50023/00 - LMI AUSTRALASIA PTY LIMITED & ANOR v BAULDERSTONE HORNIBROOK PTY LIMITED & ORS (NO 2)
JUDGMENT
1 In reasons for judgment published on 12 October 2001 ([2001] NSWSC 886), I concluded that heads of agreement entered into on or about 27 June 1997 between the second defendant, Docklands Stadium Consortium Pty Limited ("DSC") and the first plaintiff, LMI Australasia Pty Limited ("LMIA"), had contractual force but that DSC had not breached the contract when it failed to appoint LMIA to be the manager of the Colonial Stadium. There was no breach because, in my judgment, the condition precedent to DSC's contractual obligation to appoint LMIA had not been satisfied. I did find, however, that the first defendant, Baulderstone Hornibrook Pty Limited ("Baulderstone"), was liable to reimburse both LMIA and the second plaintiff, LMI/HHI Limited ("LMI"), for expenses actually and reasonably incurred in connection with the bid process envisaged by the heads of agreement. Two matters were left for further submissions, namely, the date from which interest should run on the sum to be reimbursed (being US$81,902.28) and the question of costs. I heard those submissions on 31 October 2001.
2 Mr Sullivan QC, who on that occasion again appeared for the plaintiffs, informed me that my decision with respect to the "failure to appoint" claim may become the subject of an appeal. He asked, therefore, that I make findings on the issue of damages on the assumption that, contrary to the conclusion I have reached, the "failure to appoint" case was made out, by which I mean that DSC did breach the heads of agreement by failing to ensure that LMIA was appointed manager of the stadium on the basis envisaged by the heads of agreement. Mr Macfarlan QC, who appeared for the defendants, indicated that his clients neither supported nor opposed the application made by Mr Sullivan. Because there are good reasons of practicality in favour of my deciding the issue of damages now, I shall do so before proceeding to deal with the other outstanding issues.
Damages
3 Submissions on the question of damages made in the course of the trial were, at my request, supplemented by further submissions made by both the plaintiffs and the defendants in writing. The plaintiffs' further submissions are dated 7 December 2001 and the defendants' are dated 11 December 2001.
4 It is common ground that a discounted net present value approach is the appropriate one for the determination of damages. This is because the relevant loss is the loss of the opportunity to earn and receive the remuneration envisaged by the heads of agreement. Since both parties approve that method of approach and it accords with my own view of the way in which the question of damages should be dealt with, I shall proceed in that way.
5 The remuneration envisaged by the heads of agreement has two elements. First, there is remuneration in relation to the "pre-opening phase". Under this heading and pursuant to clause 7 of the heads of agreement, LMIA would have been entitled to a payment by DSC of $23,000 per month from 1 March 1998 until the Operation Start Date which was 29 February 2000 - in other words, a total of $552,000, representing $276,000 per year for two years. The remuneration to prevail after the Operation Start Date was defined by clause 8:
"8.1 From the Operation Start Date until the termination of this Agreement the Developer [ie DSC] shall pay LMI [ie LMIA] an Annual Management Fee of Five Hundred Thousand Dollars ($500,000.00) by equal monthly instalments.
8.2 The Annual Management Fee shall be increased in each year during the term of this Agreement in accordance with increasers in the Consumer Price Index (for Victoria) in the previous year."
6 The reference to the term of the agreement is a reference to a term expiring on the twentieth anniversary of the Operation Start Date subject, however, to clause 2.3:
"The term of this Agreement may be extended for three (3) consecutive 5 Year Renewal Period after the expiration of the Initial Term, provided that, at the date of such renewal LMI (ie LMIA] is satisfactorily achieving agreed performance and operational standards."
7 In this context, seven questions arise in relation to the assessment of damages. First, there is a question as to the date as at which damages should be assessed, the candidates being the date of breach and the date of trial. The second question concerns the impact of expenses and outgoings on the income stream. Third, there is a question about the incidence of tax. Fourth, it is necessary to decide the discount rate. Fifth, there is a question whether elements of uncertainty about the continuation of the relationship for the full initial term of twenty years warrants some additional discount. Sixth, there is a question about the assumptions that should be made about extension of the initial twenty year term pursuant to clause 2.3. The seventh question concerns the rate of inflation that should be assumed for the purposes of the CPI increases provided for in clause 8.2.
8 On the first issue, the general rule is that damages for breach of contract are assessed at the date of breach, unless some later date is judged more apt to ensure that the injured plaintiff will receive fair compensation for the wrong suffered: see, for example, Johnson v Perez (1988) 166 CLR 351 at 367, 371 and 380; Hungerfords v Walker (1989) 171 CLR 125 at 146. It was submitted by Mr Sullivan for the plaintiffs that the general rule should be departed from in this case and that damages should be assessed as at the date of trial rather than the date of breach, so that there is built into the assessment the benefit of actual experience in relation to certain risks or imponderables which prevailed at the date of breach. For reasons outlined in submissions advanced on behalf of the defendants, however, I am not comfortable with this approach. No advantage is, I think, to be derived from considering subsequent events which might be thought relevant to an appreciation of risks or uncertainties prevailing at the time of breach. The course better calculated to reflect the detriment suffered by LMIA and the legal responsibility therefor of DSC is to view matters as at the date of breach.
9 That raises a question about when breach actually occurred. The appropriate approach, in my judgment, is to regard the relevant date as 1 March 1998. This is the date for which the plaintiffs contend, being the date from which remuneration would have been payable, first at the monthly rate applicable to the pre-opening phase and, from 1 March 2000, in accordance with clause 8. On the approach I have outlined, damages should therefore be assessed as at 1 March 1998.
10 I turn now to the second of the questions concerning damages to which I earlier referred, that is, the impact of expenses and outgoings on the income stream. This was one of the matters on which I sought further written submissions from the parties, given that it is clear that it would have cost LMIA something to perform the services in return for which it would have been paid the contracted remuneration. On the evidence, LMIA's activities at the relevant times were relatively modest. It had been awarded the contract to operate the Superdome at Homebush Bay in Sydney but otherwise, as I understand it, LMIA had no ongoing business and, in particular, no presence in Melbourne although, of course, its shareholders or principals, LMI and International Sports Facilities Management Pty Limited, had certain facilities and infrastructure which might have been deployed to assist LMIA. But one would expect that any such assistance would have come at the cost of some appropriate inter-company charge. At a practical level, it is to be expected that LMIA would have had to place at least one person "on the ground" on a permanent basis in Melbourne and that the employment costs associated with employing one additional staff member would have been a cost of earning the remuneration from DSC.
11 It was submitted on behalf of the defendants that the conclusion to be drawn from the evidence on this matter was that, because of the substantial degree of uncertainty about the extent of the expenses to which LMIA would be put, LMIA should be regarded as having declined to put before the Court evidence enabling it to determine the extent of the loss, with the result that the proper conclusion is that LMI has not proved any loss. I do not think this is the correct approach. As is made clear in Fink v Fink (1946) 74 CLR 127, difficulties in calculating loss arising from breach of contract must not stand in the way of a court's making the necessary and appropriate estimate. There is no basis on which the court should, in this case, conclude that such difficulty attends the estimation of off-setting expenses as to justify a conclusion that no loss has been suffered. The conclusion I draw is that, in order to earn the management fees provided for in the heads of agreement, LMIA would have found it necessary to outlay $60,000 per year (without regard to inflation) by way of additional employment and support costs to satisfy the need to establish and maintain a presence in Melbourne which it did not already have. For the period 1 March 1998 to 29 February 2000, the annual fee of $276,000 would have been reduced to $216,000 while for each year to which clause 8.1 applied, the annual fee of $500,000 would have been reduced to $440,000. Because the employment and support costs might reasonably be expected to increase with inflation, it is that reduced sum of $440,000 which should be regarded as subject to the CPI increase stipulation in clause 8.2.
12 As for the incidence of tax, it was accepted in written submissions received from counsel for both parties in December 2001 that, as the income stream would have been regarded as income subject to taxation in LMIA's hands and damages awarded for loss of that income stream would also be treated as income for tax purposes (Robert v Collier's Bulk Liquid Transport Pty Ltd [1959] VR 280; Williamson v Commissioner for Railways (1960) 60 SR (NSW) 252), there was no need to seek to accommodate the incidence of tax in the assessment of damages. I agree.
13 I come now to the question of discount rate. The aim of the discounting procedure applied in a case such as this is to convert the future and hypothetical stream of income to be derived over the relevant period into a present lump sum which represents, in terms of immediate enjoyment, the deferred stream with all of the risks, contingencies and uncertainties to which it may be subject.
14 Both LMIA and Baulderstone led expert evidence on the question of the appropriate discount rate, both experts (and the parties) being agreed as to the appropriateness of the discounted value approach.
15 Mr Slattery, a partner of Dawson Partners, chartered accountants, who gave expert evidence for LMIA expressed the opinion that the appropriate discount rate is 12%. His rationale for doing so was stated in his report as follows:
"10.3.1 The discount rate adopted reflects the return that a rational, risk-neutral investor requires to compensate them for the risks associated with the income stream which flows from their investment.
10.3.2 In its disaggregated form a discount rate consists of the return available from virtually risk free investments plus a premium for the specific risk associated with the investment.
10.3.3 The return available on government bonds is commonly used as a proxy for the risk free rate. For the purpose of deriving a discount rate I have adopted the current Commonwealth Treasury Ten-Year Bond Rate of 5.6%.
10.3.4 The receipt of the management fee by LMI Australasia is contingent on LMI Australasia satisfying its duties and obligations under the agreement. Clause 6 provides that the management fee is payable out of an operating fund into which is paid all operating revenues of the facility. Operating expenses and other payments agreed with the developer are also to be paid from this fund. The security of the management fee, and as such its inherent risk, is therefore a function of the capacity of LMI Australasia to generate sufficient operating revenues to provide for payment of the fee after allowance has been made for operating and other payments.
10.3.5 I have assumed a continuing capacity on the part of LMI Australasia to generate sufficient operating revenues to fund the annual management fee. In this respect I believe a premium of 6.4% is appropriate.
10.3.6 I have therefore formed the view that a discount rate of 12% is appropriate in determining the present value of the future management fees."
16 Baulderstone's expert, Mr Phillips of Deloitte Touche Tohmatsu, considered the rate adopted by Mr Slattery to be too low. His reason for this view was stated as follows:
"The key difference between their [ie, Mr Slattery's] opinion and mine is my assessment of unsystematic risk, risk particular to this entity and this project. In assessing this risk, I have considered the following factors:
· Size premium - LMI is a very small entity;
· Early stage of development;
· Limited history;
· Lack of negotiability of shares;
· Length of contract; and
· Value of management fee as finally negotiated."
17 Mr Phillips's conclusion was that a discount rate of 31% was appropriate. In reaching that conclusion, however, he drew certain analogies with (or inferences from) the performance of enterprises of a venture capital kind in their start-up and expansion phases and listed "smaller companies", neither of which, it was submitted for LMIA, provided any valid comparison with or guidance in relation to LMIA and its activities.
18 I think there is substance in the reservations about these aspects of Mr Phillips's approach. At the same time, however, it is clear that the Colonial Stadium itself was a start-up business without any established record and facing imponderables as to whether it would be successful in its endeavours. A degree of uncertainty on that score would appropriately be built in to the equation and I do not think that Mr Slattery's approach sufficiently accommodates that.
19 In the end, it is for the court to do the best it can in selecting an applicable rate. In my judgment, the appropriate rate lies somewhere between Mr Slattery's and Mr Phillips's. Having regard to the particular emphasis placed by Mr Phillips on the factors derived from questionable analogies, I consider the correct rate to be more towards Mr Slattery's end of the spectrum and I assess it to be 18%.
20 The next matter in the list of considerations is any element of uncertainty there may be as to whether LMIA would see out the full 20 year term provided for in clause 8. There is thus a need to form a view about the future. The following passage in the speech of Lord Diplock in Mallett v McMonagle [1970] AC 166 quoted with approval by Aickin J in Air Express Ltd v Ansett Transport Industries (Operations) Pty Ltd (1981) 146 CLR 249 is relevant to that task:
"The role of the court in making an assessment of damages which depends upon its view as to what will be and what would have been is to be contrasted with its ordinary function in civil actions of determining what was. In determining what did happen in the past a court decides on the balance of probabilities. Anything that is more probable than not it treats as certain. But in assessing damages which depend upon its view as to what will happen in the future or would have happened in the future if something had not happened in the past, the court must make an estimate as to what are the chances that a particular thing will or would have happened and reflect those chances, whether they are more or less than even, in the amount of damages which it awards."
21 I am thus called upon to assess the chances that LMIA, once appointed, would have ceased to be the manager of the stadium before the end of the 20 year term. This could have happened in any of several ways, most obviously agreement by the parties to terminate their relationship, repudiation by one which was accepted by the other or termination under the contract itself on account of unremedied breach.
22 There is nothing in the evidence which enables me to make any firm finding that termination would have occurred before the end of the 20 year term. Nor is there any apparent basis on which I may infer any degree of likelihood or possibility that this would have occurred, except for a general perception (which I do not think should be taken into account) that 20 years is a long time for any service provider relationship to remain fully acceptable to both parties. In the end, I must, I think, take the view that damages in relation to the loss of the clause 8 fee are appropriately assessed by reference to a period of 20 years.
23 The penultimate question is as to the assumption which should be made in relation to clause 2.3 of the heads of agreement:
"The term of this Agreement may be extended for three (3) consecutive 5 Year Renewal Periods after the expiration of the Initial Term, provided that, at the date of such renewal LMI is satisfactorily achieving agreed performance and operational standards."
24 It was submitted on behalf of DSC not only that the possibility of extension after 20 years was so remote that it should not be taken into account in assessing damages but also that, on the wording of the clause, neither party would have a legal right to insist on any extension. There is merit in both these contentions and particularly in the second. Clause 2.3, by its terms, does not give either party a right to extend. It may be intended to give such a right to LMIA but it does not do so in any clear way. Furthermore, the condition is, to my mind, cast in such terms as to make the whole provision uncertain. There are no "agreed performance and operational standards", nor is there any contractual mechanism for bringing any into existence. For these reasons (including remoteness), I consider the appropriate course to be to make no assumption of any relationship between the parties beyond the clearly agreed term of 20 years.
25 Finally, there is the question of the approach to be taken to the CPI increase provided for in clause 8.2 of the heads of agreement. Mr Slattery expressed the opinion that an annual increase of 3% should be assumed. Mr Phillips agreed. I am therefore content to adopt that rate of annual CPI increase.
26 Taking all these matters into account, I consider that damages should be assessed as follows:
(a) in respect of the period 1 March 1998 to 29 February 2000 - a sum of $552,000 (being 24 monthly payments of $23,000 each) plus interest at Supreme Court rates on each monthly component of $23,000 thereof from the last day of the month to the date of judgment;
(b) in respect of the income stream provided for in clause 8 of the heads of agreement - a net present value sum calculated on the basis that
(i) the net revenue receivable would have been $440,000 per year;
(ii) the period for which that net revenue would have been received is the period of 20 years commencing 1 March 2000;
(iii) the rate of CPI increase for inflation to be accommodated pursuant to clause 8.2 is 3% per annum;
(iv) a discount rate of 18% should be applied in determining the net present value of the net revenue stream as so adjusted for inflation;
(v) no allowance should be made for the incidence of tax.
27 If it became necessary for me to award damages to LMIA for the "failure to appoint" breach, I would ask the parties to attempt to agree the calculation on the basis I have just stated and, if possible, to bring in agreed short minutes, failing which I would be inclined to refer out the question of calculation under Pt.72 of the Supreme Court Rules.