Calliden Group Limited v Australian Unity Limited

Calliden Group Limited v Australian Unity Limited - [2010] NSWSC 263 - NSWSC 2010 case summary — Zoe

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xiv. The only comparison required to be made under the Deed is as between the Completion Valuation (which was a roll-forward of the June 2007 Valuation) and the December 2006 Valuation (which was a roll-forward of the June 2006 Valuation). It thus follows that those valuations should be prepared in such a way as to make that comparison meaningful. Calliden's construction thus gives 5(a) a useful operation. A requirement that the June 2007 Valuation and the Completion Valuation be prepared using unchanged methods and approaches to the selection of assumptions, however, would simply impose an additional obligation in relation to the preparation of the 31 July 2007 valuation with no objective value or benefit. A short reference to authorities 26 It is a principle of the construction of contracts that, where a contract has been entered in a business context, it should not be read in a way that is commercially unlikely to be what the parties intended: Australian Broadcasting Commission v. Australasian Performing Right Association Ltd (1973) 129 CLR 99 at 109; Cohen & Co v. Ockerby & Co Ltd (1917) 24 CLR 288 at 300; The Council of the Upper Hunter County District v. Australian Chilling and Freezing Co Ltd (1968) 118 CLR 429 at 437. The pervasive plausible commercial intention 27 The only plausible commercial intention that the parties to the Deed could have had would have been that the December 2006 Valuation and the Completion Valuation be prepared using unchanged methods and approaches to the selection of assumptions. As Calliden has submitted that is so, because only in that way could there be a meaningful comparison of the net tangible assets used to calculate the initial purchase price, and the net tangible assets as at completion. 28 Further and again as Calliden has submitted, the circumstances surrounding the entry into the Deed strongly support its construction. Returning to the authorities 29 In this regard it is clear that evidence of the factual matrix in which a contract came to be concluded is relevant to the construction of a contract where the terms are susceptible of more than one meaning: see Reardon Smith Line Ltd v. Yngvar Hansen-Tangen [1976] 1 WLR 989 at 997; Codelfa Construction Pty Ltd v. State Rail Authority of NSW (1982) 149 CLR 337. As the High Court said in Toll (FGCT) Pty Ltd v. Alphapharm Pty Ltd (2004) 219 CLR 165 at [40]:

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v. Giving significant weight to another valuation method, which is heavily dependent on assumptions that had never previously been required to be made, about which there was limited experience from which to draw, and concerning matters that had never previously been given any weight. 44 If considerations such as those outlined above were made out, it would be established that there was no "broad consistency" within the meaning of Schedule 5, clause 3.13. The different actuarial methods 45 There are various different actuarial methods that have been mentioned in these proceedings. It is convenient to presently address the terms the features of each one. The ICD method 46 The ICD, or "incurred claim development", method is a method for estimating the ultimate gross (i.e., before taking into account reinsurance recoveries) liabilities of an insurance portfolio. 47 The ICD method examines the change, or "development", of incurred claim costs (payments actually made, plus estimates on open claims) for a particular half-year period in each subsequent half-year period. The development in the amount of incurred claim costs each half-year allows the actuary to identify historical ratios from period to period, and these ratios are called "ICD factors". The actuary then uses these historical ratios, or ICD factors, to project the future development of claims. 48 For example, if an actuary were looking at claims for the half year ending June 2002, he or she would look at the total amount of incurred claims costs for that period at June 2002, December 2002, June 2003, December 2003, June 2004, and so on. 49 At the end of June 2002 the total amount paid out in claims, plus claims managers' estimates on open claims, might be $100,000. When the actuary returned to look at the incurred claims costs for that period in December 2002, the amount might have risen to $150,000. When the actuary looked at it again in June 2003, the total might have risen to $225,000. 50 The actuary would examine the change in incurred claims costs for the June 2002 half year in each subsequent period, and use that information to predict the ultimate amount of the incurred claims costs for the period. 51 The ultimate incurred claims costs can be expressed as a dollar amount, and as a percentage of the premium charged for the relevant period. The latter produces a number known as the "loss ratio". If a portfolio for a particular half-year has an ultimate loss ratio of 50%, it thus means that half of all premiums collected for the period would ultimately be paid out in claims costs. 52 Hence the ICD method, for any given period, looks at the portfolio as a whole in order to derive the projected ultimate loss ratio. It is then necessary to estimate the amount that will be recovered by reinsurance. 53 Before 2007, Ms Harrex used the ICD method to value older periods (pre-June 2002). The BF method 54 The BF method is also a method for estimating the ultimate gross (i.e., before taking into account reinsurance recoveries) liabilities of an insurance portfolio. 55 The BF method blends the actual experience of a portfolio for a particular period with the projected experience for that same period, to produce an estimate of the ultimate gross liabilities. It does so in the following way:

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g) This produced a higher gross to net factor than would have been derived from a direct translation from the PPCI plus large approach. But when combined with the lower gross liability valuation achieved by the BF construct, the net result came out only slightly higher than the PPCI plus large approach (CB3/1414). 72 As the plaintiff has contended the translation from the PPCI plus large approach to calculating reinsurance recoveries to the determination of a net to gross factor for the purposes of a BF analysis is particularly problematic. 73 In a genuine PPCI plus large analysis, the assumption made regarding the number of large claims per year is the one that is critical to the net position. That is because each additional claim adds $200,000 to the total net result. 74 The assumption made regarding the average size of large claims is not, however, critical to the net position. That is because it is assumed that all amounts per claim over $200,000 are recovered from reinsurers. As such, whether the average claim size is $250,000 or $600,000, the net position for the insurer is unchanged. All that changes is the amount recovered from reinsurers. 75 As Calliden has submitted, assumptions about the average size of large claims do become relevant, however, when the analysis is blindly applied to a different method (namely, a BF analysis). In that case it is the proportion of reinsurance recoveries compared to gross liabilities that is important. In that context, assumptions regarding average claim size do matter (because they inflate the gross position) (Trans. 314/24-36). 76 That fact reveals the true significance of Ms Harrex's assumption of an average claim size of $450,000 (as opposed to the experience, which was $350,000). By inflating her estimate in that way, Ms Harrex increased the proportion of reinsurance recoveries, which enabled her to justify a significantly higher net to gross factor. 77 It can thus be seen that Ms Harrex's construct was a most unusual method. The result was substantially derived from a faithful application of the PPCI plus large approach, but rather than implement that approach, or allow that approach to engage in a meaningful two way conversation with another approach (such as the BF method), she reverse-engineered BF and reinsurance assumptions to achieve as close an approximation as she could to the result of the PPCI plus large approach. 78 In the result, the method she adopted was neither PPCI plus large, nor proper BF. It was a genuine hybrid, or construct, with none of the integrity of either method, faithfully applied. 79 It was a method that Ms Harrex had not performed before (Trans. 131/33-35) and Mr Heath had never seen it done before (Trans. 285/13-29). Calliden's case 80 Each of the following submissions advanced by Calliden is of substance and adopted in these reasons. Case one: breach by failing to procure Ernst & Young to work 81 It cannot seriously be suggested that AU did not refuse to procure Ernst & Young to perform is work under its retainer. The facts are as follows:

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ii) AU was not entitled to terminate the Ernst & Young certification process on the basis that it did not consider that the Draft Completion Statement had been properly prepared. Calliden's primary obligation came from Clause 9.1 of the Deed, in having to prepare a pro forma statement of net tangible assets as at completion. That requirement is satisfied by a document which purports to be a Draft Completion Statement, and which contains the necessary structural elements for such a statement. The Deed specifically left the question of the compliance of Calliden's Draft Completion Statement to Ernst & Young (in the first instance) and the expert appointed under clause 9.6 (in the second instance). That is to say, cl. 9.1 required Calliden to prepare a Draft Completion Statement, and to provide that statement to both Australian Unity and Ernst & Young. One of the functions that Ernst & Young was then required to perform was to audit the statement by applying the Accounting Principles. In other words, Ernst & Young was required to determine whether the statement produced by Calliden complied with the requirements of the Deed. Given that Ernst & Young had that function, it cannot be the case that Australian Unity was entitled to refuse to "procure" (see cl. 9.2) Ernst & Young to perform its functions on the basis that AU considered that Calliden had not produced a compliant statement. By doing so, AU arrogated to itself the very function that the Deed gave to Ernst & Young. If Ernst & Young were to conclude that the statement provided by Calliden was compliant, and proceeded to issue a Certified Completion Statement on that basis, AU would be entitled to object under clause 9.5. By making such an objection, Australian Unity would be invoking the dispute resolution procedure outlined in clause 9.6. The question whether Calliden's statement complied with the Deed would then be determined by the expert appointed pursuant to clause 9.6. I accept that mechanism established by the Deed is similar to the agreement considered by the NSW Court of Appeal in Downer Engineering Power Pty Ltd v. P & H Minepro Australasia Pty Ltd [2007] NSWCA 318. In that case, it had been argued that a document that purported to be a "Completion Statement", and which contained all of the "structural elements" of such a statement had been prepared (see at [72]). The other party considered, however, that the statement that had been prepared did not conform to the requirements of the parties' agreement. It was thus contended that the process set out in that agreement for the review by an independent third party of the completion statement did not operate, because there had been a prior breach of the obligation to prepare a valid statement (see at [73])

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A similar construction is appropriate to be given to the Deed. So long as a document purporting to be a Draft Completion Statement has been produced, and which is in the required form, any questions of compliance with the requirements of the Deed are to be dealt with by Ernst & Young and, if necessary, the clause 9.6 dispute resolution procedure. It was not open to Australian Unity to terminate the process because it considers that the document produced by Calliden is non-compliant. iii) In any event, and as Calliden has contended, there is absolutely nothing in the Deed that required Calliden to incorporate blindly into the Draft Completion Statement the valuation produced by Ms Harrex. The very premise of AU's argument that Calliden was not entitled to "go behind" Ms Harrex's valuation is thus misconceived. There is nothing in the Deed (either express or to be implied) that precludes Calliden from questioning, amending or altering the valuation produced by AUGIL's actuary. Nor is there anything in the Deed that requires Calliden to use AUGIL's actuary's report to produce the Draft Completion Statement. The fact that the Deed contemplates that AUGIL's actuary will prepare the valuation does not mean that only that actuary may prepare the valuation, or that only that valuation may be used to prepare the Draft Completion Statement. The focus of the Deed is not on the identity of the person performing the valuation, but on the method by which the valuation is to be prepared. Consequently, Schedules 5 and 6 are best construed as statements identifying the principles in accordance with which the valuation is required to be prepared, and identifying the person whom it is assumed will prepare it. In the event that Ms. Harrex did not prepare the valuation, or did not prepare the valuation properly, there is nothing in the Deed that would prevent Calliden, in discharging its own obligation to "prepare" the Draft Completion Statement in accordance with the Accounting Principles, from adopting Ms. Harrex's valuation subject to amendments (or not adopting it at all). 85 In the result the finding is that AU breached of clause 9.2 of the Deed when it countermanded its instructions to Ernst & Young to perform the functions set out in clause 9.2. Clause 9.2 provided that both Calliden and AU "must procure" Ernst & Young to perform the functions set out in that clause, one of which was to determine whether Calliden's statement complied with the requirements of the Deed. Case two: breach by failing to issue proper instructions 86 On the evidence I reject the proposition contended for by AU that it instructed Ms Harrex to comply with Schedules 5 and 6 in the preparation of her reports. The following are the relevant facts:

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d. Mr Heath did not express an opinion on the topic, because he had not reconsidered his views in light of Ms Harrex's admissions (Trans. 286/16-22). 125 Importantly the Court accepts that it is not enough to demonstrate that a change was "clearly justified" to show that it was "reasonably open". Here, on no view could such a change be justified. As Calliden has contended, window dressing, manipulation and reverse engineering are not sanctioned by actuarial standards (or the law generally). Further Ms Harrex allowed herself to be pushed to the very edge of her "comfort" zone. She recognised she could, properly, have come to a much higher reserve and she in fact did this, on the standard of Schedule 6 Clause 5(a) although her work in that regard had been destroyed. 126 How, one might ask, could there ever be a clear justification for adopting a method, or an approach to the selection of assumptions that was, at best, non-genuine? Conclusion 127 In the result June 2007 and Completion Valuations did not comply with Schedule 6, clause 5. It thus follows that those valuations were not complying valuations under the Deed in the A Hudson sense. Case four: The June 2007 and Completion Valuations did not comply with schedule 5, clause 3.13. 128 For many of the same reasons as have been set out above the further finding is that that the June 2007 and the Completion Valuations were not prepared on a basis that was "broadly consistent" with prior periods, nor "in accordance with professional standards". Broadly Consistent 129 Mr Heath's opinion appears to be that as long as an "actuarial model" is used to prepare different valuations, then they will be prepared on a "broadly consistent" basis. For the reasons given above, the clause must have more meaning than that. 130 Even accepting that interpretation, however, it is clear that the "method" used by Ms Harrex (dressing up the results of one method as having been derived by another method) is not an "actuarial model". It is a sham, or a construct. No actuary giving evidence had ever seen such a model before (Trans. 131/33-35; 285/13-29). 131 The preferred construction to be given to "broadly consistent" is that it requires that the methods that are used be "similar". Mr Fry's evidence was that these methods were not "similar", and he gave cogent reasons in support of that view, namely:

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b. The second by suggesting that neither of the other actuaries who gave evidence cost any doubt on Ms Harrex's opinion that the central estimate she arrived at was a reasonable central estimate [as is also made plain in the reasons, on the evidence this proposition is rejected]. 141 However as the reasons establish, Ms Harrex herself accepted that she did not need to move to the new basis, or to release a larger amount in order to discharge her professional duties. 142 The reasons treat with the evidence given by the other actuaries and in particular with what was said to be a very difficult question in respect of which the experts were clearly hesitant. This being the question of whether or not [as in the opinion of Mr Heath] although there was nothing in the standard that sanctioned the approach taken by Ms Harrex, he was prepared to accept that she had contravened it. He was not prepared to so accept. 143 For his part Mr Fry said that it was a "very difficult" question, and that the report was "getting close to the edge of being unprofessional" (Trans. 203/25-35). He observed that the report "is less than forthcoming about how influential the PPCI plus large approach was to the selection of the final answer" (Trans. 203/36-38). 144 It is important to recall that in essence the experts called do not purport to arrive at their own valuations of the insurance liabilities of AUGIL as at 30 June 2007. Rather they were commenting on Ms Harrex's compliance with the Deed (assuming Calliden's construction of the Deed to be a correct one]. 145 And certainly as the reasons given make clear Mr Fry and nor Mr Atkins nor the Ernst & Young peer review was able to undo the damage to her credit. 146 Ultimately it is left to the Court to determine on the evidence whether Ms Harrex's opinion that the central estimate she arrived at was a reasonable central estimate in the somewhat extraordinary unusual circumstances. 147 As the reasons make clear that question is determined in the negative. Witnesses 148 It is convenient to make some comments in relation to the various witnesses who gave (or did not give) evidence in this case. Ms Gillian Harrex 149 The demeanour Ms Harrex in the witness box was unimpressive. On a number of occasions there were lengthy pauses when a difficult question was put to her. She was clearly troubled by many of the questions put to her. In my view she was not particularly forthcoming throughout her period in the witness box and on a number of occasions only made admissions when no other alternative was open to her. 150 Calliden first raised its concern that the June 2007 was not prepared in accordance with the Deed on 15 August 2007 (CB4/1921). Ms Harrex was made aware of these concerns on 16 August 2007 (CB4/1926). She immediately wrote to Colin Brigstock to arrange to discuss the matter with him "to make sure we 'have our ducks in a row' so to speak" (CB4/1939). 151 Calliden then wrote directly to Ms Harrex on 10 September 2007 seeking to understand the extent to which her 2007 Valuations complied with the Deed (CB5/2079). Again, her first reaction was to write to Colin Brigstock, saying that she "needed to discuss" the letter (CB5/2081). 152 She drafted a reply, and showed it to Mr Bruce Watson, the senior actuary at Finity. Mr Watson had not had any involvement in the matter, but nevertheless suggested that Ms Harrex change the letter to say that at the time she had told Mr Atkins that she expected a release of approximately $1 million she had "not received any data since 31 December" (CB5/2160). That statement was false, Ms Harrex knew it to be false, but she included it in any event (Trans. 182/8-18). 153 The final version of her response to Calliden, dated 14 September 2007 (CB5/2221), also contained the following false account (CB5/2222):

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viii. Mr Bellairs recognised that such an increase in the size of the release would have been a highly material fact for Calliden (Trans. 386/50-387/3). 177 So much may be accepted as generally having either been established in the course of Mr Bellairs examination or as constituting appropriate inferences flowing from that evidence. 178 However I do not accept that Calliden has proved its further contentions seeking to suggest some impropriety in relation to such interests as Mr Bellairs had in terms of bonuses should the transaction proceed. 179 There is a plethora of authority in support of the proposition that the Court is bound to see that a case pursuing allegations of this type are clearly proved: cf Neat Holdings Pty Ltd v Karajan Holdings Pty Ltd (1992) 67 ALJR 170. The gravity of such allegations has been said to be such that whereas section 140(1) of the Evidence Act 1995 (NSW) stipulates a single standard of proof for all civil cases, namely the balance of probabilities, Section 140(2) preserves the doctrine in Briginshaw v Briginshaw (1938) 60 CLR 336 at 361-362; Pedler v Richardson (unreported, Supreme Court of NSW, 16 October 1997, Young J) at 10-11. See also McLelland CJ in Eq in Watson v Foxman (1995) 49 NSWLR 315, 319. 180 Allegations such as those here sought to be made fell far short of what is required bearing in mind the gravity of the matters alleged. The evidence of Mr Pappas 181 Insofar as Mr Pappas was concerned, his evidence supported that of Ms Harrex (CB1373; Trans. 115/26-30) that she was given an instruction at the 28 June 2007 meeting to release as much as she was comfortable with, and to do so without changing method (Trans. 463/5-10). 182 During the course of his evidence it became clear that Mr Pappas was not aware that any movement in AUGIL's NTA would affect the purchase price, and did not have anything more than a very general understanding of the contents of Schedules 5 and 6 (Trans. 463/12-466/49). 183 No allegations were pursued against Mr Pappas in the circumstances. Mr Walliser 184 In the same way Calliden withdrew its allegations against Mr Walliser. Returning to the broader picture 185 Overall, AU has not given satisfactory, explanation in these proceedings for why it gave Ms Harrex an instruction to release as much as she was comfortable with, and not to change method, and why it did not provide Ms Harrex with copies of the Schedules (or otherwise instruct her in accordance with the Deed). That represents a significant lacuna in AU's case. Relief 186 Effectively Calliden has established an entitlement to declaratory relief in respect of which it has nominated 6 declarations in paragraph 47 of its further amended summons. The last of those declarations is inappropriate as in my view the fact that Ms Harrex's valuations did not comply with the provisions of the Deed, leaves the Court with no competing valuation which could substitute for the valuation required by the Deed. It is important to keep in mind that the Court has relevantly been engaged in an exercise of construction and enforcement of a contract, and is concerned neither with determining actuarial valuations itself, nor with exercising a judicial discretion as to how the entitlements of the parties ought to be established. 187 In the circumstances the Court will grant an opportunity to Calliden to indicate which of the declaratory claims sought in paragraph 47 [1 - 5] in its claims to relief are pressed. 188 I accept that the appropriate further order is to remit the matter to Ernst & Young for further consideration. The parties will be given an opportunity to address as to whether or not that further consideration should be by Ms Harrex, and if so as to the reasons for that course, and if not, as to what the alternatives may be. 189 The parties will be given an opportunity to address on costs and to attempt to consult with one another in relation to final relief. Rulings on objections 190 During the hearing the parties sensibly prepared schedules identifying which objections were pressed and which objections were not pressed. 191 Shortly after the conclusion of the hearing, the defendant's objections to the tender bundle were forwarded to the Court as an updated document reflecting the defendant's objections. 192 It is unnecessary to refer to the materials which had been removed from the court book by consent, in which respect of course, no ruling was needed. 193 Treating with page numbers being the third column in the defendants objections note:

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