Commercial & Accounting Services (Camden) Pty Ltd v Cummins

Judgment 1Denis Peter Cummins, the Defendant, is an accountant. He sold his practice to the Plaintiff, Commercial & Accounting Services (Camden) Pty Ltd on 1 April 2002 for $120,000 plus $10,000 per annum payable on 30 June for at least eight years. He became an employee of Commercial & Accounting Services and was to create a minimum of 17 hours per week of chargeable time. The practice then had 1,942 clients. The agreement for sale contained an undertaking by Mr Cummins that he would refrain from a business of accounting services or tax preparation for a period of at least three years within a radius of 10 kilometres of the business address of the practice. 2Vanessa Ann Pollett was the principal of Commercial & Accounting Services. She worked three days a week in the practice, which made a profit after she received a working wage. The client base was relatively stable year by year. 3Mr Cummins obtained a franchise to operate as a licensed financial planner under the name RetireInvest. He conducted this business in partnership and then on his own from premises close to Commercial & Accounting Services' practice. Mr Cummins worked in the practice on Mondays and Fridays and worked from his RetireInvest premises for the balance of the week. But he spent additional time at the practice in an endeavour to make up 17 hours of billable time. 4As Ms Pollett's surname was Best, she adopted Best Practice as the business name for Commercial & Accounting Services. 5In early 2009, Mr Cummins told Ms Pollett he probably would not stay on after the end of his term on 30 June 2010. Mr Cummins had determined that he would then commence an accountancy practice from his RetireInvest premises and would use every resource available to him to inform people that he had commenced this practice. 6In about November 2008, Ms Pollett retained David Phelan who operated a business advisory business providing advice on a range of business matters including business development and business management. This led to a meeting on 25 March 2009 between Ms Pollett, Mr Phelan and Mr Cummins. 7There are some differences in the accounts of the three as to what was said at the meeting but there is general agreement on the gist of the conversation. Mr Phelan said that he and Ms Pollett were embarking upon a strategy to increase the growth of Best Practice and they needed another full time accountant and Ms Pollett could not also continue the employment of Mr Cummins. 8Mr Phelan said that reference was made to Mr Cummins having informed Ms Pollett that he would set up his own accounting business in April 2010. Ms Pollett wanted to bring that date forward and Mr Cummins accepted that his employment with Commercial & Accounting Services would cease on 30 June 2009. 9Mr Phelan asked which clients Mr Cummins thought would move with him. Mr Phelan and Ms Pollett thought it was Mr Phelan who asked whether Mr Cummins was talking about a handful. Mr Cummins said that it was he who said that off the top of his head he could think of a handful, say half a dozen or so, clingy clients. 10In any event, Mr Cummins was asked to make up a list of the handful of clients and his family members and give it to Ms Pollett before 30 June 2009. Mr Phelan and Ms Pollett said the request was for a list of six clients and family members. Mr Cummins said the list was of clingy clients and family. 11On 2 April 2009, Ms Pollett had a letter posted to Mr Cummins at his business address. It was in these terms: "Dear Denis Re: Termination of Employment Contract Thank you for attending the meeting with David Phelan and myself to discuss the termination of your employment contract. The following points outline what was discussed and agreed upon. 1 Your employment contract with Commercial & Accounting Services (Camden) Pty Ltd due to expire on the 1 st April 2010 will now be terminated on the 30 th June 2009. 2 As agreed you will only approach 6 clients and family members, all of which are current clients of Commercial & Accounting Services (Camden) Pty Ltd. The list of these agreed upon clients will be supplied to us by Denis Cummins prior to his termination of employment on the 30 th June 2009. 3 All other clients, including files, lists working papers etc will remain the property of Commercial & Accounting Services (Camden) Pty Ltd. I wish you good luck in your future endeavours. Yours faithfully Vanessa Pollett BEST PRACTICE " 12Mr Cummins said he did not receive the letter. But in the weeks following the March meeting, Ms Pollett and Linda Paton, an employee of Commercial & Accounting Services, repeatedly asked Mr Cummins to provide the list of clients. 13Mr Cummins said that if the statement in the third paragraph of the letter was said at the March meeting, he did not acknowledge it. 14Mr Cummins left on Friday 26 June 2009. Before he left he wrote up a list of six clients and family members. 15On 1 July 2009 Mr Cummins dispatched letters in the following terms. I have omitted contact details: "Dear Latest News After working part-time at Best Practice for the past several years, my contract there has ended June 2009. Many people have expressed their wish to continue having their accounting & tax needs met by myself, for which I am grateful. This has necessitated my return to my own accounting and tax practice trading as Denis Cummins Public Accountant & Tax Agent. I will also continue with financial planning via RetireInvest. I will simply be at xxxxxxx Street 5 days per week now, providing all services - tax, accounting, small business services, financial planning. Our new contact details are as follows: Address xxxxxxxxxx xxxxxxxxxx xxxxxxxxxx Phone: xxxxxxxxxx Fax: xxxxxxxxxx Email: Denis@xxxxxxxx I value the relationship we have had over many years and would like to continue it, but the decision is yours to determine the best way to manage your needs. If you do wish to proceed having your accounting & tax needs met by myself, please complete the enclosed letter and return in the envelope provided to enable transfer of your tax file papers to Denis Cummins Public Accountant & Tax Agent. With best regards, Yours faithfully Denis Cummins" 16The enclosed letter addressed to Ms Pollett was in the following terms: "Dear Vanessa, I would be grateful if you could provide my tax file papers to Denis Cummins in order that he can act for me in that respect. Thank you for your past services provided. Yours faithfully" 17There was a dotted line for signature below which was the name of the client. 18There was no list of the recipients of the letter dated 1 July 2009. Mr Cummins said that the mail out continued until August 2009 in dribs and drabs from names and addresses on scraps of paper that were not kept. 19In an endeavour to identify some recipients of the letter Mr Cummins prepared three lists. List 1 contained 166 persons or 193 persons if partners were counted to whom the letter was addressed. Mr Cummins said they were clients with a personal connection outside Best Practice; clients related to RetireInvest either by family or friends or on inquiry for RetireInvest services; people known to him whose address he obtained from the White Pages; people in regular contact through his involvement in Rotary; and people who had contacted him by email over the course of the year for tax or financial advice. 20List 2 of 18 persons or 25 persons if partners are included, Mr Cummins said were recipients who had contacted him requesting that he send the letter to them. 21List 3 contained 187 people or 219 if partners are included. Mr Cummins said that the source of information for this list was RetireInvest data and records. 22How many more people received the letter is not known. The evidence in this respect was unsatisfactory. Mr Cummins said he did not compile the lists of persons to whom the letter was to be sent. He left that to his wife and daughter. 23Mrs Cummins said that list 1, list 2 and list 3 were prepared by her and her daughter, Natalie Nona Lorieri, of people to whom she intended to send the mail out letter from Mr Cummins when he stopped working for Commercial & Accounting Services. 24But Mr Cummins said the lists were created during discovery to provide background information on the persons that he considered had received the letter. 25Whatever lists were compiled by Mrs Cummins and Ms Lorieri, Mrs Cummins said they were compiled from her memory, her friends, from Ms Lorieri, from her other children, from Mr Cummins' children, from RetireInvest mailing lists, survey sheets, client lists and emails, from telephone calls received by her and Ms Lorieri, telephone calls made by her and Ms Lorieri and people approaching her in person. 26Ms Lorieri said that she and her mother built up lists of people and their contact details on Excel spreadsheets to notify people that Mr Cummins had stopped working for Best Practice. She said the lists were created by consolidating previous RetireInvest mail out lists, seminar survey responses, RetireInvest client lists and emails, and by telephoning people at their place of work, asking family and friends for details, searching the white pages and the internet for addresses based on names and suburbs. 27She said that Mr Cummins provided her with some addresses, corrected details in the lists and told her how to find out missing information. He also asked her to add people to the lists. She added the details of people who telephoned to the lists. She agreed that compilation of the mailing list largely involved extracting data that was available in terms of names and addresses at RetireInvest and putting it into a new list and making sure that the addresses and names were correct. 28From time to time Ms Pollett provided RetireInvest with a list of some clients of Commercial & Accounting Services to enable RetireInvest to give notice of its seminars to potential clients. Mr Cummins knew that this was confidential information of Commercial & Accounting Services, not to be used for any other purpose. He said that the list was given to Mrs Cummins for a mail out and she was told to then destroy the list. 29But Mrs Cummins said she only destroyed one list because it contained incorrect addresses and she had never been told the lists should be destroyed. 30Ms Lorieri said that she had never been told to destroy these lists. She agreed that such lists were not expunged from the computers at RetireInvest's premises. 31There was one list of names without addresses provided to Aaron Hodges who had been a partner of Mr Cummins from Mr Cummins' discovery. That information had clearly not been destroyed after a RetireInvest mail out. 32In the first half of 2009 RetireInvest had about 250 clients. As at August 2010 Mr Cummins had 1,093 clients, 876 of whom were former clients of Best Practice and 550 of them were clients of Best Practice when it was purchased from Mr Cummins in 2002. 33To obtain over 1,000 clients, the letter of 1 July 2009 must have gone to a lot of people who were not RetireInvest clients for they numbered only about 250. 34That confirms the evidence of Mrs Cummins and Ms Lorieri that lists provided by Best Practice for the sole purpose of mail outs for RetireInvest seminars formed a large part of the 1 July 2009 mail out. 35Mr Cummins' recollection of recipients of the 1 July 2009 letter totalled 371 or 437 if partners are included. Of these, 187 or 219 came from RetireInvest files according to Mr Cummins. That means that 184 or 218 came from other sources. But those numbers do not account for the number of clients acquired by Mr Cummins in that period and confirms the view that the lists compiled for the 1 July 2009 mail out must have extended beyond Mr Cummins' memory to lists of Best Practice clients compiled during his employment with Commercial & Accounting Services. 36That the mail out lists prepared by Mrs Cummins and Ms Lorieri must have contained a significant number of Best Practice clients is also made out by the fact that there were about 2,000 clients of Best Practice when Mr Cummins left and by January 2010, almost half of them, at 929, had left. 37Mr Cummins admitted that details of the clientele of Best Practice were confidential information. He also admitted that he owed Commercial & Accounting Services an equitable obligation not to breach its confidence. I find that he breached that obligation in utilising Best Practice client details in the mail out lists of the 1 July 2009 letter. 38This was not information that an employee was free to use after his termination of employment being the second class of information identified by Goulding J in Faccenda Chicken Ltd v Fowler [1984] ICR 589 at 599-600, that is, information that once learned necessarily remains in the servant's head and becomes part of his own skill and knowledge. 39But even if Mr Cummins was free to use this information after the termination of his employment, as Bryson J observed in Weldon & Co v Harbinson [2000] NSWSC 272 at [70]: "A former employee's entitlement to use knowledge which the former employee remembers, and the absence of an entitlement to make notes and lists while in the employment and take them and use them, are very long established and are not open to doubt or debate." 40The use by Mr Cummins of client lists of Best Practice offended these principles. 41To like effect is the statement of Heydon in The Restraint of Trade Doctrine, 2 nd ed (1999) Butterworths at 80: "The employee cannot remove, whether by using paper or using memory, a material part of the former employer's business records; but the employee can approach a particular customer or client whom that employee can recall without a list or deliberate memorisation." 42In Forkserve Pty Ltd v Pacchiarotta [2000] NSWSC 979: (2000) 50 IPR 74 at [20]; 78, Young J considered the above statement of Heydon to correctly state the law. 43In circumstances where wrongdoers' failure to keep and produce accounts of their actual expenditure on common property made it difficult to assess the compensation due to the plaintiff, Handley JA in speaking for the Court of Appeal in Houghton v Immer (No 155) Pty Ltd (1997) 44 NSWLR 46 at 59 said that the court should assess the compensation in a robust manner, relying on the presumption against wrongdoers, the onus of proof, and resolving doubtful questions against the party whose actions made an accurate determination so problematic. 44That principle applies in this case where the failure of Mr Cummins to produce a list of the persons to whom the 1 July 2009 letter was sent has made it difficult to assess damages or compensation due to Commercial & Accounting Services. 45Using the wrongdoer principle, I assume that all the 876 clients who left Best Practice were solicited by Mr Cummins using Best Practice's confidential information in the RetireInvest computers. 46Mrs Cummins and Ms Lorieri said they included in their lists friends and relatives. One could not imagine that the 876 former clients of Best Practice contained more than, say, 100 former clients who were friends and relatives of Mrs Cummins and her daughter. 47That suggests that at least 776 clients of Best Practice were solicited by Mr Cummins using confidential information. Best Practice lost 1,026 clients from 1 July 2009. 776 is approximately 75% of this number. 48Two experts, Jenny Wheatley and Andre Christian, gave evidence of the change in the goodwill of Best Practice consequent upon the solicitations of its clients by Mr Cummins. 49One method of determining the goodwill of an entity is the future maintainable earnings methodology. Under that method one ascertains normalised EBIT, earnings before interest and taxes, in the future, applies a discount rate to ascertain a present value of the future earnings and deducts the value of net tangible assets to obtain a figure for goodwill. 50The experts agreed that if the capitalisation of future maintainable earnings was the appropriate approach, normalised EBIT was the most appropriate earnings base. EBITDA, earnings before interest, taxes, depreciation and amortisation, would be used if an entity used a significant amount of plant and equipment. 51The experts agreed that if this approach was adopted, goodwill at 30 June 2009, assuming Mr Cummins was employed by Best Practice, was $241,037 and it was $157,327 if Mr Cummins was not employed by the business. The value of goodwill on this basis at 30 June 2010 was agreed to be nil. 52Mr Christian used the cents in the dollar of gross fees methodology. This method adopts an industry-wide range of cents in the dollar for gross fees attributable to commercial clients and gross fees attributable to individual clients. Mr Christian adopted a range and average recommended by Providence BSM, specialists in servicing the accounting and financial planning firms as follows: Average Non- I Return Fee bases Cents in the $ .85 to $1 for $1 = 0.925 1 -Return Fee bases Cents in the $ .50 to .85 in the $1 = 0.675 53Mr Christian took 60% of gross fees as attributable to individuals and 40% as attributable to commercial services and applied the averages to the relative percentages of gross fees and then subtracted the value of net tangible assets to arrive at a goodwill valuation. 54The experts agreed that when valuing a practice using this method, there is a fundamental assumption that the practice will be sold with restraint of trade covenants as part of the sale agreement. 55The experts agreed that without restraint of trade covenants the business could not be sold and the value of goodwill at both 30 June 2009 and 30 June 2010 would be negligible. 56The restraint of trade covenants would include non-competition for a specified period in terms of time and location and non-solicitation of clients sold by Best Practice. 57The experts agreed that by applying this method the goodwill of Best Practice at 30 June 2009, assuming restraint of trade covenants were in place, was $335,206 and, at 30 June 2010, it was $228,792. 58Mr Christian accepted that the future maintainable earnings methodology would ordinarily be the most appropriate method to adopt in valuing the goodwill of a business. But he said it was inappropriate in respect of an accounting practice under $500,000. He said that there was a ready market for the purchase of small accounting practices on this basis and not on the future maintainable earnings method for accounting practices under $500,000. He said that comparable sales from such practices confirmed the use of the cents in the dollar method. 59CPA Australia Ltd has published guidelines recommending the use of future maintainable earnings methodology for accounting business practices with annual fee levels greater than $1M and cents in the dollar of gross revenue methodology for practices with fee levels under $500,000. 60Mr Christian said that the original purchase of Best Practice by Ms Pollett was based on so many cents in the dollar of gross revenue. 61Mr Christian said that small accounting practices may be grossly undervalued using the future maintainable earnings methodology, especially with an acquisition by an existing or established firm wishing to increase its fee base with current overheads of under-utilised capacity. 62Mr Christian said there were several fundamental factors absent in the makeup and structure of the operations of Best Practice that rendered the future maintainable earnings methodology inappropriate, especially before and after the significant event of Mr Cummins termination and the subsequent loss of personal goodwill of this key employee and its significant effect on the overall goodwill of the business and its valuation. 63Ms Wheatley said the future maintainable earnings methodology was the most appropriate because it was inappropriate to assume that Ms Pollett and Best Practice would enter into the restraint of trade covenants required to realise a value under the cents in the dollar methodology. A purchaser of a practice without restraints of trade would pay only a negligible amount for goodwill. 64Ms Wheatley said that a purchaser would be more likely to rely on a calculation of capitalised future maintainable earnings when there was a history of declining gross fees. 65In her opinion the capitalisation of future maintainable earnings methodology allows a purchaser to take into account profitability, history, trends in the practice and in the industry generally. 66There was no indication that Best Practice or Ms Pollett would sell the business and Ms Wheatley said that any calculation of value needed to take into account a commercial return for Ms Pollett's personal exertion in operating the business. 67Ms Wheatley said that professional practices such as accounting firms have on occasions been sold on the cents in the dollar basis. This method was referred to as a rule of thumb. Professional practices were also sold on a multiple of EBIT. 68In Ms Wheatley's opinion, rules of thumb such as the cents in the dollar method can be used as a cross check to a primary valuation methodology but should not be definitive in determining value. 69Mr Wheately said that the cents in the dollar methodology assumes that most practices will be comparable, including similar operations, overheads, financial and corporate structures and product mixes. 70She said that the use of the method frequently leads to a practice being overpriced with little relationship to the fair value determined in accordance with acceptable valuation methodologies such as capitalisation of future maintainable earnings. 71In response to Mr Christian's reference to CPA Australia Ltd's guidelines, Ms Wheatley referred to the CPA Australia publication Selling an Accounting Practice Checklist at 5 as follows: "Your sale price may be quoted as (so many) 'cents in the dollar' of annual gross fees net of GST. This is a rather simplistic if not 'subjective' method of valuing your practice, especially when the buyer is more interested in the bottom line because it is from the profit/cash-flow that the buyer will obtain an investment return. There are a number of alternative valuation models that may be considered significantly more appropriate and objective." 72In response to this citation Mr Christian said that these statements should be considered with respect to the "reasonably clear segmentation of value methodologies that is based on the fee level of the practice" in the CPA publication Succession Planning Pathway for CPA Public Practitioners at 61. 73Ms Wheatley's riposte was to refer to this publication as follows: "56 ... the most common method employed is the capitalisation of future maintainable earnings method, followed by the rule of thumb or industry multiplier method. 57...this is the most widely used and accepted methodology in business valuations for small and medium businesses. 60 (with respect to the cents in the dollar method) ...The problem with adopting these industry standards is that they are really only applicable to those businesses that operate to an industry average. The multipliers offer no benefit or discount for those businesses that are either above or below the standard. Where you are using this method and providing a professional opinion you should consider and where appropriate comment on this. Also, in applying a standard industry method, the price should be compared to an alternative methodology to ensure the merits of the business investment." 74Ms Wheatley also said that the contents of the publication were made in the context of selling a business and retiring, or succession planning which is not the case where Ms Pollett is operating her business with no intention of retirement. 75With respect to Mr Christian's comments that Best Practice was purchased on a cents in the dollar valuation, Ms Wheatley pointed out that the purchase was on 1 April 2002, more than seven years before the 2009 valuation and eight years before the 2010 valuation. Ms Pollett was an employee who had worked for the business for 14 years. Ms Pollett did not negotiate the terms of the agreement for sale. She agreed to purchase the business because she was concerned about the financial stability of her family if she became unemployed. The business was never offered to an arm's length purchaser. 76Ms Wheatley did not agree with Mr Christian that Ms Pollett received favourable treatment on purchase but she did agree that Ms Pollett was a special purchaser and the methodology to value the amount paid by Ms Pollett in 2002 would not be reflective of the arm's length fair market value of the business at 30 June 2009 and 30 June 2010. 77Mr Christian's response was that Ms Pollett did not negotiate the business price as Mr Cummins voluntarily reduced his price by $40,000 and was flexible with respect to the initial purchase deposit. Ms Pollett would not have risked her family's financial stability by not having due regard for the financial viability of the business she was to purchase. Mr Christian pointed out that Ms Pollett's decision to buy was more than vindicated by the yearly increases of gross annual fees over a seven-year period to 2009. In Mr Christian's opinion, Ms Pollett was a special purchaser who received more than favourable treatment in the purchase of the business that an arm's length purchaser more than likely would not have received. 78In my opinion I should adopt the future maintainable earnings methodology in determining the value of goodwill. 79In the first place there was no question of the sale by Ms Pollett of Best Practice and the question of restraints of trade covenants essential to the cents in the dollar methodology does not arise. 80Secondly, Mr Christian has adopted industry multipliers the application of which assumes that Best Practice operates at an industry average. It takes no account of differences in overheads, financial and corporate structures and product mixes. The choice of a multiplier under the future maintainable earnings methodology allows for the idiosyncrasy of the Best Practice business. 81I do not see why a practice with fee levels under $500,000 should not be valued under the future maintainable earnings methodology. I regard the cents in the dollar method as a rule of thumb. 82Adopting Ms Wheatley's approach and the agreed figures of the experts there was no goodwill at 30 June 2010. It had been destroyed. The appropriate goodwill figure as at 30 June 2009 is $157,327 as it was known that Mr Cummins would not be employed by the business after that date. 83In the robust approach to damages it was submitted that I should attribute 75% of the loss of goodwill to the solicitations of Best Practice's clients by Mr Cummins as the 776 clients of Best Practice who I have found were solicited is approximately 75% of the number of clients lost by Best Practice. 75% of $157,327 is $117,995 and I will enter judgment for Commercial & Accounting Services in that amount. It is also entitled to declaratory and injunctive relief. 84In light of my decision it is unnecessary to consider the alternative claims of Commercial & Accounting Services that the vendor of goodwill is not entitled to canvass customers of the old firm following Trego v Hunt [1896] AC 7 and the claim that Mr Cummins adopted misleading and deceptive conduct contrary to the Fair Trading Act 1987, s 42. 85I will hear the parties on the appropriate terms of orders and declarations and I will hear the parties on costs.