Supreme Court of WA|2007-02-01|Before: Templeman J

CHEMEQ LTD -v- SHEPHERD INVESTMENTS INTERNATIONAL LTD & ORS [2007] WASC 16 (1 February 2007)

JURISDICTION : SUPREME COURT OF WESTERN AUSTRALIA

CITATION : CHEMEQ LTD -v- SHEPHERD INVESTMENTS INTERNATIONAL LTD & ORS [2007] WASC 16

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

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.

CHEMEQ LTD -v- SHEPHERD INVESTMENTS INTERNATIONAL LTD & ORS [2007] WASC 16 (1 February 2007)

At a glance

Court

Decision date

Before

Catchwords

Source

Catchwords

Judgment (373 paragraphs)

CHEMEQ LTD -v- SHEPHERD INVESTMENTS INTERNATIONAL LTD & ORS [2007] WASC 16 (1 February 2007)

Cases Cited (6)