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[2025] NSWSC 575
General information, not legal advice.
Supreme Court of NSW
2025-06-24
Rees J
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Source: NSW Caselaw (www.caselaw.nsw.gov.au). Converted to plain text by ZoeLaw. Not the official version.
Medium Neutral Citation: Expert Group International Pty Ltd v TransAction Solutions Ltd [2025] NSWSC 575
Hearing dates: 14-15 April 2025
Date of orders: 24 June 2025
Decision date: 24 June 2025
Jurisdiction: Equity - Commercial List
Before: Rees J
Decision: Declaration that parties bound by expert determination.
Catchwords: EXPERT DETERMINATION — vendor sells company for $2M plus ‘earn out’ based on EBIT x multiplier — expert determination clause requires chartered accountant of 10 years’ experience — expert determines earn-out payment is $9.7M — whether parties agreed to be bound by expert’s construction of contract — principles at [124]-[129] — purchaser raises proper construction of contract outside timeframe prescribed by expert determination clause — whether expert should have determined that matter at all — expert determination clause varied by letter appointing expert, at [146] — “manifest error” — where suggested error of law — principles at [150]-[153] — Bagata Pty Ltd v Runner Pty Ltd [2024] QCA 17 followed — construction not obviously wrong — no manifest error — parties bound.
RECTIFICATION — principles at [231]-[235] — purchaser’s board had authority to vary contract – board papers and minutes, contemporaneous documents and post-contractual conduct paint compelling picture of common intention – purchaser seeks to avoid bad deal by exploiting imperfect drafting – appropriate case for rectification.
JONES v DUNKEL — issue waiver — written communications with lawyer tendered — whether to draw inference where solicitor not called — whether unnecessary witness — no evidence that lawyer and client had confidential oral communication – inference not drawn, [11].
Cases Cited: 711 Hogben Pty Ltd v Tadros (No 2) [2016] NSWSC 1683
711 Hogben Pty Ltd v Tadros; Tadros v 711 Hogben Pty Ltd [2016] NSWSC 697
ABB Power Plants Ltd v Electricity Commission of New South Wales (t/as Pacific Power) (1995) 35 NSWLR 596
AGL Victoria Pty Ltd v SPI Networks (Gas) Pty Ltd [2006] VSCA 173
Ampolex v Perpetual Trustee Co (Canberra) Ltd (1995) 37 NSWLR 405
Apand Pty Limited v The Kettle Chip Co (1994) 52 FCR 474
Australian Vintage Ltd v Belvino Investments No 2 Pty Ltd (2015) 90 NSWLR 367; [2015] NSWCA 275
Bagata Pty Ltd v Runner Pty Ltd [2024] QCA 17
Chapmans Ltd v Australian Stock Exchange Ltd (1996) 67 FCR 402; [1996] FCA 474
Commissioner of Taxation v Rio Tinto Limited (2006) 151 FCR 341; [2006] FCAFC 86
Commissioner of Taxation v Rio Tinto Limited (2006) 151 FCR 341; [2006] FCAFC 86
Commissioner of Taxation v Rio Tinto Limited (2006) 151 FCR 341; [2006] FCAFC 86
Dance with Mr D Ltd v Dirty Dancing Investments Pty Ltd [2009] NSWSC 332
Drane v Aqualyng Holdings [2017] QSC 233
Ecosse Property Holdings Pty Ltd v Gee Dee Nominees Pty Ltd (2017) 261 CLR 544; [2017] HCA 12
Epping Hotels Pty Ltd v Serene Hotels Pty Ltd [2015] VSC 104
Expert Group International Pty Ltd v TransAction Solutions Ltd [2023] NSWSC 543
Flowgroup plc v Co-Operative Energy Ltd [2021] EWHC 344
Franklins Pty Ltd v Metcash Trading Ltd (2009) 76 NSWLR 603; [2009] NSWCA 407
Funtastic Ltd v Madman Film and Media Pty Ltd [2016] VSC 708
Galaxy Energy International Ltd v Eurobunker SpA [2001] 2 All ER (Comm) 912
Greencapital Aust Pty Ltd v Pasminco Cockle Creek Smelter Pty Ltd [2019] NSWCA 53
HDI Global Speciality SE v Wonkana No 3 Pty Ltd (2020) 104 NSWLR 634; [2020] NSWCA 296
Heart Research Institute Ltd v Psiron Ltd [2002] NSWSC 646
Holt v Cox (1997) 23 ACSR 590
Homepace v Sita South East [2008] EWCA Civ 1
IIG Capital LLC v Van Der Merwe [2008] 1 All ER (Comm) 435
Invensys Plc v Automotive Sealing Systems Ltd [2002] 1 All ER (Comm) 222
J Family Motel Group Pty Ltd v Baset Super Pty Ltd [2024] NSWSC 1251
James Adam Pty Ltd v Fobeze Pty Ltd (2020) 103 NSWLR 850; [2020] NSWCA 311
Kanivah Holdings Pty Ltd v Holdsworth Properties Pty Ltd [2002] NSWCA 180
King v Wallis (1949) 78 CLR 529
LCA Marrickville Pty Ltd v Swiss Re International SE (2022) 290 FCR 435; [2022] FCAFC 17
Lepcanfin Pty Ltd v Lepfin Pty Ltd (2020) 102 NSWLR 627; [2020] NSWCA 155
Mainteck Services Pty Ltd v Stein Heurtey SA (2014) 89 NSWLR 633; [2014] NSWCA 184
Mayo v W & K Holdings (NSW) Pty Ltd (in liq) (No 2) [2015] NSWCA 119
Natoli v Walker (1994) 217 ALR 201
Orica Investments Pty Ltd v Aurelius Marvel One Limited [2023] VSC 18
Pacific Carriers Ltd v BNP Paribas (2004) 218 CLR 451; [2004] HCA 35
Port Jackson Stevedoring Pty Ltd v Salmond & Spraggon (Aust) Pty Ltd (1977) 139 CLR 231
Property Investors Alliance Pty Ltd v C88 Project Pty Ltd (in liq) [2023] NSWCA 291
Queenfield Pty Ltd v Gordon Finance Pty Ltd (2019) 60 VR 118; [2019] VSC 857
SA E.Med Pty Ltd v Calvary Health Care Adelaide Ltd (No 2) [2011] FCA 835
Santos Coffee Company Pty Ltd v Direct Freight Express Pty Ltd [2010] NSWCA 14
Sara & Hossein Asset Holdings Ltd v Blacks Outdoor Retail Ltd [2023] 1 WLR 575; [2023] UKSC 2
Seymour Whyte Constructions Pty Ltd v Ostwald Bros Pty Ltd (In Liq) (2019) 99 NSWLR 317; [2019] NSWCA 11
Simic v New South Wales Land and Housing Corporation (2016) 260 CLR 85; [2016] HCA 47
SSABR Pty Ltd v AMA Group Limited [2024] NSWCA 175
Straits Exploration (Australia) Pty Ltd v Murchison United NL (2005) 31 WAR 187; [2005] WASCA 241
Strategic Publishing Group Pty Ltd v John Fairfax Publications Pty Ltd [2003] NSWSC 1134
Strike Australia Pty Ltd v Data Base Corporate Pty Ltd [2019] NSWCA 205
TX Australia Pty Ltd v Broadcast Australia Pty Ltd [2012] NSWSC 4
Westland Savings v Hancock (1987) 2 NZLR 21
Westport Insurance Corporation v Gordian Runoff Limited [2011] HCA 37; 85 ALJR 1188
Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522; [2005] HCA 17
Yan v Yangdo Pty Ltd [2024] NSWSC 1250
Zhong v Guan [2024] NSWCA 300
Texts Cited: Clive Freedman and James Farrell, Kendall on Expert Determination (5th ed, 2015, Thomson Reuters)
Category: Principal judgment
Parties: Expert Group International Pty Ltd (Plaintiff)
Transaction Solutions Ltd (First Defendant)
Frank Mulcahy (Second Defendant)
Mark Snell (Third Defendant)
Representation: Counsel:
MA Izzo SC / JS Burnett (Plaintiff)
J Giles SC / D Riordan (First Defendant)
Solicitors:
Corrs Chambers Westgarth (Plaintiff)
Mills Oakley Lawyers (First Defendant)
Corrs Chambers Westgarth (Second and Third Defendants – submitting appearance)
File Number(s): 2023/320829
HER HONOUR: This case concerns whether the parties to a Share Sale Agreement are bound by an expert determination. Under the agreement, the plaintiff, Expert Group International Pty Ltd (the vendor), sold the issued shares in Experteq IT Services Pty Ltd (the Company) to the first defendant, TransAction Solutions Ltd (the purchaser or TAS) for $2 million plus deferred consideration based on the financial performance of the Company in the two years’ post-completion, that is, an ‘earn-out’. The earn-out formula provided for the earn-out payment (Additional Payment) in the second year to be calculated by multiplying the Company’s earnings before interest and tax (EBIT) by higher multiples (being 4x, 4.5x or 5x) depending on whether the Company’s EBIT met various ‘hurdles’.
The parties executed a Variation Deed, amending the earn-out formula for the second year. As varied, the formula included the annual profits (Annualised Agreed Profits) for certain contracts with customers (Qualifying Managed Services Agreements). The parties later disputed whether the earn-out formula meant:
(a) the Annualised Agreed Profits was added to EBIT for the purpose of clearing a ‘hurdle’ and accessing a higher multiple; or (b) the Annualised Agreed Profits was added to EBIT, and the relevant multiple applied to the sum.
(a) whether the parties are bound by the expert’s construction of the earn-out formula; (b) whether the correct application of the earn-out formula was a “Disputed Matter” which fell for determination by the expert at all, given that the issue was raised outside the timeframe prescribed by the expert determination clause; (c) whether the expert determination contains a “manifest error” (the purchaser posited five errors, including the suggested mis-application of the earn-out formula); and (d) in the event that the expert determination is not binding, and the expert’s construction of the earn-out formula was wrong, is the vendor entitled to rectification of the Share Sale Agreement?
The vendor relied on the evidence of its directors, being second defendant Frank Mulcahy and third defendant Mark Snell, together with the evidence of solicitor Felicity Healy. The purchaser relied on the evidence of chairperson Ashley Jennings and chief executive officer (CEO) Shane Baker. All but Ms Healy were cross examined.
Mr Mulcahy and Mr Snell were both straight forward and made reasonable concessions. Neither were lawyers or accountants. Neither appear to have understood, or focussed on, the intricacies of the drafting of documents at the time, but went along with the deal as they understood it to be and left the details to their solicitor.
The same observations can be made of Mr Baker, who said that he did not pay attention to the detail at the time. Mr Baker left the details to the purchaser’s chief financial officer (CFO), Tony Greene. Mr Baker said that he did not intend that the Additional Payment would be the product of the multiple applied to the sum of the Agreed Annualised Profit and EBIT. He was less than emphatic in maintaining that position and put some distance between himself and the deal. I have deferred to the contemporaneous documents as to how he thought the varied earn-out formula would work, and I suspect that Mr Baker would be content with me doing so.
Mr Jennings was not so reticent. He volunteered unkind remarks about the financial performance of the Company. Some of his evidence was unlikely. Mr Jennings said that he was in “complete horror” at Mr Greene’s calculations but did not think to tell the CFO that he had got it wrong. Mr Jennings’ evidence got into difficulty at this point: see [90]-[91]. Mr Jennings’ professed understanding of how the Share Sale Agreement worked was at odds with contemporaneous documents, to which I defer.
The vendor’s solicitor, Glen Sauer, was involved in reviewing the proposed earn-out clause but did not give evidence. The purchaser sought a Jones v Dunkel inference, relying on SSABR Pty Ltd v AMA Group Limited [2024] NSWCA 175 at [183]. The purchaser submitted that, by seeking rectification, the vendor had put its state of mind in issue, giving rise to an implied waiver of privilege: Ampolex v Perpetual Trustee Co (Canberra) Ltd (1995) 37 NSWLR 405 at 411. The vendor submitted that no inference should be drawn where Mr Mulcahy did not recall any conversations with Mr Sauer about the provisions, but communicated with the solicitor by email. The vendor had tendered these emails. Nor did Mr Sauer draft the relevant provisions, unlike the solicitor in SSABR. (I do not think this last submission is a valid point of distinction with SSABR).
The vendor did not contest that it had waived privilege but, rather, that Mr Sauer was unlikely to add anything to the factual matrix. I have gone through every email which passed between Mr Mulcahy and Mr Sauer, from when the vendor gave instructions to review the first draft of the Variation Deed until the document was executed. I have also looked at Mr Sauer’s fee notes. Mr Mulcahy sought advice from Mr Sauer on a couple of occasions and invited Mr Sauer to call him: see [57]-[67]. But Mr Sauer appears to have provided all advice by email. The only occasion on which they spoke was in a Microsoft Teams meeting with Mr Greene, to finalise the amendments to the Variation Deed.
Mr Mulcahy and Mr Snell established the Company, which was an IT consulting and professional services firm. The Company was wholly owned by the vendor. Mr Mulcahy was Managing Director of the Company. (It is relevant to note that the Company did not have a CEO or CFO.) The Company provided professional IT services in ‘cloud’ technology. The majority of the Company’s work involved one-off, non-recuring projects, with government customers accounting for 45% of revenue. The Company also had a small managed services offering, which provided annuity income making up 5% of total revenue.
The difference between professional / project IT services, on the one hand, and managed services, on the other, is also relevant.
(a) Professional / project IT services typically involve the performance of a specific project for a client over short period. As Mr Mulcahy described it, there is generally a short period between initial contact with a client and beginning to undertake a project engagement, with revenue being received from the engagement within one to three months of initial contact. (b) Managed services are ongoing IT services provided to a client for between three and five years. Mr Mulcahy said that managed services contracts take between three and nine months to negotiate and sign.
Professional services generally earn less revenue and derive less profit than managed services contracts. Further, managed services contracts become more profitable in the later years of the contract, as the set-up costs are largely incurred in the early years.
By contrast to the Company’s business, the purchaser’s core business was the provision of managed services to financial services customers. The purchaser was then facing some major challenges, which were thought likely to result in a substantial decline in revenue and profit if it could not pivot into new capabilities and markets. The purchaser wanted to diversify its revenue base and was particularly interested in developing a ‘cloud’ offering.
In order to pursue this strategy, the purchaser had two options: build its own capability in-house or acquire an existing business already operating in that space. Building its own capability from scratch was thought likely to take three years and require an investment of more than $5 million, with no guarantee of success. The purchaser identified the Company as a potential acquisition target, including by reason of its credentials and track record in undertaking significant professional services projects in the ‘cloud’.
In 2018, the purchaser’s CEO, Mr Baker, began to discuss the acquisition of the Company with Mr Mulcahy and Mr Snell. Mr Mulcahy and Mr Snell said they wanted $20 million. Mr Baker told them that they were dreaming. Mr Baker said that the industry standard for valuing professional services businesses was four times EBIT. Whilst a higher multiple might be used if the business had a managed services business, the Company only had two such contracts. Mr Mulcahy replied, “Rather than complicate things with Managed Services multipliers at this stage, we can focus on a plan to measure them going forward”. The discussion as to what multiple should be applied for managed services contracts arose quite late in the negotiations: see [38].
In July 2019, a term sheet was signed. The purchase price would consist of an initial cash payment of $5 million plus two earn-out payments, subject to a cap of $20 million.
(a) The first earn-out payment was at the end of Year 1. A payment would be made based on a four (4) times earnings before interest and tax (EBIT) at the end of the first year, less the initial cash payment ($5 million). (b) A second earn-out payment was at the end of Year 2 and would be calculated using different multipliers depending on the EBIT at the end of that year. The starting point was a multiple of four (4) times EBIT, which ensured a minimum earn-out. If EBIT was greater than $3.5 million, the multiple would increase to 4.5. If the EBIT was greater than $4 million, the multiple was five (5). In each case, the payment would be based on the relevant multiple times EBIT less the initial cash payment and the earn-out payment achieved in Year 1.
A period of due diligence followed. By November 2019, Mr Greene had a due diligence report to hand. The consultant considered that the Company’s shares had only nominal value. This led the purchaser’s board to think that they may be paying too much for the Company, when the proposed acquisition was discussed at the board meeting in December 2019. The board still thought that the reason for acquiring the Company was sound. (Presumably, this was because the purchaser was looking at buying the Company for its skills and customer base, rather than its net assets.) However, according to Mr Jennings, several board members emphasised the importance of the sale contract having regard to the Company’s financial performance.
Mr Baker went back to the negotiating table. By March 2020, the initial cash payment had been reduced to $2 million plus earn-out payments. The vendor initially rejected this offer, but later accepted it on the basis of an earn-out and confidence “in driving value through the earn-out process”.
As part of the negotiations of the Share Sale Agreement, Mr Mulcahy was required to sign an employment contract with the purchaser. In May 2020, Mr Baker enquired, “One question – do you have a view on what’s the best title for you. I was originally thinking CEO Experteq for continuity but it’s causing a little confusion in the various documents as you and I will both [have] the same title. The alternative is a title such as GM Experteq or something similar”. Mr Mulcahy was happy with the title “GM Experteq”. In June 2020, Mr Baker circulated a group organisation chart with the new names and titles. The executive leadership team of the purchaser included Mr Baker as CEO, Mr Greene as CFO and Mr Mulcahy as “General Manager, Experteq”. (This is relevant for the second suggested error, being Disputed Matter No 2).
Another issue to be managed when negotiating the Share Sale Agreement was the retention of key staff. Mr Baker proposed a key personnel retention plan based on a 20% annual bonus, which would accrue over three years and be paid out at the end of the term if the staff member was still with the Company. In June 2020, the form of a letter to key employees was agreed, advising them of the transaction and retention bonuses. (This is relevant to the suggested fourth error, being Disputed Matter No 10.)
(a) a Completion Payment ($2 million), to be paid on Completion, subject to any adjustment under cl 9; and (b) Additional Payments to be paid by the purchaser in accordance with cl 10,
but capped at $20 million: cl 4.
Under cl 9, the parties were to prepare Completion Accounts in accordance with Schedule 5, so that any adjustment could be made to the Purchase Price. Relevantly, “Schedule 5 – Completion Accounts” detailed a number of accounting principles and policies which the purchaser was also obliged to have regard when preparing earn-out accounts: cl 10.6(b). Schedule 5 included a expert determination clause in similar terms to that the subject of these proceedings, in the event that the parties could not agree on adjustments to the Purchase Price. An accountant with at least 15 years’ experience, and currently practising at a top-tier accounting firm, was to determine such disputes; the determination was binding absent manifest error: para 2.4(b).
Clause 10, entitled “Earn out”, dealt with Additional Payments and largely followed the term sheet, save that the initial cash payment was less. Clause 10 began:
10 Earn Out
10.1 Additional Payments
(a) Subject to [the $20 million cap] and this clause 10, the Vendor is entitled to receive Additional Payments from the Purchaser based on the EBIT achieved by the Business … during each of the Earn Out Periods.
(b) Each Additional Payment will be determined and paid in accordance with this clause 10 and will be treated as an addition to the Purchase Price.
10.2 First Additional Payment
The Additional Payment for the first Earn Out Period will be the amount equal to four (4) times EBIT at the end of the first Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor.
10.3 Second and final Additional Payment
(a) lf EBIT for the second Earn Out Period is equal to or less than $3,500,000, then the Additional Payment for the second Earn Out Period will be the amount equal to four (4) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.2.
(b) lf EBIT for the second Earn Out Period exceeds $3,500,000 but is $4,000,000 or less, then the Additional Payment for the second Earn Out Period will be the amount equal to four and a half (4.5) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payment pursuant to clauses 10.2.
(c) If EBIT for the second Earn Out Period exceeds $4,000,000, then the Additional Payment for the second Earn Out Period will be the amount equal to five (5) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.2.
As the Additional Payment at the end of each Earn Out Period was to be reduced by the amount of the Purchase Price already paid, being $2 million, the Company needed to achieve an EBIT of $500,000 before the vendor would receive anything ($500,000 x 4 = $2,000,000 - $2,000,000 = nil). The parties referred to $500,000 as the “trigger” or “hurdle” to receive an Additional Payment. I will return to further portions of cl 10 in due course, specifically, the expert determination process prescribed in the event that the parties could not agree on Additional Payments. A third expert determination clause was to be found in cl 17, concerning the tax consequences of the transaction. Such disputes were to be determined by an expert with over ten years’ experience in tax; the expert’s decision was binding absent manifest error: cl 17.3(c); 17.4(c).
A dispute resolution procedure was also to be found in cl 22, requiring mediation. In earlier proceedings, Ball J concluded that, although the Share Sale Agreement did not expressly say so, it was implicit that any matter falling within the scope of what was to be determined by the expert was to be determined exclusively by the expert, and not by the Court following an unsuccessful mediation under cl 22: Expert Group International Pty Ltd v TransAction Solutions Ltd [2023] NSWSC 543 at [25]. Finally, cl 31.12 of the Share Sale Agreement provided that each party submitted to the jurisdiction of the courts in New South Wales in connection with matters concerning the Share Sale Agreement.
The Share Sale Agreement was completed on 14 August 2020. One of the transaction documents, and a condition precedent to completion, was a New Service Agreement between the purchaser and Mr Mulcahy: cl 1.1; 2.1(a). On 14 August 2020, Mr Mulcahy signed a contract of employment with the purchaser as General Manager, Experteq. Mr Mulcahy’s salary continued to be paid by the Company. Mr Mulcahy’s role remained largely the same, with a handful of additional duties for the purchaser.
After completion, a letter was sent to key employees including Andrew Smith, David Bourke and Dave Colvin, setting out the terms of the key employee retention bonus now offered. The key employee was eligible to receive a retention bonus in addition to their usual salary and bonus package. During the first, second and third years after completion, the retention bonus would be between 10% and 30% of their salary, depending on whether the Company achieved EBIT of (variously) less than $1 million or more than $2.5 million.
The first Earn Out Period began.
In April 2021, Mr Mulcahy sought to renegotiate the earn-out provisions in respect of managed services contracts. He approached Mr Baker and complained that the Company’s resources were being diverted to secure a number of managed services agreements, which stood to benefit the purchaser in the years to come. The cost of securing these deals would be part of the EBIT calculation for the Earn Out Periods, but the revenue and profit would be achieved after the end of the Earn Out Periods. As such, there was no incentive for the Company’s sales team to secure these engagements, rather than project IT services.
Mr Baker acknowledged Mr Mulcahy’s concerns and said he would take the matter up with the board. Mr Mulcahy asked that the profit from the full term of any managed services agreement be included in the Earn Out Period. Mr Baker thought he could probably ‘sell’ recognition of the first year of profit from such deals. Mr Mulcahy was agreeable to this course.
Mr Baker and Mr Greene began work on a proposal to incentivise the Company to win more managed services deals. As Mr Greene later reported to the purchaser’s board, the intent of the variation to the earn-out provisions was to encourage focus on managed services contracts, which were more valuable to the purchaser than professional services income. Mr Jennings acknowledged that the purchaser wanted the Company to ‘chase’ managed services deals, as they delivered long-term revenue to the purchaser; the problem was that the profits derived from such agreements went beyond the Earn Out Periods and would not be included in the calculation of Additional Payments.
By June 2021, Mr Greene and Mr Baker had finalised a proposal for the board, being a board paper with an accompanying extract of the existing earn-out clause. Mr Baker noted in his paper that, towards the end of final negotiations with the Company on the Share Sale Agreement, in particular, in respect of the multiple (4 times), the vendor raised whether the purchaser would or could treat managed services deals differently, “as they’re more valuable.” Given that this was raised so late in the negotiations, Mr Baker had advised that it would be difficult to change the arrangements, but agreed to consider the matter when the Company secured a managed services sale. The Company now looked to achieve three such sales, being to NSW Transport, Maddocks and NSW Crime Commission. This was considered to be “remarkably good news! … managed services deals … are highly valuable to TAS as they take TAS into new clients/new markets and deliver long-term annuity revenue.”
Mr Baker reported that Mr Mulcahy had now requested that the earn-out arrangements for managed services contracts be reviewed, “The Experteq GM raised that he’s encouraging the team to seek out and secure managed services opportunities, but recognizes that the effort involved in securing this business is far greater than securing professional services contracts and often delivers less value in the short-term (given the time it takes to implement these deals and that the profit is spread over a much longer period – multiyear).” Mr Baker put forward two options to the board, being:
• Retain the standard 4 times multiple for managed services deals but recognise a full year of annualised revenue against the second year of the earnout, or
• Increase the 4 times multiple to 6 times multiple for managed services deals but recognise a full year of annualised revenue against the second year of the earnout
In order to qualify for this arrangement, the managed services contract would need to meet three conditions: the contract must be executed within the two year earn-out period, “must be for a minimum of 2 years (ideally 3 years)”, and must have no exit option without payout of the contract.
Mr Baker noted that, typically, the industry paid “far more” for a managed services business than for a professional services business, “The 4 times multiple we’ve agreed to is in the range of what is paid for a professional services business, common for the former but anywhere from 6 to 10 times is not unusual for managed services business.” Further:
[the purchaser] wants to reward [Mr Mulcahy] to drive the culture and behaviour of seeking out and securing managed services opportunities. Given this is far more time consuming and less profitable (within the earnout period) than securing professional services opportunities, it is recommended to provide the right incentive to encourage this behaviour.
Mr Baker noted that the 6 times multiple “would still be on the lower end of what the industry pays for this type of business” but would drive the type of business which was most valuable to the purchaser. Mr Baker recommended offering a 4 times multiple for two-year managed services contracts and a 6 times multiple for three year contracts and, in each case, recognising a full year of annualised revenue at the second Earn Out Period.
As to how this proposal would work in practice, Mr Baker used the potential three-year managed services contract with Maddocks as an example:
Financial Implications
Using the Maddocks deal for modelling purposes and assuming an annual profit for this deal of $88k the calculation would resemble the following – noting the clause extract below from the Share Sale Agreement in relation to Earn Out:
6 x $88,000 = $528,000 (or $176k [sic] if the 4 times multiple is achieved)
Payable at the conclusion of the second earn out period only after applying the EBIT requirements in respect to the 4 times multiple (refer clause 1[0].3 below which is the scenario we expect to play out) which also accounts for the purchase price.
The TAS business unit costs applicable to Experteq managed services business will be transferred (using inter-company accounting) to the Experteq P&L in the manner prescribed including formal agreement to the fee structure.
As I read the board paper, Mr Baker then considered that the financial performance of the Company was tracking to achieve an EBIT multiple of 4 times in the second Earn Out Period: cl 10.3(a), Share Sale Agreement. (Mr Jennings said that no one then expected that the Company’s financial performance would qualify for the higher multiples in cl 10.3(b) or (c).) If the Company secured a managed services deal with Maddocks for three years, then, if Mr Baker’s recommended multiple of 6 times was used, the Company could expect to receive an additional $528,000 for the second Earn Out Period. If the Maddocks deal proved to be only a two-year contract, then a 4 times multiple would apply and result in a smaller payment.
Whatever the multiple, the product of the annual profit for the managed services contract and the multiple was an amount “P**ayable at the conclusion of the second earn out period”. This was in addition to what the vendor was presently entitled to receive under the earn-out clause. Any payment remained subject to deducting the Purchase Price already paid ($2 million) and the amount of any Additional Payment at the end of the first Earn Out Period (then expected to be nil).
The purchaser’s board considered the matter at their meeting on 22 June 2021. Mr Jennings said there was extensive debate at the board meeting in respect of the proposal. Several board members did not want to amend the Share Sale Agreement, as the vendor had agreed to its terms following protracted negotiations. The majority of the board, however, considered that the amendment would align the Company’s interests with those of the purchaser, and had the potential to increase the purchaser’s profits overall. The majority of the board preferred Mr Baker’s suggested multiple of 4 times rather than 6 times. The board minutes record:
The board asked a range of questions for more clarity on the proposed payment of 6x for any managed services business written by the Experteq team. It was explained the 6x was only available under this proposal for long term agreements of >2 years and only in the event the earnout hurdles were achieved under the Share Sale Agreement noting this clause was included in the board papers.
The board were not comfortable with the 6x proposal and determined that the earn out terms and formula as set out the Share Sale Agreement at 4x EBIT would apply but in the case of managed services business won by Experteq the full years profit of such new business would be applied to the EBIT result not from the first invoice date. This decision was subject to first understanding the financial implications in respect to this payment formula which Greene was mandated to identify and report back to the board under separate cover as the payment may impact the FY22 budget in the event it was classified as an operating and not capital expense.
I take the reference to “earnout hurdles” to be to the minimum EBIT which the Company had to achieve before the vendor could expect to receive anything, being at least $500,000 or, if an Additional Payment was made at the end of the Earn Out Period, even more. The minutes record that the board apprehended that the annual profit for a managed services contract would be added to the EBIT for the Earn Out Period and the multiple of 4 times applied to the sum, resulting in a “payment”. However, the board’s decision was subject to understanding the financial implications of the formula, which required Mr Greene to provide further material to the board, including as to whether any additional payment would be considered to be an operating or capital expense. A Work in Progress Schedule completed after the board meeting noted that the purchaser’s auditors were to provide a report in relation to any additional earn-out payment under the Share Sale Agreement and the classification of any such payment as a capital (acquisition) expense.
Mr Baker and Mr Greene continued to work on the proposal. No Additional Payment was payable by the purchaser at the end of the first Earn Out Period. The second Earn Out Period began.
On 13 September 2021, the Company entered into a managed services agreement with Maddocks. On 14 September 2021, the Company was also “short listed” in a tender for a managed services contract with the Health Care Quality Safety Commission. Mr Mulcahy thought this was a good time to press Mr Greene to recognise managed services deals in the Additional Payment for the second Earn Out Period, and did so.
On 29 September 2021, Mr Greene asked the purchaser’s solicitor, Mr Donato, how to progress the matter. Mr Greene provided the solicitor with an extract from the board papers and minutes of 22 June 2021. Mr Donato advised that a deed of variation would be needed, and offered to prepare one for review.
Mr Mulcahy also met with Mr Greene and others to discuss the allocation of costs, margins and resources between the Company and the purchaser in respect of the managed services deals. As Mr Jennings recalled it, initially the parties sought to agree on the percentages to be applied to each managed services agreement to work out an annualised agreed profit. This was later abandoned in favour of working out actual EBIT results for each managed services deal, as there were difficulties agreeing on the percentages.
By October 2021, Mr Greene had received advice from the purchaser’s accountants on the treatment of any additional earn-out payment “including any annualised [managed services] profit addition”. The accountants considered that any additional Earn Out would be capitalised as part of the purchase price. The accountants also noted that, given the financial results for the Company for the two months ended 31 August 2021, there was no evidence to suggest that a material earn-out would be due for the second Earn Out Period.
The proposal to vary the earn-out provisions came before the purchaser’s board for further consideration on 5 October 2021. The accountants attended and advised that “any earn-out payment in Year 2 (including the adjusted EBIT for annualised managed services profit under the agreed conditions) would be considered a deferred consideration and capital in nature”. The accountants then left the meeting.
The minutes record that Mr Baker then “added clarity to the earn out matter by talking to the agreed conditions and the new business that would generate the profit to be accounted”. The board resolved that the revised earn out EBIT calculation conditions be endorsed and a deed of variation be completed. That is, the board accepted the proposal presented at the previous board meeting in June 2021, now that the additional information sought had been provided.
10 Earn Out
10.1 Additional Payments
(a) Subject to clause 4.4 and this clause 10, the Vendor is entitled to receive Additional Payments from the Purchaser based on the EBIT plus, if specified below, the Annualised Agreed Profit achieved by the Business … during each of the Earn Out Periods.
(b) Each Additional Payment will be determined and paid in accordance with this clause 10 and will be treated as an addition to the Purchase Price.
…
10.3 Second and final Additional Payment
(a) lf EBIT plus the Annualised Agreed Profit for the second Earn Out Period is equal to or less than $3,500,000, then the Additional Payment for the second Earn Out Period will be the amount equal to four (4) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.1 - 10.3.
(b) lf EBIT plus the Annualised Agreed Profit for the second Earn Out Period exceeds $3,500,000 but is $4,000,000 or less, then the Additional Payment for the second Earn Out Period will be the amount equal to four and a half (4.5) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payment pursuant to clauses 10.1 - 10.3.
(c) If EBIT plus the Annualised Agreed Profit for the second Earn Out Period exceeds $4,000,000, then the Additional Payment for the second Earn Out Period will be the amount equal to five (5) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.1 - 10.3.
(d) For the purposes of this clause 10, Annualised Agreed Profit means the annualised net profit derived from new managed services business signed by the Purchaser under a formal contract, being the annualised net profit determined by the Purchaser in line with the Purchaser’s standard pricing model or as agreed between the parties (Purchaser and Frank Mulcahy) within 60 days of the date of the relevant contract, from sources secured by Experteq and/or Experteq clients which contracts satisfy the following conditions:
(i) they were signed within the 2 year earnout period;
(ii) the minimum term of the secured contract is 2 years; and
(iii) the secured contract must have no right to be terminated early without an early termination payment being payable to the Vendor.
As will be seen, negotiations then focussed on further amendments to cl 10.3(d). The only changes made to cl 10.3(a) to (c) was to correct (most) cross-references.
Mr Mulcahy forwarded the draft to Mr Snell and to the vendor’s lawyer, Mr Sauer, initially asking Mr Sauer to review the variation deed “and let me know what you think of it[s] structure and wording. Happy to jump on a call to discuss.” On 9 November 2021, Mr Mulcahy forwarded the material to Mr Sauer at his new firm, “Pls call me with any questions”.
This was the first that Mr Snell had heard of the proposed variation. Mr Snell was “a little bit surprised by … the offer at the time.” He reviewed the initial draft and sent through a series of questions on 9 November 2021. Mr Snell also spoke to Mr Mulcahy about the rationale for the proposed variation, and “what’s the benefit to TAS, because that wasn’t really understood by me at the time of reading the contract.” Mr Mulcahy explained that the amendment was to encourage Mr Mulcahy and his team to focus on managed services without being detrimental to their earn-out potential. Mr Snell left it to Mr Mulcahy to negotiate the balance of the document.
On 16 November 2021, Mr Sauer provided initial comments. The drafting of proposed cl 10.3(d) was said to be unclear. Mr Sauer proposed alternative drafting. Mr Sauer also queried whether profit from contracts which were less than two years would still be captured in EBIT. Mr Mulcahy answered some of Mr Sauer’s queries and enquired “Is there any risk here to us that contracts on TAS paper will not qualify because of the wording” of Mr Sauer’s alternate drafting. Mr Sauer answered Mr Mulcahy’s query by a further email. (Mr Sauer later rendered an invoice to the vendor, which records that all work was done on this date; the narration does not refer to any meeting or telephone call with Mr Mulcahy.)
Mr Mulcahy forwarded Mr Sauer’s comments to Mr Greene and Mr Baker. On 25 November 2021, Mr Greene replied, “All profits make up Experteq EBIT – which includes those contracts that don’t meet the annualised net profit criteria outlined above – as for those that do meet the criteria we apply the annualised formula.” The question posed by Mr Sauer had highlighted the need to ensure that the profits from any given managed services contract were put in the correct category of either EBIT or Annualised Agreed Profit, and neither missed nor double counted.
On 18 January 2022, Mr Greene provided Mr Jennings with a further draft of the Variation Deed “following our call”. (The amendments concerned cl 10.3(d) and are not presently relevant.) As to the way forward, Mr Greene noted that it was intended to arrive at an agreed annualised profit for each managed services deal, and to agree these percentages by a side letter. Once this was done, Mr Greene would complete a forecast of the EBIT result for the Year 2 Earn Out period “so we have visibility on what the Extra Payment to the Vendor may look like under the Sale Agreement earn out terms.”
“Why I ask, the Deed of Variation states:
- ‘the vendor is entitled to receive additional payments from the purchaser based on the EBIT plus, if specified below, the Annualised Agreed Profit achieved by the business …’
- ‘if EBIT plus the annualised agreed profit for the second earn out period exceeds …’
In the event any or all the Expertech managed service arrangements commence prior to 14 Aug 22, and any portion of the annualised agreed profit (AAP) is booked to Expertech’s EBIT has TAS unintentionally doubled up on that portion of the AAP.”
Mr Greene replied on 20 January 2022 that there were “2 protections” from “potentially double counting the additional payment due”. The first protection was the definition of EBIT and associated provisions in Schedule 4 of the Share Sale Agreement. The second “and stronger mitigation” was their plan to isolate the revenue from managed services deals so that they were accounted for in the purchaser’s books of account, negating any risk that the Company’s EBIT included the revenue/profit from qualifying managed services deals. Mr Jennings replied that he just wanted to make sure that the variation deed “didn’t catch us out”. Mr Greene agreed, noting that they needed to be “absolutely sure in protecting our business given this variation was the result of a TAS initiative in being fair to the Vendor.” Mr Jennings replied that it was okay to release the draft deed to the vendor for their lawyer’s review.
On 21 January 2022, Mr Greene circulated the draft which had been approved by Mr Jennings. On 28 January 2022, Mr Greene sent an email to the Company’s finance manager, copied to Mr Mulcahy, advising that the three managed services deals had to be accounted for in the purchaser’s financials “as a separate arrangement has been agreed with [Mr Mulcahy] on the profit recognition towards Year 2 – earn-out. This will avoid double counting these profits – and keep the [Company] accounts in a normalised EBIT position.” To achieve this, invoices which had been rendered by the Company the previous month would need to be transferred to the purchaser. The Company’s finance manager obliged. After this, the parties generally referred to the Company’s EBIT, adjusted to remove the Annualised Agreed Profit of managed services contracts, as “normalised EBIT”.
On 29 January 2022, Mr Sauer followed up Mr Mulcahy, “how did you end up going with this?” Mr Mulcahy provided the current draft of the Variation Deed, “Pls let me know what you think and we can put this to bed hopefully.” On 3 February 2022, Mr Sauer advised Mr Mulcahy that the amendments he had earlier proposed to the variation deed had not been incorporated. Mr Sauer marked-up the deed with the missing amendments. (These proposed amendments are not presently relevant but were mainly directed to identifying the Company’s managed services clients, contracts and pricing models with precision.) Mr Mulcahy provided this document to Mr Greene. On 4 February 2022, Mr Greene replied “your lawyer has missed the brief on this matter.” What had been agreed was an additional payment that was negotiated on a case by case basis, with an agreed profit percentage to be applied to each managed services deal. Mr Mulcahy provided Mr Sauer with Mr Greene’s response, “Pls let me know if you’d like me to set up a quick call with him to discuss.”
Later that day, Mr Greene provided the proposed percentage profits for the Maddocks deal and the NSW Crime Commission deal. Further emails ensued, agreeing on the margins for third-party revenue which formed part of these managed services contracts. On 6 February 2022, Mr Green advised Mr Mulcahy that he proposed to use these figures “for the purposes of forecasting the additional payment and potential Earn-Out” at 14 August 2022, once the half-year accounts were available.
The terms have been agreed between the parties and the negotiations are continuing on the respective %’s to be applied to the three (3) qualifying deals which will be set out in related ‘side letters’ and executed by the parties. The application of the standard TAS pricing framework is being overlayed to the pricing schedules in each of the 3 new contracts with this approach delivering the % to be annualised and to form the additional payment at the conclusion of the second earn out year i.e. 14 August 2022.
One of the matters in the Work in Progress Schedule, on which the board was updated, was the Variation Deed. The minutes record that Mr Baker spoke to “the additional earn out matter” and referred to the Variation Deed included in the board pack. He repeated the history, being that the Share Sale Agreement did not include earnings from managed services deals, of which the Company had won several since Completion, “As a result of the board decision to allow … these deals to form part of the earn out we have been negotiating with the vendors … on the appropriate formula”. Mr Baker advised that the original proposal was that there would be an agreed percentage applied to each qualifying deal, but the parties could not agree on a percentage. He recommended that actual EBIT results from each deal be used instead, using separate ledgers. The draft Variation Deed was being revised to reflect this alternative, “and our lawyer has been mandated to complete this task.”.
Mr Greene then outlined the accounting practices that would be employed to deliver the EBIT results for each of the three current qualifying deals “that would be annualised in the normal fashion before being applied to the normalised EBIT that derived from the standard operations of Experteq.” A question was raised about dispute resolution, and Mr Greene confirmed that the Variation Deed would not be executed until both parties were in full agreement. Beyond this, the board made no further resolutions in respect of the matter.
On 3 March 2022, Mr Greene and Mr Mulcahy met to discuss final numbers. There followed a large number of emails, copied to Mr Baker, attaching various iterations of the worksheets for each managed services agreement, which were to be attached to the Variation Deed.
On 14 March 2022, Mr Greene provided the final version of the Variation Deed to Mr Jennings, together with a comparison copy showing the changes to the document since it was included in the board papers in February 2022. Mr Greene explained, “The revisions account for the shift from a fixed % of recurring gross revenues to actual EBIT … . Worksheets will be attached to the deeds to support the agreed cost allocations.” Mr Greene continued to send various iterations of the worksheets to Mr Mulcahy.
On 29 March 2022, Mr Greene sent the final worksheets for the three qualifying managed services deals to Mr Jennings. The worksheets set out the fees, costs and projected profit for each qualifying managed services contract. On 1 April 2022, Mr Jennings executed the Variation Deed. Mr Greene then forwarded the deed and the attached worksheets to Mr Mulcahy for execution.
In its final form, cl 10.1 of the Share Sale Agreement, as varied, was as first circulated on 8 November 2021: see [55]. Clause 10.2 was unchanged (and now redundant). Clause 10.3 now provided: (with changes from those first circulated on 8 November 2021 underlined)
10.3 Second and final Additional Payment
(a) If EBIT plus the Annualised Agreed Profit for the second Earn Out Period is equal to or less than $3,500,000, then the Additional Payment for the second Earn Out Period will be the amount equal to four (4) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.1 and 10.2.
(b) If EBIT plus the Annualised Agreed Profit for the second Earn Out Period exceeds $3,500,000 but is $4,000,000 or less, then the Additional Payment for the second Earn Out Period will be the amount equal to four and a half (4.5) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.1 and 10.2.
(c) If EBIT plus the Annualised Agreed Profit for the second Earn Out Period exceeds $4,000,000, then the Additional Payment for the second Earn Out Period will be the amount equal to five (5) times EBIT at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.1 - 10.3.
(d) For the purposes of this clause 10:
(i) Annualised Agreed Profit means the aggregate annualised profit from Qualifying Managed Services Agreements, such annualised EBIT to be calculated and determined by the Purchaser by reference to the Purchaser's standard model (refer Approved Worksheets in Annexure A) for assessing the profitability of services provided under a managed services agreement subject to the following costing policy:
(A) each individual component and deliverable (under recurring costs) included in the approved worksheets (Approved Worksheets) (set out in Annexure A) completed for each of the Qualifying Managed Services Agreements will have 5% (ex GST) added to the cost values in the same worksheets to recognise the infrastructure support overheads applicable to the businesses of the Purchaser and Vendor; and
(B) the cost values plus the infrastructure support overheads will form the expense base to offset against the recurring revenues of each Qualifying Managed Services Agreements to deliver an EBlT value which will be annualised using the standard calculation of actual EBIT/number of days of recurring revenue*365; and
(C) in the event an out-of-scope deliverable considered to be extraordinary in nature, as agreed by the Vendor and Purchaser, acting reasonably, that is not included in the Approved Worksheets (meaning an under-scoped and under-priced deliverable or service) arises during the term of a Qualifying Managed Services Agreement and the Purchaser and Vendor are held responsible for delivery of such services, the costs plus the infrastructure support overheads rate of 5% will be expensed and accounted to the ledger of the respective deal.
(ii) Experteq Client means any client that has been introduced to the Purchaser Entity by the Company, Frank Mulcahy or any other employee or contractor of the Business.
(iii) Purchaser Entity means the Purchaser or any of the Purchaser's subsidiaries (including the Company); and
(iv) Qualifying Managed Services Agreements means:
(A) the Master Services Agreement executed between TAS and Maloch Pty Ltd … dated 6 September 2021;
(B) the Customer Agreement executed between Vendor and New South Wales Crime Commission … dated 17 December 2021;
(C) the Customer Agreement executed between Vendor and Health Administration Corporation, as represented by eHealth NSW … dated 1 December 2021; and
(D) any other agreement for managed services (New Agreement) executed during the Earn Out Period … and which satisfies the following conditions:
(i) the minimum term of the New Agreement is 2 years; and
(ii) the New Agreement cannot be terminated before the agreed term of the New Agreement; or
(iii) if the New Agreement is terminated prior to the expiry of the agreed term of the New Agreement, it must contain an early termination payment or stranded costs provision acceptable to the Purchaser.
Having finalised the terms of the Variation Deed and the accompanying worksheets, Mr Greene turned his attention to modelling what the Additional Payment for the second Earn Out Period might be. It will be recalled that, under cl 10.3 of the Share Sale Agreement, the Purchase Price already paid had to be deducted from the product of EBIT and the applicable multiple before any Additional Payment could be calculated. Mr Green prepared a spreadsheet, entitled “Earn Out Additional Payment”, which took this into account. This spreadsheet becomes important, as Mr Greene later presented it to the board.
On 11 April 2022, Mr Greene and Mr Baker spoke, apparently about the modelling of the Additional Payment in the spreadsheet. On 12 April 2022, Mr Greene emailed Mr Baker, “Following on from our conversation yesterday – I tested [Mr Mulcahy’s] response to Model 1 attached – which deducts the $2m from each transaction – the original and the revised plan. He accepted this”. I take it from this email that Mr Greene showed the spreadsheet to Mr Mulcahy. Mr Greene also emailed the spreadsheet to Mr Baker, explaining:
“Using this model, if Experteq hit $1m EBIT in their normalised accounts AND only the 3 current qualifying deals are accounted – the payout = $4.599m
If we were to exclude the $2m from the revised earn out terms you can add $2m to this number above – which is conservative given we expect more qualifying deals to be won.”
In the attached spreadsheet, Mr Greene calculated how much the vendor would receive under the Share Sale Agreement, before and after the variation. As to the forecast Additional Payment before the variation, Mr Greene used the Company’s projected EBIT, based on financial results to the end of February 2022 ($214,879) and including the revenue expected to be received under the three managed services contracts to the end of the second Earn Out Period. Forecast EBIT was $568,036. This was multiplied by 4 ($2,272,144). He then deducted $2 million. The Additional Payment was $272,144. Mr Greene then modelled what the Additional Payment would be using higher projected EBITs of $750,000 and $1 million. If the Company’s EBIT was $1 million, then the vendor would receive obtain an Additional Payment of $2 million.
As to the forecast Additional Payment after the variation, Mr Greene took the total annualised EBIT for the three managed services contracts ($1,149,910). He added the projected EBIT for the Company without the revenue earned on the three managed services contracts, which I understand to be what Mr Greene and Mr Mulcahy referred to as “normalised EBIT”. (According to Mr Greene’s later explanation to the board, this included the transitional or non-recurring fees from the managed services contracts: see [87].) Mr Greene added these two figures together and multiplied the total by 4 before deducting the $2 million already paid. This resulted in an Additional Payment of $2,599,640. (The formula at Cell L18 may have an error: the reference to L17 is presumably intended to refer to B19.) Importantly, Mr Greene applied the multiplier to the Annualised EBIT for the managed services contracts.
The forecast indicated that, after the variation, the Company would receive an Additional Payment of some $2.6 million based on its presently forecast EBIT and its existing three managed services contracts. That is, it was no longer necessary for the Company to basically double its forecast EBIT before it could expect an Additional Payment of $2 million.
On 15 April 2022, Mr Greene sent a more elaborate version of this spreadsheet to Mr Jennings, copied to Mr Baker. Mr Greene explained that he had only included the three qualifying managed services deals “noting that there are another three (3) new clients that are likely to execute qualifying agreements this month.” The calculation was now done slightly differently. Mr Greene looked at various projected forecasts of normalised EBIT, that is, without the recurring revenue from managed services contracts. He multiplied the projected EBIT by 4 and then deducted the Purchase Price of $2 million. He separately took the total Annualised EBIT for the three managed services contracts and multiplied this by 4. He added both figures together. That is, Mr Greene separately applied the multiple of 4 to normalised EBIT and Annualised EBIT for the managed services contracts, rather than adding the normalised EBIT and Annualised EBIT together before applying the multiple to the sum.
The vendor executed the Variation Deed on 21 April 2022. Mr Greene prepared to report to the board, including to provide a forecast of the Additional Payment which may be payable at the end of the second Earn Out Period. On 25 April 2022, Mr Greene sent to Mr Jennings and Mr Baker a revised spreadsheet and some commentary for inclusion in the management report for an upcoming board meeting. Like the previous spreadsheet, Mr Greene separately applied the multiple of 4 to normalised EBIT and the Annualised EBIT for managed services contracts, before adding these figures together to arrive at a total Additional Payment. Depending on the projected normalised EBIT, the total Additional Payment was up to $8 million.
On 29 April 2022, Mr Greene sent instructions to the Company’s finance manager, copied to Mr Mulcahy, to begin issuing invoices in accordance with the Variation Deed. Mr Greene advised that the revenue and expense on managed services contracts would be recorded separately in the purchaser’s accounts “so the margin available to [the Company] is clearly visible and will be added – as agreed – to the EBIT number.”
The May 2022 board papers included a management report on the Variation Deed. On 3 May 2022, the purchaser’s board considered the management report, which was supported by two worksheets:
(a) Annexure A summarised the details of the five managed services agreements that were expected to qualify under the Variation Deed for inclusion in the calculation of the earn-out, together with the value of those contracts. In addition, details were provided for a further five managed services agreements which were then ‘in the pipeline’. (b) Annexure B was another iteration of the Earn-Out Additional Payment worksheet already described.
For comparative purposes the Sale Agreement Terms in Annexure B worksheet provides the application of the original Sale Agreement obligations whereby the actual EBIT position at 14 August 2022 is the only value that forms the basis for the 4x multiple.
In arriving at these forecast options, we have used the Experteq EBIT result at 31 March 2022, added the transition or non-recurring fees from the four (4) deals (which are not part of the Variation terms) and the actual earnings from the qualifying deals from go-live billing dates (across January 2022 to April 2022) through to 14 August 2022.
In respect of our available capital in meeting the earn out obligations, we hold liquidity over $14m.
Note: It is important to recognise that all managed services deals (except Maddocks) sold and delivered in the earnout period (revenue and profit) are recognised in Experteq’s P&L and the earn-out factors apply according to the sale agreement. The Deed recognises the managed services deals which meet the criteria set out in the Deed and apply an annualised contribution for the qualifying deals. Therefore, the difference between the two (sale agreement and Deed) is the difference between the actual period of new contract billing in the earnout period versus a full year (annualised) contribution.
The minutes of the board meeting record that Mr Greene presented the worksheets modelling the additional earn-out calculations under the Variation Deed. It would appear from the minutes that he did so in some detail. Subject to various assumptions, the additional earn-out payments were between $5.4 million and $8.4 million, which included the current four qualifying clients and four prospective new clients. Mr Greene noted that there were at least two other clients in the pipeline that would qualify under the deed, if they became managed services clients. The minutes record that the directors asked a number of questions in respect of the models and the implications for the purchaser, which were clarified by Mr Greene and Mr Baker. The minutes record that a post earn-out period review would be undertaken “with the lessons from this transaction”.
Mr Jennings initially said he could not recall whether he looked at the worksheets provided by Mr Greene, and was unsure whether he reviewed the modelling. Mr Jennings agreed that the use of the multiplier in these worksheets did not accord with his suggested understanding: that the variation was limited to changing the hurdles in order for a particular multiplier to be applied. But Mr Jennings said he did not tell Mr Greene that he had got it wrong. Mr Jennings then said he had reviewed the spreadsheet and, further:
A. When I received the - the spreadsheet, my initial reaction, I recall, was surprise at … the, I suppose, EBIT annualised projections, and I felt that if it was correct, that it was a lot more than what I would’ve assumed due to the performance of the organisation.
Q. You looked at these spreadsheets, Mr Jennings?
A. I did.
Q. You were concerned about the numbers Mr Greene was coming up with?
A. I was concerned - concerned with the - the spreadsheet and the figures that were projected.
…
Q. It’s perfectly …obvious that Mr Greene is applying the four times multiple to the annualised agreed profit, isn’t it?
A. Well, I can only go by my recollection of when I - my - my reaction when I received the - the spreadsheet, and my reaction was complete horror that that figure was to be paid on those scenarios.
As the second Earn Out Period drew to a close, Mr Mulcahy was interested to know whether various managed services deals would be included in the earn-out calculation. On 10 August 2022, Mr Mulcahy met with Mr Greene and asked whether he had a view on the likely amount of the Additional Payment for the second Earn Out Period. Mr Greene showed Mr Mulcahy a spreadsheet on his laptop that included his calculation of the Additional Payment. The payment was forecasted to be more than $2 million and was calculated by adding the Annualised Agreed Profit to EBIT and then applying the multiplier. Mr Greene said that the amount still needed to be audited. Mr Mulcahy did not agree with the forecast figure but did agree with the methodology used. He asked Mr Greene to send him a copy of the spreadsheet, but it was not forthcoming.
On 14 August 2022, the second Earn Out Period concluded. On 15 August 2022, Mr Mulcahy resigned as General Manager of Experteq, giving three months’ notice. As to the next step, cl 10.4 of the Share Sale Agreement provided:
10.4 Preparation of Earn Out Period accounts
Within 60 days of the end of each Earn Out Period, the Purchaser must:
(a) cause the accounts for the Business for the relevant Earn Out Period to be prepared and audited (Earn-Out Accounts); and
(b) release a copy of the Earn-Out Accounts for the relevant Earn Out Period to the Vendor together with a copy of the auditor's report.
Clause 10.6 obliged the purchaser to prepare the Earn Out Accounts in accordance with the principles and policies prescribed in clause 10.7 and Schedule 4, the accounting policies used for the preparation of the Completion Accounts set out in Schedule 5 and Accounting Standards. Relevantly, EBIT was to be adjusted to include a full year’s remuneration of the Chief Executive Officer and the Chief Financial Officer. As mentioned at the outset, the Company did not have a CEO or CFO. The purchaser had both, being Mr Baker and Mr Greene.
On 22 August 2022, Mr Greene tasked the purchaser’s accountants with the audit process for the Earn Out Period. On 5 September 2022, Mr Greene provided Mr Mulcahy with the accountant’s audit plan, which noted that an area of focus would be on cl 10.1(a) and cl 10.3(a), (b) and (c) of the Share Sale Agreement and Variation Deed. The auditor proposed:
“We will:
- Obtain management’s Earn Out calculation and challenge judgements and assumptions used;
- Ensure the Earn Out calculation is in line with the terms of the Agreement and the Variation Deed;
- Ensure the inputs used in management’s calculation are appropriate and in line with the Approved Worksheets;”
(a) The Company’s EBIT for the year ended 14 August 2022, with balance day adjustments, was $1,086,948.61. (b) Four managed services deals qualified for consideration in the earn-out calculation, being NSW Crime Commission, Maddocks, NSW Health and Link Wentworth Housing. The annualised EBIT for these four contracts was added to the Company’s EBIT, giving a total of $1,787,017.77. (c) From this, the annual costs of the CEO/CFO ($803,206.71) were deducted, leaving $983,811.06. This figure was multiplied by 4, from which $2 million was deducted, leaving $1,935,244.25.
10.9 Vendor to calculate Additional Payment
Within 10 Business Days following the Vendor's receipt of the materials referred to in clause 10.4, the Vendor must cause the relevant Additional Payment to be calculated in accordance with clause 10.2 and/or clause 10.3 (as the case may be) and the principles set out in Schedule 4 and give the Purchaser written notice of its calculation (Earn Out Notice).
On 18 October 2022, the vendor requested a copy of the Earn Out Accounts for the second Earn Out Period in a form consistent with the terms of the Share Sale Agreement. (Clause 10.8 imposed formatting requirements for the Earn Out Accounts.) In respect of the CEO and CFO costs, evidence of such costs was sought “as our Client is not aware of any CEO or CFO being appointed with respect to the Business.”
On 27 October 2022, the purchaser provided the vendor with the Earn Out Accounts for the second Earn Out Period in the prescribed format under the Share Sale Agreement. The CEO and CFO costs were identified as those of Mr Baker and Mr Greene. The earn-out amount had reduced to $1,694,910 as a result of further costs being identified in the audit. Beyond this, the purchaser continued to use the formula as illustrated by Mr Greene’s worksheets, applying the multiple to the sum of the Agreed Annualised Profit and EBIT.
On 9 November 2022, Mr Sauer raised a number of queries with the purchaser’s calculations and suggested a meeting. On 15 November 2022, Mr Mulcahy finished work and left Experteq. On 16 November 2022, Mr Greene responded to the vendor’s requests but advised that a meeting was not thought to serve any purpose. On 23 November 2022, Mr Greene provided the vendor’s lawyer with further material, including the auditor’s files. On 1 December 2022, the vendor sought further clarification, which was provided.
On 22 November 2022, the purchaser’s board reviewed the acquisition of the Company. The acquisition was considered to have had significant value and to have been a turning point for the business. The total acquisition had cost $3.7 million compared to the projected $8 million. Importantly, there is no suggestion in the board paper that Mr Greene’s calculation of the earn out, either in the forecasts earlier presented to the board or since, was wrong.
On 21 December 2022, the vendor issued an Earn Out Notice, putting the Additional Amount payable at $9,434,142.73. Where the Earn Out Accounts and auditor’s report had been provided on 10 October 2022, the notice was issued more than 10 Business Days later, contrary to cl 10.9. In any event, the vendor advised that it did not accept the audited accounts and considered that the Company’s EBIT was $1,385,585.52. The Company considered that there were five qualifying managed services contracts, with an annualised profit totalling $1,472,950.16. This made a total EBIT of $2,858,535.68. This figure was multiplied by 4 ($11,434,143), from which the purchase price of $2 million was deducted, leaving an Additional Amount Payable of $9,434,142.73.
That is, the method used by the vendor was the same as the purchaser; the inputs were different. The purchaser points to a small portion of the Earn Out Notice, which can fairly be described as a ‘snippet’, as indicating that the vendor then understood that the Additional Payment was “4 times EBIT”. When the letter is read as a whole, together with its attached spreadsheet, it is apparent that the vendor and purchaser were then applying the earn-out formula in the same way.
10.10 Purchaser to agree or dispute Additional Payment
(a) Within 10 Business Days following receipt of the Earn Out Notice (the Earn Out Acceptance Period), the Purchaser must notify the Vendor in writing whether it agrees with the Earn Out Notice or any basis on which it disputes the Earn Out Notice which must include (an Earn Out Dispute Notice):
(i) reasonable details of each matter in dispute (Disputed Matters);
(ii) in the case of the relevant Earn-Out Accounts, a separate dollar value for each Disputed Matter; and
(iii) the reasons why each of the Disputed Matters is disputed.
(b) If, within the Earn Out Acceptance Period, the Purchaser confirms its acceptance of the Earn Out Notice or fails to give an Earn Out Dispute Notice before the expiry of the Earn Out Acceptance Period, the Vendor and the Purchaser will be deemed, on the date of that confirmation or the expiry of the Earn Out Acceptance Period (where applicable), to have agreed the amount of the relevant Additional Payment for the purposes of this document and the Additional Payment shown in the Earn Out Notice will be final and binding on the Vendor and the Purchaser.
(c) If the Purchaser gives an Earn Out Dispute Notice to the Vendor within the Earn Out Acceptance Period, the Disputed Matters, if not resolved between the Vendor and the Purchaser within 10 Business Days of delivery of the Earn Out Dispute Notice, be referred for resolution to an independent chartered accountant with over ten years' experience in the relevant area agreed to by the Vendor and the Purchaser or, failing agreement, nominated at the request of either the Vendor or the Purchaser by Resolution Institute (or a successor body) in accordance with its Expert Determination Rules (the Earn Out Expert).
On 6 January 2023, the purchaser issued an Earn Out Dispute Notice, albeit without accepting that the Earn Out Notice was valid. The purchaser responded to the matters raised in the Earn Out Notice, each of which was said to constitute Disputed Matters. The vendor’s suggested Additional Payment was said to be extraordinary.
While the purchaser addressed the ‘line items’, it but did not depart from its application of the formula to calculate the Additional Payment. Based on the purchaser’s response to each ‘line item’, the purchaser advised that the Company’s adjusted EBIT was now $260,815.95. There remained four qualifying managed services contracts with annualised profit totalling $710,973.82. The total EBIT was, therefore, $971,789.77. This total was multiplied by 4 ($3,887,159), from which the purchase price of $2 million was deducted. The purchaser’s revised calculation of the Additional Payment was now $1,887,159.
The parties met on 17 January 2023 to attempt to resolve the Disputed Matters. The vendor and purchaser did not agree the amount of the second Additional Payment within 10 business days of the Earn Out Dispute Notice or at all. The next step, under cl 10.10(c), was to refer the matter for resolution to the Earn Out Expert, but the parties could not agree on this either. The purchaser proposed three potential experts, whilst the vendor considered this to be premature.
On 6 February 2023, the vendor issued a Dispute Notice under cl 22 of the Share Sale Agreement. The purchaser replied that the dispute was governed by the expert determination procedure in cl 10. The vendor rejoined that there was nothing in the Share Sale Agreement which prevented the vendor from utilising the dispute resolution clause. Where there were fundamental differences between the parties’ interpretation of the Share Sale Agreement, the vendor said that these matters were outside the purview of an Earn Out Expert.
On 23 March 2023, the vendor commenced proceedings in this Court, seeking declarations as to the proper construction of the Share Sale Agreement. On 27 April 2023, the purchaser filed a motion seeking a stay on the basis of the expert determination clause. Mr Donato made an affidavit in support.
The parties filed written submissions, in which they took the opposite stance to that taken in these proceedings. In particular, the purchaser submitted that the Disputed Matters were overwhelmingly of an accounting nature, “To the extent they raises questions of construction, such as whether a contract meets the requirements of a contractual definition, that question is more than capable of being dealt with by a suitably qualified independent expert accountant with ten years’ experience in this area.” The purchaser submitted that the vendor should be held to its bargain, where the expert determination clause “provides for procedural safeguards. If the decision is attended by manifest error, it can be challenged. In short, there is no sufficient reason why the parties’ agreed mode of resolution should not be insisted upon.”
For its part, while the vendor’s pleading was a comprehensive assault on the expert determination clause, the vendor focussed its submissions on dissatisfaction with the Earn Out Accounts. The vendor submitted that the Earn Out Expert did not have authority to determine whether the Earn Out Accounts complied with the requirements of the Share Sale Agreement.
On 23 May 2023, Ball J granted a stay, with costs: Expert Group International Pty Ltd v TransAction Solutions Ltd [2023] NSWSC 543. Noteworthy, his Honour observed at [6]:
“… It appears to be common ground that ‘EBIT’ for the purpose of calculating the multiple in the formulas referred to in [cl 10.3] also includes the Annualised Agreed Profit.”
The qualification and experience required of the expert are particularly appropriate to deal with disputes concerning the recognition and treatment of various amounts in accounts that must, among other things, be prepared in accordance with the Accounting Standards.
On 7 June 2023, the parties submitted separate applications to the Resolution Institute for the appointment of an Earn Out Expert. The institute nominated an expert, but the purchaser did not accept this appointment. The institute then nominated Paul Croft as an expert, and both parties accepted this appointment.
As to how the expert determination was to be conducted, cl 10.11 of the Share Sale Agreement provided:
10.11 Instructions to Earn Out Expert
(a) Once the Earn Out Expert has been selected, the Vendor and the Purchaser must act in good faith and do all things within their power to agree the scope of the Earn Out Expert’s appointment and to effect the appointment (including signing the Earn Out Expert’s engagement letter and agreeing to pay the fees and expenses of the Earn Out Expert in accordance with clause 10.11(e).
(b) The Earn Out Expert will be instructed to:
(i) decide the Disputed Matters within the shortest practicable time and in any event within 15 Business Days of the referral;
(ii) apply any principles set out in clause 10.6 and Schedule 4 (and no other principles);
(iii) determine the amount of the relevant Additional Payment; and
(iv) determine whether the Purchaser had a reasonable basis for disputing the Earn Out Notice with respect to the Disputed Matters.
(c) The Vendor and the Purchaser must promptly provide the Earn Out Expert with all information and assistance reasonably requested by the Earn Out Expert. All correspondence between the Earn Out Expert and a party must be copied to the other parties.
(d) The Earn Out Expert will act as an independent expert and not an arbitrator and the Earn Out Expert's decision on the amount of the relevant Additional Payment will (in the absence of manifest error) be final and binding on the Vendor and the Purchaser.
(e) All of the costs of the Earn Out Expert will be borne by the Purchaser, unless the amount shown in the Vendor’s calculation in the Earn Out Notice is 5% or more greater than the amount of the Additional Payment determined by the Earn Out Expert, in which case all of the costs of the Earn Out Expert will be borne by the Vendor.
Clause 10.12 obliged the purchaser to make the Additional Payment as agreed or determined by the Earn Out Expert within 10 business days.
On 10 July 2023, the parties attended a preliminary conference. Mr Croft circulated a draft expert determination agreement. Further emails passed between the parties as to its terms, until agreement was finally reached. On 26 July 2023, the parties entered into an agreement with Mr Croft, appointing him as the expert under the Share Sale Agreement. In particular, the agreement stated:
Disputed Matters
9 … the matters set out in the Earn Out Dispute Notice issued by TAS to Expert Group on 6 January 2023 are in dispute between the Parties, including whether:
9.1 Certain items should be included (or excluded as the case may be); and/or
9.2 The amount specified for such items is appropriate,
in the Earn Out Accounts prepared for the purpose of calculating the Additional Payments relevant to the Second Earn Out Period.
10 Notwithstanding anything to the contrary in this agreement, the Parties agree that the Expert is to determine all matters in issue between the Parties that are relevant to the determination of the amount of the Additional Payment.
The vendor submitted that the parties were bound by the expert’s interpretation of the earn-out provisions, absent ‘manifest error’. The expert had to interpret the contract and apply the formula in order to determine the amount of the Additional Payment. Necessarily, the expert had authority to determine questions of construction. There was no bar to questions of mixed fact or law, or pure questions of law, being determined by an expert: Australian Vintage Ltd v Belvino Investments No 2 Pty Ltd (2015) 90 NSWLR 367; [2015] NSWCA 275 at [76]. The fact that an expert accountant was to be appointed as expert did not militate against the conclusion that the parties were bound by the construction adopted by the Earn Out Expert: Dance with Mr D Ltd v Dirty Dancing Investments Pty Ltd [2009] NSWSC 332 at [81] (Hammerschlag J); Orica Investments Pty Ltd v Aurelius Marvel One Limited [2023] VSC 18 at [89], [92] and [99] (Lyons J).
The purchaser submitted that the parties were not bound by the expert’s interpretation of the earn-out provisions. By the expert determination clause, the parties placed confidence in an independent expert who was to be entrusted with exercising his or her own skill and judgment within their discipline and specialised knowledge to resolve the dispute: Legal & General Life of Australia Ltd v A Hudson Pty Ltd (1985) 1 NSWLR 314 at 336. By agreeing to the appointment of an independent chartered accountant, the parties entrusted the expert to resolve matters of judgement falling within that discipline. It is unlikely that the parties intended to bind themselves to the expert’s determination on the proper construction of the provision, which is a pure question of law and one that falls outside of the expert’s specialised knowledge: J Family Motel Group Pty Ltd v Baset Super Pty Ltd [2024] NSWSC 1251 at [68] (Rees J); Australian Vintage Ltd v Belvino Investments No 2 Pty Ltd (2015) 90 NSWLR 367 at [82] (Bathurst CJ).
Where the parties have entrusted the power of decision to an expert, “the extent of the expert’s jurisdiction depends on the terms of the contract between the parties”: Clive Freedman and James Farrell, Kendall on Expert Determination (5th ed, 2015, Thomson Reuters) at 11.6-1, p 245. The ordinary principles of construction apply.
An expert may have to form a view on the construction of the contract in order to perform their task. In that event, the question is also whether the parties agreed to be bound by the expert’s construction of the contract: Australian Vintage Ltd v Belvino Investments No 2 Pty Ltd [2015] NSWCA 275 at [78], [81]. In that case, the expert had to assess the productivity of a vineyard, having regard to three matters which were “all matters of judgement and were peculiarly within the qualification of the expert”. The expert then had to apply these matters to a formula. The Chief Justice considered that the construction of the formula “was an objective matter outside of the expertise of such a person”: at [84]. Whilst the expert needed to make a decision as to the manner in which the formula operated, it was unlikely that the parties intended to bind themselves to the expert’s determination on that issue; nor did the fact that the decision was said to be final and binding compel a contrary conclusion: [81], [84]-[85].
Similarly in Strike Australia Pty Ltd v Data Base Corporate Pty Ltd [2019] NSWCA 205, a valuer mis-construed the contract, which required the valuer to determine market rent based on comparable premises “in the vicinity of the Premises”. The majority held that the parties were not bound by the valuer’s construction of that phrase, nor by the expert determination, where the valuer included properties which could not properly be considered as being “in the vicinity of the Premises”: at [49] (Basten JA) and [140]-[145] (Ward JA).
Where the provisions of the contract which the expert will have to consider are dominated by accounting concepts, and the expert is an accountant, whether the parties agree to be bound by the expert’s construction of the contract may be less obvious. As Hammerschlag J observed in Dance with Mr D v Dirty Dancing, “Financial or accounting matters will often (if not always) comprehend the proper construction of the agreement, even if it is not in dispute”: at [81].
For example, the dispute in Orica Investments Pty Ltd v Aurelius Marvel One Limited [2023] VSC 18 concerned a share purchase agreement with an earn-out provision and an expert determination clause. Absent agreement, an expert was to be appointed by Resolute Institute. The plaintiff opposed a stay application on the basis that the disputed adjustments to the earn-out figure were too complex. Lyons J disagreed, noting that it was part of the role of the expert to consider the relevant terms of the share purchase agreement and form views on construction for the purposes of reaching their determination: at [89]. Having regard to the disagreements which had already emerged between the parties, as articulated in the pleadings, most of the disputed adjustments related to accounting principles. Lyons J considered that an accountant would be well able to deal with such matters. At [91]-[93]:
91 In my view, these are the kinds of decisions that expert accountants often make in advising their clients or in reaching expert determinations. There is nothing unusual or out of the ordinary about such decisions so as to make those issues too complex or inapt for determination by such an expert.
92 As to any issues relating to the applicability of the relevant provisions of the [Share Purchase Agreement], I note the relevant definitions relied upon including Debt and Tax involve consideration of common types of financial facilities. I reiterate that these are the kinds of issues that expert accountants often determine in advising their clients or in reaching expert determinations. In this regard, I would adopt the comments of Hammerschlag J in Dance With Mr D …
93 For completeness, while in my view it may be preferable to obtain an accountant with legal qualifications to be the Expert under the [Expert Determination Procedure] in this case, I do not consider it necessary that the Expert has such qualifications.
By contrast, it has also been said that an accountant’s training lies in completely different areas than the questions of construction and legal principle: Strategic Publishing Group Pty Ltd v John Fairfax Publications Pty Ltd [2003] NSWSC 1134 at [16] (Einstein J). The fact that, by the jurisdiction clause, the parties expressly contemplated litigation in this Court is a key contextual indicator that they did not contemplate that all disputes would come before the independent accountant: Strategic Publishing at [21]. I note that the Share Purchase Agreement and the Variation Deed contained such clauses.
I have already outlined the features of the expert determination clause, which bear a strong resemblance to those described by Almond J in Funtastic Ltd v Madman Film and Media Pty Ltd [2016] VSC 708 at [54]:
“… the Independent Accountant was appointed as an expert, not an arbitrator, in order to provide an expeditious and cost-effective means of resolving disagreements with respect to the draft Completion Accounts. For this confined purpose, the parties eschewed the more formal rules and procedures of arbitration or curial process. Instead, they agreed to rely on the expertise and skill of the Independent Accountant, a highly experienced person in the field. The parties granted to the Independent Accountant a wide discretion to decide matters of procedure for determination of the draft Completion Accounts and were required to give all reasonable assistance requested by the Independent Accountant. The [Share Sale Agreement] contained a tight timetable for the provision of submissions and preparation of the Independent Accountant's report. The parties were required to instruct the Independent Accountant to make a decision on the disagreement as soon as practicable after receiving any submissions from the parties. It is evident that there was an emphasis on expedition and prompt resolution of disagreements regarding the draft Completion Accounts.”
Unlike the expert determination clauses in Dance with Mr D v Dirty Dancing and Orica v Aurelius Marvel One, cl 10 of the Share Sale Agreement specifies the qualifications of the expert, being “an independent chartered accountant with over ten years’ experience in the relevant area”: cl 10.10(c). The clause did not permit the parties to choose an expert with, say, legal experience. The parties had similarly specified the qualifications of the experts in two other expert determination clauses, being (for cl 9) an accountant with at least 15 years’ experience and currently practising at a top-tier accounting firm and (for cl 17) an expert with over 10 years’ experience in tax. The fact that the parties chose experts with different and quite particular qualifications for each expert determination clause points to the fact that the parties turned their mind to the type of problems which might require resolution under these clauses and selected a person with the qualifications necessary to efficaciously determine such disputes.
The parties apprehended that the Disputed Matters in respect of Additional Payments could be most efficaciously determined by an accountant. That is hardly surprising when one recalls that the parties’ agreement on the qualifications of the expert was recorded in the Share Sale Agreement as executed in July 2020, when the means by which any Additional Payment was to be determined were far simpler: see [29]. As cl 10.3 then stood, the task of determining the amount of the relevant Additional Payment was simply identifying, by reference to the amount of the EBIT, which multiple should be applied, before deducting the purchase price already paid and any Additional Payment made at the end of the first Earn Out Period. The only input of any complexity in the formula was EBIT, which was defined in clause 10.14:
EBIT means the verified underlying earnings before interest and tax of the Business earned in the ordinary course of business (as calculated pursuant to this clause 10 and Schedule 4).
Determining EBIT was something for which an accountant was uniquely qualified and a lawyer was not. An accountant was also uniquely qualified to analyse the Earn Out Accounts from which EBIT was derived. Those accounts were to be prepared in accordance with a waterfall of accounting principles and policies in cl 10.7 and Schedule 4, Schedule 5 and Accounting Standards then in force: cl 10.6. Should the expert, perchance, apply the wrong multiplier, or omit to deduct the purchase price already paid or any Additional Payment made at the end of the first Earn Out Period, such mathematical errors would readily qualify as a ‘manifest error’.
The expert determination clause contained a further protection for the parties, referring the matter for resolution to “an independent chartered accountant with over ten years’ experience in the relevant area”: cl 10.10(c). The “relevant area” was pin-pointed by the Disputed Matters, such matters having been identified before the expert was chosen. That is, depending on what the Disputed Matters were, the parties could focus on a chartered accountant with particular expertise in that area.
The earn-out formula in cl 10.3 became much more complex as a consequence of the Variation Deed, such that construing that clause may well be beyond the ability of an accountant. But the qualifications of the expert were not re-visited in the Variation Deed.
I conclude that the parties agreed to be bound by the chartered accountant’s determination of the amount of the Additional Payment, including to the extent that this required the accountant to consider and interpret how the earn-out clause worked. Whilst that interpretation may not be of the same quality as that given by a lawyer, it would serve its purpose in a time-limited regime designed to give a quick result. The ‘carve out’ for “manifest error” was considered enough to protect the parties if the accountant got the construction obviously wrong. It was not thought necessary to alter this arrangement when the Variation Deed was executed nearly two years later. It follows that the parties are bound by the expert’s construction of the earn-out formula, absent manifest error.
The next step in the expert determination process was for the purchaser to provide its submissions, which it did on 4 August 2023. For the first time, the purchaser now raised the issue which is the central focus of these proceedings. The vendor was said to have wrongly combined the EBIT and the Annualised Agreed Profit and multiplied the aggregate amount by 4. That calculation was said to be contrary to cl 10.3.
The accompanying profit and loss statement for the Company was also substantially changed. No longer was the profit and loss statement compartmentalised into ‘normalised’ EBIT and annualised profit for qualifying managed services deals. The income and expenses were consolidated. Nor was the 4 times multiple applied to the annualised profit for managed services deals. The purchaser now contended that the correct EBIT was $494,147.82.
That the application of the earn-out formula was an issue was news to Mr Mulcahy and Mr Snell. This is a convenient juncture to consider the second issue, being whether the purchaser could belatedly raise this issue.
The vendor contended that the purchaser could not now raise the proper application of the earn-out formula. The purchaser did not dispute the method of calculation in its Earn Out Dispute Notice. The purchaser was deemed to have accepted this method and was barred from disputing it. The proper application of the earn-out formula was not a “Disputed Matter” for the purpose of the Share Sale Agreement.
The vendor submitted that the Share Sale Agreement did not provide a mechanism for taking a “non-Disputed Matter” into account in determining the amount of the Additional Payment. As such, the mechanism under the Share Sale Agreement for determination of the amount of the Additional Payment must be determined without reference to any “non-Disputed matter”. That outcome was said to be consistent with the structure of the Share Sale Agreement, which provided for an expeditious and efficient resolution of disputes. That would be defeated if the parties could raise new disputes on a ‘rolling basis’ outside of the framework of the contractual notices contained in the Share Sale Agreement. A term of a contract which imposes a limitation in respect of a contractual claim will ordinarily be enforceable according to its terms: Port Jackson Stevedoring Pty Ltd v Salmond & Spraggon (Aust) Pty Ltd (1977) 139 CLR 231 at 238-239 (Barwick CJ); Santos Coffee Company Pty Ltd v Direct Freight Express Pty Ltd [2010] NSWCA 14 at [17].
The purchaser submitted that there was no basis for this contention in the Share Sale Agreement. The process required the vendor to identify error in the relevant accounts. It did not require the purchaser to then identify further error. Further, the expert was required to do more than determine the “Disputed Matters”. The expert was required to determine the amount of the “Additional Payment”, which required the expert to apply the formula in cl 10.3 in accordance with the Share Sale Agreement: cl 10.11(b)(iii). That obligation was not altered by the content of the earlier notices.
Further, the purchaser submitted that, in the terms of engagement executed by the expert and the parties, it was agreed that the expert was “to determine all matters in issue between [them] that are relevant to the determination of the amount of the Additional Payment”. That was a permissible course for the parties to take, as cl 10.11(b) of the Share Sale Agreement simply identified the minimum content of what the expert was to be instructed to do. It did not fetter the parties’ ability to later agree between themselves that the expert was to resolve any other matters in issue between them that might have emerged subsequent to the Earn Out Dispute Notice.
The purchaser did not identify the proper application of the earn-out formula in its Earn Out Dispute Notice and, thus, it was not a Disputed Matter within the meaning of cl 10.10(a). Nor was it a subject on which the parties endeavoured to resolve their differences within 10 Business Days of delivery of the Earn Out Dispute Notice. It was not a Disputed Matter which the parties would refer for resolution to the Earn Out Expert under cl 10.11(b). That sub-clause provided that the Earn Out Expert “will be instructed to …decide the Disputed Matters” within a confined timeframe. The output of that task was twofold: to determine the amount of the Additional Payment; and, to determine whether the purchaser had a reasonable basis for disputing the Earn Out Notice with respect to the Disputed Matters. The boundaries for the expert’s time-constrained task were marked by the Disputed Matters.
I agree with the vendor that, whilst the expert was tasked with determining the Additional Payment, that was to be understood and determined in light of the Disputed Matters which had been notified. But it remains the case that the expert was tasked with determining the amount of the Additional Payment. That required the expert to have regard to the provisions of the Share Sale Agreement which provided how that amount must be determined, being cl 10 as varied. As such, it makes no difference in the result, as the expert had to consider the earn-out provisions in any event.
Further, like any contract, an agreement to resolve a dispute by expert determination may be varied. After a protracted period of negotiation, the parties agreed, in their letter appointing the expert, that “Notwithstanding anything to the contrary in this agreement … the Expert is to determine all matters in issue between the Parties that are relevant to the determination of the amount of the Additional Payment”. (As earlier mentioned, this portion of the agreement repeated Ball J’s judgment.) The proper construction of the earn-out clause was a matter in issue between the parties that was relevant to the determination of the amount of the Additional Payment. I conclude that the parties varied their agreement to resolve disputes by expert determination, and entrusted this issue to the expert, notwithstanding that it was not a Disputed Matter within the meaning of cl 10.10(a)(i).
On 18 August 2023, the vendor provided its submissions. On 25 August 2023, the purchaser provided submissions in reply. On 2 September 2023, Mr Croft sought further information. On 8 September 2023, the vendor provided the information sought by Mr Croft. On 10 September 2023, the purchaser did likewise, protesting Mr Croft’s refusal to adjust the timetable for the information to be provided. On 15 September 2023, and in light of the purchaser’s complaint, Mr Croft circulated an interim decision, declining to extend the expert determination process. The purchaser issued a termination notice to Mr Croft. Mr Croft responded that the notice was invalid.
On 22 September 2023, the expert issued his determination, concluding that the amount of the second Additional Payment was $9,663,200 and that the purchaser did not have a reasonable basis for disputing the Earn Out Notice. Of most significance, in terms of monetary value, the expert agreed with the vendor as to how the earn-out formula operated.
Of the expert’s determination of 16 Disputed Matters, the purchaser says five contain manifest errors. Before turning to the suggested errors, it is necessary to consider what is meant by ‘manifest error’.
The precise meaning of manifest error depends on the particular contract and the context in which it is used: Sara & Hossein Asset Holdings Ltd v Blacks Outdoor Retail Ltd [2023] 1 WLR 575; [2023] UKSC 2 at [30]. “Manifest error” has been construed in commercial contracts as “plain and obvious” or “clear and obvious” or “obvious or easily demonstrable without extensive investigations”: Galaxy Energy International Ltd v Eurobunker SpA [2001] 2 All ER (Comm) 912 at [16] (Thomas J); Funtastic Ltd v Madman Film and Media Pty Ltd [2016] VSC 708 at [54] (Almond J); IIG Capital LLC v Van Der Merwe [2008] 1 All ER (Comm) 435 at [52] (Lewison J).
“Manifest error” has been described as “apparent on the face of the [expert] determination and reasons” (TX Australia Pty Ltd v Broadcast Australia Pty Ltd [2012] NSWSC 4 at [20] (Brereton J)), or an oversight or blunder so obvious as to admit no difference of opinion, or a conclusion “obviously wrong” and “apparent to the judge upon a mere perusal of the [arbitral] award itself without the benefit of adversarial argument”: 711 Hogben Pty Ltd v Tadros; Tadros v 711 Hogben Pty Ltd [2016] NSWSC 697 at [50] (Stevenson J). In sum, a ‘manifest error’ is “indeed narrow. An arguable error will not suffice, however well founded the allegation of error may ultimately prove to be”: Sara & Hossein v Blacks at [34].
In Bagata Pty Ltd v Sunstorm Pty Ltd [2024] QCA 17, Martin SJA (Morrison JA and Williams J agreeing) held that a suggested error of law must also be manifest. The analysis of the primary judge, Applegarth J, was upheld being (at [28] of the Court of Appeal’s judgment):
If it be the case that certain questions of law, such as the proper construction of a contract, can only produce one right answer, this does not circumvent the requirement for a “manifest error”. The error in answering the question of law must be apparent or obvious from a reading of the reasons. I respectfully adopt what was said in Flowgroup plc v Co-Operative Energy Ltd [2021] EWHC 344 at [32]:
If, pursuant to the contract, the expert is engaged … to make determinations on matters of contractual interpretation, I see no reason why a challenge should not have to circumvent the manifest error test as I have enunciated it.
The purchaser submitted that Bagata v Sunstorm did not reflect the law of this State, which was said to be addressed in Australian Vintage v Belvino and Strike Australia. However, ‘manifest error’ was not addressed in those judgments. I am obliged to follow the Queensland Court of Appeal unless I conclude that their Honours were plainly wrong: Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 177 CLR 485; [1993] HCA 15 at 492; Farah Constructions Pty Ltd v SayDee Pty Ltd (2007) 230 CLR 89; [2007] HCA 22 at [135]. I hold no such view. I also note that the decision relied upon by Applegarth J, being Flowgroup plc v Co-Operative Energy Ltd, was recently cited with apparent approval by the Supreme Court of the United Kingdom in Sara & Hossein v Blacks at [32].
In sum, the parties agreed that, absent manifest error, they were bound by the expert determination. Thus, in examining each of the following suggested errors, I am looking for a ‘manifest error’ and nothing less. The fact that the expert may have taken something into account which perhaps he should not, or made a mistake or was negligent does not necessarily qualify, assuming, of course, that the expert made his determination in accordance with the terms of the contract: Legal & General Life of Australia Ltd v A Hudson Pty Ltd (1985) 1 NSWLR 314 at 335-336 (McHugh JA); Holt v Cox (1997) 23 ACSR 590 at 597 (Mason P); Kanivah Holdings Pty Ltd v Holdsworth Properties Pty Ltd [2002] NSWCA 180 at [74] (Giles JA); Australian Vintage v Belvino at [74] (Bathurst CJ).
(i) As set out in its engagement plan, the auditor designed and conducted review procedures on the methodology for calculating the Second Additional Payment as prepared by TAS management, to ensure it was in line with the [Share Sale Agreement] and [Variation Deed]. The auditor’s report did not disclose any negative assurance or adverse findings on that methodology;
(ii) Annualised Agreed Profit is an EBIT balance by reference to cl.10.3(d)(i) of the [Variation Deed], wherein it is defined to mean “the aggregate profit from Qualifying Managed Services Agreements, such annualised EBIT*…*” (my emphasis) . While I accept TAS’s view (at TAS_RS 28) that a strict application of 10.3(d)(i) might cause the multiplier to double, that concern is hypothetical and incongruent with how the Second Additional Payment was actually calculated (as set out in the Dispute Notice); and
(iii) The commercial objective of inserting an earn out into a share sale agreement would not be achieved if the multiple was not applied to the sum of EBIT and Annualised Agreed Profit. In my experience in providing financial due diligence services to businesses selling or acquiring businesses, which included designing and reviewing earn out provisions in sale agreements, one of the primary objectives of an earn out provision is to bridge the selling price expectations gap between the purchaser and vendor, such that:
a) The vendor commits to paying a higher consideration contingent on the underlying business achieving agreed performance criteria; and
b) The vendor accepts the risk of receiving a lower upfront consideration should the underlying business not achieve the agreed performance criteria.
In my view, that objective, presumably being the “objective commercial outcome” referred to in EG_RS 47(e), would not be achieved on TAS’s approach as it would not compensate Expert Group for the risk it assumed where the Company achieves the agreed performance criteria.
The purchaser submitted that, contrary to the plain language of clause 10.3(a), the expert read EBIT as “EBIT plus Annualised Agreed Profit”. The language admitted of no constructional choice that might justify reading the words “plus Annualised Agreed Profit” into the clause. This was a manifest error within the meaning of cl 10.11(d) as the error was plain on the face of the determination and was “clear and obvious”: Yan v Yangdo Pty Ltd [2024] NSWSC 1250 at [123]-[127].
The purchaser submitted that there was nothing in the legitimately relevant surrounding circumstances which might alter that conclusion: Mainteck Services Pty Ltd v Stein Heurtey SA (2014) 89 NSWLR 633; [2014] NSWCA 184 at [74]. Where the context suggested that the purpose of amending the clause was to incentivise the Company to secure managed services contract, increasing the base number, as distinct from the multiple, was not the only viable means of delivering the incentive. The vendor would be incentivised to improve the Company’s performance by permitting the addition of Annualised Agreed Profit to the EBIT result when calculating the trigger amount, that is, the amount that determined the applicable multiple. If the hurdles to higher multipliers could be met, the actual EBIT result stood to be increased by 50% (with a 4.5 multiple) or 100% (with a 5 multiple), depending on the level attained. The purchaser submitted that this was an appropriately measured incentive which fairly recognised the Company’s poor financial performance. It was inherently unlikely that the purchaser would agree, in those circumstances, to deliver “the complete windfall” that is now sought by multiplying Annualised Agreed Profit by 4.
Further, the purchaser submitted that the expert’s construction gave rise to double counting. The definition of ‘EBIT’ included no carve out for revenue which might have been derived from a ‘Qualifying Managed Services Agreement’. The revenue that the Company earned from managed services during the second Earn Out Period fell with the scope of EBIT. Nor did Annualised Agreed Profit carve out revenue already accounted for under the definition of EBIT.
The vendor submitted that cl 10 was ambiguous, given the introductory words of cl 10.1(a) refer to the vendor being entitled to receive Additional Payments “based on the EBIT plus… the Annualised Agreed Profit”. That language introduced a constructional choice, being whether the Additional Payment was calculated by reference to EBIT plus Annualised Agreed Profit or whether the Additional Payment is calculated by reference to EBIT only (with Annualised Agreed Profit being limited to determining the multiplier). The language of cl 10 as a whole made clear that the Annualised Agreed Profit was to be calculated by applying the multiplier to the sum of “EBIT” and “Annualised Agreed Profit”. “Annualised Agreed Profit” was, itself, an annualised EBIT figure, noting that the definition of “Annualised Agreed Profit” referred to “annualised EBIT”, “EBIT value” and “actual EBIT”. Any inconsistency in the use of the terms Annualised Agreement Profit and EBIT in clause 10 was readily resolved by adopting the construction adopted by the Earn Out Expert. Nor was there an issue of “double-counting”. The managed services agreements were included in the purchaser’s accounts to avoid this possibility and were not included in the Earn Out Accounts. The purchaser only put these figures back into the calculations when making its submissions to the expert.
Beyond the parties’ submissions, the expert had some information as to commercial context. The vendor’s submissions had attached a statutory declaration by Mr Mulcahy, in which he described his dealings with Mr Baker, which led to the Variation Deed. Mr Mulcahy said the variation was designed to incentivise the Company to pursue managed services deals. Mr Mulcahy said the concept was that, in addition to EBIT, any Additional Payment would include an annualised profit amount from certain qualifying managed services contracts won during the Earn Out Period. Mr Greene’s email of 25 November 2021 was attached to the statutory declaration, in which Mr Greene confirmed “All profits make up Experteq EBIT – which includes those contracts that don’t meet the annualised net profit criteria outlined above – as for those that do meet the criteria we apply the annualised formula.”
In response to Mr Mulcahy’s statutory declaration, the purchaser simply submitted that the expert should pay it no regard but should confine himself to the clear and unambiguous language of cl 10.3. The purchaser admitted that it had made a mistake by combining the Annualised Agreed Profit to EBIT. But the vendor was not entitled to take advantage of this mistake. It was said to “beggar belief” that the vendor maintained the incorrect formula in the face of the clear and unambiguous language of the clause and also claimed that there was a mutual understanding between the parties contrary to the terms of that clause.
The expert determined that the formula in cl 10.3(a) to (c) worked as follows:
Second Additional Payment = ([EBIT + Annualised Agreed Profit] x 4) - $2M
The expert gave four reasons: first, the purchaser’s management had calculated the payment in this manner, and the auditors took no issue with it. Second, such a construction achieved the objective commercial purpose of such clauses. Third, Annualised Agreed Profit was an EBIT figure in any event. Fourth, the parties had implemented accounting procedures to prevent the double-counting which may otherwise result from including Annualised Agreed Profit in EBIT. A lawyer may not have taken all of these matters into account, but the parties did not give this task to a lawyer.
As to the commercial context of the Variation Deed, the expert had less far information to hand that is now before the Court. He had Mr Mulcahy’s statutory declaration. He was also aware that purchaser did not dispute the description given by Mr Mulcahy, but simply said that it was irrelevant.
As to the contract itself, it is certainly the case that cl 10.1(a) suggested that the Additional Payment would be the sum of two things: “the EBIT plus, if specified below, the Annualised Agreed Profit”. Where the bulk of the amendments to the Share Sale Agreement, by the Variation Deed, concerned the criteria of the managed services agreements which qualified for inclusion in Annualised Agreed Profit, and how that figure would be calculated, the reference to “if specified below” may be read as picking up those detailed requirements. If the managed services agreement so qualified, then the vendor could expect to receive an Additional Payment based on EBIT plus the Annualised Agreed Profit from those agreements.
As earlier set out, EBIT was the earnings before interest and tax of the Business, meaning the business of the Company. Annualised Agreed Profit meant the aggregate annualised profit from Qualifying Managed Services Agreements, “such annualised EBIT to be calculated” by the purchaser by reference to the worksheets annexed to the Variation Deed to “deliver an EBIT value which will be annualised using the standard calculation of actual EBIT/number of recurring revenue*365”: cl 10.3(d), reproduced in full at [75].
I agree that, read literally, cl 10.3(a) to (c) has the effect that the sum of EBIT and Annualised Agreed Profit is used to identify the correct multiple only. The multiplier is not applied to the sum of EBIT and Annualised Agreed Profit but to EBIT alone. Clause 10.1(a) can be read consistently with the literal meaning of cl 10.3(a) to (c), where the Additional Payments were “Subject to … cl 10” and “based on” EBIT plus Annualised Agreed Profit.
As so read, sub-cls 10.3(a) to (c) still provided an incentive to the Company, as winning managed services contracts increased the possibility that a higher multiplier would be applied to EBIT, when calculating the Second Additional Payment. The expert obviously did not think much of the incentive thereby created, having regard to earn-out clauses used more widely. But the clause still works textually and, in theory at least, provided an incentive for the Company to pursue managed services contracts in the second Earn Out Period.
I have determined that EBIT should not include the TAS Group CEO and CFO costs of $803,207 for the following reasons:
(i) Cl.10.7(c) states “EBIT will be adjusted to include an expense comprising a full year of remuneration (including superannuation) of the CEO and CFO as a separate adjustment”. It does not state that the CEO/CFO costs are to be adjusted for the TAS Group CEO/CFO costs;
(ii) On the basis of TAS’s reasoning for including the TAS Group CEO/CFO costs, from an accounting perspective the adjustment is in fact an allocation of the TAS Group CEO/CFO costs as the Company did not actually incur those costs. As an allocation, it is subject to principle 4 of Schedule 4 to the SSA, which permits an allocation of shared services where the allocation methodology has been agreed between the Parties. TAS has not provided any documents that the allocation methodology (being a 100% allocation) was agreed between the Parties. Principle 4 of Schedule 4 to the SSA cannot be applied without agreement between the Parties;
(iii) In my view as an accountant, any adjustment to the Company’s P&L for the TAS Group CEO/CFO costs should be also mirrored in TAS’s FY22 audited consolidated financial statements to ensure compliance with Australian Accounting Standards, for accounting consistency and to avoid any possible material misstatement in the consolidated financial statements. TAS has not provided a copy of its audited consolidated financial statements for the year ended 30 June 2022. There is no sufficient accounting evidence confirming that the proposed CEO/CFO adjustment to EBIT is replicated and reported correctly under Australian Accounting Standards in TAS’s audited FY22 consolidated financial statements.
The purchaser contended that EBIT was to be calculated in accordance with cls 10.6(a), 10.7 and Schedule 4 of the Share Sale Agreement, and to include a full year of remuneration of the Chief Executive Officer and Chief Financial Officer. Those officers were of the purchaser and their combined remuneration totalled $803,207. Their wages should have been included, but were not, and this was a further manifest error.
The purchaser noted that there was an error in cl 10.7(b). Schedule 4 had a section headed ‘Operating Expenses’ with the line item ‘CFO’. That item was marked with a ‘Y’ under the column heading ‘Include’, indicating that the expense was to be included within the Reference P&L as an expense item in the calculation of EBIT. As a matter of construction, the specific treatment in cl 10.7(c) of the expenses associated with the remuneration of the Chief Executive Officer and Chief Financial Officer took precedence over the more general treatment of the various income and expense items set out in the Reference P&L, made applicable by cl 10.7(b): Chapmans Ltd v Australian Stock Exchange Ltd (1996) 67 FCR 402; [1996] FCA 474 at 411 (Lockhart and Hill JJ); LCA Marrickville Pty Ltd v Swiss Re International SE (2022) 290 FCR 435; [2022] FCAFC 17 at [59]. Were the position otherwise, the reference to ‘Chief Financial Officer’ in 10.7(c) would be redundant, as the cost would have already been dealt with under cl 10.7(b). That difficulty was avoided by resolving the conflict, such as it was, between apparently inconsistent provisions on the basis that cl 10.7(c) qualified cl 10.7(b), thus ensuring that both have meaning and effect: Greencapital Aust Pty Ltd v Pasminco Cockle Creek Smelter Pty Ltd [2019] NSWCA 53 at [52].
The purchaser further submitted that the mandate in cl 10.7(b) to exclude certain items did not catch the CFO line item because the mandate applied only to items appearing under the heading ‘Excluded’ in the Reference P&L. There was no such heading in the Reference P&L. As the CFO line item appeared under the heading ‘Include’ in the Reference P&L, it sat outside the mandate of cl 10.7(b) and did not fall to be excluded from the calculation of EBIT. Given the direction in the chapeau to cl 10.7 as to the order of precedence, cl 10.7(c) then applied. Alternatively, cl 10.7(b) was to be read as if “Excludes” reads “Includes” and “Y” reads “N”. The Reference P&L still had work to do as it provided the template for the Earn Out Accounts: cl 10.8.
The vendor submitted that the Earn Out Expert’s approach to the allocation of the CEO/CFO costs was not a manifest error. The Earn Out Expert was correct to recognise that cl 10.7(c) does not refer to an adjustment for the entire remuneration of the purchaser’s CEO or CFO. There was no basis in the language of the clause to infer an intention to make such an allocation or adjustment, where cl 10 was otherwise dealing with expenses of the Company. Further, following completion, Mr Mulcahy performed the role of “CEO” notwithstanding that his role was titled “General Manager” to avoid confusion with Mr Baker. Where Mr Mulcahy’s salary was already included as an expense in the Earn Out Accounts, there was no objective basis to construe the clause as requiring a further adjustment. Finally, there was no agreement between the parties as to the amount of any allocation of any costs of the purchaser’s CEO/CFO, and any adjustment or allocation as unilaterally proposed by the purchaser would possibly be inconsistent with Australian Accounting Standards and involve material misstatements in the purchaser’s financial statements.
In addition to the parties’ submissions, the expert was provided with Mr Mulcahy’s statutory declaration, which described in some detail how his title was changed when the Company was acquired by the purchaser, as earlier described: see [25].
As to the contract, it will be recalled that Earn-Out Accounts were the audited accounts for the Business for the relevant Earn Out Period (cl 10.4(a)), where Business was defined as follows “the business of the Company …”. Clause 10.6 obliged the purchaser to prepare the Earn Out Accounts “for the Business” in accordance with accounting principles and policies prescribed in clause 10.7 and Schedule 4, Schedule 5 and Accounting Standards. (Nothing in Schedule 5 is obviously relevant to the second suggested manifest error.)
Clause 10.7 provided: (emphasis added)
10.7 Specific principles and policies
In preparing the accounts for the Business, the following principles and policies and processes must be followed in the following order:
(a) must reflect any adjustments highlighted by the auditor and documented in the auditor's report;
(b) EBIT will be calculated based on the Reference P&L line items but must exclude the line items which, in the Reference P&L, are denoted as 'Y' under the heading 'Excluded' and any Once-off Revenues and Once-off Expenses; and
(c) EBIT will be adjusted to include an expense comprising a full year of remuneration (including superannuation) of the Chief Executive Officer and the Chief Financial Officer as a separate adjustment item.
As earlier noted, EBIT meant the earnings before interest and tax of the Business as calculated under cl 10 and Schedule 4. Reference P&L were reference profit and loss statements set out in Schedule 4, as amended in accordance with the principles set out in that Schedule and cl 10: cl 10.14.
Although capitalised, Chief Executive Officer and Chief Financial Officer were not defined. Where cl 10.7 was concerned with “preparing the accounts for the Business”, and EBIT meant the earnings before interest and tax of the Business, being “the business of the Company”, I consider that the ordinary meaning of Chief Executive Officer and Chief Financial Officer is to such officers of the Company.
The required adjustment was to include a full year of the CEO and CFO’s remuneration, not just the expense incurred at the point in time in the accounting year when the Earn-Out Accounts were prepared: cl 10.7(c). The adjustment was to be done after calculating EBIT based on Reference P&L line items, as required by cl 10.7(b). Schedule 4 provided as follows:
Reference P&L
| Allocation principles | Method of allocation | | 1 | Allocated wholly to the category of directly or indirectly generating the revenue or incurring the expense of the Business. (i.e. where the revenue is generated by the Business, it is allocated to EBIT of the Business) | | 2 | Not allocated to the category of directly or indirectly generating the revenue or incurring the expense of the Business. In this instance the revenue or expense is wholly allocated to the EBIT of the Purchaser. | | 3 | For 'Personnel Expenses' as a whole: o The expenses of workers carrying out their duties in the Business are to be allocated to the Business for the duration of the duties carried out at the Business. o The expenses of all other staff are to be will be allocated to the Purchaser. | | 4 | The revenue or expense arises as a result of the use of shared services or leads. In this instance the revenue or expense will allocate to the Business on a transfer pricing basis or agreed allocation basis, being agreed between the Purchaser and Vendor. |
There followed a chart of accounts for profit and loss items. Unlike the description in cl 10.7(b), the Reference P&L did not have a heading ‘Excluded’ but did have a heading, “Include”. For each account, a column indicated whether that account should be included (with a “Y” or “N” opposite the account name) and then a number (for example, 1 or 4) identifying the applicable Allocation principles. Amongst these accounts was “CFO”, which was to be included (“Y”) using Allocation principle 4. That is, this expense arose as a result of the use of shared services and would be allocated to the Business on a transfer pricing basis or agreed allocation basis, as agreed between the vendor and purchaser.
The Share Sale Agreement is replete with errors, including incorrect cross-references and typographical errors. This is not surprising in a lengthy and complex commercial document, which has been the subject of extensive negotiation and substantive amendment. The fact that the headings in the Reference P&L do not correspond with cl 10.7(b) is not fatal. One can give a businesslike interpretation to the table. A portion of the “CFO” operating expense is to be shared with the Business, by transfer pricing or allocation as agreed. This suggests that the “CFO” expense was not that of the Business, but would be shared with the business in the manner stated. I take the “CFO” to be a reference to the purchaser’s CFO. This is not inconsistent with a subsequent adjustment to include an expense comprising a full year of remuneration of the Company’s CEO and CFO. There was no double deduction as the adjustments relate to officers of different companies.
The purchaser’s proposed construction does not work as, having made an allocation of the CFO’s operating expense under cl 10.7(b), it would be odd to make a further adjustment by including a full year’s remuneration for the CFO as well. I do not accept the purchaser’s submission that the more specific treatment in cl 10.7(c) was to take precedence over the more general treatment described in cl 10.7(b), when the chapeau to cl 10.7 mandated the opposite, requiring that the listed accounting principles and policies “must be followed in the following order …”, being (b) then (c). Nor does that produce redundancy, given how I consider that “Chief Financial Officer” should be construed as a reference to the Company’s CFO.
As to whether the expert made a manifest error, the expert identified the obvious difficulty, being that Chief Executive Officer and Chief Financial Officer were not stated to be the purchaser’s CEO and CFO. But even if it was a reference to the purchaser’s CEO and CFO, then the expert considered that the appropriate Allocation principle was No. 4, but there was no evidence that any such allocation basis had been agreed. (If EBIT was to be adjusted under cl 10.7(c), then it is not clear why the Allocation principles in Schedule 4 needed to be applied.) Nor was there any evidence that the purchaser had made the same adjustment in its accounts, in order to ensure accounting consistency. (The relevance of the third reason is not clear to me, but I am not an accountant.)
I have determined that EBIT should not be adjusted to include the bonus expense of $6,000 for the following reasons:
(i) Pursuant to cl.4.11 of Schedule 5 to the SSA, incentive and bonus payments are excluded from EBIT unless the payments are made under a bonus or incentive scheme operated by the Company prior to completion. TAS submits that the discretionary bonuses were paid in line with TAS performance management policies. On the basis of the information provided to me, I am not satisfied that the bonus payments were made under a policy a bonus or incentive scheme operated by the Company prior to completion;
(ii) TAS has not provided information showing that the bonus payments were actually incurred; and
(iii) See comments on Balance Day adjustments at Dispute matter [4](v) above.
TAS submits that a “Balance Day adjustment” was made pursuant to accounting standards and applies the matching principle. The Earn Out Accounts do not include a balance sheet as at 14 August 2022. The TAS Reply Submission does not provide details as to the actual adjustment made (journal posted). From the information provided, it is not possible to determine whether the Balance Day adjustment relates to the TAS Group consolidated balance sheet or the Company balance sheet.
The purchaser submitted that by Schedule 4, “Wage Entitlements” and “Wages and Salaries” were costs to be brought to account in preparing the Earn Out Accounts. The employee bonuses should have been included in those amounts. Further, the purchaser contended that the Earn Out Accounts were to be prepared in accordance with accounting principles: Schedule 5, Share Sale Agreement. The Company operated a bonus or incentive scheme, under which it made bonus payments of $6,000 to employees, being Fahad Memon and Svend Petersen. Their contracts were entered into prior to Completion and continued during the second Earn Out Period. The expert was said to have erred by omitting to adjust the EBIT component of the second Additional Payment by including the bonus payments as an expense. Alternatively, the expert erred in concluding that there was no bonus or incentive scheme in operation.
The purchaser submitted that reference to Schedule 5 gave rise to infelicities, where Schedule 5 was concerned with the accounts for completion purposes, rather than for the calculation of the earn out payments, some 12 or 24 months later in time. There were two constructions available, neither of which was adopted by the expert. First, Schedule 5 cl 4.11 meant what it said and was directed to provisions and accruals. Recognising a cost actually incurred or paid, such as a bonus, was neither a provision nor an accrual. Second, in order to ensure that clause 10.6(b) was given work to do, the language in Schedule 5 ought be construed in such a way as to make sense, being:
4.11 Bonus and other incentive schemes
No provision or accrual shall be included in the [Earn Out] Accounts in respect of any bonus or incentive scheme except where that scheme was introduced by the Company prior to [the end of the second Earn Out Period]. Bonus or incentive accruals in respect of scheme periods which bridge [14 August 2022] will be calculated on a pro-rata basis, based on the actual performance against the bonus target up to [14 August 2022]. The Vendor will not be liable for, and the [Earn Out] Accounts shall not reflect, any increased pro-rated amounts resulting from improved performance after [14 August 2022].
The purchaser confirmed in its submission to the expert that the amounts were allocated as an expense in accordance with AASB 101. The bonus payments were not included by the expert in his calculation of EBIT as the expert did not adopt the construction of clause 4.11 of Schedule 5 for which the purchaser contended, nor account for those payments as “Wage Entitlements” and “Wages and Salaries” within the Reference P&L in Schedule 4. The expert’s determination miscarried as a result of his mis-construction and was liable to be set aside.
The vendor submitted that any bonus payments were made pursuant to a bonus scheme operated by the purchaser, being a bonus scheme introduced after Completion. Nor did the purchaser provide any evidence to the expert that the bonus payments were incurred by the Company. The expert determined the issue given the terms of the Share Sale Agreement, the absence of any evidence that the bonus payments were made under a policy or scheme in place prior to Completion and the absence of any evidence that the bonus payments were in fact incurred. There was no manifest error.
The vendor submitted that the purchaser now advanced a different construction to that contended for before the expert, being that item 4.11 operated in respect of schemes introduced prior to the end of the Earn Out Period, rather than prior to completion. The contention that the Earn Out Expert made a manifest error by failing to construe the contract in a manner that was not identified at the time cannot be accepted. In any event, the Earn Out Expert determined that the purchaser failed to provide information that the bonus payments were in fact incurred. There is no error suggested in that determination.
While due diligence was underway, the Company entered into contracts of employment with service desk technician, Mr Memon, and service desk team leader, Mr Petersen. Clause 17 of both contracts provided that the Company may elect to pay a discretionary payment to the employee, such as an incentive-based payment upon various considerations, including the profitability and future forecasts of the business and the employee’s performance. These employment contracts appear to have been made available to the expert in a Zip file.
Come the Share Sale Agreement, Schedule 4 provided that Superannuation, Wage Entitlements, Workers Compensation and Wages & Salaries were to be included using Allocation principle 1. That is, these expenses were allocated wholly to the EBIT of the Business.
The purchaser submitted to the expert that bonus payments to these employees “were authorised by the TAS executive based on the performance management policies TAS employs across both business units (TAS and Experteq) and such decisions do not require the authorisation of any other person.” The purchaser also submitted that the two employees “were awarded bonus payments based on TAS discretionary bonus program”. The bonus payments were said to be awarded “as part of our discretionary bonus scheme”.
In response, the vendor submitted to the expert that para 4.11 of Schedule 5 precluded bonuses paid under a scheme introduced by the purchaser after Completion. Further, despite request, the purchaser had not provided any material to prove that the bonuses had, in fact, been paid. The general ledgers provided insufficient detail and did not assist.
Schedule 5 was to be taken into account when preparing the Earn Out Accounts: cl 10.6(b). Schedule 5 concerned the preparation of “Completion Accounts”, being the accounts of the Company as at Completion. Obviously enough, using Schedule 5 when preparing the Earn Out Period accounts – two years after Completion – was not going to be a perfect fit. But it is the accounting policies used for the preparation of the Completion Accounts which are taken up by cl 10.6(b) and, thus, the mis-matched specifics can be put to one side. Para 4.11 of Schedule 5 was considered by the expert to be relevant, and stated:
4.11 Bonus and other incentive schemes
No provision or accrual shall be included in the Completion Accounts in respect of any bonus or incentive scheme except where that scheme was introduced by the Company prior to Completion. Bonus or incentive accruals in respect of scheme periods which bridge the Completion Date will be calculated on a pro-rata basis, based on the actual performance against the bonus target up to the Completion Date. The Vendor will not be liable for, and the Completion Accounts shall not reflect, any increased pro-rated amounts resulting from improved performance after the Completion Date.
Para 4.11 is concerned with balance sheet items, including provisions and accruals. The Earn-Out Accounts contain profit and loss items. Provisions and accruals become profit and loss items in subsequent accounting periods, as revenue and expenses are recognised. What the expert appears to have taken from para 4.11 of Schedule 5 is that bonuses and incentives paid under schemes introduced by the Company are to be taken into account when calculating EBIT, but the Company should not have its EBIT reduced by bonuses or incentive schemes put in place by the purchaser.
Where the expert had accounting expertise, it was for him to consider how the accounting principles in Schedule 5 – to which he was required to have regard – should affect his determination of the Disputed Matters. I struggle to see why it was a manifest error. It makes sense that the Company’s EBIT should not be reduced in the Earn Out Periods if, say, the purchaser introduced new bonus schemes after Completion and reduced EBIT by giving large bonuses to employees during those periods. This would be an easy way to avoid an Additional Payment.
The extensive amendments to para 4.11 proposed by the purchaser strain the principles of correction by construction. I do not accept that those corrections obviously follow or that para 4.11 as amended is clearly what the parties intended: Zhong v Guan [2024] NSWCA 215 at [38] per Kirk JA.
I accept that the contracts of employment, entered into before Completion, made provision for a bonus. But the purchaser stated in its submissions that the bonus was awarded under the purchaser’s bonus program. Applying the accounting principle in para 4.11, it was not obviously wrong for the expert to exclude those bonuses from the EBIT calculation. Further, the expert was not provided with sufficient documentation to be satisfied that the bonuses had, in fact, been paid. In the circumstances, I am not satisfied that this determination was a “manifest error”.
I have determined that EBIT should not be adjusted to include the STI Program FY23 accruals of $35,800 for the following reasons:
(i) Pursuant to cl.4.11 of Schedule 5 to the SSA, incentive and bonus payments are excluded from EBIT unless the accruals are made under a bonus or incentive scheme operated by the Company prior to completion. TAS submits that the accruals were made in accordance with normal accounting policies and practices. On the basis of the information provided to me, I am not satisfied that the STI Program FY23 accruals were made under a policy a bonus or incentive scheme operated by the Company prior to completion;
(ii) TAS has not provided details as to the assumptions, methodology and criteria adopted in the calculation;
(iii) Under Australian Accounting Standards, STI are recognised when the expected cost to arise from a “present legal and constructive obligation…as a result of past events” (paragraph 19 AASB 119 Employee Benefits). TAS has not provided any evidence as to the basis of the accrual calculation, including assumptions made. It is not possible to determine that the STI accrual was made in accordance with which requires
(iv) See comments on Balance Day adjustments at Dispute matter 5(v) above.
As for bonuses, the purchaser contended that the Company operated a bonus or incentive scheme under which it accrued amounts described as STI (short term incentive) Program FY23. This related to the employment of Andrew Smith, David Bourke and David Colvin. These accruals of $35,800 were referable to the business conducted by the Company. The purchaser’s submission to the expert confirmed that the cost of these incentives ($35,800) had been accrued for the FY23 period to the end of the second Earn Out Period. The expert failed to adjust EBIT by including these expense items.
The vendor submitted that the STI Program FY23 was operated by the purchaser and introduced after Completion. The scheme pursuant to which these bonus payments were accrued was said to be "the group's remuneration policy". This was not a scheme introduced by the Company. The expert's determination of this issue was based on the terms of the Share Sale Agreement (being a similar analysis as for the third suggested error) and the absence of any details as to the assumptions, methodology and criteria adopted in the calculation. In addition, the expert referred to the absence of any evidence of the basis of the accrual calculation, including assumptions, from which it would be possible to apply Accounting Standards to the alleged expense. Further, the purchaser did not provide the expert with any evidence that such bonus payments were incurred by the Company. There was no manifest error.
In its submission to the expert, the purchaser submitted that a number of staff on the Company’s payroll were awarded short term incentives (STIs) as a function of their performance reviews and under the terms of the business’ remuneration policy. These expenses had been accrued for the 2023 financial year to the end of the Earn Out Period in accordance with normal accounting practices and policies.
The vendor submitted to the expert that the general ledgers had insufficient detail to determine whether these accruals had, in fact, been recorded. Nor had any evidence been provided to permit an understanding of the basis of the STIs. It was unclear whether the normal accounting policies referred to were those of the Company or the purchaser, or how this complied with relevant Accounting Standard AASB 119. Where the 2023 year had now closed, the actual bonuses paid should be known.
This incentive scheme was introduced shortly after Completion, to encourage key employees to stay with the Company notwithstanding its acquisition by the purchaser: see [26], [33]. As I understand it, the $35,800 was the retention bonus which had been accrued to the end of the second Earn Out Period, but had yet to be paid. Applying the accounting principle in para 4.11 of Schedule 5, the expert did not consider it appropriate to take this accrual into account, where the bonus scheme had been introduced after Completion. Again, where the expert had accounting expertise, it was for him to consider how these principles should affect his determination of the Disputed Matters. His view was not obviously wrong. The expert was also not satisfied as to how the accrual had been calculated and how it accorded with Accounting Standards. That is, the purchaser failed at a level of accounting principle and evidentially. I am not satisfied that either basis was a “manifest error” on the part of the expert.
I have determined that EBIT should not be adjusted to include the Neller commission payment of $52,500 and the additional accrual of $9,500 for the following reasons:
(i) The commission payment would be excluded from EBIT as a once-off expense under 10.7(b) of the SSA;
(ii) Pursuant to cl.4.11 of Schedule 5 to the SSA, incentive and bonus payments are excluded from EBIT unless the accruals are made under a bonus or incentive scheme operated by the Company prior to completion. TAS has not provided evidence that the commission payment was made pursuant to an Expert Group incentive scheme in operation prior to completion;
(iii) TAS does not provide a copy of the relevant incentive plan pursuant to which the Neller commission payment was made. Expert Group submitted a copy of the Experteq Commission Plan template for FY22, which includes the performance criteria required to be satisfied by employees to earn a commission payment. The Neller commission payment was converted to a lumpsum amount in respect of a future 5- year period. I am not satisfied that the Neller commission payment was made in accordance with the performance criteria in the Experteq Commission Plan template for FY22;
(iv) Expert Group submits that there is a further $9,500 Neller commission payment adjustment included in the line item “Wages – Entitlement”. That amount is included as an adjustment by Expert Group in its response to the Earn Out Accounts provided by TAS on 27 October 2022. TAS has not provided any information in its submissions as to the nature of that payment. Absent any supporting documentation, I consider it reasonable to adjust EBIT to exclude the additional $9,500 payment to Mr Neller; and
(v) See comments on Balance Day adjustments at Dispute matter 5(v) above.
The purchaser contended that, during the second Earn Out Period, the Company operated a bonus or incentive scheme described as Experteq IT Services Sales Staff Commission Plan, which was availed of by an employee named Mark Neller. The Company was entitled to review this plan at the end of the financial year and adjust commissions. Such an adjustment was made in respect of Mr Neller in the amount of $52,500 and was referable to the business conducted by the Company. The purchaser’s submission to the expert confirmed that the expense was allocated to the profit and loss account for the FY23 period to the end of the second earn out period.
The purchaser submitted that this was not a ‘once off expense’ under cl 10.7(b) of the Share Sale Agreement, as it was a payment made under a bonus or incentive scheme which contemplated the making of bonus payments from time to time. The expense was matched to revenue included in EBIT referable to NSW Crime Commission becoming a customer of the Company. The expert should have adjusted EBIT by including an expense item in respect of Mr Neller’s commission payment. Failure to do so constituted a manifest error.
The vendor denied this and said that the scheme was introduced after Completion. The Earn Out Expert’s characterisation of the expense as a once-off expense was quintessentially an accounting question, and there is no basis to impugn the Earn Out Expert’s determination of that issue. The basis upon which the commission was said to be payable was a negotiation between the purchaser’s Chief Commercial Officer and Mr Neller. The purchaser did not provide the expert with any evidence that the bonus payments were incurred by the Company or that any such bonus payments had been calculated correctly. The expert’s determination was based on the commission payment being a once-off expense for the purpose of cl 10.7(b). The commission payment was treated as an incentive or bonus payment, such that the payment was excluded by reason of item 4.11 in Schedule 5. The Earn Out Expert was not satisfied that payment was made in accordance with what appeared to be the relevant performance criteria. The only material before the Earn Out Expert appears to have been the template. There was no manifest error in the Earn Out Expert’s approach.
Once-off Expenses Expenses which are non-recurring such as those which are once-off, infrequent or unusual and/or arise as a result of discontinued operations.
After Completion, on 31 August 2021, the Company entered into a sales staff commission plan with salesperson, Mr Neller. It appears from the determination that the expert was not provided with a copy of this document, but only a ‘template’. On 31 March 2022, the Company entered into a 5-year managed services agreement with NSW Crime Commission. Mr Neller became entitled to commission.
In its submission to the expert, the purchaser said that the payment of commission to Mr Neller was made based on the Company’s previous bonus / commission structure and was a negotiated outcome between the purchaser’s Chief Commercial Officer and Mr Neller. The purchaser further explained that 30% of Mr Neller’s commission had been attributed to normalised EBIT and the remaining 70% to Annualised Agreed Profit, said to be by agreement with Mr Mulcahy.
In its submission to the expert, the vendor disputed any agreement to bear a portion of Mr Neller’s commission. The purchaser was said to have provided no evidence that the commission had, in fact, been paid. According to the template provided by the purchaser, Mr Neller was not entitled to be paid the commission. Nor was it clear why the purchaser had pre-paid the commission, where the managed services agreement had five years to run and Mr Neller may not be entitled to all of the commission. The purchaser had provided no evidence that the commission was paid under a commission structure previously used by the vendor. Reliance was placed on para 4.11 of Schedule 5. The vendor submitted that the commission should be excluded as a Once-off Expense, where the purchaser had accepted that the commission payment was non-recurring.
Whether the commission was a Once-off Expense involves an accounting concept which the expert was well qualified to consider. Whether he was right or wrong is not the issue, but whether he was obviously wrong. I agree with the purchaser that the expert’s conclusion appears odd. Perhaps it was because the commission had been paid up-front rather than over the course of the five-year managed services contract to which it related. But it probably would have been easier for the expert to decide the matter if he had been provided with a copy of the relevant document. It is harder to criticise the conclusion reached where the expert was largely reliant on the parties’ assertions and a ‘template’.
Nor does it matter, where the expert continued to hold the view that the accounting principle in para 4.11 of Schedule 5 applied. There is no doubt that the incentive scheme was introduced by the Company after the Completion Date. The expert’s view that that principle applied in this situation is not obviously wrong, for reasons earlier stated.
Nor was the expert satisfied that the purchaser had accounted for the commission appropriately, given the absence of relevant documents. Overall, the expert’s rejection of this expense item was not a manifest error.
10.3 Second and Final Additional Payment
(a) If EBIT plus the Annualised Agreed Profit for the second Earn Out Period is equal to or less than $3,500,000, then the Additional Payment for the second Earn Out Period will be the amount equal to four (4) times EBIT plus the Annualised Agreed Profit at the end of the second Earn Out Period less the Purchase Price already paid by the Purchaser to the Vendor including the amount of the Additional Payments pursuant to clauses 10.1 and 10.2.
At the time of entry into the Variation Deed, the parties were said to be under a common mistake that the written instrument conformed with their common intention. The purchaser denied this.
As the vendor has already succeeded on its primary contention, it is only necessary to deal with this claim briefly in the event that I am wrong about whether the parties were bound by the expert’s construction of the earn-out formula and / or whether the expert’s construction was a manifest error.
The vendor submitted that this was a compelling case for rectification, given the purchaser’s contemporaneous calculation of the forecast second Additional Payment was consistent with the clause as rectified. While there can sometimes be an issue as to whose state of mind should be attributed to a corporate party, when determining common intention (SSABR Pty Ltd v AMA Group Limited [2024] NSWCA 175 at [149]-[156]), this was said to present no difficulties here. The relevant decision-maker was the board of directors. The chairperson, CEO and CFO all shared the common intention, as reflected in materials provided to the board, both before and after execution of the Variation Deed. Whilst members of the board other than Mr Jennings did not give evidence, the Court does know what the board was told, including models graphically demonstrating how the varied clause would work. The standard of “clear and convincing proof’ of a common intention was said to be comfortably satisfied: Property Investors Alliance Pty Ltd v C88 Project Pty Ltd (in liq) [2023] NSWCA 291 at [130] (Kirk JA); SSABR Pty Ltd v AMA Group Limited [2024] NSWCA 175 at [139]-[140].
The vendor submitted that the fact that the Variation Deed was drafted by lawyers was of little significance and no more than reasons for caution, given even experienced solicitors can misrecord their clients intention: Franklins Pty Ltd v Metcash Trading Ltd (2009) 76 NSWLR 603; [2009] NSWCA 407 at [461] (Campbell JA). The drafting did not materially change from the first draft prepared by Mr Donato. That draft was prepared in answer to Mr Greene’s instruction that the intention of the amendment was to have an amount “payable” at the end of the second Earn Out Period calculated by reference to annual profit from managed services agreements. The words adopted in the original draft – which it may be inferred were intended to give effect to that instruction – were not the subject of any subsequent negotiation. The limited work undertaken by Mr Sauer and his team in respect of the draft Variation Deed – less than 4 hours between November 2021 and February 2022 – undermined any submission that the words in the draft Variation Deed were the subject of extensive negotiation between lawyers such that it could be inferred that it is unlikely that the language used in the clause contained any errors.
The purchaser submitted that the vendor had not discharged its “heavy onus” given suggested frailties in the evidence of Mr Mulcahy and Mr Snell and the absence of evidence from Mr Sauer. The omission of evidence from Mr Sauer left a gap in the evidence bearing upon the vendor’s state of mind at the time of entering into the Variation Deed: SSABR at [187(3)]. (For reasons earlier stated, I decline to draw this inference). There was said to be no contemporaneous documents indicating that the vendor held a mistaken belief. The Earn Out Notice was said to point in the opposite direction. (For reasons earlier stated, I do not agree with this either). Nor were there any contemporaneous communications indicating that the purchaser was aware that the vendor was labouring under a mistaken belief when the parties entered into the Variation Deed: [2015] NSWCA 119 at [59]. There is no evidence which might support a finding of unconscientious departure from the common intention of the parties, which was the rationale informing the remedy.
… equity focuses on what it is unconscientious for a party to assert about the contract. The rationale is that it is unconscientious for a party to a contract to seek to apply the contract inconsistently with what he or she knows to be the common intention of the parties at the time that the written contract was entered. In other words, when a plaintiff succeeds in a claim for rectification, the plaintiff is found to have been justified in in effect saying to the defendant “you and I both knew, when we entered this contract, what our intention was concerning it, and you cannot in conscience now try to enforce the contract in accordance with its terms in a way that is inconsistent with our common intention.
Rectification is granted only upon clear and convincing proof, being not only that the written document does not correctly record the common intention of the parties, but what the common intention of the parties actually was: Franklins v Metcash at [451]. As such, rectification in equity is a departure – albeit it one which is circumscribed by the insistence on cogent proof – from the objective theory of contract: Seymour Whyte Constructions Pty Ltd v Ostwald Bros Pty Ltd (In Liq) (2019) 99 NSWLR 317; [2019] NSWCA 11 at [15].
In establishing what the actual intentions of the parties were, there is no requirement for communication of that common intention by express statement, but it must at least be the parties’ actual intentions, viewed objectively from their words or actions, and must be correspondingly held by each party: Simic v New South Wales Land and Housing Corporation (2016) 260 CLR 85; [2016] HCA 47 at [104] (per Gageler, Nettle and Gordon JJ). As Kiefel J observed in Simic at [42]-[43]:
… A court, in determining whether the burden of proof is discharged, may be said to view the evidence of intention objectively, in the sense that it does not merely accept what a party says was in his or her mind, but instead considers and weighs admissible evidence probative of intention. ….
It is not to be expected that parties to contractual negotiations will express themselves in terms of their intentions. It is therefore to be expected that proof to the necessary standard will usually require some manifestation of the intention of each party by their words or conduct and that the requisite common intention will be a matter of inference for the court from that evidence. …
As Tipping J also observed in Westland Savings v Hancock (1987) 2 NZLR 21, “the fact that a party has acted as if the document stood in the form into which it is sought to be rectified is strong evidence of the existence of an intention of the part of that party to contract in those terms”: at 32. This was followed in Ryledar Pty Ltd v Euphoric Pty Ltd (2007) 69 NSWLR 603; [2007] NSWCA 65, where Tobias JA (with whom Mason P and Campbell JA agreed) added, “Such conduct is obviously of significance but, depending on other evidence, if any, it is not necessarily conclusive although in the absence of any such evidence it may be”: at [184].
Where an agreement has been reduced to writing through a process of negotiation between solicitors over a period of months and is clearly a matter of great commercial significance to the parties, that situation is itself a factor that tends to make it less likely that the parties have recorded their common intention incorrectly: Franklin v Metcash at [460]. However, Campbell JA noted “we know that sometimes even experienced solicitors take or are given inadequate instructions, or misunderstand their instructions, and in consequence misrecord their client’s intention, so these matters are no more than reasons for caution in making the factual findings upon which a rectification order is based”: at [461]. Likewise, in Queenfield Pty Ltd v Gordon Finance Pty Ltd (2019) 60 VR 118; [2019] VSC 857, a case involving a drafting error by a solicitor, Riordan J observed, “It is the common mistake which enlivens the doctrine of rectification and to deprive the party of the remedy on the basis that it was party to the mistake, would be to substantially deny the remedy of utility”: at [85].
If the only evidence before the Court was the oral evidence of Mr Mulcahy, Mr Snell, Mr Baker and Mr Jennings, then I would not be satisfied to the requisite standard that an order for rectification ought be made. Their recollections were, no doubt unwittingly, affected by hindsight and self-interest to varying degrees. However, to their evidence may be added a significant body of contemporaneous documents. The imprecise language used in individual records, whether the board papers, board minutes or emails, means that I would not be satisfied that rectification should be ordered having regard to any individual document. But the cumulative effect of these contemporaneous documents is clear. To this may also be added the parties’ strongly consistent post-contractual conduct. The result is compelling.
The purchaser’s board had authority to enter into the Variation Deed. The board resolved to adopt Mr Baker’s proposal to vary the earn-out arrangements on 22 June 2021, subject to various questions being satisfactorily answered. As earlier detailed, Mr Baker’s proposal envisaged a payment being made to the vendor based on the multiple being applied to what became known as Annualised Agreed Profit: see [43]-[45]. The board, according to the minutes, understood this proposal and agreed ‘in principle’: see [46]-[47].
In September 2021, Mr Greene instructed the purchaser’s solicitor, Mr Donato, to prepare the Variation Deed. Mr Greene’s instructions were, effectively, to prepare a document to give effect to the board’s resolution on 22 June 2021 to adopt Mr Baker’s proposal. I infer that Mr Donato read Mr Baker’s board paper and the minutes. I infer that Mr Donato endeavoured to give effect to the board’s decision in the draft Variation Deed.
In October 2021, while Mr Donato was in the process of drafting the Variation Deed, the board formally approved Mr Baker’s proposal, where the board’s accounting query had been answered in the meantime: see [53]. Nowhere in the board papers or minutes from June or October 2021 is there any suggestion that Annualised Agreed Profit would be added to EBIT for the purpose of identifying whether the Company had passed a ‘hurdle’ to qualify for a higher multiple. The board paper and minutes are premised on the multiple being applied to the annualised profits of managed services contracts, with a view to making a payment to the vendor of the resulting sum.
Throughout this period, Mr Mulcahy was regularly meeting with Mr Baker and Mr Greene to progress the variation and the accompanying worksheets. It is highly likely that they discussed how the varied earn-out formula was going to work, as it was a matter of keen interest and the reason why they were meeting.
When the draft Variation Deed was first circulated in November 2021, Mr Snell asked Mr Mulcahy what the variation was about. From what he was told by Mr Mulcahy, and from Mr Snell’s review of the draft Variation Deed, he understood that there was to be a change to the payout calculation, “I had taken it that Annualised Agreed Profit was being added to EBIT, and referred to henceforth as EBIT.” The sum would be multiplied by the multiplier. On reviewing the document again on 21 April 2022, Mr Snell said that he understood that the Annualised Agreed Profit was being added to the EBIT to accumulate, “the impression I had after reading the whole document was that they were being added together.”
For these reasons, I make the following orders:
Declare that the plaintiff and first defendant are bound by the expert determination of Paul Croft dated 22 September 2023.
Order the first defendant to pay $9,663,200 to the plaintiff, together with interest accruing at the current Reserve Bank of Australia cash rate target plus 3% per annum.
Direct the parties to provide a calculation of the interest, preferably agreed, within 7 days, so that judgment can be entered accordingly.
First defendant to pay the plaintiff’s costs of the proceedings, including the cross-claim.
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Expert Group International Pty Ltd
TransAction Solutions Ltd [2025] NSWSC 575
(1995) 35 NSWLR 596
(1995) 37 NSWLR 405
(1994) 52 FCR 474
(2015) 90 NSWLR 367
(1996) 67 FCR 402
(2006) 151 FCR 341
(2017) 261 CLR 544
(2009) 76 NSWLR 603
(2020) 104 NSWLR 634
(2020) 103 NSWLR 850
(1949) 78 CLR 529
(2022) 290 FCR 435
(2020) 102 NSWLR 627
(2014) 89 NSWLR 633
(1994) 217 ALR 201
(2004) 218 CLR 451
(1977) 139 CLR 231
(2019) 60 VR 118
(2019) 99 NSWLR 317
(2016) 260 CLR 85
(2005) 31 WAR 187
(2005) 221 CLR 522
(1985) 1 NSWLR 314
(1993) 177 CLR 485
(2007) 230 CLR 89
(2007) 69 NSWLR 603
It remains possible that Mr Sauer spoke to Mr Mulcahy and gave advice orally. But there is just no sign, in the contemporaneous records, that he did. Nor did Mr Mulcahy recall any conversations with Mr Sauer. Mr Mulcahy was a credible witness. It is not necessary for a party to call an unnecessary witness: Apand Pty Limited v The Kettle Chip Co (1994) 52 FCR 474 at 490. I decline the draw the inference as it would result in me making an unwarranted assumption, being that Mr Sauer did give advice beyond that recorded in his emails, and that his evidence as to the content of that advice would not have assisted the vendor.
The purchaser’s CFO, Mr Greene, did not give evidence. The vendor sought a Jones v Dunkel inference. The purchaser did not suggest otherwise. I readily infer that Mr Greene’s evidence would not have assisted the purchaser.
The purchaser’s solicitor, Norman Donato, did not give evidence. The vendor sought a Jones v Dunkel inference. The purchaser made no submissions in this regard either. An initial question is whether the purchaser has put its state of mind in issue and, thus, waived privilege as well: Commissioner of Taxation v Rio Tinto Limited (2006) 151 FCR 341; [2006] FCAFC 86 at [54]. In its pleading, the purchaser denied that there was a common mistake at the time of entry into the Variation Deed “and further says that the written instrument … conformed to the common intention of the parties as evidenced by the parties’ execution of the agreement.” That is, the purchaser contended that its state of mind (at least) conformed with the contents of the Variation Deed. The purchaser thereby put its state of mind in issue as well.
The purchaser does appear to have waived privilege in at least some communications with its lawyer in respect of the Variation Deed. In evidence is an email from Mr Greene to Mr Donato, giving initial instructions, and a letter from Mr Donato to Mr Greene giving advice as to the way forward. But no further emails are in evidence, providing various drafts of the Variation Deed to the purchaser, or any related advice.
Given the purchaser’s silence on this subject, and that fact that the purchaser appears to have waived privilege over its communications with Mr Donato, I will proceed on the basis that the purchaser accepts that privilege has been waived. I can thus draw the inference if otherwise available. The Variation Deed was drafted by Mr Donato’s firm. Mr Donato’s evidence would have been relevant. He was in the purchaser’s ‘camp’. No explanation was given for his non-attendance. I infer that Mr Donato’s evidence would not have assisted the purchaser’s case.
Mr Jennings raised the same query as Mr Sauer. On 19 January 2022, Mr Jennings emailed Mr Greene, “Just doing a final review and I’m trying to get my head around if any portion of annualised agreed profit on managed services secured … Expertech … may get included in Expertech’s EBIT in the second term.” Further:
Mr Mulcahy arranged a Microsoft Teams meeting with Mr Greene and Mr Sauer on 7 February 2022 “for a quick chat to finalise the wording in the Deed.” On 9 February 2022, Mr Mulcahy provided Mr Sauer with an updated version of the deed, “Pls let me know what you think.” On 14 February 2022, Mr Sauer advised Mr Mulcahy that it looked like the purchaser had accepted most of his draft “which is good”. As to further amendments suggested by Mr Sauer, Mr Mulcahy replied, “Given that this is outside of the original sale agreement and is a benefit to us, I am reluctant to push it with them too much as they are being very understanding and cooperative.” This appears to have been Mr Sauer’s last involvement before the Variation Deed was executed. (Mr Sauer later rendered a fee note for his services. The narration did not refer to any meetings or telephone calls with Mr Mulcahy, other than participation in the Teams meeting on 7 February 2022, together with Mr Greene.)
Mr Mulcahy arranged a further meeting on 15 February 2022 “to work through the 3 pricing worksheets and the framework used to derive the %’s to be applied to generate a TAS/EXP revenues.” In advance of the meeting, Mr Greene provided the proposed percentage profits and Agreed Annualised Profits for each of the managed services contracts, being Maddocks, NSW Crime Commission and an E-Health contract, making a “total value of $482,020 to add to the normalised EBIT in the Experteq P&L …”.
Mr Greene again looked at how the Additional Payment would increase if normalised EBIT was $750,000 or $1 million. Mr Greene also looked at how the Additional Payment would increase if Annualised EBIT for the managed services contracts increased to $1.5 million, against each of the forecast normalised EBITs. According to this spreadsheet, the total Earn Out Payment was forecast to be as much as $8 million.
As to the next step, cl 10.10 of the Share Sale Agreement provided:
Further, the vendor submitted that the commercial purpose of the Variation Deed, and relevant surrounding circumstances known to the parties which bear upon construction, include that there was no contemporaneous record that any person expected that the Additional Payment would be calculated other than by reference to the 4 times multiple. The material before the board expressly stated that this was the expectation. There was no contemporaneous evidence to corroborate that the clause was intended to have the effect contended for by the purchaser. There was no suggestion from anyone that it was thought that the Company had any hope of getting beyond the first bracket and thus, on the purchaser’s construction of the clause, it would not incentivise the Company very much at all. It also beggared belief that the parties put so much effort into the minutiae of the Annualised Profit figures if it mattered only to get the earnings into a different bracket, rather than to multiply every dollar of Annualised Agreed Profit by 4.
Finally, the vendor submitted that the objective intention of the parties was that each dollar of Annualised Agreed Profit would result in a payment of $4 to the vendor, once the $500,000 trigger had been reached. The Court can correct the language by construction: James Adam Pty Ltd v Fobeze Pty Ltd (2020) 103 NSWLR 850; [2020] NSWCA 311; HDI Global Speciality SE v Wonkana No 3 Pty Ltd (2020) 104 NSWLR 634; [2020] NSWCA 296; Zhong v Guan [2024] NSWCA 300 at [23]-[38]. The obvious mistake (or absurdity) can readily be corrected by reading the words “plus the Annualised Agreed Profit” after “EBIT” where it appears for the second time in clause 10.3(a). The fact that (at least) two approaches were fairly arguable meant there could be no manifest error.
To resolve the construction of the clause, having regard to the commercial context and the competing contentions of the parties, the expert treated Annualised Agreed Profit as a figure to be included in EBIT. Given the definitions of EBIT, Business and Annualised Agreed Profit, that was not obviously wrong. The potential double-counting which this treatment may cause had, in fact, been addressed by the accounting procedures put in place by Mr Greene to avoid just that. A textual obstacle to the expert’s construction is the consistent, separate treatment of EBIT and Annualised Agreed Profit in cl 10.1(a) (“… EBIT plus … the Annualised Agreed Profit…”) and cls 10.3(a) to (c) (“If EBIT plus the Annualised Agreed Profit is [$], then the Additional Payment is [multiple] times EBIT”).
Is the expert’s construction of the earn-out formula a “manifest error”, in the sense that it is plainly and obviously wrong, so obvious as to admit no difference of opinion, and apparent on a mere perusal of the expert determination without the benefit of adversarial argument. I would say not. The construction was arguable and, indeed, argued at some length by two experienced commercial silks before me, who marshalled the usual competing collection of authorities emphasising, on one hand, the primacy of the text or, on the other hand, the importance of context and the ability of the Court to correct by construction. I would not say that the expert’s construction was the better or correct construction, but forming that view was not a “manifest error”.
The expert’s conclusion was not a manifest error. Indeed, I agree that the purchaser’s CEO and CFO were not referred to in cl 10.7(c). If anything, the reference was to Mr Mulcahy. Whether a portion of the purchaser’s CFO wage should have been included under Allocation principle 4 did depend on whether there was a transfer pricing basis or agreed allocation basis. There was no evidence before me on this subject, and apparently no evidence before the expert either. This ground fails.
In the result, the expert determination stands.
The purchaser submitted that decision-making authority regarding entry into the Variation Deed was vested in the board. That decision was made on 22 February 2022. The board had before it the Variation Deed, which contained clauses 10.3(a)-(c) in the form in which those clauses were expressed at the time of execution. It had not been involved in the negotiations, with the exception of limited involvement by Mr Jennings. There was no proper evidentiary basis to conclude that the board intended the Variation Deed to mean other than what the draft deed it considered and approved objectively conveyed.
Mr Mulcahy’s evidence as to his understanding took some twists and turns. It was not clear whether Mr Mulcahy got confused (for which he could be forgiven) or whether his answers reflected what he thought at the time, what he understood the Variation Deed to, in fact, provide, or what he had come to think. In any event, Mr Mulcahy initially said that he understood that EBIT and Annualised Agreed Profit were the same, “my view was that EBIT contained Annualised Agreed Profit.” Mr Mulcahy conceded that the words in the proposed Variation Deed did not say that, but “what I was thinking at the time was Annualised Agreed Profit and … EBIT were one and the same”. Mr Mulcahy said he did not have accounting or financial training and thought “At least they’d be used for calculating the same thing.” Mr Mulcahy later conceded that EBIT did not include Annualised Agreed Profit, “That wasn’t my view at the time, but I accept that that’s what the words say. But that’s not what I thought.” He then agreed that he knew at the time that EBIT and Annualised Agreed Profit were distinct (which may be explicable given how he and Mr Greene separated the two by ‘normalised EBIT’ to prevent double-counting). Whilst he recognised that EBIT and Annualised Agreed Profit were two different things, his view was that “towards the calculation at the end, they would be the same thing.”
As noted at the outset, neither Mr Mulcahy or Mr Snell were lawyers or accountants; their skills lay in IT. They appeared to me not to have grappled with the intricacies of the drafting at the time, but went along with the deal as they understood it to be and left the detailed document review to Mr Sauer. That does not mean that these gentlemen were not bound by their execution of the Variation Deed. But it does mean that, to the extent that their misunderstanding as to how the Variation Deed would operate was shared by the purchaser, then equity may rectify the document to accord with that common intention.
In fact, Mr Sauer did not suggest any substantive amendments to cl 10.3(a) to (c). Nor does Mr Mulcahy appear to have given Mr Sauer any detailed instructions, beyond asking him to review the document “and let me know what you think of it[s] structure and wording.” There is no evidence that Mr Mulcahy gave more expansive instructions in conference as to how he understood the varied earn-out formula should work. For reasons earlier given, I do not infer that evidence given by Mr Sauer would not have assisted the vendor.
Turning to Mr Baker, he was not a member of the board. His understanding is tangentially relevant, as he put forward the proposal to vary the earn-out provisions to the board and answered the board’s questions. Mr Baker said that he did not intend that the Additional Payment would be the product of the multiple applied to the sum of the Agreed Annualised Profit and EBIT. As earlier mentioned, Mr Baker was less than emphatic in maintaining this position and put some distance between himself and the deal.
Mr Baker also said that, as the profit derived from managed services contracts was already included in EBIT, he considered that profit would be double counted if the Additional Payment was calculated as the product of the multiple against the sum of EBIT and annualised profit. He did accept, however, Mr Greene’s explanation on 20 January 2022 that there would be no double counting, although said he was “not on the detail of that” as all accounting was done by the CFO. He also appeared to accept that the same problem of double counting would occur elsewhere in cl 10.3.
Mr Baker did not recall looking at the spreadsheet prepared by Mr Greene as to how much the earn-out was likely to be. Nor did Mr Baker review the Earn Out Accounts, or Mr Greene’s calculation of the Additional Payment, as the amount calculated was not outside his expectation. As Mr Baker was not surprised by the amount of the Additional Payment, he said he did not notice an error in the calculation of the Earn Out Amount.
Overall, Mr Baker’s evidence as to his understanding at the time does not align particularly well with his report to the board on this subject, or his participation in subsequent board meetings without demur. I defer to Mr Baker’s understanding as evidenced in these documents. If Mr Baker’s concern was ‘double counting’, that was addressed by Mr Greene before the Variation Deed was executed, by implementing a change to accounting procedures to ensure that the accounts for qualifying managed services contracts were maintained by the purchaser. Beyond this, Mr Baker appears to have left the details to Mr Greene and did not check the worksheets as they were circulated, either before or after the Earn Out Amount was calculated.
Turning to Mr Greene, he was the architect of the varied earn-out provisions. He was not a member of the purchaser’s board, but a source of information as to how the varied arrangements would work. I infer that the evidence of Mr Greene would not have assisted the purchaser.
Turning the all-important board, the board agreed to Mr Baker’s proposal to vary the earn-out arrangements ‘in principle’ in June 2021 and then formally resolved to adopt the proposal in October 2021. The matter became before the board again on 22 February 2022, when the board papers included a draft Variation Deed. According to the minutes, Mr Baker informed the board that the deed would be amended to change the annualised profits for managed services contracts from agreed percentages to actual EBIT results. The board was told that Mr Donato was in the process of amending the document. Mr Greene also informed the board of the change in accounting practices to avoid double counting.
At odds with Mr Jenning’s recollection, the minutes do not record Mr Baker giving the board a detailed explanation of the varied earn-out formula, including that the effect of the formula was to enable the vendor to access a higher multiple, rather than the multiple being applied to the sum of EBIT and the annualised profit of qualifying managed services contracts. Having regard to the minutes, it is more likely that this did not happen, where the deed was then being amended by Mr Donato. It is less likely in these circumstances that board members read the draft Variation Deed closely, where they had been told that it was not in final form. This may explain why no-one picked up any drafting error at the time.
The Variation Deed did not then come back before the board until after it had been executed by both parties. The Variation Deed was executed by Mr Jennings. It is not suggested that he did not have authority to do so. That authority was conferred by the board’s resolutions in June and October 2021. After Mr Jennings executed the Variation Deed but before it was executed by the vendor, Mr Jennings had the opportunity to review Mr Greene’s worksheet, which set out clearly how the varied earn-out formula was expected to work. What is plain from that worksheet is that the Annualised Agreed Profit from the Qualifying Managed Services Agreements was multiplied by 4.
Whilst Mr Jennings variously said that he did or did not look at the worksheet, I note that Mr Greene asked, in his cover email, to confirm Mr Jennings’ availability to participate in a meeting in the coming days “for us to talk through this subject”. As the chairperson of the board, and the board member with whom Mr Greene and Mr Baker were dealing on this matter, it is more likely than not that Mr Jennings would have reviewed the worksheet in respect of an issue which had financial implications for the purchaser, and in preparation for a meeting with the CFO, and I so find. Mr Jennings did not ‘raise the alarm’ that the forecast Additional Payment of some $4.6 million was not what he had in mind.
Before the vendor executed the Variation Deed Mr Greene also showed Mr Mulcahy the worksheet modelling the forecast earn-out payment and Mr Mulcahy “accepted this”: see [77].
The board’s understanding as to how the Variation Deed worked may be inferred from the fourth board meeting, after the deed had been executed. The management report explained how the varied earn-out formula would work. Mr Greene demonstrated it further during the board meeting using the worksheet as a visual aid. The board members asked questions about it. The board did not voice any disagreement with the workings of the arrangements under the Variation Deed, as explained by Mr Greene and clarified in subsequent questions and answers.
Mr Jennings said that if he had understood that there had been a prospect that the Additional Payment would be approximately $7 million higher than that estimated when entering into the Share Sale Agreement, he would not have agreed to the Variation Deed and believed that his fellow board members would have shared his views. However, Mr Greene did forecast that the Additional Payment could be up to $8 million on current projections. Mr Greene’s management report noted “In respect of our available capital in meeting the earn out obligations we hold liquidity over $14m.” The minutes of the board meeting record an expectation that the Additional Payment may be $5.4 million to $8.4 million. That is, the board appreciated how much the Additional Payment might be and was advised by the CFO that the purchaser had sufficient liquidity to cover that obligation. I did not accept Mr Jenning’s evidence on this subject: see [90]-[91].
The purchaser then conducted itself as if the Variation Deed was in the form that the vendor now seeks. Mr Greene showed the worksheet to Mr Mulcahy again at the end of the second Earn Out Period: see [92]. The purchaser calculated the Earn Out Amount using the method in Mr Greene’s worksheet. When the board reviewed the acquisition of the Company in November 2022, there was no suggestion in the board paper that Mr Greene’s calculation of the earn-out, either in the forecast earlier presented to the board or as since calculated by the purchaser, was wrong. The vendor calculated the Earn-Out Amount in the same way.
The purchaser did not depart from this approach in its Earn Out Dispute Notice: see [107]. When Ball J gave judgment in May 2023, his Honour noted that it was “common ground that ‘EBIT’ for the purpose of calculating the multiple in the formulas referred to in [cl 10.3] also includes the Annualised Agreed Profit”: see [113]. It was not until Mr Croft had been appointed that the purchaser first put forward an alternative construction of the earn-out formula, in August 2023. That does not mean that that construction was not correct, but it does strongly suggest that the purchaser had not thought of it until then. This is consistent with the purchaser sharing a common intention with the vendor, when the Variation Deed was executed more than two years earlier.
When the vendor provided the expert with Mr Mulcahy’s statutory declaration, setting out his negotiations with Mr Baker and Mr Greene in respect of the Variation Deed, and his understanding as to how it was to operate, the purchaser did not cavil with Mr Mulcahy’s description but simply invited the expert to treat it as irrelevant. This suggests that the purchaser did not disagree with Mr Mulcahy’s description at the time.
I conclude that the purchaser held a common intention with the vendor that the earn-out formula, as varied, would operate by applying the multiple to the sum of EBIT and Annualised Agreed Profit, before deducting the purchase price already paid. That was what the Variation Deed was intended to effect. Clause 10.3, as varied, was lengthy and complex. Whilst Mr Donato likely intended to produce that result by his drafting, his failure to do so was not picked up by Mr Sauer, who does not appear to have been given comprehensive instructions.
The businesspeople involved focussed on their negotiations of the deal but did not delve into the interstices of the drafting. That the clause as drafted produced a different result does not appear to have been discovered until much later, when the purchaser’s legal representatives prepared submissions to the expert. (I infer that the evidence of Mr Donato would not have assisted the purchaser.) The purchaser thereafter sought to extract itself from what it regarded as a bad deal by exploiting imperfect drafting. Equity would not permit that result, as it would be unconscientious for the purchaser to thereby extract itself from what was, in fact, agreed. For these reasons, I would have ordered rectification of cl 10.3 in the manner proposed by the vendor.