Due diligence
134 After a false start, Sullivan's due diligence in connection with the proposed purchase of MCP or its assets proposed by the Information Memorandum commenced on 22 May 2000. It involved the inspection of documents at MCP's Rydalmere premises. Mr Adair represented McKechnie in connection with the due diligence process, as did representatives of the accounting firm, Arthur Andersen. Mr Sullivan, Mr Wanchap and Mr Craig Carter, partners of the firm Hall & Chadwick, participated in the due diligence on behalf of Sullivans. Prior to the commencement of the due diligence Mr Wanchap had been provided with a copy of the confidential information memorandum which described suppliers by letter, rather than name [KA 10].
135 Five lever arch files of documents were made available to Mr Wanchap for inspection. File 3 for the Australian business included 'supplier agreements'. The only agreement with ACBB which was included in the due diligence material was the Trading Agreement, the last page of which was marked 'Appendix V'. There was no such appendix attached to the Trading Agreement. Neither the Heads of Agreement nor either of the Letters of Intent was included in the due diligence material, nor were they mentioned during the course of the due diligence process.
136 On 23 December 1999 Allen Allen & Hemsley had advised McKechnie [R 2/713] that prospective purchasers should be required to ask questions in written form and that answers would likewise be supplied in writing. No oral questions should be answered, and no questions should be answered verbally. Mr Adair was furnished with a copy of this advice on 5 January 2000 [R 2/712]. At the commencement of the due diligence Mr Fink of Arthur Andersen Corporate Finance explained the process. He said the requests for documents and information were to be made in writing. Requests could be made for formal interviews of members of the senior management team, however, they could not be approached informally. Mr Sullivan was told that if he wanted access to documents other than those included in the due diligence materials, he should request them.
137 In the period between 22 May and 24 May 2000 Mr Wanchap formulated on a running basis a list of what became 39 written questions. Answers were received to eight of those questions. The questions relating to suppliers, or to ACBB were questions 19 and 36. Question 19 was:
'19 Do the due diligence files provided cover all material contracts including:
(a) licence, supply, distribution and sales agreements;
…'
Mr Wanchap asked that question because he was not satisfied that the material provided included all material contracts.
138 Question 36 was as follows:
'36 Details of costs associated with establishment of ACBB arrangement included in financial results for the financial period ended 30 April 2000, ie additional travel costs, costs re Woolworths stock repackaging etc.'
[R 2/989, 990]
The question about the costs associated with the establishment of the ACBB arrangements was provoked as a result of an analysis of MCP's balance sheet. The costs were included as a sub-item amongst many other items. Mr Wanchap regarded the items as sufficiently substantial to ask a question about it. No answer was received to either of these questions. As a result Mr Wanchap did not know, one way or the other, whether the files provided covered all material contracts in the area covered by question 19.
139 Mr Wanchap did not ask any written question specifically in relation to 'Appendix V' to the Trading Agreement. He said that he asked Mr Adair to provide a copy of the Trading Agreement with all attachments. Whilst Mr Adair offered to provide a copy if he was able to find the original, none was ever produced. Mr Adair, in his evidence in reply, denied that this request was made: Adair 20.5.03 [182].
140 Mr Wanchap did not know what products the Trading Agreement applied to or what, if any, commitments had been made by MCP to ACBB in terms of the Trading Agreement. In his view the Trading Agreement was just a standard purchase contract, which had no work to do unless enlivened by a purchase order. Mr Wanchap did not ask for copies of, or make any enquiries about, anything answering the description of a memorandum of purchase commitment. He agreed that he could have done so. He observed in cl 11 that the agreement contemplated bulk orders for six monthly periods, but he did not ask to see any of these orders. Mr Wanchap advised Mr Sullivan that he did not know what goods the Trading Agreement applied to.
141 Mr Wanchap's evidence was that he did not know during the due diligence process who supplier B was, but that he believed that Mr Sullivan did know because of his familiarity with the industry. Mr Wanchap accepted in cross-examination that the reference in the information memorandum to tenure and exclusivity 'could be mutual. Could be one way'. He did not enquire which. Mr Sullivan did not raise any matter with him concerning contracts with suppliers.
142 According to Mr Wanchap, at no time prior to completion of the sale to Sullivans did the vendors or their representatives inform Mr Wanchap that MCP was a party to a contract that included constraints on its ability to purchase products such as a requirement that MCP purchase products exclusively from ACBB, or to purchase minimum quantities of product from ACBB.
143 Mr Sullivan said that he had formed the view that MCP was losing money and that its financial losses were attributable to large overheads and the manner and price at which MCP was acquiring its products. If Mr Sullivan was to turn the business around, he would have to have the flexibility to buy from suppliers other than ACBB's current suppliers. The business was not viable in his view unless MCP could significantly reduce the costs of its product acquisitions. It was evident to Mr Sullivan that MCP was buying wrongly, as other sources of supply were available at 30 per cent less.
144 Mr Sullivan said that he reviewed the Trading Agreement during the due diligence. In his view the Trading Agreement contained no restriction on MCP in terms of where it could purchase packaged curtain accessories or any other products. There was no obligation imposed on MCP to purchase products exclusively from ACBB, nor was MCP required to purchase minimum quantities of products. At no time during the due diligence process did any representative of the vendors offer any additional information or documentation in relation to ACBB other than the Trading Agreement. He says that at no time was he told that a 'mutually exclusive contract' was in place with ACBB. Mr Sullivan said that he understood cl 2.3 of the Information Memorandum to mean that suppliers A, B, D and N were supplying MCP exclusively.
145 Mr Sullivan says that if he had been informed that there was a mutually exclusive contract in place with ACBB he would have asked for complete details of such a contract. He would not have proceeded with the purchase of MCP had he been aware that MCP had a mutually exclusive contract with ACBB, as ACBB now alleges, because if that were so, he would have had a limited ability to turn the company around.
146 Mr Sullivan said that he made a point of being at the due diligence process himself and he said that his focus, primarily, was to ensure that there were no restrictions on MCP's ability to change suppliers. However, neither he nor anybody on his behalf made any enquiries on this issue even though he appreciated that if he wanted information, he had to ask for it. Mr Sullivan did not ask to see any purchase orders or the Memorandum of Purchase Commitment referred to in the Heads of Agreement even though it was material to know whether there were any long term supply agreements with ACBB. Mr Sullivan decided to complete the purchase even though he knew that Mr Wanchap had sent questions to Arthur Andersen Corporate Finance asking for details of any agreements and other documents concerning supply agreements, and he knew that this information had not been provided.
147 Mr Sullivan says that when he went into the due diligence he did not know the identity of the suppliers who were designated by an alphabetical letter. However, during the course of the due diligence he came to learn that ACBB was the supplier referred to as supplier B. He said that he was not sure how he came to learn of this, but he believes that 'either Greg Wanchap, Carter or somebody else' mentioned the correlation. He looked at the Trading Agreement knowing fully that ACBB was the supplier of the drapery hardware package goods products. Earlier in Mr Sullivan's cross-examination, whilst denying the conversation to which Mr Adair deposed at the start of the due diligence process, he accepted that at some stage of the due diligence he would have discussed ACBB with Mr Adair, but he asserted that nothing was said about exclusivity. Mr Sullivan does not depose to any conversation with Mr Adair in which Mr Adair gives an account of MCP's relationship with ACBB, which is different from that contended for in Mr Adair's evidence. Mr Sullivan's position would thus seem to be that whilst ACBB was mentioned in discussions with Mr Adair, the discussions did not descend to the level of a discussion as to the terms of the trading relationship between ACBB and MCP.
148 Mr Sullivan's evidence as to his state of knowledge is inconsistent with the evidence of Mr Adair. In par [65] of Mr Adair's affidavit of 23 December 2002, in the context of discussing page 6 of the Information Memorandum [KA 10] at the start of the due diligence process, Mr Adair says that he said to Mr Sullivan:
'Michael, there are four suppliers to MCP who have supply agreements with us. The largest of those suppliers is ACBB which is code named "B" in the Information Memorandum. ACBB has a 5 plus 5 Exclusive Agreement with us and MCP is in the process of transferring further products to ACBB including extrusions and the CH Trading component.'
149 In par [66] of Mr Adair's affidavit of 23 December 2002 he deposes to a further conversation which he had with Mr Sullivan about a participant in the bid process having directly approached one of MCP's strategic suppliers ACBB. The conversation included the following:
'They have approached ACBB, but I wouldn't worry about it. We've got those guys stitched up to a 5 + 5 mutually exclusive deal …'
In Mr Adair's affidavit in reply [128] he says that he specifically recalls a conversation with Mr Sullivan on about 26 June 2000 which include words to the following effect:
'ACBB's and ABC's products represent the bulk of all MCP packaged products. As you know, MCP is required to buy all of its nominated products exclusively from ACBB.'
150 These alleged conversations involve a departure from the protocol deliberately and carefully adopted for the due diligence process of requiring questions and answers to be reduced to writing. Mr Adair said that he did depart from that protocol, 'but it was to give Mr Sullivan a quick 5 or 10 minute overview before he commenced due diligence' [T351]. Mr Adair claims not to have deliberately concealed the existence of other agreements between ACBB and MCP apart from the Trading Agreement. He assumed that once Sullivans had gone through the files, questions would have been asked and other documents called for. The following curious exchange occurred in cross-examination [T352]:
'Do you understand your reference to mutual exclusivity in the conversation that you said that you had with Mr Sullivan to be a reference to no more than the trading agreement? --- No.
You understood it to be a reference to more than that did you? --- It was a state of affairs of the business of MCP Australia and I was discussing the major suppliers and major customers and key people, just a thumbnail sketch of it.
Did you understand when you told him about mutual exclusivity that you were talking about contractually binding obligations other than those set out in the trading agreement? --- No.
Thank you. I've got nothing further, your Honour.'
151 There is a clear and direct conflict between the evidence of Mr Adair and the evidence of Mr Sullivan as to what, if anything, was said by Mr Adair to Mr Sullivan during the course of the due diligence on the topic of mutual exclusivity. It was put to Mr Adair in cross-examination that he did not mention the words, mutually or exclusive, to Mr Sullivan in any of his dealings with him in connection with the due diligence process or at all. That suggestion was rejected by Mr Adair.
152 I prefer the evidence of Mr Adair to that of Mr Sullivan as to what Mr Sullivan was told in relation to ACBB during the due diligence process. Mr Sullivan's evidence as to the absence of any enquiry as to the terms of any trading relationship between ACBB and MCP, and his professed lack of knowledge as to that matter are inconsistent with his evidence that his purpose of being at the due diligence process himself was to ensure that there were no restrictions on MCP's ability to change suppliers. Mr Sullivan denied that at the commencement of the due diligence Mr Adair outlined the major suppliers by name, identifying them, and claimed that he learnt that information from Mr Carter or Mr Wanchap. Mr Wanchap was not the source of the information, and no basis has been shown for an assumption that Mr Carter was privy to the information.
153 The probabilities are that it was Mr Adair who supplied the information to Mr Sullivan at the commencement of the due diligence process, as he says. Mr Sullivan conceded that he had a conversation with Mr Adair during the due diligence in which ACBB was discussed but 'it was never brought up in the context of an exclusivity discussion' and no questions were asked of Mr Adair in relation to the Trading Agreement. It is improbable to the point of it being unbelievable that Mr Sullivan, given his objective in attending the due diligence, was neither given nor obtained any information as to the trading relationship between ACBB and MCP other than the terms of the Trading Agreement itself.
154 Some support for this conclusion can be derived from the conversation between Mr Sullivan, Mr Adair and Mr Chenery in mid-July 2000 referred to in [166] - [168] below. I accept Mr Chenery's version of that conversation. Mr Chenery and Mr Adair were telling Mr Sullivan in that conversation that there was an agreement between ACBB and MCP which required MCP to source product from ACBB. Mr Sullivan does not express any surprise at what he was being told. He simply said to Mr Adair: 'Kevan there is no reason why MCP cannot source products from alternative suppliers'. The statement which Mr Sullivan attributes to Mr Adair: 'Michael, you know there is a supply agreement with ACBB' is inexplicable if this was the first occasion on which Mr Adair told him that MCP was constrained to acquire products from ACBB.
155 It may well be, as Mr Sullivan says, that after he was given information in relation to ACBB he reviewed the Trading Agreement, and came to the conclusion that it contained no restriction on MCP in terms of where it could purchase products. That would be consistent with the conversation referred to above.
156 Some further support for the conclusion which I have reached is provided by the exclusion of Mr Adair and Mr Chenery from the meeting with Mr Epov and Mr Dong on 15 August 2000 referred to in [170] below. The probabilities are that Mr Sullivan excluded them from that meeting because of a perception on his part that they were likely to side with Mr Epov on the question of whether a trading relationship existed between ACBB and MCP under which products were to be procured from ACBB. As I will later explain, Mr Adair may not have correctly understood what the legal relationship between the parties was, but that is not to the point.
157 That also helps to explain why after receipt of a fax from Mr Epov of 19 August 2000 as to the exclusive relationship which Mr Epov claimed to exist between ACBB and MCP, Mr Sullivan made enquiries on that matter from persons other than Mr Epov and Mr Chenery, although they were then accessible to him (see [177] below).