provides the same result. This result represents a value for the business as a whole (this can also be referred to as the "enterprise value" of the business) (e) The value of the business as a whole (as calculated in (d) above) is then compared to the value of net tangible assets utilised in operating the business (referred to as the Net Business Assets). It is necessary to have regard for this factor because a potential buyer would need to acquire these net assets if the business were sold. The difference between the value of the business as a whole (as calculated in (d) above) and the Net Business Assets represents the value of the intangible assets of the business (which are referred to in this report collectively as the 'goodwill' of the business). In the circumstances where the value of the business (under the capitalisation of FME methodology) exceeds the value of Net Business Assets (i.e. there is a positive value for goodwill), then it is appropriate to continue to adopt the capitalisation of FME methodology as the primary valuation methodology (where this is not the case, refer paragraphs 4.7 to 4.8 below) (f) The value of the goodwill of the Business as derived above is assessed for reasonableness. One way to assess the reasonableness of the goodwill amount is to compare it to the FME of the Business and in doing so, determine how long it would take a potential buyer to recoup the funds spent on the intangible assets (i.e. goodwill) acquired. 4.6 Once the value of the business as a whole has been established according to the above steps, the value of the entity housing the business (e.g. a company or trust) is determined by aggregating the value of the business and the value of any remaining non-business assets and liabilities of that entity. These non-business assets could include artwork, a portfolio of shares in listed companies (or similar investments) and these liabilities will include any debt obligations of the entity as at the valuation date. 16In section 5 of her report she analyses the financial performance of the company and its present position. She made some adjustments to the balance sheet as at 30 June 2011 and that balance sheet, including allowance for adjustments as set out in the following table: --- Dissection of Adjusted Balance Sheet --- Description per the accounts Notes Reported position Valuation Adjust-ments Adjusted Balance Sheet Business Surplus/ Goodwill Debt ASSETS $ $ $ $ $ $ Current assets CBA Seven Hills 32,199 - 32,199 32,199 Trade debtors 441,960 - 441,960 441,960 Hire product - current 1 1,470,844 - 1,470,844 1,470,844 Provision for stock loss - prior year 1 (45,470) - (45,470) (45,470) Provision for income tax 2 5,974 - 5,974 5,974 Total current assets 1,905,507 - 1,905,507 1,873,308 - 32,199 Non-current assets Security assets on hire - 70km 3 3,432,223 - 3,432,223 3,432,223 Less: accumulated depreciation 3 (2,179,199) - (2,179,199) (2,179,199) Motor vehicles - at cost 134,276 - 134,276 134,276 Less: accumulated depreciation (74,624) - (74,624) (74,624) Office furniture and equipment 16,294 - 16,294 16,294 Less: accumulated depreciation (11,252) - (11,252) (11,252) Future income tax benefit 4 - 117,797 117,797 117,797 Goodwill (as determined by Deloitte) - 100,000 100,000 100,000 Total non-current assets 1,317,718 217,797 1,535,514 1,317,718 217,797 - Total assets 3,223,225 217,797 3,441,022 3,191,026 217,797 32,199 LIABILITIES Current liabilities Sundry creditors 703 - 703 703 Trade creditors 243,117 - 243,117 243,117 Loan - Julie and Sr Morgan 5 805,273 - 805,273 805,273 Loan - JJCC 6 410,000 - 410,000 410,000 Provision for GST 50,324 - 50,324 50,324 Bank overdraft 265,818 - 265,818 265,818 Loan - John Callaghan 148,000 - 148,000 148,000 Loan - Brendon 222,077 - 222,077 222,077 Loan - John Hicks 194,771 - 194,771 194,771 Total current liabilities 2,340,083 - 2,340,083 294,144 - 2,045,939 Non- current liabilities HP Liability fences - Westpac 1,390,529 - 1,390,529 1,390,529 Less: unexpired charges (289,437) - (289,437) (289,437) HP Liability - Laurentide Car 7 28,831 - 28,831 28,831 Less: unexpired charges (4,349) - (4,349) (4,349) Total non-current liabilities 1,125,575 - 1,125,575 - - 1,125,575 Total liabilities 3,465,657 - 3,465,657 294,144 - 3,171,513 Net assets (242,432) 217,797 (24,636) 2,896,882 217,797 (3,139,315) EQUITY Ordinary A Class Shares 500 Accumulated loss (242,932) Total equity (242,432)
Source: Financial statements of Ready Fence Notes
Notes
22She then went on to determine that the value of all the shares on issue by the company was nil as at the valuation date.
Mr Thompson's evidence 23In contrast to Ms Exner, Mr Thompson purported to use the Earnings Before Interest, Tax, Depreciation and Amortisation ("EBITDA") approach. 24In final submissions the plaintiff did not rely upon the conclusions that Mr Thompson put forward in his reports as to the value of his shares. This was no doubt as a result of: (a) the initial mistake in attributing the value of the business to the value of the shares; (b) evidence that Mr Thompson had used a price earnings multiple in his capitalisation rate and not an EBITDA multiple; (c) a complete inability to explain how he calculated the 2010 depreciation number of $295,666. 25As was said in submissions: HIS HONOUR: The obvious thing that flows from those submissions is that you do not wish me to consider the actual valuation that Mr Thompson puts forward, you are now basing it on hers, no doubt, in some respects, relying on what he said about some aspects. HARRIS: I think that his methodology was, perhaps, flawed, but that does not mean that you completely ignore his evidence. For example, he said that depreciation needed to be adjusted so as to be realistic. That is undoubtedly true, in my submission. He said that a control premium was appropriate, and that appears now to be accepted. He said that when calculating future maintainable earnings, one should assume or add a 7.5 per cent increase on the past maintainable earnings, and that is not agreed. But when one looks at the reasons why he came to that conclusion, and in the absence of any compelling evidence to the contrary, you ought to accept that. And, then, I concede that his range of multiples was incorrect, but the factors that he identified as justifying a multiple which was towards the top of the range, apply equally to Ms Exner's range as they do to his range. Again, in the absence of any evidence that there is some very significant whisk to this company, or there are significant problems, or anything of that nature, the multiple ought be set towards the top of the range, in my submission. So, there are aspects of his evidence upon which I would rely, but I think that it appears that the methodology that he adopted, his formula, was not as appropriate as the formula that Ms Exner had suggested. [T 317 lines 26-50] 26Having abandoned Mr Thompson's conclusions as to valuation the plaintiff's submitted on the basis of evidence that was before the Court that applying Ms Exner's methodology produced a result of a value for the shares at $1.9 million. 27This was done by adding matters to Ms Exner's Appendix E, Appendix F, value of the business and value of the shares. These recalculations, which I will now set out, were annexures to the plaintiff's submissions. The adjusted Appendix E was as follows: Net Assets ($242,432) Add back accumulated tax depreciation $2,179,199 ________ $1,936,767
Add to maintain 2009 & 2010 accounting treatment (T182) $531,936
Subtract depreciation at 5.25% prime cost $514,980 ________ Adjusted net assets $1,953,723
28The adjusted Appendix F was as follows: 2010 2011
Net profit (375,624) (335,905) Adjustments Income not recorded (T250-253) 107,202 Interest 72,711 122,662 Leasing 76,957 88,689 Legal costs - 265,859 Depreciation 616,534 (damage etc) Depreciation 382,343 478,184 (as per tax returns) _______ _______
Less depreciation 176,995 180,191 (5.25% prime cost) _______ _______ EBIT 595,926 546,500
29The amended value of the business was as follows: 2010 and 2011 average EBIT $571,213 Add 7.5% $42,841 _______
Using earnings multiple of 6 6 x $614,054 = $3,684,324
Value of business $3.684m Adjusted net assets $1.953m _______ Goodwill $1.731 Say $1.7m
30The amended value of shares applying Ms Exner's reasoning in paragraph 6.25 was as follows: Net assets $1,953,723 Add future tax benefit 117,797 _______ $2,071,520 Say $2m
Add goodwill $1.7m _______
Value $3.7m 47.2% $1.7465 Say $1.75m
With 8% net control premium (T240.30) $1.89m Say $1.9m
31The starting point of the submissions was of course the point that Ms Exner made out that the financial documents on which she based her report could be relied upon. This proved not always to be the case. In summary, the following points were put forward by reference to the various annexures, which I have set out above. 32 Annexure E is adjusted by substantial change to the depreciation. It was suggested that the depreciation was excessive and using an actual sale of some fencing on 30 June 2011 which had been purchased earlier on 1 December 2007 the actual sale price was said to justify a flat rate or straight line depreciation of 5.25% rather than the company's 10% or 13.3% depreciation on a diminishing value method. 33There was also an add back of $531,936 to the assets due to a change in the accounts in 2011. 34In Annexure F the following amendments were made.
Depreciation in the company's accounts 37The largest asset owned by this company is its trading stock namely the fencing that is on hand and hired out or resold. One thing that did not happen in this matter is a valuation of that asset. One is thus left with book entries as to the value of this trading stock that of course has been depreciated during the period of its ownership by the company. 38However both Ms Exner and Mr Thompson agreed that it was beyond their expertise to form an opinion about whether the asset represented a fair market value and agreed that in the case of any doubt it is appropriate to have a formal market valuation of the assets. Mr Thompson did not qualify his report on the need to have a valuation. 39There was some evidence suggesting that as the fencing was spread over a hundred sites around New South Wales it would be impossible to value. That may or may not be the case and absent any evidence from a valuer about how he would go about valuing stock in those circumstances I would not conclude that it is not possible. Be that as it may the simple fact is that the parties have not commissioned such a valuation. This leads to the question raised by the plaintiff about the correct value of the stock as a result of the treatment of it in the books of the company. 40The plaintiff's submissions on this aspect are as follows: 13. Ms Exner nevertheless recognised that a willing buyer and the willing seller would go behind the depreciation figures in the accounts so as to try to identify the actual deterioration rate or value of the fence (T201.47, 202.5) and, in circumstances where the only allowance in the accounts for stock that has been lost or written off is an amount of $45,470 (being "provision for stock loss - prior years" in current assets), and where any other records of stock damaged, lost or stolen is recorded by the company's bookkeeper Julie Simpson (T255.5), but she is not called to give evidence and no such records are tendered into evidence, it ought be inferred that the only stock of the company which has been lost or destroyed, or is otherwise unusable, is contained within the provision of $45,470. In any event, Mr Callaghan considered that Mr Gulwadi would know if there was other stock which had been lost, damaged or destroyed (T255.6) but Mr Gulwadi's evidence confirmed that the only stock which had been lost, damaged, destroyed etc was the stock referred to in that provision (T140.15, 144.26-145.21). 14. There is evidence in the 2011 depreciation schedule that stock which had been purchased on 1 December 2007 for $642,059 (scil.$581,175) was sold on 30 June 2011 for $471,053, notwithstanding that it had by then been written down to $262,927. Thus, according to the company's records, this stock had depreciated at a flat rate of only 5.25% per annum. 15. Ms Exner agreed that this sale would be a "starting point" for identifying the actual rate of depreciation of stock (T204.33) but said that further information would be needed to determine whether "the context of this sale applies to all of the stock". There was, however, no evidence from the defendants to the effect that the sale was not made on market at arms-length for the reasonable market value of the stock. Mr Callaghan, at T251-3, did not recall a single transaction of $471,053 (and again referred to the records for this sale or sales as being something which Julie Simpson and Mr Gulwadi could give evidence about: T251.44), but did not indicate that there was anything unusual or atypical about this sale. The company did not tender any evidence to show this was not a normal sale (or sales) made by a willing (but not eager) vendor to a willing (but not eager) purchaser, even though any such evidence, if it existed, would have been known to the company and its director and State Manager and could easily have been produced. In these circumstances, this sale is the best - and indeed the only - evidence of the actual rate by which the fence might have depreciated and, in determining the value of the shares, an adjustment ought be made to the accounts of the company so as to reflect depreciation at a prime cost rate of 5.25%, rather than at a diminishing value rate of 15% or 20% as in the company's accounts. 41The first thing to note about the calculations in paragraph 14 is that the rate of 5.25% per annum is derived using the figure of $581,175 which comes from the 2009 -2010 depreciation schedule rather than the 2011. If one worked on the 2011 depreciation schedule, one would have a straight line depreciation of approximately 7.6%. The initial points made by the defendants were that determining the value of stock is a matter of expertise and it is inappropriate for me to engage in this exercise which has been suggested by the plaintiffs. Secondly both valuers agreed that they did not have the expertise and thirdly, that you either adopt the accounts or a fair market value of assets but you do not do a hybrid approach. Fourthly, they pointed out that if you use a straight line depreciation of 5.25% this means that the fencing has a life of 19 years. 42In the depreciation schedules the effective life is shown as either 10 or 13 1/3 years but that is simply an application of taxation allowable rates to the particular asset. Those rates would however have some relationship to reality. 43There was a revaluation of the fencing stock carried out by the directors in 2010. There is some debate as to when it happened but I am satisfied that it happened after June 2010 and eventually as a result of interaction between Mr Brendan Callaghan and the external accountant, Mr Gulwadi, there was a write down in the accounts for the year end 30 June 2010 of $616,533 as an additional depreciation item. In doing the valuation, Mr Brendan Callaghan said he was concerned because he knew some of the stock was getting upwards of 8 years old. The company had at that stage been operating for only 8 years. 44I note that Ms Exener had regard to the tax office life of 10 years when applying a straight line depreciation to the one off adjustment of $616,534. See her note 3 to annexure F. The application of this approach is more likely to reflect the true value of the stock rather than the value in the accounts, which is a product large rates of accelerated depreciation. 45I will accept the plaintiffs approach but use a straight line rate of 10%
The missing $531,936 46The plaintiffs' adjusted Appendix E added in the sum of $531,936 to maintain the 2009 - 2012 accounting treatment of stock. In its submissions it said the following at paragraph 8: There was clearly a change in the way the accounts were prepared for the 2011 year: (i) the depreciation schedule for 2009 showed the total cost price of hire stock still owned by the company of $1,964,963 and the balance sheet for 2009 showed the total paid to purchase hire stock at $2,496,900, a difference of $531,937. Ms Exner agreed that this amount could represent the hire stock which had previously been sold (T181.35), but the defendants have not explained what the difference referred to (ii) the 2010 depreciation schedule showed total cost price of hire fence still owned by the company at $3,371,339, and the balance sheet showed total spent on hire fence of $3,903,275: ie a difference of $531,936, and effectively the same amount as in the 2009 accounts (iii) however, the 2011 depreciation schedule showed total cost price of hire stock still owned by the company at $3,432,223 and the total spent on hire fence in the balance sheet is the same amount: the $531,936 difference has disappeared. If the treatment in the 2011 accounts had been the same as in the 2009 and 2010 accounts, then the amount of "security assets on hire" in the non-current accounts in 2011 would have been an additional $531,936, or $3,964,159 47This is said to be supported by the cross examination of Ms Exner (T181-182). The following appears in her cross examination (T181:4 - 182:46): Q. If you go to the 2009 balance sheet which is attached to your report, do you have that? A. Yes. Q. Under non-current assets 2009 the total amount identified there is $2,496,899? A. Yes. Q. Indicating that the total amount that has been spent by the company acquiring hire assets as at 30 June 2009 was that 2.496 amount? A. Yes. Q. But when we go to the 2009 depreciation schedule the amount spent on fence there only appears to be about $1.96 million? A. Yes. Q. The difference is $531,938, you can take that from me, and that would be, can I put this to you, please tell me if I am wrong, the purchase price of hire stock which had been purchased but has since been sold? A. Not necessarily. Q. What else could that relate to? A. The depreciation schedules are the schedules that are annexed to the tax returns and the tax legislation requires that, or allows certain adjustments to be made to the cost of assets, for example, if you sell some fixed assets then rather than declare the profit as assessable income you can under certain circumstances reduce the cost of your existing or replacement assets by that amount, so these two numbers do not necessarily agree. Q. And so the proposition I put to you may be correct, the difference of $531,938 might represent hire stock which had been previously sold? A. It may do, I don't know. Q. And you are saying it also might be really just reflecting a write down of the purchase price of the stock for tax purposes? A. Yes, it might be a combination of the two. Q. Are there other possibilities? A. There may be, there is always a possibility, I don't know, I can't, there is no point speculating, I would need to have a look to see what the reasons were. They are the ones that spring to mind. Q. Go to the depreciation schedule of 2010? A. Yes. Q. You will see that the total amount paid out for hire fencing is now $3.37 million approximately? A. Yes. Q. And if you go to the 2010 balance sheets you will see the total amount identified under non-current assets as having been paid for hire fences $3.903 million approximately? A. Yes. Q. I can tell you the difference between those two figures is $531,936, which is almost exactly the same as the difference between the corresponding figures for the 2009 year? A. Right. Q. You understand what I am putting? A. I understand. Q. Indeed, you would expect to see, wouldn't you, if there had been for example a sale of hire stock previously that had taken some assets out of the ownership of the company or if there had been a write down of the value for tax purposes, you would expect to see whatever the figure was that was written down or whatever the figure was that was the proceeds of sale of that stock, you would see that flowing through each year, wouldn't you? A. Yes. Q. The fact you have almost exactly the same amount in the 2010 year is consistent, something you would expect to see? A. Yes. Q. If you go to 2011 you will see the depreciation schedule, indicating total spent on hire stock of about $3.43 million? A. Yes. Q. And if you go to the 2011 balance sheet, you will see in fact the security assets of hire under non-current assets are identified as being exactly the same amount? A. Yes. Q. There has been some change in the account treatment for these assets between, on the one hand 2009 and 2010, and on the other hand, 2011, hasn't there? A. Apparently, yes. Q. What you would have expected to have seen in 2011, the security assets on hire on the balance sheet should have been about $531,936 higher than it appears to be? A. Well, I am not sure. Without knowing the reasons for the discrepancies in previous years, I can't say that. 48However a consideration of the whole of the cross-examination shows that Ms Exner does not support the theory for adding back in the sum. She cannot agree due to the lack of information. 49In support of the plaintiffs approach to the case it referred to the legal principle that "all evidence is to be weighed according to the proof which it was in the power of one side to have produced, and in the power of the other to have contradicted": Blatch v Archer (1774) 1 Cowp. 63 at 65, Morgan v Babbercock & Willcocks Limited [1929] HCA 25; (1929) 43 CLR 163 at 178, Hampton Court Limited v Crooks [1957] HCA 28; (1957) 97 CLR 367 at 371-2, Australian Maintenance & Cleaning Pty Limited v AMC Commercial Cleaning (NSW) Pty Limited [2011] NSWCA 103 at [64]. 50Having demonstrated, in my view correctly, that the accounts of the company were inaccurate it was pointed out by the plaintiffs that Mr Brendan Callaghan had sworn an affidavit which contained commentary on accounting matters which he frankly conceded that he did not understand (T275.3) and, although his father was: (i) the sole director of the company; (ii) the person who therefore was obliged to ensure that the accounts were true and fair each year; (iii) in Sydney, and otherwise available to give evidence; (iv) and indeed had sworn an affidavit earlier in the proceedings which had not been read no evidence was called from him to explain these anomalies. 51It would have been within the power of the defendants to call evidence to explain this anomaly in the 2011 accounts. However the use to which this anomaly was to be put was not apparent until the plaintiffs counsel commenced his closing submissions and handed a written copy of his submissions to the defendants. There had been no attention drawn to this matter in the experts' reports. I would not draw an adverse interest against the defendant on this matter and note that it is for the plaintiffs to prove their case. 52 In my view it is not appropriate to include the amount given the lack of reasons referred to by Ms Exner.
Addition of income not recorded of $107,202 53The first matter to deal with in respect of this document is the income not recorded of $107,202 in the year ended 30 June 2011. This sum relates to the sales of fencing in the 2011 year, which is shown in the trading statement at $423,951. 54The depreciation schedule showed sales of $471,000 and there was some evidence of Mr Brendan Callaghan regarding an additional sale to CLM Infrastructure of some $60,000 to $70,000. It was submitted that the actual sales were wrong in the accounts and that they are understated by at least $107,202. 55A consideration of the cross examination of Mr Brendan Callaghan shows that the sales of the 2007 stock totalling $471,053 might have been a number of sales during the year. The $60,000 to $70,000 sale is unlikely to have been included in the sales referred to in the depreciation schedule, as it was a sale of new fence in 2010 and 2011. It is likely to have been purchased and resold in a short period. 56In these circumstances I think it is appropriate to include this additional income.
Leasing charges 57The next matter to be dealt with is a question of whether one should add back the leasing charges. This arises because one of the forms of financing adopted by the company was to have finance provided by Westpac by leases in respect of fence purchased. 58The assets that are acquired using this source of finance are included in its assets in its balance sheet. Ms Exner, who did not make an adjustment for these charges as she regarded them as operating leases rather than finance leases, conceded that if the leasing charges are in relation to finance leases and if the leasing charges represent interest then she would add them back into her calculations. 59Mr Gulwadi who was aware of the detail of the leases and their use for financing the purchase of stock was happy deduct them as an interest expense in the management accounts. 60Having regard to this evidence I will accept the leasing costs.
The revaluation in 2010 and the write-down of $616,533 61This write-down appears on the profit and loss statement for the company for the year ended 30 June 2010. There are two versions of the accounts for this year in evidence and the amount which appears in the later version has this expenditure being: "depreciation - damages and updated conditions $616,533". 62As I have mentioned, according to Mr Brendan Callaghan he carried out the revaluation in July 2010 and says that he notified Mr Gulwadi, the external accountant, by a letter of 1 August 2010. Somewhat contrary to this Mr Gulwadi on 16 December 2010 suggests by email that there should be a re-valuation and they it supplied to him on 20 December 2010. There was evidence from Mr Brendan Callaghan that he created the response of 20 December 2010 by cutting and pasting from his earlier document on file. 63It is apparent that in affidavits sworn by John and Brendan Callaghan and Mr Gulwadi in February 2011 that they all annexed copies of the 2010 accounts which did not reflect the re-valuation. As a result of this it was suggested in submissions that the re-valuation was carried out sometime after the orders were made in these proceedings on 14 March 2011 in order to suppress the apparent value of the shares. It was noted that prior to that time the defendants had been defending an application to wind up the company by attempting to demonstrate that there was a viable profitable valuable company but that after that time as a result of the orders that were made it was in the first defendant's interests for the value to of the shares to appear as low as possible. 64Mr Gulwadi gave an explanation of why he had not incorporated the revaluation in the initial 2010 accounts (T152-5). This explanation was almost unbelievable. Notwithstanding this, and although the motivations referred to by the plaintiffs are present, I am satisfied that Mr Brendan Callaghan's explanation of how and when he did the revaluation is correct. 65It was also submitted that the revaluation could not be correct. The basis for that submission was as follows: 26. The revaluation could not be correct in any event. In July 2010 the depreciation schedule shows that stock purchased for $1,406,376 - ie 60% of the hire stock then held by the company - was only 6 months old. 2.5km of that stock had been purchased from China (T266-7), presumably at a cost of $26,000 per kilometre, or $65,000 in total. The balance of that stock - approximately $1.341m worth - was presumably purchased in Australia at $42,000 per kilometre. A revaluation of that stock at $28,000 per kilometre, when it was only 6 months old, was clearly unrealistic. 66Mr Brendan Callaghan dealt this with when he was cross-examined about the revaluation and he rejected the suggestion that it could not be correct. It is to be noted that the revaluation stated that it would cost $3 to $4 for dismantling to bring it back to the shed and the $28,000 covered not only the recently acquired stock. There were also problems with the quality of the recently acquired stock, which required repairs. I accept his evidence on this issue and the revaluation. 67However I also note that Ms Exner removed this item in her annexure F but also added an adjusted item of depreciation of $61653. Her reasons for doing so were as follows: As stated in paragraph 5 9 of this report, I have been advised that the fencing lure assets were revalued to market value at 30 June 2010 (and these assets were previously recorded at cost) As the carrying value was in excess of its market value, the Company wrote down the value of the fencing hire assets in the accounts which resulted m an expense described as "Depreciation - damages and updated conditions" of $616,534 being a journal adjustment dated 30 June 2010 I consider that this expense is, in effect, a "catch up" depreciation adjustment to correct the fact that the actual depreciation charge booked previously has been insufficient and has not accurately reflected the decline in the value over the useful life of the fencing hire assets The tax return of the Company for 2010 shows that fencing stock is depreciated over a useful life ranging from 10 to 13 years (on a diminishing value basis) For the purpose of this valuation, I have assumed that the average useful life of the trading stock is 10 years (on a straight line basis) and have reallocated this one-off adjustment on this basis, so as to normalise the historical earnings of the Business. 68These reasons seem logical and I will follow her approach.
The value of the business 69As can be seen from above the plaintiff suggests an additional 7.5% should be added to take into account the significant increases in the hire business. The plaintiff's submissions on this are as follows: 17. At paragraph 4.5(b) of her report, Ms Exner states that expected future earnings must be assessed, and that this may involve an adjustment to past earnings so as to reflect expected growth in earnings. Mr Thompson was of the same opinion and, after having, at the first page of appendix 1 to his first report, set out the significant past annual increases in hire income, and noted that the hire income was, (as the company conceded), by far the main part of the business, he concluded that the average of the past earnings should be increased by 7.5% to allow for an expected continuation of the growth in that business. 18. Ms Exner appeared to accept that growth in the major part of the business might justify an additional 7.5% increase when calculating future maintainable earnings, but she was not aware that that had occurred in the present case: all that she knew was that the total revenue had stayed at $2.7m for two years (T207-8). Having regard to the spectacular growth in the hire income each year since 2006, which, on page 12 of his first report, Mr Thompson notes as being in excess of 20% each year, it is not unreasonable to apply an increase of 7.5% of recent historic earnings when calculating future maintainable earnings. 70The assumptions in these submissions are not in accord with the evidence. As Ms Exner pointed out in para 7.16 of her report: The W&M Report adopts an FME figure that is, in essence, an average of the adjusted earnings (before depreciation) for 2010 and 2011. This average is increased by a growth factor of 7.5%, after "having regard to the level of annual increase in Fencing Hire Income" during 2008 to 2011.There is no explanation provided in the W&M Report as to why this growth rate has been applied or how it has been determined. The application of a growth rate is inconsistent with the negligible increase in total sales revenuefrom 2010 to 2011 and runs contrary to the significant decline in the adjusted profit of the Business over the same period, which, according to the W&M Report, fell from $695,964 in 2011 to $530,800 in 2011. In view of these recent trading results of the Business, it is unclear why a potential buyer of the Business would attributed any "growth factor" into an assessment of the FME of the Business. 71In my view there is no proper basis for adopting the 7.5% uplift. The other evidence referred to below supports this approach.
The appropriate multiplier 72As can be seen from the modified value of the business the plaintiff suggests that a multiplier of six times the future maintainable earnings is appropriate. It is to be noted that the multiplier is different depending on whether one applies it to an EBIT calculation or to an EBITDA calculation. As Ms Exner determined that the earnings of the business were not sufficient to give rise to any goodwill based upon the capitalisation of the FME methodology she had to value the company on a net asset basis. Thus she did not select a multiplier to apply to an EBIT approach. 73However in paragraph 6.16 of her report when discussing the applications of multipliers in the WNM report she indicated that normally multipliers in respect of the sale of businesses of this size are commonly in the order of between 3 and 7. In her discussion of the multiplier adopted for the purposes of the EBITDA calculations made by Mr Thompson she demonstrated at paragraph 7.27 that an implied EBIT multiplier from the data in his report and his valuation would give a range from 29.9 to 35.5. She illustrated how in public companies operating in this area in Australia and overseas that the average EBIT multiples were in the order of 9.6 and the only Australian one was in the order of 6.7. This was merely done for illustrative purposes and certainly shows that the multiplier used by Mr Thompson produced quite anomalous results. In her cross examination she firmly rejected the suggestion that the public company results to which she referred were relevant to the nature of the company concerned in this case. 74In the plaintiff's submissions the only thing which they put forward using Mr Thompson's evidence was his evidence that any multiplier ought to be towards the top end of the range. However the views of Mr Thompson were predicated upon, inter alia, the fact that Ready Fence was in steady growth and a low risk category. In forming this opinion he only had regard to the earlier affidavits of Brendan and John Callaghan, which did not deal with later evidence that became available from Mr Brendan Callaghan as to the difficulties which the company was having in maintaining the business. Mr Thompson apparently agreed (T79.1-29) that if those facts were correct then the company is not in a low risk category. In my view there is no reason not to accept those facts referred to by Mr Brendan Callaghan. The basic facts are not challenged. I do not find any assistance from Mr Thompson's suggestions as to the nature of the business. It is not in the low risk category and its growth in revenue appears to have stalled between 2010 and 2011 and its profits declined. 75The only evidence of an appropriate multiplier is the range given by Ms Exner at 3-7 and given the nature of what is now happening to the business I would have thought that a multiplier in the order of 3 would be appropriate.
Restraint of trade 76It can be seen that the amended calculation by the plaintiffs' gives a value for goodwill of $1.731million. 77In this case we are dealing with a situation which is not the same as a sale in the open market in that it is for the purposes of court orders allowing one party to buy out the other. There is no mechanism in the short minutes to impose a restraint of trade on the party being bought out and this plainly raises the spectre of the Callaghan's, having been bought out, being able to set up in opposition. 78Mr Thompson was cross-examined about this and also taken to Ms Exner's calculation of goodwill of $100,000. That calculation simply reflects, as has been pointed out earlier in this judgment, the actual start up costs, which would be avoided by someone who had purchased the shares and the existing operating business. Given the proposition that there is no restraint of trade preventing someone from going around the corner and starting up in opposition Mr Thompson conceded that in the absence of a restraint of trade clause Ms Exner's assessment of goodwill was appropriate. 79Given my conclusions as to goodwill which are set out below this debate has become otiose.
The value of the shares 80One of the adjustments, which have been made to the value of the shares, is to add an 8% net control premium. Initially Mr Thompson was of the view that because the delivery of a parcel of 47.2% of the shares would give majority control the control premium should be added to the value. The plaintiff's submitted that Ms Exner agreed that a control premium was appropriate. After giving the matter some consideration overnight she gave evidence that there would also be a negative premium attaching to the value of the shares caused by the fact that they represented a parcel of less than 50%. It was submitted that she ultimately concluded that after allowing what she considered to be an appropriate negative premium and adding the control premium an 8% increase in the value of the shares would be appropriate. 81The plaintiff's in their submissions agreed with Ms Exner's approach and for this reason have added it in to their calculations. 82It is thus appropriate to apply a control premium and assuming the shares do have a value then 8% is the appropriate value to reflect this premium. 83The respective annexures and tables changed to take account of the adjustments I have determined are as follows: Depreciation Recalculation For 30/06/11 At 10% Prime Cost Original Cost Date of Purchase Depreciation Period Depreciation Component Depreciation Amount Written-down value 30/06/11 $454,699 01/07/04 7 yrs 70% $318,289 $136,410 $393,746 16/06/06 5 yrs 50% $196,873 $196,873 $277,929 01/07/06 5 yrs 50% $138,964 $138,965 $122,380 01/11/06 4 ½ yrs 45% $55,071 $67,309 $47,148 01/02/07 4 ½ yrs 45% $21,216 $25,932 $87,886 01/03/07 4 ½ yrs 45% $39,548 $48,338 $1,406,376 31/12/09 1 ½ yrs 15% $210,956 $1,195,420
Total: $980,917 $1,614,374
Adjusted Appendix E Net Assets ($242,432) Add back accumulated tax depreciation $2,179,199 ________ $1,936,767
Add to maintain 2009 & 2010 accounting treatment (T182) nil
Subtract depreciation at 10% prime cost $980,917 ________ Adjusted net assets $955,850
Adjusted Appendix F 2010 2011
Net profit (375,624) (335,905) Adjustments Income not recorded (T250-253) 107,202 Interest 72,711 122,662 Leasing 76,957 88,689 Legal costs - 265,859 Depreciation 616,534 (damage etc) Depreciation (61,653) (61,653) (damage etc) Depreciation 382,343 478,184 (as per tax returns) _______ _______
Less depreciation 337,133 343,220 (5.25% prime cost) _______ _______ EBIT 374,035 321,818
Value of Business 2010 and 2011 average EBIT $347,926 Add 7.5% nil _______
Using earnings multiple of 3 3 x $347,926 = $1,043,778
Value of business $1,043,778 Adjusted net assets $955,850 _______ Goodwill $87,928 Say $100,000
Value Of Shares Per Ms Exner Paragraph 6.25 Net assets $955,850 Add future tax benefit 117,797 _______ $1,073,647
Add goodwill $100,000 _______
Value $1,173,647 47.2% $553,961
84I determine that the value of 47.2% of the shares in the first defendant is $598,277. I will hear the parties on costs. 85Exhibits can be returned on the usual undertaking by the solicitors to retain them for the appeal period. Annexure A AMENDED SHORT MINUTES OF ORDER By consent, the Court makes the following declarations and orders:
DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 24 September 2012
Araujo
Ready Fence