Halkett v APG & Co Pty Ltd

FACTS

1. APG is the trustee for the Beaujolais Unit Trust. The second defendant, Sports Fashions Group Pty Ltd, owns the ordinary units in the trust. APG and Sports Fashions Group are part of the Marshall Group of Companies, being an informal grouping of companies and trusts which are majority beneficially owned by members of the Marshall family, including cousins John Marshall and Andrew Michael. Mr Martin has been employed by Marshall Investments Pty Ltd for many years and served as a director on the boards of various companies within the Marshall Group of Companies, including APG.
2. At the time of these events, APG operated more than 200 "free-standing" retail stores as well as "concession" stores in David Jones and Myer department stores. APG also earned revenue from online sales via its website and partner sites including those operated by The Iconic and David Jones.

Accounting policies

1. APG's financial statements were audited by PricewaterhouseCoopers. For the 2015 financial year, APG earned revenue of some $273 million and enjoyed a profit before tax (PBT) of some $6.5 million. The notes to the accounts set out the accounting policies adopted in the preparation of the financial statements, including new or amended accounting standards published by the Australian Accounting Standard Board (AASB).
2. As those familiar with the history of accounting standards would expect, APG's audited financial statements did not separately identify "abnormal" or "extraordinary" items. While clause 85 of AASB 101 Presentation of Financial Statements permitted an entity to present additional line items, headings or sub-totals in a profit and loss statement "when such presentation is relevant to an understanding of the entity's financial performance," clause 87 provided: An entity shall not present any items of income or expense as extraordinary items, in the statement(s) presenting profit or loss and other comprehensive income, or in the notes.
3. For those unfamiliar with the history of accounting standards, for many years accounting standards permitted "abnormal" and "extraordinary" items to be presented separately from, and not included within, the revenue and expense figures used for the presentation of PBT in financial statements.
4. Abnormal items are items of revenue and expense, and other gains and losses, brought into account in the period, which although attributable to the ordinary operations of the business entity are considered abnormal by reason of their size and effect on the results of the period.
5. Extraordinary items are items of revenue and expense, and other gains and losses, brought to account in the period, which are attributable to events or transactions outside the ordinary operations of the business entity. In 2002, AASB 1008 Statement of Financial Performance noted that it was extremely rare for a transaction or other event to give rise to an extraordinary item. Further, at 5.5.2: Whether an item is clearly distinct from the ordinary activities of the entity and is therefore an extraordinary item is determined by the nature of the transaction or other event that gives rise to that item. A transaction or event may be extraordinary for one entity but not extraordinary for another entity because of the nature of the entities' respective ordinary activities.
6. The accounting standard gave examples of events or transactions that may give rise to extraordinary items: the expropriation of assets (in a political environment where expropriations are rare) or an earthquake or other natural disaster (where an entity does not operate in a region subject to such events).
7. Mr Meredith said the normal practice was to classify items of revenue or expense as abnormal or extraordinary that met the relevant definition. The reporting entity would then present PBT without the abnormal or extraordinary item and then, in the next line item, record the abnormal or extraordinary item, and then incorporate those items into the 'bottom line' of net profit. If the abnormal or extraordinary item related to revenue or expenses, then this item would not be included in the calculation of Earnings before Interest and Tax (EBIT).
8. The separate reporting of abnormal and extraordinary items drew criticism as there was a perception that companies were misusing the classification of items to improve or distort their reported earnings before such items. By 2006, accounting standards required these items to be included in the calculation of PBT.
9. Thus, APG's audited financial statements no longer disclosed abnormal and extraordinary items. However, APG continued to adjust its earnings results when reporting its financial results in other contexts, including to the board and to its bank. Mr Ross said that it is still common for businesses - outside the context of the preparation of their audited financial statements - to exclude the impact of 'one-off' items when reporting EBIT or other levels of profitability. Indeed, Mr Ross's experience is that it remains common practice for management to refer to abnormal or extraordinary items in commentary provided with financial statements.

Hiring Mr Halkett

1. In 2015, APG hired Mr Halkett as chief executive officer. In November 2015, Mr Halkett became a director of APG and its chairman. Part of Mr Martin's role was to assist APG's board and management with settling their financial statements; he worked closely with Mr Halkett and APG's chief financial officer on financial reporting.
2. In February 2017, Mr Halkett signed the financial statements for APG for the period 2016 financial year. The company's profit before tax declined from $6.5 million to a loss of some $4.3 million. In August 2017, Mr Halkett signed a letter of employment with APG in respect of his role as chief executive officer and executive chairman. Mr Halkett's role was described as "lead[ing] the development of APG & Co's key strategies to drive a dramatic turnaround improvement in the profitability and ultimately attractiveness for sale of the Company." The agreement was to be dated "When equity agreement signed."

Equityholders Agreement

1. On 29 September 2017, the defendants, existing equityholders and Mr Halkett executed an Equityholders Agreement. The recitals noted that the parties had agreed to issue a 5% equityholding to Mr Halkett; the agreement would govern the terms on which equityholders held their securities. The agreement covered a wide range of topics not presently relevant but intended to regulate the equityholders' rights and obligations in respect of board representation, notice and quorum of board meetings, voting, profit distributions and the like.
2. Repeating the sentiments in Mr Halkett's letter of employment, clause 2.1(b) of the Equityholders Agreement recorded the parties' mutual intention to improve the financial and operating performance of the business and, on doing so, to seek a sale of the business within three years: clause 2.1(b). The parties agreed to act in good faith in their dealings with each other and to exercise their rights and perform their obligations acting reasonably: clause 2.2.
3. Clause 6, "Funding and Financial transparency," acknowledged that no equityholder was obliged to provide debt or equity funding to the business; if additional working capital was needed, the defendants would seek to secure this from a reputable bank or financial institution on reasonable terms: clause 6.1(a) and (b). Clause 6.1(b) continued: (emphasis added) If additional working capital or financial accommodation cannot be sourced in this manner, then the Board may: (i) offer to borrow some or all of the amount required from Equityholders … provided that all Equityholders have the opportunity (but not obligation) to participate in that funding opportunity …; and/or (ii) issue new equity (Shares and Units) to fund some or all of the additional capital requirement, provided that: (A) the terms of the issue of the equity are approved [by the board including the representatives of Mr Marshall and Mr Michael]; and (B) the new equity (Shares and Units) must be offered to Equityholders in proportion to their equityholdings, in accordance with clause 10 of this Agreement; and (C) the new equity must be issued for Fair Market Value.
4. The significance of this clause for present purposes is that it deploys the same defined term, Fair Market Value, and thus may have significance for how the term ought be construed. The defendants submitted that clause 6.1 indicated that Fair Market Value may be calculated where securities were sold to third parties, whilst the plaintiff submitted that Fair Market Value would only be used where new securities were sold to existing equityholders.
5. The answer lies in the definition of Equityholders and clause 10, which gave equityholders pre-emptive rights in respect of the sale of existing securities. Clause 1.1 contains the following definition: Equityholder means each party to this Agreement that holds Securities, and any other person to whom Securities are issued or transferred in accordance with this Agreement.
6. As that term is used in clause 6.1, Equityholders are those who hold securities when APG seeks to raise additional working capital. It is these Equityholders who must be given the opportunity to lend the additional working capital to the company and to whom the new equity must be offered "in accordance with clause 10." Turning to clause 10, clause 10.1 provided: 10.1 Pre-emption rights in relation to APG … (a) … any Equityholder (Seller) wishing to Dispose of any or all of its Securities (Sale Securities) must, prior to doing so, give a notice (Transfer Notice) to the other Equityholders (non-selling Equityholders) and [APG] that it intends to Dispose of the Sale Securities. (b) The Transfer Notice must: (i) specify the price per Sale Security (Sale Price), being the price for one (1) Share and one (1) Units; (ii) constitute an unconditional, irrevocable offer to sell the Sale Securities to the Non-Selling Equityholders at the Sale Price; and (iii) specify the period for which the offer remains open, which must be not less than 45 days after the date of the giving of the Transfer Notice (Offer Period). (c) A Non-selling Equityholder may, by notice (Acceptance Notice) to the Seller before 4:00pm on the last day of the Offer Period, accept the offer and must state the number of Sale Securities being accepted. An Acceptance Notice once given is irrevocable. (d) Where Acceptance Notices are received for a greater number of Securities than the Sale Securities, the Sale Securities will be allocated among the Non-selling Equity Holders who have accepted the offer in proportion to their respective holdings of Securities. (e) If Acceptance Notices are received for all or part of the Sale Securities, the Proposing Transferor must immediately upon close of the Offer Period notify each Non-Selling Equityholder who has lodged an Acceptance Notice as to the number of Sale Securities it is required to purchase (being the number accepted by it or allocated to it in accordance with clause 10.1(d)), and the relevant Non-selling Equityholder must purchase that number of Sale Securities by payment of the Sale Price within 5 Business Days after receipt of notice from the Seller. (f) Upon payment by a Non-selling Equityholder in accordance with clause 10.1(e), the Seller must transfer the appropriate number of Sale Securities to that Non-selling Equityholder and deliver to that Non-selling Equityholder a duly executed transfer and share certificates in respect of the Sale Securities. (g) If at the close of the Offer Period Acceptance Notices have not been received for all of the Sale Securities, the Seller may at any time upon to the expiration of three months after the close of the Offer Period transfer that part of the Sale Securities which have not been purchased by a Non-selling Equityholder in accordance with this clause 10 to any other third party approved by the Board, on a bona fide arm's length basis at any price per Sale Security not being less than the Sale Price and on other terms and conditions not more favourable to the third party than the terms and conditions contained in the Transfer Notice. Clause 10.2 applied the same provisions to the sale of shares in Sports Fashions Group.
7. Read literally, clause 6.1(b) and clause 10.1 cannot stand together: a new security must be offered to Equityholders "in accordance with clause 10" - being at the Sale Price set by the equityholder - and "be issued for Fair Market Value," being the product of the formula in Schedule 1. The Court is entitled to approach the task of construction on the assumption that the parties intended to produce a commercial result, construing the contract so as to avoid making commercial nonsense or working commercial inconvenience: Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640; [2014] HCA 7 at [35] (per French CJ, Hayne, Crennan and Kiefel JJ). The words of every clause must, if possible, be construed so as to render them all harmonious one with another: Australian Broadcasting Commission v Australian Performing Right Association Ltd [1973] HCA 36; (1973) 129 CLR 99 at 109 (per Gibbs J). Preference is given to a construction supplying a congruent operation to the various components of the whole: Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522; [2005] HCA 17 at [16] (per Gleeson CJ, McHugh, Gummow and Kirby JJ).
8. Having regard to these principles, I consider that what clause 6.1(b)(ii)(B) is referring to the process set out in clause 10, but not the price. More specifically, clause 6.1(b)(ii)(B) is referring to part of the process, being how the new equity "must be offered to Equityholders". Clause 6.1(b)(ii)(B) does not refer to the procedure in clause 10 for offering securities to third parties.
9. Clause 10.1(d) to (g) sets out the procedure for allocating securities to Equityholders in the event that they wish to buy more or less securities than are on offer. Once that process has been completed, that is, the new equity "has been offered to Equityholders in accordance with clause 10", then the requirements of clause 6.1(b)(ii)(B) have been satisfied. If the new equity has not been wholly taken up by Equityholders, then the process continues in accordance with clause 6.1(b), which clearly states that new equity must be issued for Fair Market Value: clause 6.1(b)(ii)(C). That is, Fair Market Value may be used when issuing new equity, either to Equityholders or third parties.
10. Continuing with clause 6 of the Equityholders Agreement, the parties agreed to be transparent with each other concerning the financial affairs of APG and the trust, and their accounting methodologies and results of operations: clause 6.2. The parties agreed to use all reasonable endeavours to conduct the business in accordance with the medium to long term strategic plan adopted by the board: clause 6.4, clause 1.1 (definition). Clause 7 dealt with the distributions of profits: regard was to be had to the business's financial position, free cashflow and the cashflow required to be retained to fund the strategic initiatives of the business as set out in the strategic plan.
11. Clause 8 restricted the issue of new securities, while clause 9 restricted the parties' ability to dispose of existing securities. In particular, clause 9.1(d) provided: (emphasis added) Halkett is currently employed as the CEO of the Business and as Executive Chairman of APG. If Halkett ceased to be employed with APG and the Business, then the Existing Equityholders shall have the right (but not the obligation) to buy (or to procure that the Company buys back) all of the Halkett Equity for a price equal to their Fair Market Value. The Existing Equityholders shall exercise that right by serving a notice under this clause 9.1, which shall be deemed to be a Transfer Notice given by the Halkett Nominee under clause 10.1 for a Sale Price equal to the Fair Market Value of the Halkett Equity, and shall trigger the pre-emption provisions in clause 10. …
12. Existing Equityholders meant Mr Marshall and Mr Michael: clause 1.1. As such, it fell to these parties to prepare the Transfer Notice, including the calculation of Fair Market Value.

Post-contractual events

1. Following execution of the Equityholders Agreement, Mr Halkett was issued with some 5% of issued securities. The 2017 financial year saw an improved financial result, with APG reporting profit before tax of some $4.3 million. For the 2018 year, profit before tax increased to $12.8 million. In the 2019 year, profit before tax increased further to $14 million.
2. In October 2019, APG decided to close all Myer concession stores. The decision was proposed by Mr Halkett and approved by the board. The company's strategy paper which supported the closure pointed to financial benefits in doing so and anticipated that the loss of revenue would be offset by other initiatives in the 2020 and 2021 financial years, including an increase in revenue from David Jones concession stores.
3. Mr Ross analysed the financial results for Myer concession stores and noted that these stores were profitable, accounting for 20% of APG's revenue and 25% of EBIT. Whilst APG might expect a modest saving in indirect head office costs associated with exiting the Myer stores, APG could expect to see a reduction in EBIT of about $8.415 million a year as a result of this decision. All Myer concession stores had closed by February 2020.

COVID-19

1. In March 2020, the Commonwealth, State and Territory governments announced lockdowns in response to the COVID-19 pandemic. On 23 March 2020, Mr Halkett wrote to all APG's staff, advising that most were being stood down and all stores were being temporarily closed. APG would no longer staff its "concession" stores. Only a "very small team" would remain "to support the online business." On 24 March 2020, all APG's free-standing stores were shut down nationwide. APG's sole source of revenue became online sales.
2. APG had a foreign currency hedging policy of maintaining sufficient foreign exchange to settle at least nine to 12 months' worth of financial settlements estimated to become due to foreign manufacturers of apparel. On 24 March 2020, APG's management team sold all of APG's entitlements to receive US dollars. Forward contracts of over US$39,903,565 were sold in one day, leaving APG unhedged. No formal board meeting of APG was convened or held to approve this transaction prior to it occurring. The decision to undertake this transaction was contrary to APG's policy; Mr Martin had never seen APG become completely unhedged, even during the Global Financial Crisis from 2007 to 2009. This transaction resulted in a one-off foreign exchange gain of some $7.96 million. This foreign exchange gain was included in APG's results for the 2020 financial year.
3. On 30 March 2020, the Commonwealth Government announced "a historic wage subsidy to around 6 million workers … through their employer … The $130 billion JobKeeper payment will keep Australians in jobs as [we] tackle the significant economic impact from the coronavirus. The payment will ensure eligible employers and employees stay connected while some businesses move into hibernation." According to the Prime Minister and Treasurer's joint media release, the payment would be made to employers "for up to six months, for each eligible employee that was on their books on 1 March 2020 and is retained or continues to be engaged by that employer. … Eligible employers will be those … who self-assess a reduction in revenue of 30 per cent or more, since 1 March 2020 over a minimum one-month period."
4. Mr Ross noted that APG's decision to close the Myer concession stores produced the unexpected but beneficial outcome that, as a result of its impact, APG became entitled to receive JobKeeper payments. APG proceeded to submit JobKeeper declarations and received JobKeeper payments. As for the replacement revenue for Myer concession stores anticipated by APG's management, there was no information available to suggest whether these expectations were met. Mr Ross considered that it was reasonable to assume that revenue derived through David Jones stores did not increase in the manner anticipated by APG's management as a result of the onset of the COVID-19 pandemic.
5. APG's financial statements for the 2020 year reported that PBT had roughly halved to some $7.5 million. The notes to the financial statements referred to the impact of COVID-19, which had required management to apply further judgment in particular areas. Note 5 to the accounts provided details in respect of salaries and on-costs. For the first time, these costs now included: Government subsidy expense 4,603,197 Government subsidy reimbursement (9,140,397)
6. As Mr Martin explained, "Government subsidy expense" was payments made to staff for hours not actually worked, while "Government subsidy reimbursement" was total JobKeeper receipts. The net figure was ($4,537,200). As the defendants put it, APG received something of a 'windfall' from JobKeeper.
7. On 2 June 2020, Mr Halkett gave 12 months' notice of his resignation. In March 2021, APG lodged its last JobKeeper Declaration. It is common knowledge that JobKeeper was extended beyond the initial six months and came to an end on 28 March 2021: treasury.gov.au/coronavirus/jobkeeper; section 144, Evidence Act 1995 (NSW). Mr Halkett's employment came to an end on 2 June 2021.

Buyout

1. On 5 November 2021, PricewaterhouseCoopers advised APG that the audit of the 2021 financial year was substantially complete. The auditor provided financial statements which "are not expected to change materially." APG's PBT had improved slightly to some $8.88 million. The notes to the financial statements again recorded the impact of COVID-19 on management's task in preparing the financial statements. In respect of salaries and employee benefits, the notes also reported: Government subsidy additional expense 2,534,320 Government subsidy reimbursement (12,236,640) That is, APG again received something of a windfall from JobKeeper, being $9,702,320.
2. On 11 November 2021, the defendants issued a buyback notice to Mr Halkett under clause 9.1 of the Equityholder Agreement, proposing to acquire his securities for $1,395,299.44. Attached to the buyback notice was the defendants' calculation of Fair Market Value as at 10 November 2021, prepared by Mr Martin.

FAIR MARKET VALUE

1. Fair Market Value means the amount determined in accordance with Schedule 1: clause 1.1 (definition). Schedule 1 commences: Schedule 1 Fair Market Value The steps for determining Fair Market Value are: 1. Determine the Fair Market of all existing Equity (prior to any new issue) 2. If new Equity is to be issued, determine the issue price of the new Equity being issued.
2. The introduction reflected the fact that Fair Market Value was used in two ways: to buy out Mr Halkett's equity and also to issue new equity under clause 6.1(b)(ii), being either to Equityholders or third parties.
3. The first part of Schedule 1 concerned the fair market value of all existing Equity, which was to be determined using the following formula: (emphasis added) 1. FMV of all existing Equity The Fair Market Value of existing Equity shall be determined as: FMV = (VM x Relevant EBIT) - Net Debt Where EBIT means Earnings before Interest and Taxation as determined using generally accepted accounting principles and consistent with how these principles have been applied in prior years for APG and after accounting for all abnormal or extraordinary items. FMV = the Fair Market Value of all Equity in the Company and Trust VM = the Valuation Multiple, which equals 5.2 Relevant EBIT = the average earnings before interest and taxes of the Trust and Company over the following periods as applicable: (a) If the FMV fails to be determined at any point earlier than the second anniversary of this Agreement, the period shall comprise the last 2 financial years (and if the date triggering the calculation of EBIT is more than 6 months through a financial year, the year to date EBIT will be pro-rated to make a full year and will be included in the calculation); and (b) otherwise, the applicable period shall be the 3 preceding financial years (and if the date triggering the calculation of EBIT is more than 6 months through a financial year, the year to date EBIT will be pro-rated to make a full year and will be included in the calculation) In each case the first full financial year shall be the year ended 30 June 2017. Net Debt means all financial indebtedness of the Company and the Trust (including any subsidiaries) (excluding trade debtors), less cash on hand.
4. In short, the formula gathers EBIT over several earnings periods identified by the definition of Relevant EBIT. Adjustments are then made to EBIT for each earning period, if necessary, to ensure that the figure is "consistent with how [generally accepted accounting] principles have been applied in prior years for APG and after accounting for all abnormal or extraordinary items". The first adjustment - to ensure consistency - was presumably intended to ensure that raw financial data made its way into the profit and loss statement by uniform accounting treatment over the relevant earnings periods, to ensure that one was comparing 'apples with apples' in each reporting period. The second adjustment - accounting for abnormal or extraordinary items - was presumably directed to removing material, non-recurring revenue or expense items which produced a 'bottom line' which was not indicative of APG's underlying and ongoing business operations. I will consider these adjustments in more detail at [62].
5. An average was then taken of these adjusted EBITs, presumably to even out the 'highs' and 'lows'. To this average figure is applied a multiple of 5.2. This formula is common. The multiple is applied to average earnings as a rough means of assessing the value of the business having regard to expected future earnings. The chosen multiple may reflect the particular industry or the desirability of a particular business. From this figure is deducted Net Debt, which I will consider in more detail at [90].
6. The second part of Schedule 1 concerned calculating the value of any new equity being issued: 2. Calculate the value of any new equity issued Include the subscription price for any new equity as cash on hand in the calculation of net debt and then divide the FMV by the percentage of new shares being issued.
7. That is, the formula was adjusted in the event that Fair Market Value was being calculated for the purpose of the issue of new equity, being either to Equityholders or third parties.

The calculation

1. The defendants' calculation of Fair Market Value was based on the audited financial results for the 2019, 2020 and 2021 years and cash and debt balances as at 10 November 2021, that is, gathering the earning periods described in sub-paragraph (b) of the definition of Relevant EBIT. The parties agreed that this was the relevant sub-paragraph.
2. For the 2019 year, EBIT as reported in the audited financial statements was $14,762,058. No adjustments were made to this figure. For the 2020 and 2021 years, however, substantial adjustments were made, both in favour of, and against, Mr Halkett.
3. In the 2020 financial year, EBIT as reported in audited financial statements was $10,242,545. To this, adjustments were made "to apply accounting principles consistently." In total, these adjustments increased EBIT by $5,295,818, being an adjustment in respect of AASB 16 Leasing, recognition of derivative financial instruments, translation of foreign currency assets/liability and recognition of a make good provision. Adjustments for the same reasons were made for the 2021 financial year, which reduced EBIT by $3,316,532.
4. To explain one of these adjustments, the notes to the 2020 financial statements referred to a change in accounting policies, where AASB 16 Leases had been adopted retrospectively from 28 July 2019. On adoption, APG recognised lease liabilities in relation to leases which had previously been classified as 'operating leases' under the principles of AASB 117 Leases. The notes set out the practical expedients implemented by the company in applying AASB 16. The adjustments made "to apply accounting principles consistently" included an adjustment to ensure that the accounting treatment in 2019 continued in the 2020 and 2021 years.
5. Over both years, the adjustments "to apply accounting principles consistently" favoured Mr Halkett by $1,979,286 and no complaint is made on this account. What the plaintiff objects to, however, is further adjustments for abnormal or extraordinary items. 1. The first such item was "Effect from sale of FX Hedge Book." In the 2020 year, EBIT was reduced by $7,956,812 and, in 2021, increased by $2,095,477. 2. The second item was "Job Keeper Contribution from Govt," reducing EBIT in both 2020 and 2021 by $4,537,200 and $9,702,320 respectively, being, effectively, the 'windfall' received by APG from JobKeeper in each year.
6. Mr Martin explained that, in calculating the adjustment for JobKeeper, he deducted the total amount that APG had paid to staff who were not working during the relevant period - an expense APG only incurred because of the JobKeeper program - from the total amount of JobKeeper payments received. For the 2020 financial year, Mr Martin deducted $4,603,197 (being the amount paid to staff for hours not actually worked during the relevant period) from $9,140,397 (being the total JobKeeper receipts for the period) to arrive at a net figure of $4,537,200. Using the same methodology in the 2021 financial year, Mr Martin deducted $2,534,390 from $12,236,640, giving a net amount of $9,702,320. These figures were the same figures as disclosed in APG's financial statements: see [37], [40].
7. In the result, the 2019 EBIT was unchanged, the 2020 EBIT was reduced from some $10.2 million to some $3 million and the 2021 EBIT was reduced from $11.4 million to $428,738. The average Relevant EBIT was $6,078,382. After applying the multiple of 5.2, the enterprise value was some $31.6 million. From this was reduced Net Debt, being cash at close of business on 10 November 2021 less debt, being -$2,925,148. In the result, Fair Market Value of Mr Halkett's 5% of equity holding was $1,395,299.44.

"After accounting for all abnormal or extraordinary items"

1. The plaintiff pointed to three suggested errors in the defendants' calculation of Fair Market Value. First, properly construed, the definition of EBIT was said to require that earnings be calculated after including abnormal or extraordinary items. The plaintiff submitted that "accounting for" meant "to include," where the definition of EBIT should be read with the following emphasis: EBIT means Earnings before Interest and Taxation as determined using generally accepted accounting principles and consistent with how these principles have been applied in prior years for APG and after accounting for all abnormal or extraordinary items.
2. It was submitted that "before" required one to exclude "Interest and Taxation" from the earnings figures used for EBIT and "after accounting for" requires one to include all "abnormal or extraordinary items" in those figures. "Before" and "after" are antonyms. A reasonable person in the position of the parties at the time the Equityholders Agreement was signed would not have understood the word "before" and the phrase "after accounting for" to have the same effect. "Accounting for" the items thus meant to include, not exclude, them.
3. Resolving this turns on the proper construction of the Equityholders Agreement. The principles to be applied are well-established and uncontentious. The immediate problem with the plaintiff's submission is that the presence of the word "before" is explained by the fact that it forms an integral part of a notorious phase frequently abbreviated, "Earnings before Interest and Taxation" or EBIT. As such, "before" is not an antonym (a word of opposite meaning) to "after" in this context.
4. The plaintiff further submitted that his suggested construction was consistent with his role under the employment contract: to bring about change in APG's business, whether or not that created abnormal or extraordinary items. I cannot conceive how a chief executive officer's performance of their role, no matter how innovative, could bring about an extraordinary item. I accept it is possible that their efforts could result in an abnormal item, with either positive or negative results on the 'bottom line'. It must be borne in mind, however, that the purpose of the calculation of Fair Market Value was not to further reward an outgoing chief executive officer for changes to the company's performance as a result of their efforts. Rather, the formula was to assess the value of the securities, either to be paid to the plaintiff or, potentially, Equityholders or third parties in the course of raising working capital. The value sought to be ascertained rested on the company's estimated future financial performance, rather than unusual financial effects brought about by a chief executive officer's historical efforts to "drive a dramatic turnaround improvement" in the company's profitability and saleability.
5. The plaintiff further submitted that, given the history of changes in accounting standards, it was not surprising that the clause expressly confirmed what the accounting standards now provided, that is, that abnormal and extraordinary items were to be included. However, generally the words of a contract should be interpreted in a way which gives them an effect, rather than a way in which makes them redundant; this is not an invariable rule, for example, it may appear that the words have been included out of abundant caution: AFC Holdings Pty Ltd v Shiprock Holdings Pty Ltd [2010] NSWSC 985; (2010) 15 BPR 28,199 at [13] (per Ball J), approved in XL Insurance Co SE v BNY Trust Company of Australia Limited [2019] NSWCA 215 at [72] (per Gleeson JA, Bell P and Emmett AJA agreeing). According to the history of accounting standards as recited by Mr Meredith, the change in accounting standards occurred more than a decade before the Equityholders Agreement was executed. Viewed objectively, the parties would not have thought it necessary to re-state what had been the position for so long. That is, the words were not included out of abundant caution.
6. Of course, the meaning of the contract is determined objectively, by reference to what a reasonable person would have understood the contract to mean having regard not only to the text of the document but to the surrounding circumstances known to the parties and the purpose and object of the transaction: Pacific Carriers Ltd v BNP Paribas (2004) 218 CLR 451; [2004] HCA 35 at [22] (per Gleeson CJ, Gummow, Hayne, Callinan and Heydon JJ). Those circumstances included that, while APG's audited financial statements no longer disclosed abnormal and extraordinary items, APG continued to adjust its earnings results when reporting its financial results in other contexts, including to the board and to its bank. Whilst Mr Halkett did not give evidence, I infer from the nature of his role that he was familiar with this management practice. At the time when the Equityholders Agreement was executed, a reasonable person would have understood the phrase "and after accounting for all abnormal or extraordinary items" to identify another occasion on which APG's reported earnings may be adjusted in this way.
7. The definition of EBIT requires the parties to take two steps. First, the parties must identify EBIT "as determined using generally accepted accounting principles consistently with how principles have been applied in prior years for APG". "Generally accepted accounting principles" is not defined in the Equityholders Agreement. Generally accepted accounting principles has been described as an undefined term in Australia: Brand v Digi-Tech (Australia) Ltd [2002] NSWSC 416 at [1212] (per Einstein J).
8. APG was obliged to ensure that the accounts and financial reports of the trust and the company were prepared in accordance with the Accounting Standards and audited: clause 6.5, Equityholders Agreement. Accounting Standards was defined (clause 1.1) as: Accounting Standards means the accounting standards approved under the Corporations Act and the requirements of that law about the preparation and content of accounts, as applicable to the Company and, where applicable, SFG.
9. As such, the first step calls for an examination of the company's accounts for the relevant years, including the notes to those accounts, to ascertain how generally accepted accounting principles have been applied by the company.
10. The definition then calls for a second step - indicated by the word "and" - being to take EBIT as identified by the first step and then, "after accounting for all abnormal or extraordinary items," arrive at EBIT as defined. The definition requires the parties to do something in order to account for such items; it is only "after" having taken this second step that EBIT is revealed for each reporting period, of which an average is taken and to which a multiple is applied and from which Net Debt is deducted.
11. Whilst I accept that "accounting for" something may have the consequence that it is included, I do not consider that the ordinary meaning of the phrase has that unvarying result. The verb can have more than one meaning depending on the context in which it is used: R v Francipane (Unreported, Supreme Court of New South Wales Court of Criminal Appeal, 23 December 1998) (per Sperling J, McInerney J agreeing). The best approach to the question of what these words mean in their context may be to consider the situation as it exists when the time comes for the action to be taken (in that case, to order a real estate agent to "account for" profits to their principal): Kehoe v Porter; Ex parte Porter [1957 St R Qd 480 at 491 (per Hanger J).
12. Here, the time for the action to be taken is when, either, the Existing Equityholders calculate Fair Market Value for the purposes of acquiring the plaintiff's securities, or when the board issues new equity to Equityholders or third parties for the purpose of raising additional working capital. In the latter scenario, at least, the price of the securities will need to be commercially attractive in order for Equityholders or third parties to take up the offer of new equity, and thus make funds available to APG for additional working capital. Equityholders and third parties will be unlikely to acquire new equity if Fair Market Value calculated in accordance with the schedule does not meet the description implicit in the defined term.
13. In the context in which this phrase is used in the definition of EBIT, I consider that "accounting for" abnormal or extraordinary items means that such items must be considered and, if appropriate, allowance made which may result in the item being included, excluded or an adjustment made. To what end? So that EBIT used in the formula to calculate enterprise value is reflective of underlying and ongoing business operations, undistorted by material, non-recurring revenue or expense items.
14. The experts agreed that the accounting impacts on reported EBIT of the sale in the 2020 year, and the re-purchase in 2021, of APG's "FX Hedge Book", and the receipt of JobKeeper contributions from the Federal Government, could reasonably be considered abnormal or extraordinary. The experts also agreed that the appropriate accounting treatment for the one-off foreign exchange gain was to exclude it from EBIT.

Accounting for JobKeeper

1. The experts agreed that the receipt of JobKeeper contributions from the Federal Government could reasonably be considered abnormal or extraordinary. The experts did not agree, however, on the appropriate treatment for JobKeeper receipts, this being the second error alleged by the plaintiff. Specifically, the plaintiff contended: … if the JobKeeper Item was an abnormal or extraordinary item, properly accounting for it in accordance with Schedule 1 to the Agreement did not permit its exclusion from the calculation of earnings in circumstances where it operated by way of counter-balance to the adverse impact of COVID-19 on the revenues of the business.
2. Alternatively, the plaintiff contended that the defendants should not have excluded JobKeeper payments without also including the level of business revenue absent COVID-19. This alternative argument fell away, where the experts agreed that abnormal or extraordinary items could only relate to revenue or expense items that had already been recorded within the financial records used to prepare financial statements. It was not appropriate to make further adjustments to try and accurately reflect the 'counter factual,' that is, how APG's business would have performed without COVID-19. For example, it was not possible to include sales that might have been, but were not achieved, because of an event like the COVID-19 pandemic.
3. Returning to the plaintiff's primary contention, whether the requirements of Schedule 1 rendered it impermissible to exclude JobKeeper from the calculation of earnings calls for an examination of the terms of the Equityholders Agreement. As already observed, Schedule 1 requires EBIT for the relevant earning periods to be gathered and adjusted, including "after accounting for all abnormal or extraordinary items". This required the Existing Equityholders to consider such items and, if appropriate, make an allowance for the item which may result in the item being included, excluded or an adjustment made. The task involves, by its nature, the exercise of judgement.
4. The Equityholders Agreement did not permit the Existing Equityholders to undertake this task unconstrained. In doing so, the Existing Equityholders were obliged to act in good faith and to perform their obligations acting reasonably: clause 2.2. "Acting reasonably" has an important temporal aspect, focussing attention on the parties' conduct at the time: Sugar Australia Pty Ltd v Lendlease Services Pty Ltd [2015] VSCA 98 at [142] (per Kaye JA, Osborn and Ferguson JJA agreeing on this issue). Further, the phrase "acting reasonably" also imports the notion of an objective standard of conduct. That is, the defendants must have been acting reasonably, viewed objectively, having regard to the information and facts then known, or which reasonably ought to have been known to them at the time: Sugar Australia at [144]. The Fair Market Value calculated by the Existing Equityholders in good faith and acting reasonably is what the plaintiff was entitled to receive under the contract: Walton v Illawarra [2011] NSWSC 1188 at [39]-[42] (per McDougall J); Republic of Turkey v Mackie Pty Ltd [2019] VSC 103 at [75] (per Bell J).
5. The plaintiff does not allege that the defendants breached the Equityholders Agreement. Specifically, the plaintiff does not allege that the defendants did not act in good faith or reasonably. As I read the pleading (reproduced at [69]), the contention is simply that the defendants' accounting treatment was wrong. Essentially, the plaintiff is asking the Court to ensure a standard of contractual performance not required by the contract, and in the absence of any suggestion of breach. The Court's power to grant such relief is not obvious.
6. Mr Martin calculated Fair Market Value. He is a chartered accountant and intimately familiar with APG's business operations over the relevant period. He swore three affidavits and was not required for cross examination. The plaintiff submitted that he was not required to cross examine Mr Martin, when his explanation of what he did was minimal. The correct position is that the plaintiff never called into question the reasonableness of Mr Martin's calculation, but simply asserted that, as a matter of construction of the Equityholders Agreement or, perhaps, the application of accounting principles, the defendants' adjustments for abnormal or extraordinary items was impermissible. It is not for the Court to determine the 'correct' accounting treatment for JobKeeper payments and replace Mr Martin's judgement with its own, given the terms of the contract and in the absence of any pleaded allegation that Mr Martin failed to perform the task in conformity with the standard of performance prescribed by that contract.
7. If I am wrong about this, then the expert evidence indicated that reasonable minds may differ as to whether the appropriate accounting treatment was to include or exclude JobKeeper payments. Mr Meredith was of the view the extraordinary event which may give rise to extraordinary items was the COVID-19 pandemic, not JobKeeper payments. It was incorrect to analyse JobKeeper payments in isolation from the broader effects of COVID-19 - including any impact on sales and margin - to determine whether the overall impact of COVID-19 was a loss or a gain. Even with the receipt of JobKeeper, APG's reported EBIT dropped from the 2018 to 2021 financial years. Any adjustment for an extraordinary item should be to 'add back' the overall impact on reported EBIT that occurred as a result of the pandemic. That is, the adjustment would likely have the effect of increasing the underlying EBIT in the calculation of Fair Market Value. While it was not possible to calculate the impact of APG's withdrawal from Myer stores on reported EBIT in the 2020 and 2021 financial years, nor calculate the net impact COVID-19 had on reported EBIT in those years because of insufficient information, Mr Meredith considered that the likely net impact of the COVID-19 pandemic would have been negative. In his view, adjusting for JobKeeper in isolation was not an appropriate accounting treatment and would produce a perverse result.
8. Mr Ross disagreed that accounting for abnormal or extraordinary items involved the approach described by Mr Meredith. That is, it was not necessary to identify an extraordinary event, then identify the event's impact overall, and then make an adjustment. The receipt of JobKeeper payments was itself an extraordinary item for which an adjustment could be made. Mr Ross was also of the view that it was by no means clear that COVID-19 had an overall negative effect on the EBIT of APG's business for, essentially, three reasons. First, available financial information for APG's business included significant revenue growth in its online business during the 2020 and 2021 years. Second, a large portion of the reduced EBIT was unrelated to the pandemic. The decision to close the Myer concession stores accounted for 30% of the change in EBIT in 2020 and 50% of the change in EBIT in 2021. Indeed, APG may well have become entitled to receive JobKeeper due to its own decision to terminate its relationship with Myer. Third, having reviewed APG's financial results from 2016 on, the results in 2020 and 2021 were within the "normal" range of historical EBIT for the APG business.
9. The plaintiff accepted that the definition of EBIT called for a judgement to be made as to how an abnormal or extraordinary item should be treated. The plaintiff also accepted that it would be an incredibly difficult exercise to reconstruct APG's accounts and make adjustments for all the effects of COVID-19. Given that the purpose of JobKeeper was to replace revenue so that business could continue as regularly as possible, the appropriate adjustment was to leave JobKeeper revenue in the financial statements, that is, make no adjustment. The fact that no adjustment could be made for sales which might have been made in the absence of COVID-19 was said to support this conclusion. The allowance made by the defendants - excluding only the portion of JobKeeper payments which exceeded the cost of staff who were not working - was said to be insufficient, as it did not take into account all the effects of COVID-19 on the business.
10. The defendants submitted that the idea that the COVID‑19 pandemic caused a downturn in sales for this business was not an uncontroversial proposition, nor obvious from any of the financial material. JobKeeper provided something of a windfall for this business. Mr Martin had explained the adjustment made in respect of JobKeeper payments, to allow for the fact that some of JobKeeper payments went to employees while the rest went into the bottom line of the business as a part of profit. Nor was it clear that the COVID‑19 pandemic could be considered an extraordinary event when the buyback notice was prepared, as it had then occupied three financial years' of business activity and was "the new normal." What was extraordinary, in the sense of being outside the ordinary course of business and unlikely to occur, was the massive financial contribution being made by the federal government, based on the number of employees a business had. That was announced as being a temporary measure. The reasonable view could have been taken at the time that it qualified as an extraordinary event or transaction in its own right.
11. The purpose of the JobKeeper scheme was two-fold, as analysed in Swiss Re International Se v LCA Marrickville Pty Ltd (Second COVID-19 insurance test cases) [2021] FCA 1206; (2021) 394 ALR 461. After reviewing the legislation and extrinsic material, Jagot J concluded at [397]: … The scheme was intended to assist businesses and workers. And it assisted workers by assisting businesses to pay the workers' wages. In so doing the scheme both provided support to businesses and saved the businesses money in the form of wages that the business otherwise would have to pay. The scheme reduced losses of eligible businesses by subsidising their wages bill. While the Commonwealth may not have subjectively characterised this as compensatory scheme it had the effect and inferred purpose of compensating eligible business for losses that would otherwise be suffered - the cost of wages while revenue was suppressed by COVID-19 and all of its consequences … Not challenged on appeal: LCA Marrickville Pty Ltd v Swiss Re International Se [2022] FCAFC 17; (2022) 290 FCR 435 at [452]-[453].
12. That is, JobKeeper payments benefited businesses in two ways: by paying the wages of employees who were not immediately needed, or able, to work in the business; and providing general financial support to the business. In the case of APG's business, it is perhaps simplistic to describe the net surplus received as a 'windfall'; that surplus supported APG's business more generally, where it is apparent that overall revenue fell. Similarly, it may be somewhat simplistic to say that APG's drop in EBIT was unrelated to COVID-19. Whilst the decision to close the Myer concession stores was unrelated to the pandemic, the inability to raise replacement revenue was affected by the pandemic.
13. The impact of the COVID-19 pandemic on APG's business is not straightforward and neither expert was able to give a definitive analysis. The defendants pointed to EBIT generated by different sales channels. The figures were (in $m): Sales channel 2017 2018 2019 2020 2021 Free standing stores 3.268 4.759 9.228 1.356 3.868 David Jones 8.047 8.952 13.678 11.426 14.810 Myer 8.514 9.084 9.593 2.970 0 E-commerce 4.593 3.840 6.219 13.861 14.386 Total 24.422 26.635 38.718 29.613 33.064 Change on prior year 2.213 12.083 (9.105) 3.451

1. I note that the 2019 financial year had a substantial increase in EBIT, without which the reductions in EBIT for the following years would have appeared unremarkable. The EBIT generated by free-standing stores in 2020 was substantially lower, where these stores were not closed until the third quarter of that year. The closure of Myer concession stores was considered by Mr Ross. The increase in online sales is apparent, albeit much of this may also have preceded the COVID-19 lockdowns. It is a complex picture.
2. APG's EBIT for available years, including adjustments to apply accounting principles consistently and excluding the FX hedge book, was as follows (in $m): 2016 2017 2018 2019 2020 2021 Adjusted EBIT (3.357) 5.461 13.523 14.762 7.581 10.131 JobKeeper (4.537) (9.702) EBIT after Jobkeeper adjustment (3.357) 5.461 13.523 14.762 3.044 0.429 Impact of closure of Myer stores (per Ross) (3.506) (8.415)

1. One way of summarising this data would be to say that APG's EBIT in the 2020 and 2021 financial years was in line with historical performance but for the effect of the closure of Myer concession stores (see last row). Another way of summarising this data would be to say that APG's EBIT in the 2020 and 2021 financial years was materially down due to the COVID-19 pandemic but is more in line with historical trends if no adjustment is made for the JobKeeper payments (see first row). The experts do not agree.
2. Whilst some accounting matters may have a single correct treatment, abnormal or extraordinary items do not appear to be one of them. Indeed, as I understand Mr Meredith's recitation of the history of accounting standards, it was the diverse accounting treatment for abnormal or extraordinary items when led to the accounting standards ultimately prohibiting such items being separately accounted for in audited financial statements.
3. The experts agreed that the decision to treat items as abnormal or extraordinary was subjective. They disagreed as to the appropriate accounting treatment for JobKeeper payments. Both were highly experienced and had good reasons to support their professional judgment. As Mr Ross noted, major corporations have accounted for JobKeeper differently. Some companies can, and do, treat the receipt of JobKeeper payments as exceptional and therefore, in his opinion, abnormal or extraordinary. Qantas elected to make no adjustment for the receipt of JobKeeper payments whilst AUB Ltd (another ASX 200 listed company) removed the JobKeeper payments when deriving "Underlying EBIT." Mr Ross observed that businesses have significant scope for judgment as to what they consider abnormal or extraordinary items.
4. Here, when accounting for extraordinary or abnormal items, consideration was given to whether an adjustment should be made for JobKeeper payments. An adjustment was made, being to exclude a portion of the JobKeeper payments, to the extent that those payments exceeded APG's staff costs. I am not satisfied that the accounting treatment was, on the balance of probabilities, wrong. The plaintiff has not discharged his onus.

Net Debt

1. The third suggested error in the calculation was said to be that Net Debt should have been calculated as at 31 July 2021, said to be a point in time consistent with the calculation of EBIT. The definition of Net Debt did not specify the point in time at which financial indebtedness and cash on hand are to be determined.
2. Mr Meredith and Mr Ross agreed that, when conducting a valuation, valuers seek to adopt financial information derived consistently on a temporal basis. As Mr Ross explained, when valuing shares using a valuation methodology which begins when valuing a business and then deducts debt, valuers will seek to derive the value of the business at the transaction date and the valuation of the debt in the relevant entity at that date. The commercial and practical reason for this approach is that, if the value of the business and its associated debt is determined at a date significantly removed from the transaction date, the resulting transaction price will not reflect the substance of the transaction.
3. Focusing on this contract, it is not clear to me how identifying Net Debt as at 31 July 2021 achieves temporal consistency with Relevant EBIT, where Relevant EBIT is an average over varying periods, depending whether the calculation is to be done before or after the second anniversary of the contract, and more than six months through a financial year. Depending precisely when a calculation of Fair Market Value has to be undertaken, the Relevant EBIT is the average earnings over a variety of timeframes. Relevant EBIT bears no ready correlation with the closing date of the last financial year absorbed into that calculation. Further, where the formula requires the financial results for a period to be pro-rated in some circumstances "to make a full year [to] be included in the calculation," it is not easy to see how the end-date for this extrapolated period would work; this date may be in the future and it will not be possible to determine Net Debt at such a date.
4. The method of calculating Fair Market Value is an average and does not suggest that 30 June 2021 is the date of which Net Debt should be calculated, any more than it suggests that the correct date is 30 June 2020 or 30 June 2019. Rather, I consider that the correct date for calculation of Net Debt is the date closest in time to the acquisition of the shares, being either when a notice is issued under clause 9.1 of the Equityholders Agreement or when the board issues new equity under clause 6.1(b). The longer the gap between the calculation of Net Debt and the buyback/new equity issue, the greater the potential for the market value of the securities to depart from that calculated by the formula in Schedule 1. Any significant gap between Fair Market Value as calculated by the formula and concept implicit in that defined term will undermine the operation of both clauses, including the defendants' ability to raise additional working capital. No adjustment to Fair Market Value need be made on this account.

ORDERS

1. For these reasons, I make the following orders: 1. Dismiss the Summons filed on 31 May 2022 with costs. 2. Notify any errors or omissions within seven days.

DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 06 September 2023