Leviston v PQ Management Pty Ltd

Which methodology ought to have been used? 11 As mentioned above, the key challenge to the outcome of the valuation process conducted by Mr Ashby related to the methodology used to calculate EBITDA in section five of his report, which concerned the second limb of the valuation order. From that, Mr Ashby's task was to perform a calculation of 2.2 times the EBITDA of TWA as at 30 June 2020. However, he was not given any explicit guidance as to the appropriate EBITDA figure to input into that calculation, other than a note in parentheses in the relevant part of the valuation order that EBITDA meant "the earnings of Treated Waste Agencies Pty Ltd before interest, taxes, depreciation and amortization calculated in accordance with the Australian Accounting Standards". 12 As he went on to acknowledge in his report, neither the term "EBITDA" nor the phrase "earnings before interest, tax, depreciation and amortisation" was, to his knowledge, defined in any Australian Accounting Standards: paragraph [5.3.1(a)]. In cross-examination, he further identified that he was not specifically aware of any definition of "earnings" in Australian Accounting Standards. This led him to make a critical decision that one-off and non-recurring items could be taken to fall within the meaning of "earnings" for accounting purposes, since there was "no occasion for normalisation under Australian Accounting Standards". Those one-off and non-recurring items were therefore captured in Mr Ashby's concept of "EBITDA in accordance with Australian Accounting Standards", which has been described in these reasons by the shorthand label "accounting EBITDA". 13 In calculating that accounting EBITDA, Mr Ashby also included adjustments for rent and hire of plant and equipment, in reliance upon the Australian Accounting Standards Board standard "AASB 16 Leases". As he explained in his report, TWA's financial statements (which formed the starting point for the calculation of accounting EBITDA) included rent or lease expenses which, in his view, would not have been included in TWA's profit and loss statement had the financial statements been prepared in accordance with AASB 16 Leases: paragraphs [5.2.3(c)]. It was therefore appropriate for the expenses to be added back in and thereby negated, so as to ensure that EBITDA was determined in accordance with the applicable Australian Accounting Standards. 14 The consequence of all this was that the accounting EBITDA was not normalised, and included adjustments on account of AASB 16 Leases, such that was determined to be $873,231. By contrast, the EBITDA determined and used in section four of Mr Ashby's report in relation to the first limb of the valuation order (described in these reasons as the "valuation EBITDA") was $480,000. This gives a difference of almost $400,000. 15 The most important difference between the valuation EBITDA and the accounting EBITDA was that the former was normalised. This process of normalisation produced a sizeable disparity between the figures because TWA's earnings in the financial year ending 30 June 2020, which Mr Ashby described in his report as a data point on which he placed "stronger reliance" in the overall determination of the valuation EBITDA: paragraph [4.9.1(b)]: were affected by certain extraordinary receipts. In particular, TWA had received: (a) a COVID-19 cashflow boost from the Australian Taxation Office of $50,000; (b) a Job Keeper Subsidy of $132,000; and (c) abnormal gross profits of $150,000. 16 The valuation EBITDA also did not include the additional rent and hire expenses that had been added back into the accounting EBITDA pursuant to AASB 16 Leases, which totalled approximately $59,500. As Mr Ashby clarified in cross-examination, those expenses were still outgoings to the business and so would not be added back into EBITDA in the usual normalisation process. 17 The importance of the distinction between the valuation EBITDA and the accounting EBITDA in this case was revealed most clearly when Mr Ashby acknowledged in cross-examination that the latter had not been determined for the purpose of carrying out a valuation, strictly speaking. Instead, it had been determined by reference to accounting standards for the purpose of performing a simple calculation. The former was, by contrast, clearly and properly used to perform a valuation exercise as a part of the CFME method. 18 The question, then, is whether Mr Ashby was right to conduct a true valuation exercise for the purpose of the first limb of the valuation order whilst performing a mere calculation by reference to accounting principles for the purpose of the second limb. The answer to that question requires the valuation order to be considered more closely, in conjunction with the principal reasons. 19 Although the question has historically been attended by some controversy, the weight of contemporary authority supports the view that an order of the Court is to be read and understood in the context of the reasons for which it was made, even if the order is apparently unambiguous: see Australian Energy Ltd v Lennard Oil NL (No 2) [1988] 2 Qd R 230, 232 per Andrews CJ (with whom Kelly SPJ agreed); Yates Property Corporation Pty Ltd v Boland (1998) 89 FCR 78, 78 - 79 per Drummond J (with whom Sundberg and Finkelstein JJ agreed); Athens v Randwick City Council (2005) 64 NSWLR 58, 70 [28] - [29] per Hodgson JA (with whom Tobias JA agreed), 78 - 80 [129] - [140] per Santow JA (with whom Tobias JA agreed); Hamersley Iron Pty Ltd v National Competition Council (2008) 247 ALR 385, 398 - 399 [83] - [85] per Weinberg J; AVS Group of Companies Pty Ltd v Commissioner of Police (2010) 78 NSWLR 302, 322 - 323 [98] - [104] per Campbell JA (with whom Handley AJA agreed); Oswal v Apache Corporation (No 4) [2014] FCA 1291 [51] per Gilmour J; Smith v Comcare (2014) 64 AAR 205, 218 [65] per Robertson J; Australian Competition and Consumer Commission v ACN 117 372 915 Pty Limited (in liq) (formerly Advanced Medical Institute Pty Limited) [2015] FCA 1441 [53] per Moshinsky J; Hancock Prospecting Pty Ltd v Wright Prospecting Pty Ltd [2018] WASCA 185 [58] per Mazza, Mitchell and Beech JJA; Lim v Comcare (2019) 165 ALD 217, 226 - 227 [40] - [41] per McKerracher, Markovic and Snaden JJ; Doyle v Commissioner of Police (No 2) [2020] NSWCA 34 [58] per Leeming JA; Ganesh v National Australia Bank Ltd [2021] VSCA 45 [74] per McLeish, Sifris and Kennedy JJA; Johnson v CUB Pty Ltd (2021) 287 FCR 520, 532 - 533 [50] per Bromwich and O'Callaghan JJ. 20 In the present case, the approach ultimately adopted by Mr Ashby, of employing the valuation EBITDA for the purposes of the first limb of the valuation order and the accounting EBITDA for the purposes of the second limb, was entirely fair. His report was exceptionally helpful in this regard, and no criticism can be made of his decision to attend to the task required of him in this manner. It was apparent that he recognised the imprecision in the wording of the valuation order, and this might conceivably be taken to indicate some ambiguity in its terms. When one has regard to the principal reasons, however, it becomes more apparent that the intention behind the valuation order was for a true valuation exercise to be conducted under both limbs. The second limb was not intended to involve a simple calculation on accounting principles. Rather, it was intended, essentially, to be a baseline valuation, which would set a minimum price for Mr Leviston's 30% shareholding based on a capitalisation multiple of 2.2 in the event that, for whatever reason, that capitalisation multiple used for the purposes of the first limb of the valuation order was found to be lower. For the second limb of the valuation order to perform that intended function effectively, it was appropriate for the same valuation EBITDA to be used across both limbs. 21 Certain paragraphs of the principal reasons make apparent that the intention was for Mr Leviston's 30% shareholding to be valued in this way, and not priced by reference in part to a valuation and in part to a calculation on accounting principles. Paragraphs [155] to [163] of the principal reasons speak consistently of the "valuing" of the shares, in the context of ascertaining the appropriate relief for the statutory oppression in this case, and of the "valuation" and the "valuation task" that was to be conducted. The reasons then go on to address the "method of valuation" from paragraph [164]. The conclusion ultimately drawn in that section is expressed at paragraph [168] as being that: … the valuation of Mr Leviston's shareholding in TWA should roughly follow the price for which [the shares] would have been transferred if they had been sold under the Shareholders Agreement with the valuation occurring on 30 June 2020. In that respect Mr Leviston's 30% shareholding (being 60,901 fully paid ordinary shares) is to be valued at the greater of the amount equal to 30% of the market value of all of the shares in TWA or 30% of 2.2 times EBITDA. 22 It should be noted that this passage is very similar to the final terms of the valuation order, but does not make mention of Australian Accounting Standards. The same can be said of paragraph [174], which states as follows: Otherwise, there should be an order that PQ Management acquire Mr Leviston's 30% shareholding (being 60,901 fully paid ordinary shares) in TWA at a price being the greater of the amount equal to 30% of the market value of all of the shares in TWA or 30% of 2.2 times EBITDA, such values to be determined as at 30 June 2020. 23 The conclusion drawn at paragraph [168] also directs attention to the terms of the Shareholders Agreement, which were set out fairly extensively at earlier points in the principal reasons. Most relevantly, cl 15 of that agreement prescribed an approach for the valuation of shares for the purposes of certain other provisions in the agreement. It provided: 15. VALUATION 15.1 Valuer The value of a Shareholder's Shares for the purposes of Clauses 8 and 14 shall be deemed to be the relevant proportion of the market value of all the Shares in the Company as determined by an independent party agreed upon by the Shareholders, or failing such agreement determined by an appropriately qualified professional nominated by the President for the time being of the Queensland Law Society Inc. at the request of the Company or any Shareholder (Valuer) using proper Accounting Standards. The parties agree that such valuation must not be less than 2.2 times the operating net profit of the Company before tax (including management remuneration and superannuation) and that this is the minimum potential value for the purposes of Clauses 8 and 14. 15.2 Shareholder Co-Operation Each of the Shareholders will co-operate with, and will collectively ensure that the Company and its accountants cooperate with the Valuer in providing all necessary information to enable such valuation to be made. The valuation will be made in accordance with currently accepted accounting and valuation principles and the cost of the valuation shall be borne by the Defaulting Shareholder. 24 The basic structure of the valuation order can be perceived in cl 15.1, which required that the value of the shares be determined as "the relevant proportion of the market value of all the Shares in the Company" (the first limb), but then specifies that this valuation "must not be less than 2.2 times the operating net profit of the Company before tax (including management remuneration and superannuation)" (the second limb). It is apparent from cl 15.2 that the parties' intention was that the valuation would be performed in accordance with, inter alia, currently accepted "valuation principles". It was apparent from his evidence at the hearing that Mr Ashby considered the normalised EBITDA to be most appropriate for the task of valuation. 25 For the purpose of crafting the appropriate relief for oppression in these proceedings, certain adjustments were made to the methodology prescribed by cl 15 on the basis that, as noted in paragraph [167] of the principal reasons, "the agreement was poorly drafted and it would only be productive of additional disputation were it to become the foundation of any court ordered share purchase". However, it may be that the language ultimately used in the valuation order still drew too heavily upon the infelicitous drafting of the Shareholders Agreement. In particular, when the term "EBITDA" was included in the second limb of the order, the definition of that term from the Shareholders Agreement (with some minor changes) was also inserted there in parentheses. That definition provided that EBITDA was the "earnings of the Company before interest, taxes, depreciation and amortization calculated in accordance with the Accounting Standards". It is on this basis that "Australian Accounting Standards" came to be mentioned in the valuation order, despite the principal reasons not otherwise having suggested that accounting principles would have any bearing on the valuation of Mr Leviston's 30% shareholding. 26 It follows that, while Mr Ashby should not be criticised for the way he approached the task required of him, the methodology he employed for the purpose of the second limb of the valuation order was incorrect. He ought to have used the valuation EBITDA derived in relation to the first limb for that purpose, rather than the accounting EBITDA. 27 The valuation EBITDA identified by Mr Ashby was $480,000. Multiplying this figure by 2.2 and taking 30% of the result gives $316,800. As that amount of $316,800 is less than the amount of $479,029 calculated under the first limb of the valuation order, it follows that PQ Management is prima facie required to pay $479,029 to acquire Mr Leviston's 30% shareholding in TWA, subject to the adjustments contemplated by the other orders in the principal reasons.

Was too much reliance placed on the normalised EBITDA of TWA in the financial year ending 30 June 2020? 28 The conclusion drawn above in respect of the first challenge to Mr Ashby's report directs attention to the valuation EBITDA of $480,000 as a key component of the prevailing first limb of the valuation order. This makes it necessary to consider the second challenge to the report, which squarely concerned that figure. Mr Lyons, for the defendants, submitted that the Court should, using the same data as is set out in Mr Ashby's report, assess the valuation EBITDA (and, in turn, 30% of the value of all shares in TWA) at a lower amount. He contended that Mr Ashby had fallen into error in the course of determining the valuation EBITDA by relying only on the normalised EBITDA of TWA in the financial year ending 30 June 2020 to arrive at the figure of $480,000. 29 As mentioned previously, the valuation EBITDA represented TWA's future maintainable earnings. In his report, Mr Ashby stated that, in assessing that figure, he had regarded the four matters which were listed at paragraph [4.9.1] as follows: (a) his calculation of TWA's normalised EBITDA from FY16 to FY20; (b) a stronger reliance on FY20 normalised EBITDA as the most recent indication of financial performance, noting the stronger financial performance in years after FY17 following a change in the ownership of TWA; (c) his analysis of trends in TWA's customer revenue and concentration; and (d) economic and industry analysis as at 30 June 2020. 30 It was put to Mr Ashby in cross-examination that he had not in fact had any, or any adequate, regard to the matters listed in (a), (c) and (d) because the figure of $480,000 on which he settled was very close to the "FY20 normalised EBITDA" referred to in (b), which was $479,885. Mr Lyons submitted that Mr Ashby ought to have had more regard to the normalised EBITDA figures for the four financial years ending 30 June 2016 through to 30 June 2019, and that the decision to place foremost weight on the data for the financial year ending 30 June 2020 had produced too optimistic an outlook, particularly when regard was had to the risks associated with the COVID-19 pandemic and general trends in the plumbing industry. The ultimate contention was that Mr Ashby should have taken a weighted average of the figures for the three most recent years, with the normalised EBITDA for the financial year ending 30 June 2020 being weighted at 60% and the two preceding years weighted at 20% each. 31 This contention should be rejected. It was sufficiently apparent from Mr Ashby's report, and his evidence in cross-examination, that he did take into account all of the matters listed at paragraph [4.9.1] of his report. The fact that he preferred to attribute most weight to one particular data point does not reveal any error. As Mr Ashby explained in evidence, and I accept, whilst he took into account the figures for each of the five relevant financial years, he placed greater reliance on the normalised EBITDA from the most recent income year because that is what a willing but not anxious buyer and seller would do. In particular, as he reasoned, a seller who had recently generated a very high EBITDA relative to previous years would need to be incentivised to part with the business, unless they were pessimistic about their ability to generate the same EBITDA in the future. In this case, in Mr Ashby's judgment, it would not be unreasonable for a seller to believe that the business could replicate its results in the financial year ending 30 June 2020, such that there was no basis upon which to apply a discount. It followed that the normalised EBITDA of TWA in the financial year ending 30 June 2020 was the data point that would necessarily carry the most weight. 32 I also accept Mr Ashby's explanation as to why the figure of $480,000 was not made lower by the risks associated with COVID-19 and by general industry trends. As to the former, he made clear in cross-examination that the effects of COVID-19 had already been accounted for in his analysis: TWA's financial results had actually improved with the onset of the pandemic, and so his calculation of the normalised EBITDA of the company for the financial year ending 30 June 2020 included a negative adjustment to exclude abnormal gross profits. As to the latter, Mr Ashby simply noted that he had accorded little weight to the data regarding general industry performance because it was at odds with the demonstrated results of the specific business the subject of the valuation exercise. There is no reason to regard that approach as inappropriate. 33 On a fair reading of Mr Ashby's report, it is apparent that he made an assessment of, and considered, the normalised EBITDA of TWA in each of the five years leading up to the relevant date for the valuation. He also had regard to other more general data, which he considered might conceivably have a bearing on his conclusion. He ultimately found, however, that most weight should be given to the results of the business in the financial year ending 30 June 2020, as represented by its normalised EBITDA for that year, and this conclusion has not been shown to have involved any error. It is therefore appropriate to use the valuation EBITDA of $480,000 determined by him as part of the CFME method for the purpose of performing the task required by the first limb of the valuation order.

Should a lower capitalisation multiple have been used? 34 Finally, Mr Lyons contested Mr Ashby's selection of a capitalisation multiple of 3.00 to use as part of the CFME method in connection with the first limb of the valuation order. That multiple was chosen as the midpoint of a range of 2.75 to 3.25, which was determined by Mr Ashby by reference to a number of data points. The choice of the midpoint was explained at paragraph [4.2.2] of the report as follows: The midpoint value is simply the midpoint between the high and low ends of the range and is not necessarily any more accurate than any other value in the valuation range. However, to the extent a single market value may be required for the Proceeding, I would adopt the midpoint for that purpose in the absence of any better guide. 35 Mr Ashby later explained at paragraph [4.10.1] of his report that he had constructed the range of 2.75 to 3.25 having regard to: (a) an analysis of the earnings multiples implied by PQ Management's acquisition of 70% of TWA's equity effective 1 August 2017; (b) an analysis of implied earnings multiples from comparable listed company trading data as at 30 June 2020; (c) an analysis of multiples paid for the acquisition of comparable companies and businesses for the five-year period up to 30 June 2020, which tended to indicate lower multiples in general (relative to the comparable listed companies) and for a number of private company acquisitions included in the dataset; and (d) consideration of the size of TWA and the growth and risk factors relating to the future maintainable earnings figure that he had assessed. 36 Mr Lyons advanced two main reasons in support of the defendants' contention that a lower multiple of 2.75 should have been adopted from this analysis. 37 It was first submitted that Mr Ashby had erred by taking into account as a relevant data point a multiple of 3.1, which was implied from the transaction by which PQ Management had acquired 70% of the equity of TWA (as per point (a), above). This multiple was overstated, so it was said, because it not only reflected the consideration that PQ Management was willing to provide for the shares in TWA, but also reflected some additional amount that had been paid for a contractual arrangement by which Mr Leviston would remain as a licensed nominee in the business for a period of three years. Because the purchase of Mr Leviston's 30% shareholding pursuant to the orders of this Court would not be accompanied by any comparable contractual arrangement, the multiple for that transaction should be something less than 3.1. The suggestion appeared to be that Mr Ashby's choice of 3.00 did not reflect a sufficient reduction. 38 As Mr Ashby said in cross-examination, however, it was not possible to ascertain how much value Mr Leviston's contractual obligation had contributed to the price paid by PQ Management for 70% of the equity in TWA in the sale effective 1 August 2017. In the absence of any concrete information from which to discern the effect of the additional contractual arrangement on the purchase price, if any, there was simply no reason to approach the multiple of 3.1 with any great scepticism. 39 This analysis should be accepted. There is no reason to adjust down the capitalisation multiple of 3.00 chosen by Mr Ashby on account of the fact that the purchase of Mr Leviston's 30% shareholding is not to be accompanied by any comparable contractual arrangement. The suggestion to the contrary relies too heavily on what is, essentially, speculation that the prior purchase of equity in TWA did involve some consideration passing on account of Mr Leviston's ongoing role in the business, and that this fact requires the multiple for the present transaction to be markedly less than 3.1. 40 The second issue was whether the multiple ought to be reduced to take into account the effects of the COVID-19 pandemic. Mr Lyons contended that, in the course of Mr Ashby's analysis of multiples implied by or derived from comparable trading data and transactions (as per points (b) and (c), above), he had not taken into account the risks associated with the pandemic or placed appropriate weight on data points that apparently reflected those risks. 41 However, Mr Ashby observed in the course of his evidence in cross-examination that the analysis of comparable historical data that he had conducted in his report had not been particularly helpful in determining an appropriate capitalisation multiple. He had ultimately placed more reliance on his experience in valuing small-to-medium enterprises in a range of industries in Queensland and elsewhere, and merely considered the historical data in a broad, qualitative sense in the course of exercising his professional judgment. Whilst the comparative sales data provided some assistance, after adjusting for the size of the entities in question and the type of services that they provided, the valuation exercise had essentially required him to consider the growth and risk factors of TWA and the extent of the temporal connection between the collected data and the case at hand. Accordingly, the question as to whether the data accounted for any risks associated with COVID-19 could have little bearing on the overall assessment of the capitalisation multiple. 42 In any event, Mr Ashby emphasised that the risks associated with COVID-19 should not be accounted for in both the capitalisation multiple and in the future maintainable earnings figure, since they would in that way be "double-counted". As he relevantly pointed out, he had already taken into account the financial impact of COVID-19 on TWA by making normalisation adjustments to exclude abnormal gross profit from the company's EBITDA in the financial year ending 30 June 2020, as part of his calculation of the valuation EBITDA. If he reduced the multiple as well, the effect of the pandemic on the business would, improperly, be accounted for twice. That explanation revealed that Mr Ashby had appropriately considered the impact of COVID-19 on the performance of TWA, albeit that he regarded that impact as positive in this case, rather than negative. There was accordingly no need to decrease the multiple. 43 It follows that it is not possible to justify any departure from the capitalisation multiple of 3.00. It is apparent from Mr Ashby's report that he derived that capitalisation multiple having appropriate regard to, amongst other things, TWA's size, access to capital markets, diversification and management capability, relative to comparable businesses: paragraphs [4.10.5] - [4.10.14]. Those matters led him to conclude that the multiple in this case should be at the lower end of the range of multiples for the comparable companies and transactions that he analysed. This conclusion was supported by his analysis of the earnings multiples implied by PQ Management's acquisition of 70% of TWA's equity, effective 1 August 2017. Although he was quite thoroughly cross-examined on these issues, he was unshaken in his opinion and his explanations for his conclusions remain well-founded.

Conclusion 44 Despite the most valiant attempts by Mr Lyons to dislodge Mr Ashby's assessment of 30% of the market value of all of the shares in TWA as at 30 June 2020, the figure of $479,029 on which he settled should be accepted. For the reasons expressed above, that figure should prevail over the figure produced by his calculation of 2.2 times EBITDA in accordance with Australian Accounting Standards. It follows that PQ Management is prima facie required to pay $479,029 to acquire Mr Leviston's 30% shareholding in TWA. 45 This amount must be adjusted in accordance with the other orders in the principal reasons. Specifically, the sum of $169,163.77 must be deducted from it, along with any interest on that sum, calculated from 30 June 2020 on the same basis as interest that is payable pursuant to s 51A of the Federal Court of Australia Act 1976 (Cth) on pre-judgment amounts. The remainder is payable by PQ Management as the purchase price for Mr Leviston's 30% shareholding in TWA. He is entitled to judgment in that amount, together with interest from 30 June 2020, in accordance with the principal reasons. 46 It is therefore appropriate to declare that, for the purposes of the calculations required by order 4 of the Orders of this Court dated 8 July 2022, the price to be paid by PQ Management Pty Ltd for the 30% shareholding (being 60,901 fully paid ordinary shares) of Mr Andrew Troy Leviston in Treated Waste Agencies Pty Ltd is $479,029. 47 The parties should have some time to confer as to the mathematical calculations required to ascertain the precise amount to which the plaintiff is entitled pursuant to orders 4, 5 and 6 of the orders of 8 July 2022. 48 They may also be heard on the question of costs. I certify that the preceding forty-eight (48) numbered paragraphs are a true copy of the Reasons for Judgment of the Honourable Justice Derrington.

Associate: Dated: 22 August 2023 SCHEDULE OF PARTIES QUD 166 of 2020 Defendants Fourth Defendant: TREATED WASTE AGENCIES PTY LTD