JP MORGAN INSTITUTIONAL SERVICES AUSTRALIA LTD (NOW KNOWN AS BTA INSTITUTIONAL SERVICES AUSTRALIA LTD) (ABN 48 002 916 396)

Contract - Construction and performance - Public company agrees to redeem bonds if specified amount of annual revenue not achieved - Agreement provides that portion of bond money be kept in bank account - Whether interest is revenue - Company executes contract to deliver product to overseas distributor - Whether price to be paid should be recognised as revenue despite dispute as to terms of payment

Plaintiff : Mr B C Oslington QC, Mr E M Corboy SC & Mr B D Luscombe

First Defendant : Mr C G Colvin SC & Mr M N Solomon

Second Defendant : Mr C G Colvin SC & Mr M N Solomon

Third Defendant : Mr C G Colvin SC & Mr M N Solomon

Fourth Defendant : Mr C G Colvin SC & Mr M N Solomon

Sixth Defendant : Mr C G Colvin SC & Mr M N Solomon

Codelfa Construction Pty Ltd v State Rail Authority of New South Wales [1982] HCA 24; (1982) 149 CLR 337

Home Building Society Ltd v Pourzand [2005] WASCA 242

Jones v Dunkel [1959] HCA 8; (1959) 101 CLR 298

Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd [2006] FCAFC 144

Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616

McCann v Switzerland Insurance Ltd [2000] HCA 65; (2000) 203 CLR 579

Prenn v Simmonds [1971] 1 WLR 1381

Verner v General and Commercial Investment Trust [1894] 2 Ch 239

1 TEMPLEMAN J: The plaintiff in this action is Chemeq Ltd ("Chemeq"), an Australian company, the shares of which are listed on the Australian Stock Exchange. Chemeq produces acrolein based polymer, a chemical which is used for the prevention and control of intestinal bacterial diseases in intensively reared livestock, particularly pigs and poultry.

2 On 31 January 2005, for the purpose of raising capital to extend its operations, Chemeq issued convertible bonds ("the bonds") to the value of $60,000,000 to the first and second defendants and Mizuho International plc ("Mizuho").

3 On 27 October 2005, Chemeq entered into Heads of Agreement with the first and second defendants with a view to varying the terms and conditions incorporated in the bonds if (as was then proposed) Mizuho should transfer its bonds to the second defendant or entities associated with it.

4 Early in 2006, Mizuho did transfer its bonds. At all material times since then, the bonds have been held by the first, second, third, fourth and sixth defendants ("the bondholders").

5 The fifth defendant is a security trustee for the other defendants. In that capacity, the fifth defendant holds a fixed and floating charge granted by Chemeq on 23 May 2005, over all its assets.

6 When the bonds were issued in January 2005, the terms and conditions attaching to them were set out in sch 1 to a deed entitled Convertible Bond Deed Poll executed by Chemeq.

7 The amended terms and conditions were set out in annexure A to a deed entitled Deed of Amendment and Restatement (Convertible Bonds Deed Poll) ("the Deed Poll") made by the plaintiff on 12 April 2006. Relevantly for present purposes, the amended terms and conditions were those which had been recorded in the Heads of Agreement of October 2005.

8 The crucial provision is cl 2.9 in the amended sch 1. Under the heading "Milestone Covenants" (which, by cl 1.2, is for convenience only and does not affect the interpretation of the terms and conditions) it provides:

"While the aggregate Face Value of Convertible Bonds which the Initial Bondholders hold in aggregate is greater than 50% of the aggregate Face Value of all Convertible Bonds then on issue, the Issuer undertakes:

(a) to achieve total gross revenue from all sources of at least $4,000,000 for the financial year ending 30 June 2006; and

(b) to hold Liquid Assets of at least $24,000,000 on 30 June 2006."

9 Chemeq contends in this action that it complied with cl 2.9(a) by achieving total gross revenue of over $4,000,000 in the financial year ending 30 June 2006. There is no dispute about Chemeq's compliance with cl 2.9(b). Chemeq's case is that the revenue comprised:

• $2.333 million by way of interest on moneys held on deposit; and

• sales revenue of $1.785 million, including sales of $1.452 million to a South African close corporation known as Inviro Animal Health Solutions CC ("Inviro").

10 The bondholders dispute that there has been compliance. In essence, they contend that:

• on the proper construction of cl 2.9(a), the expression "total gross revenue from all sources" does not include interest (there is no dispute as to the amount of interest earned); and

• Chemeq did not achieve the sale of products to Inviro in the amount of $1.452 million and accordingly did not achieve that amount of revenue by 30 June 2006.

11 It is common ground between the parties that if Chemeq failed to comply with cl 2.9(a), the bondholders would be entitled to require their bonds to be redeemed, failing which, they would be entitled to exercise their rights under the fixed and floating charge referred to above.

12 In the belief that there had been non-compliance by Chemeq, the bondholders served Notices of Redemption in October and November 2005. Chemeq responded by commencing this action. The writ was issued on 9 November 2006. Chemeq then sought an interlocutory injunction to restrain the bondholders from acting on their Notices of Redemption. However, on being informed that the action could be tried in January, the parties agreed, on the basis of mutual undertakings, that the status quo could be preserved until then.

13 The relief sought by Chemeq in the action included declarations that it has complied with cl 2.9(a) of the Deed Poll and a declaration that the various Notices of Redemption are of no effect. An injunction was sought to restrain the bondholders from taking any action under the fixed and floating charge for the alleged non-compliance with cl 2.9(a).

14 In addition, Chemeq claimed damages against the bondholders, on the basis that the issue of the Notices of Redemption and the associated publicity had caused it to suffer a loss of reputation. This claim was not pursued at trial.

15 The contest at trial was between Chemeq and the bondholders. The fifth defendant, the security trustee, did not participate. At the commencement of the trial, counsel for the fifth defendant was given leave to withdraw on the basis that her client agreed to be bound by the decision. However, the fifth defendant reserved the right to participate in any argument about costs or the formulation of orders which might affect it.

16 It is clear that if it is to obtain the declarations it seeks, Chemeq must succeed on both of its contentions summarised above. The issues are separate: that is to say, the question whether Chemeq achieved the sale to Inviro is not affected by the construction issue: and vice versa. It will be convenient to deal first with the Inviro sale issue because it provides some background to the construction issue.

17 Chemeq's case is based on an order for 2000 units (of 20 litres) of its product at a price of $720 per unit, placed by Inviro on 20 September 2005. Chemeq contends that the product was delivered, that Inviro was obliged to pay the price, and that on the application of the relevant Australian Accounting Standard, Chemeq was entitled to bring that revenue into account in the year ended 30 June 2006.

18 The order was obtained for Chemeq by its then sales and marketing manager, James Geldart. He was assisted by Chemeq's Chief Executive Officer and Managing Director, Lindsay David Hale Williams. Mr Williams was appointed to those positions when he joined Chemeq on 1 August 2005.

19 Mr Williams gave evidence at trial but Mr Geldart did not. He is no longer employed by Chemeq, having been retrenched in September 2006. No representative of Inviro gave evidence.

20 In these circumstances, my consideration of the Inviro transaction is based principally on Mr Williams' evidence. As I have noted above, Mr Williams did not join Chemeq until August 2005. However, from 2001 onwards, Chemeq's principal consultant veterinarian, Dr Alistair Murdoch, visited South Africa from time to time for the purpose of dealing with the regulatory authorities and identifying potential customers for Chemeq. Dr Murdoch gave unchallenged evidence about these matters. I accept his evidence in its entirety.

21 I also place considerable reliance on the contemporaneous documents contained in the trial bundle (exhibit 1). That is because, with one exception to which I shall refer below, it is not suggested by the parties that the documents are other than they appear to be. I therefore proceed on the basis that the documents (including emails) were produced on or about the dates they bear by the persons who are named as their authors, that the facts they record are true and the views they express were held genuinely.

22 Mr Williams was cross-examined in considerable detail over some two days by leading counsel for the bondholders. Mr Williams gave careful and considered evidence. Where it appeared from a document that his recollection had been inaccurate, he readily accepted that to be so. I formed the impression that Mr Williams was a generally reliable witness and I accept most of his evidence.

23 In the narrative which follows, I set out my findings of fact. Where I refer to something said by Mr Williams or recorded in a document, it may be assumed that I accept the statement to be true.

24 Dr Murdoch joined Chemeq on 5 January 2001 when it had only six employees. His role then was to look after the marketing, technical, and commercial side of the business. On the basis of his experience in the pharmaceutical industry, Dr Murdoch knew that many of the global pharmaceutical companies used South Africa as a test market. They did so (although the South African market is relatively small) because the regulatory approval system and consumer base were similar to those in many first-world countries. However, the South African regulatory approval system was considerably quicker than the systems in such countries. By marketing the product in South Africa, Chemeq hoped to obtain a good indication of its likely reception in other markets.

25 Although most pharmaceutical companies have affiliated companies in other countries, Chemeq had no affiliate in South Africa. Chemeq therefore took advantage of Austrade assistance which was available in South Africa with a view to appointing a South African agrichemical company known as TABS Trading ("TABS") as its distributor in that country.

26 In 2001, Dr Murdoch met Dr Pieter Grimbeek in South Africa. Dr Grimbeek is a specialist pig veterinarian. Dr Murdoch came to understand that the South African pig industry was dominated by specialists such as Dr Grimbeek and that producers would not consider purchasing Chemeq's product unless their consulting veterinarians approved its use. However, Chemeq's strategy was to sell product both to the owners of piggeries and to veterinarians. Although TABS was neither a veterinarian nor a producer, its proprietor believed he could sell product through his contacts in the agricultural sector and develop commercial levels of sales in the intensive animal health industry on the east coast of South Africa, in Durban, East London and Port Elizabeth.

27 In late 2003 to early 2004, Dr Murdoch became aware from his discussions with Mr Geldart that TABS was no longer Chemeq's preferred distributor in South Africa. At about that time, discussions were initiated with Dr Grimbeek and two other specialist pig veterinarians, Drs Pieter Vervoort and Peter Evans, with a view to their becoming Chemeq's distributors in South Africa.

28 It was as a result of those discussions that Drs Grimbeek, Vervoort and Evans formed Inviro. It was incorporated on 16 July 2004 (exhibit 1/584).

29 In October 2004, Dr Grimbeek visited Chemeq's production plant at Rockingham. In a subsequent email to an unidentified recipient, which he copied to Dr Murdoch and Mr Geldart, Dr Grimbeek said:

"The production plant in Rockingham is absolutely magnificent, probably overcapitalised, but it may be the best investment ever made by Chemeq in the years to come. The in-house standards, quality assurance and other GMP standards are world class."

Dr Grimbeek went on to say that Inviro had been appointed as the distributor in South Africa for poultry and pigs and that:

"We are extremely excited and cannot wait for the commercial product to arrive (hopefully early Jan 2005). We feel the application in the broiler market to be really interesting and all sorts of shuttle programs can be devised. In many ways we may be the guinea pigs (in a nice way) but what an exciting future!

Chemeq may be the first truly good alternative to antibiotics. Like yourself we have trialled and tested and agonised over probiotics, prebiotics, enzymes, acid oils, acidifiers, snake oil and magic white powders with results varying from satisfactory (but expensive) to disappointing. Let's hope that this Australian invention is a workable alternative." (exhibit 1/1015 - 1016)

30 Dr Grimbeek's reference to Inviro having been appointed as Chemeq's distributor in South Africa was to a Distribution Agreement, signed on 24 August 2004, albeit with the qualification that Inviro was executing the agreement:

"On the understanding that some amendments to agreement will be made as per emails 25 and 26 August 2004." (exhibit 1/2558)

31 The email dated 25 August 2004, from Dr Evans to Mr Geldart, contained the statement:

"The sales budget is understood not to be binding on the distributor in any way to purchase the budgeted quantity of product.

NB page 14 - 10.2 states the Distributor must purchase at least 80% of the product specified.

Please re-phrase or delete." (exhibit 1/2554)

The inference is that as Chemeq's distributor, Inviro was not willing to purchase any greater quantity of product than it sold.

32 I have referred above to the fact that the bonds were issued on 31 January 2005. The Subscription Agreement between Chemeq and the then bondholders (including Mizuho) contained in cl 12.2(c) a "milestone covenant" in which Chemeq undertook to each subscriber:

"... by 30 September 2005, to provide evidence to the Subscribers satisfactory to the Subscribers (acting reasonably) of confirmed purchase orders at a price consistent with [Chemeq's] business plan for the combined sale of a minimum of 2,000 20 litre containers of CHEMEQ polymeric antimicrobial for the 12 month period ending 30 June 2006." (exhibit 1/31)

33 By August 2005, Chemeq had not obtained purchase orders sufficient to satisfy the covenant. On 13 August, Mr Williams travelled to South Africa in order to meet potential customers and to meet an accountant about Chemeq's registration in South Africa.

34 Together with Mr Geldart, Mr Williams met representatives of Rainbow Farms (South Africa's largest commercial poultry producer), Woolworths and County Fair Foods Pty Ltd. Mr Williams was "not comfortable" with the responses he received from Rainbow Farms but he regarded it as early days. County Fair was favourably disposed to the product but there were still issues.

35 Mr Williams and Mr Geldart subsequently met Drs Grimbeek, Vervoort and Evans. Drs Vervoort and Evans said they were leaving Inviro in order to concentrate on their own businesses. Dr Grimbeek was negotiating to buy them out and to continue Inviro on his own. Although there was no discussion about purchases by Inviro, there was a discussion about the market generally.

36 In early September 2005, Mr Williams had a number of discussions with Mr Geldart in order to identify potential customers. Mr Williams was concerned that Chemeq would not achieve unconditional orders for 2000 units of product by 30 September as required by the milestone covenant.

37 In the course of their discussions, Mr Williams and Mr Geldart identified County Fair and Rainbow Farms as potential sources of conditional orders. They thought TABS and Inviro might place unconditional orders for small quantities of product and conditional orders for larger quantities.

38 Mr Williams did not have any specific conditions in mind, although he thought that conditions relating to satisfactory trial results or on-sale or consignment might have been requested. However, he realised that conditional sales might not count for the purpose of the milestone covenant.

39 At this stage, Mr Geldart was in South Africa. On 6 September, Mr Williams sent an email to Mr Geldart in which he set out his thoughts on approaches to potential customers. He referred to the fact that "we must do everything we can to get the 2000 units of sales":

"You will appreciate that I, as I know you are, am very concerned now about whether we are going to lock away the necessary sales. We have to do everything possible. I have a regular phone hook up with Mizuho etc on Thursday at 4 pm (WST) and I will have to let them know the state of play (I will have to email the Board prior to that as well to ensure they are aware before I tell Mizuho)." (exhibit 1/483)

40 Mr Geldart responded to the various points made by Mr Williams in an email of the same date. He concluded by saying:

"As always I have '2000 (30/09)' tattooed on my forehead." (exhibit 1/482)

41 On 8 September, Mr Williams reported by email to other directors of Chemeq that the news from South Africa was "not good". This was because there had been an outbreak of Newcastle's Disease, a respiratory disease affecting poultry. It could not be treated with Chemeq's product. Having incurred substantial costs in medication, the poultry producers were not in a position to commit to Chemeq. Mr Williams said:

"Discussions with our distributor (Inviro) are taking place today and it is unclear at this stage what if anything they might be able to commit to." (exhibit 1/486 - 487)

42 For these reasons, Mr Williams was "about 90% certain that we will not achieve the 30 September covenant in relation to sales".

43 I infer that the discussions to which Mr Williams referred, were to involve Mr Geldart and Dr Grimbeek.

44 It was against that background that Mr Williams travelled to South Africa where he arrived on Thursday, 15 September.

45 By 16 September, the prospects looked more encouraging. Dr Grimbeek emailed a letter to Mr Geldart in which, despite gloomy references to Newcastle Disease and two exotic diseases which had devastated the pig industry, he remained optimistic about Chemeq's prospects as a replacement for antibiotics.

"I am sure that with some concentrated effort we could sell 2000 x 20 lt drums by June of 2006. The bulk of the sales will be in the Poultry market. Of course there are conditions, and one of them is appointing a dedicated person to fulfill [sic] the needs of the market."

47 Dr Grimbeek concluded by looking forward to Mr Geldart's visit on 18 September (exhibit 1/2564 - 2565).

48 On the morning of Sunday 18 September, Mr Williams and Mr Geldart met Dr Grimbeek at his house in Potchefstroom. Mr Williams was very impressed by what he saw. He recognised Dr Grimbeek as "a man of obvious wealth". His house:

"was in a nice part of ... Potchefstroom ... on a large block of land. It was extremely well maintained, extremely well fitted-out premises and a number of antiques and the like around. It exuded wealth when you went there." (TS 242)

Mr Williams was aware that Dr Grimbeek had a number of businesses, including a cattle farm on a large acreage near his house. Dr Grimbeek told Mr Williams that he was in the process of selling his piggery and was looking for something to do with the money derived from that sale. At some stage Mr Geldart (who was himself South African) told Mr Williams that Dr Grimbeek was a man of high standing: a proud man, who valued his reputation.

49 Mr Williams' recollection was that the meeting with Dr Grimbeek commenced with a discussion about the market in South Africa. Dr Grimbeek then said words to the effect:

"I've been through it all, done the calculations and I think I can place an order."

Mr Williams asked what sort of order. Dr Grimbeek said:

"I've been through the figures and subject to discussions with the bank, I would like to place an order for 2000 units."

Mr Williams then asked how much would be conditional and how much would be unconditional, to which Dr Grimbeek replied that it would all be unconditional, subject to a further meeting with the bank on the Monday to confirm its approval to finance the purchase.

50 As I have noted above, Mr Williams was expecting that, at best, Inviro would place an order which was at least partly (and probably substantially) conditional. He therefore asked Dr Grimbeek if he was sure about his offer. Dr Grimbeek said:

"Yes. I've done the figures and I'm very excited about the prospects. I am very keen to make the order."

51 Dr Grimbeek went on to explain his reasons for making the order. These included the prospects for selling the Chemeq product to poultry farms and that he wanted to try to extend the application of the product to other areas relating to both poultry and pigs. Having explained his reasons, Dr Grimbeek said words to the effect:

"I am very excited about this. I am going to be able to get out there and sell this product. This is going to go really well."

52 Later in the meeting, Mr Williams asked Dr Grimbeek when he wanted to take delivery of the product. Dr Grimbeek said that it would be over the period to 30 June 2006. However, Dr Grimbeek was content to take delivery by shipping-container quantities of 300 - 400 units.

53 Down to this point of the meeting, there had been no discussion about the price to be paid by Inviro. When that matter was raised, Mr Williams said the price would need to be about whatever was required by the covenant in the bonds. He told Dr Grimbeek he could not recall exactly but that it was about $720 per unit. The recommended retail price was to be the equivalent of $850 per unit.

54 Dr Grimbeek said that was not exactly the price he was looking for: he thought it would be lower. This was no doubt because under the Distribution Agreement, the prices for product used for pigs and poultry were $560 and $680 per unit respectively.

55 Mr Geldart then suggested that Chemeq "can probably throw in Product for marketing purposes". He told Dr Grimbeek that if he chose not to give the product away but to sell it, that effectively represented a lower price per unit. Dr Grimbeek said "that sounds alright". Mr Williams then said that in due course he would tell Dr Grimbeek what the exact price of the product would be and how much extra product would be given to him for marketing purposes.

56 It will be recalled that in Dr Grimbeek's letter of 16 September he referred to the need to appoint a person for the purpose of selling Chemeq products.

57 Dr Grimbeek raised this matter at the meeting on 18 September. He said:

"I want to get a 'Mr Chemeq' on board. James and I have discussed this. I would like to employ this person."

58 Mr Williams made no commitment: he said he would like to think about that proposal and talk to Mr Geldart about it.

59 There was then some discussion about a need to change the Distribution Agreement. Dr Grimbeek said he wanted to be the exclusive supplier of the Chemeq products for the whole of South Africa. Mr Williams said there were issues with Rainbow Farms, Early Bird and County Fair who believed they were big enough not to require a distributor but to deal direct with Chemeq. He told Dr Grimbeek that Chemeq needed him to carry out the day to day administration and was happy to pay a service fee to cover his activities in relation to those matters. He explained to Dr Grimbeek that Chemeq would receive orders from Rainbow Farms, Early Bird and County Fair and would invoice them. Dr Grimbeek said he understood that would be the position.

60 The business side of the meeting ended with Mr Williams referring to the possibility that Dr Grimbeek might not have sold all the product by 30 June 2006. This was not a matter to which Dr Grimbeek had referred previously. Mr Williams raised it out of concern for Dr Grimbeek's position (TS 90).

61 Dr Grimbeek said he did not think this would be an issue but that it would be good to make some provision to cover that eventuality.

62 Mr Williams did not refer in his evidence to the discussion of any other arrangements designed to protect Dr Grimbeek. However, I infer from an email sent to him by Mr Geldart on 20 September that some assurance was given to Dr Grimbeek that he would be compensated for the fact that Inviro would be purchasing product from Chemeq at $720 per unit, compared to $680 per unit under the Distribution Agreement. I shall refer below to this email.

63 Following the meeting, Dr Grimbeek entertained Mr Williams and Mr Geldart at lunch. There was no further discussion of business matters.

64 On the following day, 19 September, Mr Williams flew on to Kuala Lumpur.

65 Before his departure from South Africa, Mr Williams sent an email to Mr Geldart, setting out his thoughts on matters including the proposed contract with Dr Grimbeek. In that context, Mr Williams' email included the following points:

"• We need to address the position of price. We do not want him selling at below RRP of A$850 without our agreement, but not sure whether RSA has any resale price maintenance etc laws like in Oz that would prohibit this.

• We also need a mechanism that keeps [Dr Grimbeek] whole if we are forced to sell lower and he gets forced to take a lower margin. This could be done with free product, but Bondholders would see through that. Maybe better with provision of Select Dosers or the like or reflecting it in his DA margin on other sales or post 30 June 2006 sales. We need to be careful with this, but I do not want [Dr Grimbeek] exposed.

...

• We should have some say/input into the 'Chemeq' person he engages." (exhibit 1/490)

66 In my view, it is clear that Mr Williams was not there concerned to address the possibility that Inviro might not sell the product which was to be the subject of the purchase order for 2000 units. Mr Williams' concern was that Dr Grimbeek should achieve a sufficient profit by selling at a retail unit price equivalent to $850, when he was being required to purchase at a wholesale price of $720. Mr Williams was concerned that if Chemeq was "forced to sell lower", that is, at a price below the hoped-for retail price, then Dr Grimbeek would need to reduce his retail price in order to compete, and therefore accept "a lower margin". It would be necessary to make some provision in order that Dr Grimbeek would not be "exposed" to a risk of this kind.

67 Mr Williams seems to have believed that if Dr Grimbeek was given free product, this would effectively reduce the sales order price of $720 per unit, with the result that Chemeq would not satisfy the covenant. Hence Mr Williams' observation that "Bondholders would see through that".

68 Mr Williams was therefore exploring possible ways of achieving his objective by other means, possibly through the new Distribution Agreement between Chemeq and Inviro which would govern their relationship beyond the order for the 2000 units.

69 In the course of a lengthy cross-examination about his email of 19 September, it was put to Mr Williams that:

"... what you proposed was an arrangement whereby the order would provide for the 720 but the distribution agreement would provide for discounts from the 720 amount; in other words, you knew from the beginning that you had to get a price recorded in a purchase order at $720 in order to satisfy the covenant but you knew that to get Dr Grimbeek to commit to that you had to agree to record somewhere the other arrangements that you had discussed?"

"To provide him some benefit that countered the higher wholesale price, that's correct."

70 It was then put to Mr Williams that he had proposed to deal with these matters in the Distribution Agreement in order that they could be kept from the bondholders. He said:

"I'm not sure that I was as solidified on where it would at this point in time but that's where it ended up, I agree."

71 Mr Williams went on to say that at that stage he had not considered whether the Distribution Agreement should be provided to the bondholders. However, he accepted that given the nature of the arrangement that had been documented, it would be necessary to provide the Distribution Agreement to the bondholders, as well as the sales order, so that they could see the terms upon which the order had been agreed (TS 82).

72 On 20 September, Mr Geldart sent an email to Mr Williams to inform him that Dr Grimbeek had decided to place an unconditional order for 2000 units of product and that he would be formulating a letter to that effect. (Dr Grimbeek had by that stage obtained an R 8,000,000 facility from his bank.) Mr Geldart said he thought it was important to raise an official order form as well. He said:

"Please could you advise me as to the selling price ... you want me to charge [Inviro] in order to satisfy the covenant."

"We need to achieve A$717 so suggest you make it A$720." (exhibit 1/500)

74 In my view, it is surprising that Dr Grimbeek was prepared to place an order for 2000 units of product without knowing precisely what price Chemeq would be charging. The explanation, I think, lies in the fact that from Dr Grimbeek's perspective, his position was protected by the representation made to him that he would not suffer financially if he was unable to sell the product or if Chemeq was obliged to sell to other customers in South Africa at a retail price less than $850 per unit, the price at which it was expected that Inviro would be selling.

75 Although these matters had not been resolved with Chemeq by 20 September, Mr Geldart sent an email to Dr Grimbeek and Mr Williams later on 20 September in which he said to Dr Grimbeek:

"Pieter, as discussed, you will be compensated for the differential in the selling price AUD$680 (Distribution Agreement) vs. AUD$720 (sales order) either via product or a mutually acceptable method. The AUD$720 is what is required for the Bondholders as the base case scenario." (exhibit 1/516)

76 On 20 September, Dr Grimbeek signed sales order SO1006 in Chemeq's standard form on behalf of Inviro as purchaser.

77 The terms and conditions of sale were set out in the document. Clause 2 provided that the terms and conditions constituted a complete and exclusive statement of the agreements and understandings between Chemeq and the purchaser with respect to the subject matter and that it superseded all prior arrangements, written or oral. All additions and modifications to the terms and conditions were to be in writing, signed by both Chemeq and the purchaser.

78 Clause 6 provided that the product was to be supplied on a strictly COD basis: and cl 9.1 provided that ownership and property in the products passed from Chemeq to the purchaser only when payment in full had been received by Chemeq (exhibit 1/518 - 519).

79 As soon as the sales order was placed, Chemeq commenced the preparation of a new Distribution Agreement. Following some negotiations, the Distribution Agreement was executed on 29 September (exhibit 1/586a - w).

80 The Distribution Agreement appointed Inviro as Chemeq's exclusive distributor of its products in South Africa. However, Chemeq remained entitled to market and make sales of products to three poultry producers Rainbow Farms, County Fair Foods and Early Bird, directly or indirectly or through any agent or intermediary including TABS. Under the heading of "Market Support", Chemeq agreed to deliver at the same time as product was delivered under sales order 1006, 134 20 litre units of product on a complimentary basis to assist Inviro with "preliminary marketing of product" in South Africa (cl 5(4)).

81 Under the heading "Sales Targets and Reporting Requirements", it was provided by cl 6(2) that Inviro would be entitled to receive 300 20 litre units of complimentary product if it had not been able to sell (or take orders for) any product by 30 June 2006. The amount of complimentary product would reduce on a pro rata basis for any actual sales of (or orders for) product prior to 30 June 2006. An illustration was given: if Inviro had sold, or taken orders for, 1000 units of product by 30 June 2006, it would be entitled to 150 units of complimentary product.

82 Under the heading "Orders, Prices, Terms of Supply", cl 9(4) required Inviro to pay the price and all amounts legitimately included on the invoice, in Australian dollars, within 30 days from the date of the statement generated by Chemeq.

83 The price was set out in sch 3. The prices for pig and poultry products were $555 and $675 per unit respectively. However, the parties confirmed that Inviro had already placed sales order 1006 which was "made upon and subject to the terms of this agreement" except that the price to be paid by Inviro was $720 per unit.

84 The recommended retail price for both pig and poultry products was $850.

85 Clause 5(3) imposed on Inviro an obligation to employ a full-time staff member to be dedicated to the promotion of Chemeq, the product and Inviro in South Africa.

86 On 24 September, Chemeq announced to the Australian Stock Exchange that it had signed the order with Inviro which provided for the shipment of Chemeq products worth approximately $1.4 million over the succeeding nine months. In the announcement, Dr Grimbeek was quoted as saying that he was pleased with the growing interest developing in Chemeq product among commercial pig and poultry producers in South Africa. Dr Grimbeek approved the terms of the announcement before it was published (exhibit 1/577).

Chemeq's expectations in South Africa are not met

87 The announcement of the Inviro sale to the Stock Exchange made reference to Chemeq's belief that further orders from the South African pig and poultry sectors might be forthcoming in the near future. That belief was based on the success achieved by Chemeq in a series of trials with Rainbow Farms.

88 Mr Williams believed that the adoption of Chemeq's products by Rainbow Farms would have significantly enhanced Chemeq's prospects of sales to other producers. However, in December 2005, Rainbow Farms decided not to proceed with further trials of Chemeq product until March 2006 at the earliest.

89 In early December 2005, Inviro appointed the "Mr Chemeq" envisaged in previous discussions and as required by the Distribution Agreement. He was Rudolf Van Der Veen, who was appointed by Dr Grimbeek as a commission agent. Mr Geldart informed Mr Williams in an email dated 7 December 2005 that he had been training Mr Van Der Veen and had updated Dr Grimbeek on "the Rainbow position". Mr Geldart said that Dr Grimbeek was very concerned about "the ability to reach the 2000 units by 30 June 2006" (exhibit 1/597).

90 Mr Van Der Veen and Dr Grimbeek soon produced a draft business plan for the sales and distribution of Chemeq's products in South Africa (exhibit 1/601 - 638) - draft. The goals set out in the draft plan included:

"Establish and ensure sales of 2000 drums of CHEMEQ (40,000 litres) in the South African market by the 30th of June 2006."

The draft business plan contained a detailed study of the potential markets for Chemeq products in South Africa. Although the wholesale price to be paid by Inviro for the order of 2000 units was $720 per unit, the draft report proceeded on the basis that the price was $575 per unit for the pig product and $675 per unit for the poultry product. But even this, the authors believed, was far too high. They proposed a price of $510 per unit for both pig and poultry products.

91 Dr Grimbeek and Mr Van Der Veen argued their case for a price reduction at a meeting in South Africa on 4 February 2006, attended by Mr Williams, Mr Geldart and Dr Murdoch for Chemeq. Mr Williams said he did not agree with the proposal to reduce the price but would reflect on it. He felt that the solution was to take "a more innovative approach to achieving sales and do more marketing".

92 After the meeting, Mr Williams went from South Africa to London and was away for some two weeks.

93 On 5 March, Dr Grimbeek sent an email to Mr Geldart which he copied to Dr Murdoch and Mr Van Der Veen. Dr Grimbeek said:

"My Inviro comments are serious and Chemeq Ltd needs to seriously reassess where to position the product in the market. Now that I have worked with it I can assure you it is not the wonder drug we all considered it to be and it does not deserve the price premium placed on it. PRICE IT where everybody cannot afford NOT to use the product not the other way around." (exhibit 1/655)

94 Mr Geldart responded by an email in which he said he understood and sympathised with Dr Grimbeek's concerns and the issues he had raised. He asked Dr Grimbeek whether he had a price figure he believed was fair to both parties (exhibit 1/655).

95 Dr Grimbeek did not answer that question until 15 March when he sent a status report on Chemeq sales to Mr Geldart (exhibit 1/650 - 651).

96 In his report, Dr Grimbeek referred to information he had obtained at a Pig Expo on the previous day. The information related to the use of a disinfectant called Agribac which had been used to treat poultry at a cost of 2.8 cents per bird. The treatment was administered at certain stages in the life of each bird. Had Agribac been used for the whole of the bird's life it would have cost 31 cents, a cost similar to the Chemeq product "but we are not sure of any additional benefits". Dr Grimbeek continued:

"Now to answer your question? What should CHEMEQ cost? James, I don't know. It is however too expensive at present. We need to price for a 'whole of life' broiler treatment at about 16 cents a bird, and a last week treatment cost of about 4 to 5 cents per bird.

The result of this will be that we will sell a drum to the broiler and pork producers at about R2200.00, and that [Inviro] will have to purchase from Chemeq Ltd at about R1400.00 per drum (308AUD).

We might reduce income in the short term but the product will become more financially accessible to all producers, poultry and pork, and sales should rocket. The margin (per drum) is smaller and [Inviro] will have to renegotiate commissions and payments.

What to do about our deal? I have to purchase 2000 drums @ 720AUD by 30 June 2006.

Remember, if the 2000 unit order does not move and the product expires on [Inviro], Chemeq Ltd will inherit a bankrupt distributor. [Inviro] will have to discount product into the market whether it likes to or not."

"(1) There is a 'good hype' about this product.

(2) It is not as good as you think it is.

(3) It must be positioned correctly, the present price is too high."

Dr Grimbeek referred to some other products which were "dirt cheap are available and severely restrict our chances to enter the market" (exhibit 1/650 - 651).

97 Mr Williams was concerned about the lack of success in marketing Chemeq's products in South Africa. However, he did not agree to a price reduction because he was not convinced that course was justified commercially. In addition, he was concerned to ensure that Chemeq did not prejudice its position in relation to its covenant with the bondholders. Mr Williams believed that Dr Grimbeek was attempting to renegotiate both the Distribution Agreement and the sales order, despite the fact that Inviro was bound to take delivery of the product and pay for it.

98 Accordingly, Chemeq arranged for the product to be shipped to South Africa and for Inviro to be invoiced.

99 Evidence about the shipment of product to South Africa pursuant to SO 1006 was given by Jacqueline Delia Quinn, Chemeq's Supply Chain Manager. Mrs Quinn's evidence was not challenged and I accept it. On the basis of that evidence, I find the following facts.

100 Inviro's order for 2000 units of product was shipped from Fremantle in four consignments (which contained some additional units):

101 Invoice 63 referred to a price which was incorrect. It was replaced by invoice 67 on 5 April 2006.

102 The product was shipped under INCOTERMS 2000 DDU (Delivered Duty Unpaid).

103 The consignments were all shipped to the port of Durban, from where they were trucked to the warehouse of UTi Worldwide Inc in Jet Park, Johannesburg. The dates of arrival in Durban, release by the South African Customs and delivery to the warehouse were as follows:

104 Chemeq maintained its own stock of product at the UTi warehouse. However, the consignment of 2000 units for Inviro was not part of Chemeq's inventory.

105 The duty payable on the product in order for it to be released by Customs, was the South African Value Added Tax (VAT). All of the VAT was paid by Inviro, as required by cl 9(12) of the Distribution Agreement.

106 According to the invoices relating to each shipment, the dates for payment were:

107 However, by cl 9.4 of the Distribution Agreement, the price was payable 30 days from the date of a statement generated by Chemeq. According to Mr Williams, a statement relating to invoices 66, 67, 70 and 71 was produced on about 17 May. That evidence was not challenged and I accept it (although I note that the statement to which Mr Williams referred (exhibit 1/1098 - 1099) is dated 7 November 2006).

108 It follows that Inviro was obliged to pay for the product on or about 16 June 2006.

109 On 1 June, at Chemeq's request, Dr Grimbeek emailed a letter drafted by its Financial Controller confirming that Inviro had taken delivery of 2000 units of product and stating that:

"... Chemeq Ltd's sales order SO 1006 is now complete, and accepting delivery of the 2 000 20L units of (product) fulfils the terms and conditions of the sale." (exhibit 1/733)

110 In fact, as I have noted above the last consignment of product did not reach the UTi warehouse until 7 June. However, it was released by Customs on 2 June, suggesting that Inviro had paid the VAT on 1 or 2 June.

111 Mr Geldart visited South Africa between 25 May and 6 June 2006. He subsequently produced a sales report in which he referred to meetings he had with various players in the pig and poultry market.

112 In relation to Inviro, Mr Geldart referred to a meeting with Dr Grimbeek. In his summary of the meeting he noted that Inviro had accepted the delivery of 2000 units and that a letter of confirmation had been provided to Chemeq's accounts department. In relation to "issues" Mr Geldart noted:

"• Insecurity over the viability of CHEMEQ in RSA

...

• Lack of 'demand' for CHEMEQ

• Expiring stock." (exhibit 1/754 - 755)

113 Although Mr Geldart did not refer in his sales report to the date of his meeting with Dr Grimbeek, it appears from a document on Inviro letterhead dated 2 June 2006 that the meeting was held on 31 May (exhibit 1/746). However, Mr Geldart did not give this document to Mr Williams until 7 August.

114 Chemeq does not accept the authenticity of this document. However, I am satisfied that it was prepared by Dr Grimbeek on or about 2 June and that it records his version of the discussions of 31 May. The document referred to the following "business points" having been agreed:

"1. [Inviro] to confirm by letter that they have received the order of 2 000 drums, 20L Chemeq and fullied [sic, fulfilled] the covenant. This has been done.

2. [Inviro] is now the owner of the product and responsible for its keep but not the immediate payment therefore as previously discussed.

3. Due to the poor sales record of the product due to an excessively high trading price, (see previous correspondence) [Inviro] will only pay Chemeq for product as and when it is drawn from the UTI warehouse. UTI are the distribution agents. [Inviro] will pay the amount within 60 days of drawing the product.

4. Chemeq has agreed to replace any expired stock and to credit [Inviro] should it be necessary. Expired stock is a big problem at present.

5. Chemeq has offered [Inviro] one 20L free for every two purchased in an attempt to reduce the price to the end user. The present price of 720AUD will still be valid, but one free drum is issued with every two purchased, reducing the price in effect to [Inviro] of AUD480 per drum. At the present exchange rate R 5.03 to 1AUD, a single drum will therefore cost [Inviro] R 2 414.40 in South African terms. As and when the full quota of two thousand drums are drawn, Chemeq will in negotiation with [Inviro] then supply a final 1 000 drums but in effect only receive payment for 2/3 of both consignments.

6. [Inviro] is to pay the full VAT on the order of 2 000 drums. These invoices have been received from UTI and the respective amount are R 268 951.20, R 319 090.52 and R 239 306.90 respectively. A total of R 827 348.62. This will be paid on 2 June 2006.

7. A termination of our agreement was also discussed. [Inviro] will do everything in its power to market the 2000 units in the next financial year ending February 2007. If by the end of this period no real success has been achieved Chemeq may ask [Inviro] to stand down as its South African distributor, or earlier by mutual agreement and subject to the distribution agreement. Chemeq will then irrevocably release [Inviro] of its payments commitments on any stock that is not sold. [Inviro] will have no further claim against Chemeq or vice versa. It is agreed that at least 1 000 drums should be sold into the market by end of February 2007, of which only two thirds are to be redeemed in the effort to introduce the product into the market.

8. Both parties understand the importance of the large poultry integrators and their purchasing powers. Rainbow and the Astral group are acknowledged to be clients of Chemeq Australia, and that sales into these companies will contribute part of the 2 000 + 1 000 drums. Messrs Rainbow and Astral will be invoiced by Chemeq Australia, and [Inviro] will be paid a sales commission of 17.5% on the sales price of 480AUD per drum, this equal to 84 AUD per unit.

9. [Inviro] and Chemeq understand the sensitivity of these discussions and will honour the confidentiality thereof."

115 The document made provision for signature by Mr Geldart on behalf of Chemeq and for Dr Grimbeek on behalf of Inviro and for the signatures of two witnesses. However, there is no evidence that the document was ever signed.

116 Mr Geldart reported to Mr Williams about his meeting with Dr Grimbeek on 31 May in an email which reached Mr Williams on 1 June at 2.18 am. Allowing for the time change between Perth and South Africa, the email would have been transmitted by Mr Geldart on the evening of 31 May.

117 Mr Geldart said he had met Dr Grimbeek that afternoon "to discuss SO1006". He said Dr Grimbeek wanted to sleep on a number of issues for a further meeting to be held on the morning of 1 June. He said:

• At what price will we invoice [Dr Grimbeek] for the product to be delivered under SO 1006. The original contract was for 2,000 units at a price of $720, we have now dropped the price to $480. Given the changes in selling price to [Inviro] there is an additional 946 units due to him. My feeling is that we invoice him at $720 and for every 2 units he buys he receives 1 unit 'free'. This maintains the Sales order. However he is leaning towards Chemeq Ltd invoicing him for all the product at $480 as it will be less confusing.

• Discussed the extended trading terms, what sunset clause do you want to place on the order. I believe that should there still be significant amounts of product remaining at a 'sunset date' [Inviro] will consider terminating the DA (?)

• Discussed the 'letter' of acceptance as forwarded to me by Colleen (26/5/06). He is comfortable with the wording and will get that off to Chemeq in the morning.

Please could you provide me with your thoughts ASAP." (exhibit 1/730)

118 Mr Williams responded at 9.09 am that morning. He said:

Mr Williams requested that Mr Geldart discuss the matters with him any time after 6 am in South Africa.

119 It is clear that there is a close correlation between the significant matters said to have been agreed in Dr Grimbeek's document of 2 June and the matters raised by Mr Geldart in his email to Mr Williams. However, it is impossible to determine what was said or what (if any) agreement was reached between them.

120 Following the end of the financial year, it was necessary for Chemeq to decide whether it had performed the covenant contained in cl 2.9(a) of the Deed Poll.

121 On 4 July 2006, Mr Geldart sent an email to Dr Grimbeek in which he said:

"Sorry to be a pain and once again ask you to assist Chemeq in ensuring that the Revenue covenant is fulfilled. The auditors are concerned that the letter we asked you to provide us may not be sufficient for them. I have been in discussions with our CFO and he requests that you send me an email with the following text:

'Dear James

I refer to my letter of 1 June 2006 in which I acknowledge receipt of CHEMEQ product under sales order SO 1006 and your recent inquiry with regards to payment of this order.

You will note that I have paid the VAT on this order and confirm my intention to pay for the goods.

You will appreciate that I have only recently received the complete shipment.

Yours sincerely

Dr P Grimbeek

Inviro Animal Health Solutions'

...

Please could you start a fresh email for this 'letter'."

122 Dr Grimbeek's response to Mr Geldart's email was not precisely in the proposed terms. Dr Grimbeek added a qualification to the crucial second paragraph so that it read:

"You will note that I have paid the VAT on this order and confirm my intention to pay for the goods as discussed in our marketing plan." (exhibit 1/2844)

(emphasis supplied)

123 In his cross-examination, Mr Williams said he did not know what was intended by the reference to the marketing plan but assumed it was a reference to Dr Grimbeek's letter of 2 June 2006. In my view, that must be so.

124 The reference in Mr Geldart's email to the request from Chemeq's CFO is to the Chief Financial Officer, Brian Mangano. There is no evidence that Mr Mangano or Mr Geldart told Mr Williams about the request made of Dr Grimbeek to provide the letter of comfort. However, Mr Geldart copied the response to Mr Mangano and Mr Williams on 5 July.

125 There is no evidence from Mr Williams about his reaction (if any) to the statement of Dr Grimbeek's intention to pay for the Chemeq product "as discussed in our marketing plan". However, Mr Williams was apparently unconcerned, because on 7 July Chemeq announced to the stock market that it had achieved revenue in excess of $4,000,000 for the financial year ended 30 June 2006. The revenue was said to have been earned from product sales, interest and other revenue (exhibit 1/838).

126 By 4 August 2006, no payment had been made by Inviro. On or about that date, Mr Williams and Mr Geldart telephoned Dr Grimbeek to discuss payment of the outstanding account. Mr Williams told Dr Grimbeek that there was pressure from the directors of Chemeq and that they needed to see "some sign of payment". He asked for a payment of about $200,000 by the end of the following week.

127 Dr Grimbeek said he could make such a payment. He said nothing about any other arrangements being in place. However, he had informed Chemeq on 5 July that he intended to pay in accordance with an arrangement which, from his perspective, differed markedly from the Sales Order and the Distribution Agreement.

128 Further, in an email to Mr Geldart on Sunday, 6 August, Dr Grimbeek said he had been "somewhat caught unawares" by his and Mr Williams' telephone call (exhibit 1/745). He therefore set out what he referred to as "the saga", starting with Mr Geldart's visit of June 2006 and their discussions. Dr Grimbeek said:

"We discussed the payment terms and the understanding that Chemeq Ltd had that the market was difficult to crack and that [Inviro] would pay Chemeq as product was drawn."

129 On the morning of 7 August, Mr Geldart forwarded Dr Grimbeek's email to Mr Williams, Mr Mangano and Mr Mc Henry (another director of Chemeq) with a request to discuss.

130 The discussion took place later that day, when Mr Geldart gave Mr Williams a copy of Dr Grimbeek's letter of 2 June. Mr Williams instructed Mr Mc Henry and Mr Geldart to telephone Dr Grimbeek and "sort it out".

131 Mr Geldart emailed Dr Grimbeek and asked him to nominate a convenient time to receive a telephone call from Mr Mc Henry and himself.

132 On 8 August, Mr Geldart prepared a letter to Dr Grimbeek in terms proposed by Mr Williams. The letter offered deferred payment terms in recognition of Inviro's efforts to establish Chemeq's product. The terms required payment of $200,000 within seven days of agreement to the proposal, $600,000 by 28 February 2007 and the balance of approximately $600,000 by 31 May 2007.

133 Dr Grimbeek was asked to sign the letter on behalf of Inviro, to signify its acceptance of the terms.

134 Mr Geldart sent the letter on 8 August, under cover of an email in which he said he would instruct Chemeq's accounts department to look out for "the agreed deposit of R 1,000,000.00" (exhibit 1/840 - 842).

135 No such payment was made. Instead, on 10 August Dr Grimbeek emailed a letter to Mr Williams in which he said he had given instructions for the payment of what I assume to be small invoices relating to product purchased by Inviro and sold to its clients. He went on to say:

"On numerous previous occasions and by mutual consent [Inviro] and Chemeq Ltd have agreed that due to the poor sales record of the product and its excessively high trading price that [Inviro] will only pay Chemeq Ltd for product that it has drawn and sold in the market, (refer letter dated 2 June 2006).

A large part of the 2 000 drums held in stock in South Africa is for Chemeq Ltd to supply to its own clients, namely Astral (Country Fair / Early Bird) and Rainbow. These two poultry producers constitute at least 60% of the market. At no time did [Inviro] agree to pay the full amount on the product received, but it did agree to help Chemeq Ltd to fulfill its covenant to its bankers and investors respectively. [Inviro] has continuously been reassured by Chemeq Ltd that it would not be 'sold down the river.' Why have the goalposts been moved?

[Inviro] was also reassured that it was 'cheaper' for Chemeq Ltd to hold the stock rather than [Inviro] due to the difference in prime lending rates between Australia and South Africa.

The request has now arisen for [Inviro] to pay for the product that is in the UTI warehouse with payments being expected immediately, again on the 28th February 2007 and the balance on the 31st May 2007. This is in total contradiction to the meeting held between James Geldart and Pieter Grimbeek on 2 June 2006.

[Inviro] will discuss these issues next week with both James Geldart and Bill Mc Henry." (exhibit 1/844 - 845)

136 Mr Williams did not respond to Dr Grimbeek's letter. He said in his evidence that he "afforded no credibility to the allegations in the light of all the previous inconsistent statements and actions by Grimbeek", particularly his agreement, on 4 August, to pay $200,000. However, as I have noted above, Dr Grimbeek claimed to have been taken by surprise on 4 August: he recanted soon afterwards.

137 Mr Williams said further, that Dr Grimbeek's assertion that Inviro had never agreed to pay the full amount for the product received was "completely at odds with the Sales Order and the Distribution Agreement". This is true, on a literal construction of those documents. However, Dr Grimbeek appeared to be suggesting that the relationship between Chemeq and Inviro was not governed by those documents alone.

138 On 14 August, Mr Geldart and Mr Mc Henry met Dr Grimbeek in South Africa. They met again on 17 August. However, as reported by Mr Geldart on that day, Dr Grimbeek maintained his position. Further, he served a formal notice of termination of the Distribution Agreement with effect from 1 September (exhibit 1/848).

139 As a result of these developments, Mr Williams came to the conclusion that Chemeq had little option but to pursue Inviro for the recovery of the debt. A letter of demand dated 29 September was sent to Dr Grimbeek by Mallesons Stephen Jaques, acting on behalf of Chemeq.

140 Dr Grimbeek wrote to Mr Mangano on 9 October. He complained that the letter of demand "was truly offensive, insulting and not in the spirit of the agreement between Chemeq Ltd (as represented by Mr David Williams and Mr James Geldart) and myself both verbally and in electronic communication" (exhibit 1/864).

141 He complained further about what he regarded as a defamatory statement by Chemeq to the Australian Stock Exchange, which had apparently prompted communications from aggrieved shareholders who had abused Inviro and Dr Grimbeek "for devious business conduct, which is unjust".

Chemeq's accounts for the year ended 30 June 2006

142 Despite the stance taken by Dr Grimbeek, Chemeq maintained the position as announced to the Australian Stock Exchange on 7 July, that the Inviro sale should be recorded as revenue in Chemeq's accounts for the financial year ended 30 June 2006, without qualification. However, that view was not shared by Chemeq's auditors, Ernst & Young.

143 In the accounts, which were published on 29 September, the auditors said:

"We have been unable to verify whether it is probable that economic benefits associated with sales of goods disclosed in the company and consolidated income statements in the sum of $1,469,895 will be realised. There is currently a dispute as to whether the terms of the sales agreement has been varied, which raises doubt as to the appropriate timing for the recognition of these sales" (exhibit 1/836).

144 In making this statement, the auditors had regard to Australian Accounting Standard AASB 118, produced by the Australian Accounting Standards Board ("AASB") and taking effect from 1 July 2004. Such standards are made pursuant to s 334 of the Corporations Act 2001 (Cth), and have the force of law.

"to prescribe the accounting treatment of revenue arising from certain transactions and events" (exhibit 1/1949).

146 The Standard refers to the fact that the "primary issue in accounting for revenue is determining when to recognise revenue". Paragraph 14 provides that:

"Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably."

147 Chemeq submits that, having regard to the opening words of par 14, the appropriate date on which to recognise revenue from the sale of goods is the earliest date on which all of the conditions (a) to (e) have been satisfied (TS 456).

148 In the present case, it is submitted, that date was 1 June 2006. By then, Inviro had acknowledged receipt of all 2000 units of product. On Chemeq's case, pars 14(a) and (b) of the Standard had been satisfied, there was no issue as to pars 14(c) and (e), and it was probable that Inviro would pay for the product, thereby satisfying par 14(d).

149 I do not accept that the appropriate date for the application of the Standard was 1 June 2006. The Standard must be applied in accordance with a framework published by the AASB in July 2004, which applied from 1 January 2005. It is entitled "Framework for the Preparation and Presentation of Financial Statements" ("the Framework") (exhibit 1/1903).

150 Under the heading "The Probability of Future Economic Benefit", par 85 of the Framework provides:

"The concept of probability is used in the recognition criteria to refer to the degree of uncertainty that the future economic benefits associated with the item will flow to or from the entity. The concept is in keeping with the uncertainty that characterises the environment in which an entity operates. Assessments of the degree of uncertainty attaching to the flow of future economic benefits are made on the basis of the evidence available when the financial statements are prepared. For example, when it is probable that a receivable owed by an entity will be paid, it is then justifiable, in the absence of any evidence to the contrary, to recognise the receivable as an asset. For a large population of receivables, however, some degree of non-payment is normally considered probable; hence an expense representing the expected reduction in economic benefits is recognised." (emphasis supplied)

151 On that basis, the appropriate date for considering whether Inviro would pay for the product consigned under SO 1006 was in September 2006, when Chemeq's financial statements were being prepared.

152 In my view, the Framework approach to this issue is, with respect, eminently sensible. When a trading organisation prepares its financial statements on an accruals basis (as does Chemeq) there will frequently be occasions on which a purchaser of goods is not required to make payment until after the end of the financial year in which the goods have been delivered.

153 It may well be necessary for financial statements to be prepared before payment has been made. That being so, the best estimate of the probability of payment is likely to be the latest.

"Revenue is recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. In some cases, this may not be probable until the consideration is received or until an uncertainty is removed. For example, it may be uncertain that a foreign governmental authority will grant permission to remit the consideration from a sale in a foreign country. When the permission is granted, the uncertainty is removed and revenue is recognised. However, when an uncertainty arises about the collectability of an amount already included in revenue, the uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised."

155 Chemeq submits that if, as a result of developments since June 2006, uncertainty has now arisen as to the collectability of the Inviro debt, the appropriate course is that set out in par 18: to include the revenue in the Financial Statements (thereby satisfying Chemeq's covenant with the bondholders) and to treat the uncollectable amount as an expense.

156 I do not accept that submission for the following reasons. The treatment of an uncollectable debt as an expense is appropriate in respect of "an amount already included in revenue". However, "revenue" is defined in par 7 of AASB 118 as:

"the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants."

157 It follows, I think, that if there is sufficient uncertainty about the collectability of a debt when the decision must be taken whether to recognise it as revenue, it should not be recognised at all.

158 Secondly, the treatment of an uncollectable debt as an expense is appropriate "when an uncertainty arises". This suggests a change in the circumstances which had existed when the decision was made to recognise the revenue: not a change in the perception of those circumstances; nor the receipt of new information which demonstrates that the original decision should not have been made. That was a view expressed by Peter Douglas Robertson, a Chartered Accountant called by Chemeq, whose evidence I accept (TS 295).

Was the Inviro debt properly recognised as revenue?

159 The decision to recognise the Inviro debt as revenue was taken on 4 September 2006, at a meeting of Chemeq's Audit Committee.

160 As appears from draft minutes of the meeting, the members of the Committee were Chemeq's chairman, two directors and the company secretary. Mr Williams attended together with four other invitees, including representatives of Ernst & Young.

161 It seems that draft financial statements had been prepared in which provision had been made against the Inviro debt on the basis that its recovery was doubtful. However, the decision was taken to remove the provision on the basis of Mr Williams' advice to the Committee that Inviro had "represented to management that it had obtained financial support" [exhibit 1/861, as corrected by Mr Williams in his evidence].

162 In evidence given in re-examination, Mr Williams explained in some detail the reasons for his confidence, as at 1 June 2006, that the Inviro debt would be paid. In summary, they were as follows:

(1) Dr Grimbeek had a long-standing relationship with Chemeq. He was well known to people in the company who all spoke very highly of Dr Grimbeek as being "an honourable person". Dr Grimbeek's bankers had a similarly high regard for him, as set out in previous correspondence: see exhibit 1/593.

(2) The parties entered into the SO 1006 transaction in September 2005 knowing that it might not be possible to on-sell the product. This was addressed in the Distribution Agreement with the result that Chemeq had "a firm footing to proceed to recover" the debt.

(3) Dr Grimbeek had not committed Inviro to the purchase until he had satisfied himself that his bank would make a R 8,000,000 facility available, as it did.

(4) Mr Geldart informed Mr Williams on about 2 June 2006 that Dr Grimbeek's bank was continuing to provide that support.

(5) Dr Grimbeek "was a man of obvious wealth". He lived in substantial premises in Potchefstroom, which was a wealthy area. Dr Grimbeek's house was near an attractive golf course in which, as Mr Williams understood it, Dr Grimbeek was quite prominent.

(6) Dr Grimbeek had a cattle farm on a large acreage near his house. In September 2005, Dr Grimbeek said he was in the process of selling his piggery and was looking for something to do with the proceeds of sale.

(7) Mr Williams knew Dr Grimbeek was a man of high standing: he was a proud man who valued his reputation and would not wish to see it tarnished.

(8) If it became necessary to take proceedings to recover moneys owed by Inviro to Chemeq, it was likely that Dr Grimbeek would pay because he would not want to be associated with a liquidated or defaulting company: he would see that as a personal slight.

(9) Dr Grimbeek was an astute businessman, so that any discussions with him "would be conducted in a fulsome business way".

(10) There were a number of other people or groups interested in coming into South Africa and taking over Dr Grimbeek's position: in particular, Civa of France and some Taiwanese who had developed relationships with a former director of Chemeq, Graeme Major, and who were keen to take Chemeq's product into Taiwan.

163 Mr Williams was then asked whether anything had happened by 30 June 2006 either to change his belief or the reasons for his belief in the recoverability of the Inviro debt. Mr Williams said he was not really worried at that stage because he thought that the moneys were not due until about 30 June, statements having been issued at the end of May (in fact, as noted above, Mr Williams' earlier evidence was that the statements had been issued on or about 17 May).

164 Mr Williams was then asked whether the strength of his belief in recovery had altered at all between 30 June and 29 September. Mr Williams said that his belief "had wavered a little" because he had been unsuccessful in obtaining payment. He said in those circumstances, he thought it appropriate to make "a prudent provision" in the accounts. However, he was advised by the auditors that under the new international accounting rules, known as AIFRS, it would not be proper to make a provision without some objective evidence such as a document from the debtor expressing his intentions in relation to payment (TS 241 - 245).

165 It is common ground between the parties that the standard for determining whether a debt is recoverable is the balance of probability. In my view, that is the correct approach: it follows from the use of the word "probable" in par 18 of AASB 118. However, the parties disagree about the way the Court should approach the question whether Chemeq was right to regard it as probable that the Inviro debt would be recovered.

"the question is not answered by the Court reaching its own decision on the issue of recoverability. The question for the Court is whether it was open to Chemeq through a proper application of accounting standards, to reach a decision that the purchase price was recoverable.

The issue raised is similar to the question arising on appeal from interlocutory decisions and some administrative decisions. If the Court is satisfied that the interlocutory or administrative decision has been based on the correct law applied to relevant facts, the Court will not overturn the decision, even if the Court would have reached a different conclusion to that reached by the decision maker." (closing submissions, par 4.4)

167 Chemeq relies on the fact that no challenge was made to Mr Robertson's opinion that the relevant judgment should be based on objective and subjective considerations.

168 The bondholders accept that, up to a point, the judgment as to whether economic benefits will flow to an entity involves subjective considerations. In my view, that must be so. There may well be matters known only to the decision maker which are relevant to the decision and which will be given a weight according to the judgment of the decision maker. However, I do not think that must lead to the conclusion for which Chemeq contends because I do not consider that the analogy with interlocutory or administrative decisions is valid.

169 Such decisions typically involve the exercise of a discretion. In the present case, the issue is whether an accounting standard has been applied properly. This suggests an objective approach: it would be pointless to establish a standard if its application was dependent entirely on subjective views.

170 In my view, the present case is more analogous to the circumstances in which a company is considering whether to declare an interim dividend before there has been a final determination of the profits from which the dividend is to be paid.

171 In Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616, Mahoney JA said (at 629):

"What matters, by way of incomings or outgoings, actual or accrued, may or must be taken into account in determining the revenue profit for that particular period, has been the subject of consideration in many cases: see Palmer's Company Law, 22nd ed., vol. 1, p. 799 et seq., pars. 72-11 et seq., where some of the cases are referred to. It has been said that this is to be determined by 'men of business' and, presumably, those advising them in the keeping of their accounts: Lee v. Neuchatel Asphalte Co. [(1889) 41 Ch D 1 at 21], per Lindley L.J.; but this does not depend upon, e.g., the whim or idiosyncracy of the persons concerned, and no doubt the court will, in an appropriate case, hold that particular items should have been brought to account in determining whether a revenue profit has been earned, or earned in a particular period: Verner v. General and Commercial Investment Trust".

172 The reference by Mahoney JA to Verner's case is to [1894] 2 Ch 239 at 266. There, Lindley LJ said:

"A dividend presupposes a profit in some shape, and to divide as dividend to the receipts, say, for a year, without deducting the expenses incurred in that year in producing the receipts, would be as unjustifiable in point of law as it would be reckless and blameworthy in the eyes of businessmen."

173 Further, in the volume of Palmer's Company Law to which Mahoney JA referred, there is a reference at par 72 - 17 to the judgment of Chitty J in the unreported decision in Re Midland Land and Investment Corporation Ltd, where his Lordship said:

"In declaring a dividend, in my opinion, in trading concerns, the directors are entitled to put an estimate on the value of their assets from time to time, in order to ascertain whether there is or is not a surplus remaining after providing for liabilities; and where they make those valuations from time to time on a just and fair basis, and take all the precautions which ordinary prudent men of business engaged in a similar business would do, they are entitled to treat the surplus thus ascertained as profit."

174 Applying those principles to the present case, I consider that it is for the Court to determine whether as at September 2006, prudent men of business in Chemeq's position, possessed of the information relevant to the Inviro debt, would have regarded the debt as recoverable, on the balance of probabilities.

175 In my view, the answer to the question is clear: the Inviro debt would not have been regarded as recoverable. Indeed, that was Mr Williams' preferred position. As I have noted above, he felt that it would have been prudent to make some provision against the debt but believed he was prevented from doing so by the accounting regime then in place, as explained to him by Chemeq's auditors.

176 Further, the auditors themselves were not satisfied that the debt was recoverable. By saying, in their qualification to Chemeq's accounts, that they had been unable to verify whether it was probable that the economic benefits associated with the sales of goods to Inviro would be realised, the auditors were, I think, signalling that they could not determine where the balance of probability lay. That being so, a judgment that payment was more likely than not, would clearly have been imprudent.

177 In any event, I consider that having regard to the attitude expressed by Dr Grimbeek since 2 June 2006, it was improbable that he would commit funds to Inviro to enable it to pay the amounts charged by Chemeq in relation to SO 1006. Put shortly, I think it is clear from Dr Grimbeek's letter of 2 June to Mr Geldart, from the qualification he added to the letter of acknowledgment prepared by Chemeq which he signed on 5 July 2006, and from his letter to Chemeq dated 10 August 2006, that he considered Inviro was not bound to make payment except in relation to product it had actually sold. Dr Grimbeek's position appears to be based on a contention that the contractual relationship between Inviro and Chemeq is not defined simply by the Sales Order and the Distribution Agreement. It is true that on 15 March 2006, Dr Grimbeek had referred to the fact that he had to purchase 2000 drums of product at $720, by 30 June 2006. However, he had clearly changed his position since then.

178 It is submitted on behalf of the bondholders that it was no mere coincidence that Dr Grimbeek proposed to place an order for 2000 units at $720, for delivery by 30 June 2006, when this was precisely what Chemeq required in order to satisfy the covenant then in place. The bondholders submit that the inference should be drawn that Dr Grimbeek responded to a request from Mr Geldart to place the required order at a time when Chemeq apparently had no other prospect of satisfying the covenant.

179 In my view, it is appropriate to draw that inference. It is supported by the following five pieces of evidence:

(1) It was Mr Williams' recollection that on 18 September 2005, Dr Grimbeek said "I think I can place an order". In my view, this is the language of someone who was responding to a request.

(2) In Dr Grimbeek's email dated 16 September 2005 to Mr Geldart, he said:

"I am sure that with some concentrated effort we could sell 2000 x 20 lt drums by June of 2006."

This suggests a joint effort on the part of Inviro and Chemeq, rather than Inviro alone. Again, it is consistent with a response to a request.

(3) In Mr Geldart's email dated 4 July 2006 to Dr Grimbeek, he said:

"Sorry to be a pain and once again ask you to assist Chemeq in ensuring that the Revenue covenant is fulfilled." (emphasis supplied)

(4) In Dr Grimbeek's letter dated 10 August to Mr Williams, he said:

"At no time did [Inviro] agree to pay the full amount on the product received, but it did agree to help Chemeq Ltd to fulfil its covenant to its bankers and investors respectively." (emphasis supplied)

(5) A draft of the proposed Distribution Agreement between Chemeq and Inviro, prepared after Inviro had placed SO 1006, contained the statement:

"The parties acknowledge that [Chemeq's] belief is that at least 2,000 units of the Product should be able to be sold by [Inviro] in the period ending 30 June 2006 ..." (exhibit 1/527)

This provision was not included in the final version of the document. However, it gives rise to the inference that the Inviro order resulted from Dr Grimbeek's acceptance of a proposition put to him by Mr Geldart, rather than from his own initiative.

180 The significance of the fact, as I find it to be, that Dr Grimbeek placed the Inviro order at Mr Geldart's request, is reflected in the discussions he had with Mr Williams and Mr Geldart on 18 September and in his letter to Mr Williams of 4 August 2006. That is to say, although Dr Grimbeek no doubt expected to derive some income from the sale of Chemeq product, he appreciated that he was providing much-needed assistance to Chemeq and expected to be safeguarded from loss. That was the point of the discussions on 18 September about the possibility of Inviro being unable to sell product or being forced to compete in a market in which Chemeq was selling directly to companies such as Rainbow Farms at prices below those at which Inviro would be required to sell in order to maintain its margin. This, I think, might explain why Dr Grimbeek considered that the agreement he had with Chemeq was not defined only by the Sales Order and the Distribution Agreement.

181 Mr Williams denies that Chemeq has made any other agreement with Inviro. Whether that is so, may have to be determined in litigation in South Africa. It is therefore inappropriate for me to express any view as to the likely outcome of any such litigation, particularly, when I have heard only Mr Williams' account of the various discussions involving Dr Grimbeek.

182 However, even if it is assumed that Chemeq has a legal entitlement to the Inviro debt, and that it will obtain a judgment for the full amount of the debt, it seems to be more probable than not that the judgment would not be satisfied. That is because Inviro is apparently the South African equivalent of a two-dollar company, with no significant assets. Although Dr Grimbeek had arranged a facility of R 8,000,000 from his bank, there is no suggestion that the bank was under any obligation to make payments to Chemeq unless directed by Dr Grimbeek.

183 Mr Williams' belief that Dr Grimbeek was an honourable man who would not want to be associated with a failed company must be set against Dr Grimbeek's belief that he has been treated very shabbily by Chemeq which, from his perspective, has reneged on at least an informal agreement to ensure that he did not suffer financially if the product could not be sold.

184 As far as it is possible to tell from the correspondence, Dr Grimbeek's belief is genuine. It is true that in correspondence and in discussions with Chemeq's auditors in September and October 2006, he made some contradictory assertions: (exhibit 1/862a, b, 863, 864). However, even though his defence to Chemeq's claim may not have been articulated precisely, his position remains unchanged: having regard to the agreement made between Inviro and Chemeq, Inviro will not be making the payment sought by Chemeq. In these circumstances, I think it likely that a proud and wealthy man such as Dr Grimbeek, is more likely to defend his position than to surrender to pressure.

185 For all these reasons, I consider that Chemeq ought not to have recognised the Inviro debt as revenue, with the result that it did not satisfy the covenant contained in cl 2.9(a) of the Deed Poll.

186 I have reached this conclusion on the assumption (which the bondholders do not accept as valid) that pars 14(a) and (b) of AASB 118 were satisfied by the delivery of product pursuant to SO 1006 and its acceptance by Inviro.

187 On the view I take of the revenue recognition point, it is not necessary to resolve this issue. However, out of deference to the submissions made by the parties, I shall set out my views.

188 As to par 14(a), the bondholders contend that neither the payment of VAT by Inviro, nor the delivery of product to the UTi warehouse resulted in the risk of ownership being transferred to Inviro.

189 I accept that the payment of VAT did not transfer the risk of ownership. That is because both cl 9.3 of the terms and conditions relating to SO 1006 and cl 11.1 of the Distribution Agreement provided that the risk would pass on delivery.

190 Although Dr Grimbeek's acceptance of delivery on 1 June 2006 may have been premature, there is no doubt that delivery into the UTi warehouse had been completed by 7 June.

191 However, the bondholders contend that this was not an unconditional delivery pursuant to SO 1006, because agreement had been reached between Mr Geldart and Dr Grimbeek (as recorded in his letter of 2 June) that Inviro would not be required to pay for product until it was on-sold.

192 If that was so, then, by par 16(b) of AASB 118, Chemeq would have retained a significant risk of ownership.

193 This issue can be resolved only by findings about what was said at the meeting between Dr Grimbeek and Mr Geldart: whether or not Dr Grimbeek thought he had reached agreement is irrelevant.

194 Mr Geldart, who was retrenched by Chemeq in September 2006, was not called to give evidence. After leading counsel for the bondholders foreshadowed a submission based on Jones v Dunkel [1959] HCA 8; (1959) 101 CLR 298, it was established through Dr Murdoch that Mr Geldart was dismayed, disappointed and upset by his retrenchment (TS 253). Dr Murdoch gave evidence also, that Mr Geldart is now living at Armadale, some 25 kilometres from Perth.

195 No evidence was given on behalf of Chemeq about whether Mr Geldart was approached as a potential witness, or whether that was considered by Chemeq's legal advisers: these matters were not raised in cross-examination.

196 In general terms, the inference which may be drawn in the unexplained absence of a witness who might have been expected to give evidence for a party, is that if the evidence had been given, it would have been unfavourable to that party's case: Jones v Dunkel (supra).

197 In the present case, the bondholders contend that Mr Geldart could have been expected to be called by Chemeq, that he would have given evidence about a number of meetings with Dr Grimbeek (including those at which Mr Williams was present) and that his absence is unexplained.

198 In my view, the circumstances of Mr Geldart's retrenchment, and his attitude towards Chemeq to provide some explanation for not calling him, such that I would decline to draw adverse inferences from his absence.

199 I pause to note that Chemeq has made a Jones v Dunkel submission based on the bondholders' failure to call Dr Grimbeek to give evidence. However, in all the circumstances, I would not have expected them to do so.

200 In any event, even if Mr Geldart did enter into some agreement with Dr Grimbeek, I doubt whether he would have had authority to bind Chemeq. As I understand Mr Williams' evidence (especially exhibit 2, at [63] and [93]), Mr Geldart had no such general authority: nor is there any evidence that Chemeq held him out as having such authority.

201 That being so, I consider that, on the balance of probabilities, there was no variation of the contractual term between Chemeq and Inviro, that the risk of ownership in the product passed on delivery. Indeed, Dr Grimbeek appears to have acknowledged at least that proposition. In his letter of 2 June 2006, he said:

"[Inviro] is now the owner of the product and responsible for its keep ..."

202 I emphasise that the resolution of this issue in Chemeq's favour has no bearing on the probability of economic benefits flowing to it. That is because, even if Chemeq has an unassailable legal entitlement to payment, it cannot extract payment from an insolvent company.

203 Shortly before 23 May 2006, a decision was taken within Chemeq to reduce the wholesale price of its product to $480 per unit. The decision is reflected in an email from Mr Mc Henry to Mr Geldart on 23 May referring to recent discussions with Mr Williams about that matter (exhibit 1/1570).

204 It appears from the email that the price reduction was to take effect for the following 12 months. That was also Mr Williams' evidence, which I accept (TS 177).

205 A price reduction of this kind would have left Inviro in the embarrassing position of holding much more expensive stock, which it would then have been unable to sell. On Mr Williams' evidence, this situation could have been avoided by Chemeq supplying to purchasers from Inviro, one free unit of product for every two purchased.

"Chemeq has offered [Inviro] one 20L free for every two purchased in an attempt to reduce the price to the end user. The present price of 720AUD will still be valid, but one free drum is issued with every two purchased, reducing the price in effect to [Inviro] of AUD480 per drum."

207 It is not clear from this extract whether Dr Grimbeek was referring to a proposal to provide the free units to Inviro itself, or to its customers. However, one of the options to which Mr Geldart referred in his email of 1 June was that Inviro be charged $480 per unit. It was that proposal which drew from Mr Williams the response that the invoice would not change.

208 It was submitted by leading counsel for Chemeq that whether or not Chemeq provided free product, the value of the order would not change. That is because, Chemeq would still be charging $720 for each of the 2000 units sold to Inviro.

209 However, the bondholders submit that because no additional product was supplied by 30 June 2006, one-third of the product supplied up to that date must be regarded as free product. On that basis, the value of the order would have been reduced by one-third to a level below that necessary to satisfy the covenant in cl 2.9(a) of the Deed Poll.

210 The bondholders rely on Mr Williams' evidence in cross-examination that the free product was not to have been supplied after the 2000 units had been taken. However, Mr Williams went on to say that the 2000 units were delivered under the order which required payment at $720 per unit and that "separate to that was the additional free product ..." (TS 205).

211 Mr Williams' further evidence in relation to this matter was not entirely clear. However, I understood the sense of it to be that the proposal was never formalised. I accept that to be the case.

212 It follows, that the resolution of this issue must depend on the same considerations as were relevant to the risk of ownership issue referred to above. And in the absence of evidence to contradict Mr Williams, the conclusion must be the same: that the issue is resolved in Chemeq's favour.

213 In 2006, when product was supplied pursuant to SO 1006, it had a shelf life of 12 months.

214 There is an exchange of emails between Dr Grimbeek and Mr Mc Henry on 19 September 2006, from which it appears that Chemeq agreed to replace, free of charge, some stock held by Inviro which had expired by May and June 2006 (exhibit 1/3010 and 3014 - 3015).

215 Mr Williams' evidence was that this agreement did not relate to the 2000 units, but to product delivered previously (TS 193). He seemed to accept subsequently that there was an inference to be drawn from the documents that the agreement related to stock generally (TS 194). However, I do not draw that inference. That is because Dr Grimbeek's email of 19 September referred to only seven units, having expiry dates of May and June. I think it unlikely that the product supplied pursuant to SO 1006 would have had such an early expiry date. I therefore consider that Mr Williams' initial response was more likely to be correct.

216 In any event, even if Chemeq had agreed to replace product delivered pursuant to SO 1006, that agreement would not affect Inviro's obligation to pay for the product at the outset. I therefore reject the submission made on behalf of the bondholders that Chemeq's obligation to replace expired stock reduced the value of the revenue for the year ended 30 June 2006.

217 This is another issue which falls away as a result of the view I have taken in relation to the revenue recognition point. However, again, I shall summarise my views in relation to it.

218 It will be recalled that the covenant contained in cl 2.9(a) of the amended Deed Poll imposed on Chemeq an obligation:

"to achieve total gross revenue from all sources of at least $4,000,000 for the financial year ending 30 June 2006 ..."

The issue is whether, on the true construction of that covenant, interest earned by Chemeq on funds on deposit could properly be included as revenue.

219 Chemeq contends that the construction of cl 2.9(a) is clear and unambiguous. It relies on cl 1.3(e) of sch 1 which contains the following provision:

"In these Terms and Conditions, unless the context requires otherwise, a reference as [sic, to]:

...

(e) an accounting term is a reference to that term as it is used in accounting standards under the Corporations Act, or, if not inconsistent with those standards, in accounting principles and practices generally accepted in Australia."

220 Chemeq then points to the Framework document which, in par 74, provides:

"Revenue arises in the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent."

Revenue is defined in almost identical terms in the statement of the objective of AASB 118. Further, pars 29 - 30 of AASB 118 refer to the basis on which revenue in the nature of interest is to be recognised.

221 In these circumstances, it is submitted that the parties must be taken to have intended that interest would be included in revenue for the purpose of cl 2.9(a). It is submitted that if this is not so, it would be necessary to read cl 2.9(a) as if it imposed an obligation to achieve:

"total gross sales revenue; or

total gross revenue from all sources apart from interest."

222 The fact that the parties did not include those additional words (as they might so easily have done) when they knew that Chemeq would be earning interest on the balance of moneys raised through the issue of the convertible bonds, suggests that they did not intend to do so: and there is nothing in the context which requires any other conclusion.

223 Chemeq relies on the judgment of Mason J in Codelfa Construction Pty Ltd v State Rail Authority of New South Wales [1982] HCA 24; (1982) 149 CLR 337 at 352:

"The true rule is that evidence of surrounding circumstances is admissible to assist in the interpretation of the contract if the language is ambiguous or susceptible of more than one meaning. But it is not admissible to contradict the language of the contract when it has a plain meaning."

224 However, in a passage immediately preceding that quoted above, Mason J said:

"In DTR Nominees Pty Ltd v Mona Homes Pty Ltd [1978] HCA 12; (1978) 138 CLR 423 at 429, Stephen and Jacobs JJ and I, following Prenn v Simmonds [1971] 1 WLR 1381, in a joint judgment said:

'A court may admit evidence of surrounding circumstances in the form of "mutually known facts" "to identify the meaning of a descriptive term" and it may admit evidence of the "genesis" and objectively the "aim" of a transaction to show that the attribution of a strict legal meaning would "make the transaction futile" ... ' "

And after the first of the passages cited above, Mason J went on to say:

"Generally speaking facts existing when the contract was made will not be receivable as part of the surrounding circumstances as an aid to construction, unless they were known to both parties, although, as we have seen, if the facts are notorious knowledge of them will be presumed."

225 It follows, I think, that the "plain meaning" of a contract may be different from the "strict legal meaning" where evidence of the genesis or objective aim of the transaction may demonstrate that the strict legal meaning is inappropriate. If this is correct, it is not necessary to identify ambiguity in order to admit evidence of the relevant surrounding circumstances as an aid to construction.

226 The extent to which extrinsic evidence of this kind is admissible has been the subject of much judicial consideration in recent years. However, I respectfully adopt the approach suggested by the Court of Appeal in Home Building Society Ltd v Pourzand [2005] WASCA 242. There, at [30], McLure JA (with whom Wheeler JA agreed) referred to the observation of Gleeson CJ in McCann v Switzerland Insurance Ltd [2000] HCA 65; (2000) 203 CLR 579 at [22], that commercial contracts should be given a business-like interpretation and that interpreting a commercial document requires attention to the language used by the parties, the commercial circumstances which the document addresses, and the object which it is intended to secure. Thus, the language used by the parties is only one of the three considerations to be taken into account in construing a commercial document.

227 McLure JA went on to refer to the fact that in Codelfa (supra) Mason J "set out with evident approval the statement by Lord Wilberforce in Reardon Smith Line Ltd v Hansen-Tangen [1976] 1 WLR 989 that:

'In a commercial contract it is certainly right that the court should know the commercial purpose of the contract and this in turn presupposes knowledge of the genesis of the transaction, the background, the context, the market in which the parties are operating.' "

There, Lord Wilberforce was effectively repeating the observations to that effect he had made in Prenn v Simmonds [1971] 1 WLR 1381.

"The implication in the above statements of principle is that surrounding circumstances can be used in the interpretation of contracts whether or not an ambiguity is found to exist." [32]

229 Although her Honour held that it was unnecessary to attempt to reconcile the cases because the relevant expression in the Home Building Society Ltd case (supra) was ambiguous, Murray AJA apparently had no such inhibition. At [62] his Honour said:

"I should say that in my view, whether or not there was properly to be regarded as ambiguity in the terms of the deed to be construed by the Court, evidence of the surrounding circumstances known by the parties to the deed and the purpose and object of the transaction reflected in the deed was admissible and regard might be had to it as an aid to the proper construction of the deed: Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd [2004] HCA 52; (2004) 219 CLR 165 at [40], where the High Court applied its decision given only a few months earlier in Pacific Carriers Ltd v BNP Paribas [2004] HCA 35; (2004) 218 CLR 451 at 461 - 2 [22]."

230 A similar conclusion was reached by the Full Court of the Federal Court in Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd [2006] FCAFC 144.

231 It will be recalled that cl 2.9(a) of the schedule to the Deed Poll was amended by the Heads of Agreement executed by the parties in October 2005.

232 In par 4 of their amended defence, the bondholders set out the circumstances said to have been known to Chemeq and the original bondholders at that time. However, the circumstances were set out rather differently in the bondholders' closing submissions.

233 In my view, the following circumstances (which fall broadly within par 4 of the amended defence) were known to the parties when they entered into the Heads of Agreement, and are relevant to the true construction of cl 2.9(a):

(1) The original milestone covenant, contained in cl 12.2(c) of the Convertible Bonds Subscription Agreement of 31 January 2005, imposed on Chemeq the obligation:

"to provide evidence to the Subscribers satisfactory to the Subscribers (acting reasonably) of confirmed purchase orders at a price consistent with [Chemeq's] business plan for the combined sale of a minimum of 2,000 20 litre containers of CHEMEQ polymeric antimicrobial for the 12 month period ending 30 June 2006."

Although the order for 2000 units of product placed by Inviro on 20 September 2005 appeared to satisfy the original covenant, Mizuho disputed that was so.

(2) In Chemeq's management accounts for August 2005, its expected net revenue from sales for the year to 30 June 2006 was shown as $9,308,288 (exhibit 1/3311). The same accounts also projected interest income of $2,377,658 in the same period. The interest income was not included as "revenue". It was Mr Williams' evidence that monthly management accounts in that form were sent to the bondholders (TS 69). In other words, it was not Chemeq's practice to treat interest income as revenue for those purposes.

This is illustrated by a diary note made on 20 October 2005 by Mr Williams in a three-way telephone conversation he had with Morris Roche Wyatt Junior and James Michael Cullinane. Mr Wyatt and Mr Cullinane were portfolio managers employed by companies in the Stark Group. It was they who dealt principally with Chemeq in the negotiations which led to the parties entering into the Heads of Agreement in October 2005.

In his diary note, Mr Williams referred to projected revenue of $9.3 million: a figure which did not include interest.

(3) Mr Williams gave evidence that since his appointment as Chemeq's CEO and managing director, he had been exploring ways to commercialise Chemeq's technology by means other than sales of product. These included "arrangements whereby people will pay milestone fees, signing-up fee, royalties" (TS 173). Mr Wyatt's evidence was that Mr Williams told him of his wish to "pursue some of the royalty opportunities that I'm exploring and some of the other commercialisation of Chemeq" and that he was hoping to derive revenue from those activities, on which he was spending a lot of time (TS 360 - 361).

(4) The convertible bonds had been issued to raise funds to enable Chemeq to commercialise its products globally. This was the basis upon which Chemeq's shareholders were invited by its former chairman and CEO, Dr Graham Melrose, to authorise the issue and conversion of convertible bonds in February 2005 (exhibit 1/2609). Thus, the subscribers to the convertible bonds must be taken to have been concerned not only to earn interest on moneys advanced to Chemeq, but also, to see its revenue increase through commercialisation of its products. As Mr Williams accepted, the investment of money was not Chemeq's principal business undertaking (TS 201).

234 If interest is properly to be included as revenue for the purposes of cl 2.9(e), then Chemeq had effectively satisfied the covenant by October 2005 (subject, of course, to Inviro paying for the product, about which there then appeared to be no doubt). That being so, from a commercial perspective, the covenant would be of little, if any, utility.

235 Mr Williams' evidence was that in his discussions with Mr Wyatt and Mr Cullinane, one or other of them said that they wanted the covenant to be achievable by Chemeq because "we are trying to make it easy for you" (exhibit 3, par 14); or "we want to make it easy for you to get there" (TS 219).

236 This evidence was given by Mr Williams over objection, on the basis that it was extrinsic evidence which (on Chemeq's case) is inadmissible (TS 214).

237 Mr Wyatt denied that he or Mr Cullinane said that the covenant should be something that Chemeq could achieve easily (TS 356).

238 Mr Wyatt's evidence was that there was negotiation about the amount of revenue to be included in the covenant. He said that because Chemeq expected to achieve sales revenue of about $2.6 million down to 30 June 2006, and because the sale to Inviro was in an amount of about $1.4 million, the revenue target should be set at $4 million, this being the sum of the two figures (exhibit 8, par 50).

239 Mr Wyatt's evidence in cross-examination was that he said to Mr Williams something to the effect:

"Well, $4 million would put you just at your plan" (TS 354).

240 In my view, it is clear enough that whatever was said in the course of the conversation between Mr Wyatt and Mr Williams, was said in the course of negotiations and is therefore inadmissible in any event. However, in case I am wrong in that view, I should record that I do not accept Mr Williams' evidence. I prefer Mr Wyatt's evidence that he considered the figure of $4 million as a sales revenue target which was achievable. I think it improbable that he would have proposed a figure which, if it included interest, had already been achieved.

241 I am therefore satisfied that in the conversation referred to above, Mr Williams was discussing sales figures with Mr Wyatt and Mr Cullinane. I accept Mr Wyatt's evidence that in October 2005, when considering the Heads of Agreement, the meaning of the term "revenue" under the Australian Accounting Standards was not discussed (TS 365): and there is no suggestion in Mr Williams' evidence to the contrary.

242 In these circumstances, I consider that the term "revenue" is not used in cl 2.9(a) as an accounting term, but rather as a reference to revenue from all the sources which might become available to Chemeq through the commercialisation of its product. This construction is, I think, supported by the fact that Chemeq was to achieve total gross revenue. The earning of interest on funds on deposit can hardly be said to be an achievement. Further, because there is little or no cost involved in earning interest, it would be inappropriate to refer to income of that kind as gross revenue.

243 I therefore conclude that it was not open to Chemeq to include interest earned on funds on deposit as revenue for the purposes of cl 2.9(a), so that on this ground also, Chemeq's claim is unsuccessful.

244 For the reasons given above, I conclude that Chemeq's action should be dismissed.