THE NOVEMBER COMPILATION REPORTS CLAIM
141The plaintiff says that the combined PBT was $663,085 (approximately) and not $1,060,440, as stated in the November compilation reports. It claims that this was a breach of warranty (a) because the Nicholases gave it information which was not true and was misleading in a material respect, in that the November compilation reports overstated the year to date PBT by approximately $397,356.
142Alternatively, it says that by the November compilation reports the Nicholases represented that Admed's PBT was as stated, which representation was, because of the overstatement, misleading or deceptive or likely to mislead or deceive in contravention of s 42 of the Act. It says that but for this misrepresentation it would not have entered into the Agreement.
143The plaintiff puts that the overstatement of PBT was the consequence of an understatement of cost of sales in the trading account in Admed's November compilation report, which was carried over to its profit and loss account.
144Its submissions do not challenge the opening and closing stock figures. It puts, rather, that the figure for purchases is significantly understated. It says that the only credible explanation for this is that the cost of sales made in November 2005 was brought to account in the December 2005 compilation reports. In other words, it says that the November compilation reports did not include all the cost of sales expenses which were incurred to generate sales in the period they cover.
145For breach of warranty the plaintiff claims as its loss, the amount representing the difference between the true worth of the shares it received and the value they would have had, had the warranty been true, that is, had the year to date profit in the November compilation reports been accurate.
146It puts that the consideration paid under the Agreement is the price actually negotiated in an open and unrestricted market between a knowledgeable, willing, but not anxious buyer and a knowledgeable, willing, but not anxious seller at arm's length and therefore reflects the value the shares would have had had the warranties been true.
147It puts that the true worth of the shares is the value of the underlying business. It contends that this should be assessed by determining the present value of the projected future earnings of the business.
148For the alleged misleading and deceptive conduct it claims as its loss, the difference between the consideration it paid and the true value of the shares it received. This amount is less than the breach of warranty claim because part of the consideration paid to the Nicholases was by way of the issue to them of redeemable preference shares in MMT, which issue (in the absence of redemption) cost the plaintiff nothing. The money consideration actually paid by the plaintiff is $11.97M made up of $10.08M paid on 1 February 2006, and $1.89M paid in December 2006 in respect of the partial redemption of the redeemable preference shares.
149The Nicholases deny any breach of warranty (a) and deny that their conduct was misleading or deceptive.
150They say that it has not been established that the November compilation reports overstated the year to date PBT. Indeed, they say that those reports are correct.
151They say that, even if the November compilation reports overstated the year to date PBT, those reports formed part of a much wider body of information which they gave the plaintiff (either directly or by making it available through the due diligence process) and that, seen in the context of the wider information, the November compilation reports were not misleading.
152With respect to the misleading and deceptive conduct claim, they put that if (contrary to their primary contention) there was an overstatement of PBT, the plaintiff suffered no loss because it would have proceeded with the purchase anyway.
153They take issue with the plaintiff's approach to quantification. They say that if the plaintiff had established an understatement, its damages would be limited to that amount or, alternatively, that the method used to determine true value should be the same one used by the plaintiff in reaching the price.
154To establish breach of warranty the plaintiff must establish on the balance of probabilities that the information given to it was not true and was misleading in a material respect.
155The plaintiff cannot recover substantial as opposed to nominal damages for breach of warranty unless it proves both the fact and the amount of damage it suffered; Luna Park (NSW) Ltd v Tramways Advertising Pty Ltd (1938) 61 CLR 286; Watts v Rake (1960) 108 CLR 158 at 159.
156Generally, the measure of damages for breach of warranty is the amount representing the difference between the price paid for the shares and their true value at the time. See Wenham v Ella (1972) 127 CLR 454; HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd (2004) 217 CLR 640 at [35]; EW Blanch Pty Ltd & Anor v Cooper & Anor [2005] NSWCA 217 at [118].
157However, in Campbell v Backoffice Investments Pty Ltd (2009) 238 CLR 304 at [164] the Court made the observation that if the price paid by the plaintiff was fixed by a method later used to assess the "true" value it is not self-evident that damages for breach of warranty should in that case be assessed as the difference between the price paid and the value of what was bought.
158To establish breach of s 42 of the Act, the plaintiff must show on the balance of probabilities that the conduct complained of induced error or was capable of inducing error.
159To recover damages it must show that it suffered loss which was caused by the conduct complained of. This is to be determined by approaching the matter in a common sense and practical way.
160The measure of damages on this count is the amount representing the difference between the position the plaintiff is in and the position it would have been in had the misleading conduct not occurred. See I & L Securities Pty Ltd v HTW Valuers (Brisbane) Pty Ltd (2002) 210 CLR 109.
161The core issue for determination of liability and quantum in both the breach of warranty claim and the misleading conduct claim is thus whether the plaintiff has established on the balance of probabilities that the November compilation reports reflect an overstatement of PBT and, if so, the extent of it.
162I will deal with this issue first.
163At the outset it is necessary to refer to the principles which govern determination of whether the plaintiff has proved its damage.
164Mere difficulty in establishing damages does not relieve a court from responsibility of estimating them as best it can. For example, the assessment of damages for a loss which depends on future chances or possibility of benefit may be fraught with difficulty and attended by uncertainty but this does not relieve a court from the responsibility of attempting to assess them as best it can. Where there has been an actual loss of some sort the common law does not permit difficulties in estimating the loss in monetary terms to defeat an award of damages. A lost commercial advantage or opportunity is a compensable loss, even where there is a less than 50 per cent likelihood that the commercial advantage will be realised. Damages for breach of contract are to be assessed by reference to the probabilities or possibilities of what would have happened: Sellars v Adelaide Petroleum NL (1994) 179 CLR 332 at 349; The Commonwealth v Amann Aviation Pty Ltd (1991) 174 CLR 64 at 125; Malec v JC Hutton Pty Ltd (1990) 169 CLR 638 at 643.
165Those kind of cases where loss suffered cannot be proved with precision are to be distinguished from those where it can. In JLW (Vic) Pty Ltd v Tsiloglou [1994] 1 VR 237 at 241 and following, Brooking J discussed the two types of cases. As his Honour remarked, where precise evidence is obtainable, the court naturally expects to have it; where it is not, the court must do the best it can. Whether a tribunal of fact is at liberty to award substantial damages depends on the nature of the loss in the particular case and the evidence led in it. There is no rigid dividing line between cases in which guesswork is permissible in assessing damages and cases in which it is not. The borderline between guesswork and rational assessment is itself indistinct, as is the line between evidence that is precise and evidence that is not.
166In Troulis v Vamvoukakis [1998] NSWCA 237, Gleeson CJ said
As Deane J observed in The Commonwealth v Amann Aviation Pty Ltd (1991) 174 CLR 64 at 118-119, the limitations of the curial process, or the nature of the subject matter in question, often mean that the task of assessing damages involves a pragmatic exercise of a kind traditionally left to the good sense of a jury. Where, however, what is involved is the valuation of the goodwill of a business, and the plaintiff fails to adduce either reliable evidence of the trading results of the business, or evidence as to how one goes about valuing such a business, then there is an absence of the raw material to which good sense may be applied. Justice does not dictate that, in such a case, a figure should be plucked out of the air.
167The plaintiff's case is that the November compilation reports understate the PBT to 30 November 2005 because, on the accruals method of accounting, they understate the cost of sales to that date by an amount of $397,356 (although the plaintiff pleads this to be an approximate amount). Whereas the PBT was shown as $1,060,441, it says only $663,085 was earned. Its valuation evidence proceeds on the establishment of a figure for the understatement.
168The critical figure of the overstatement ought to be one capable of precise assessment by reference to Admed's and Abbetta's books and records. It involves four components: sales, opening stock, purchases and closing stock, which components yield the total trading profit which is carried over to the profit and loss account. There is no dispute between the parties as to the sales figure. There is also apparently no dispute between them as to the opening and closing stock figures. The plaintiff's essential case is that the closing stock figure was too high because it reflected the value of inventory for which payment had not yet been made.
169Determination of the understatement involves assessing how much of the value of the stock on hand at 30 November 2005 was yet to be paid for. One would expect, at a minimum, production and identification of records of payment, corresponding to unpaid invoices at that date. Either way, the claimed overstatement (if there was one) is undoubtedly capable of being the subject of precise evidence.
170This is a case where the Court would naturally expect to have that evidence, in particular from the plaintiff which had control of Admed and Abbetta for a number of years and where, under its stewardship, their accounts were audited. The failure on its part to produce that evidence must be evaluated in the light of its power to have done so: Hampton Court Ltd v Crooks (1957) 97 CLR 367 at 371.
171The plaintiff, however, did not approach the matter by reference to unpaid invoices related to stock on hand as forming part of the cost of sales calculation or by reference to evidence of payments for it.
172Mr Potter gave evidence that the financial records and information regarding the accounting processes and controls available to him did not enable him to form an opinion on the truth and correctness of the compilation reports without performing a full reconstruction of the transactions of Admed throughout the period under review. He said, further, that the information available to him was limited and that ordinarily a complete reconstruction of the financial accounts would be required to accurately assess the extent to which the cost of sales have been underestimated, but that such an exercise was outside the scope of his report. In his Supplementary Report in Reply, he says that he relied on the Micronet system's reported cost of sales to estimate the understatement in cost of sales in the compilation reports for the period July to November 2005 "in the absence of any other comprehensive data being available". He did say, further, that in his opinion, and based on his experience, a full reconstruction would be impractical and not possible with any degree of precision . However, he did not explain why this was so, particularly, in relation to the ascertainment of stock on hand for which payment was due as at 30 November 2005.
173Mr Potter calculated the cost of sales for the period July to November 2005, as recorded on the Micronet system, and compared it to the cost of sales in the compilation reports for the same period. He calculated the accumulated difference between the two sources to be $397,356, the Micronet figure being higher to this extent. He concludes that the reason for the difference is that the compilation reports do not fully reflect the cost of sales.
174He identified some individual sale transactions in those reports on which no cost of sale is recognised and expresses a concern that it is possible that the cost of sales based on those reports may be further underestimated.
175Additionally, Mr Potter carried out a comparative analysis of Admed's gross margins. His opinion is that Admed's gross margin for November 2005 (of 67.6 per cent) and Abbetta's gross margin (of 55.35 per cent) - combined 66 per cent - was implausibly high. His opinion is that their gross margins for December 2005 (Admed 20.77 per cent and Abbetta 45.8 per cent) - combined 11.5 per cent - was implausibly low. He calculated the cost of sales ratio for the five months to 30 November 2005 to be 54 per cent which in his opinion was inconsistent with FY03 (38 per cent), FY04 (36 per cent) and FY05 (37 per cent and 39.5 per cent if one adopts Micronet as accurate). He opines that the reported cost of sales ratio for the five months ended 30 November 2005 was 54 per cent and that this is not consistent with the prior year reported results or his analysis of the sales and margins disclosed in the sales reports extracted from Micronet. His view is that the true and correct ratio was in the order of 60 per cent.
176In addition to relying on Mr Potter's opinion, the plaintiff puts that the 19 December 2007 letter from the Nicholases then solicitors contains an admission that the November compilation reports overstated PBT.
177The fundamental thesis underlying Mr Potter's opinion is that the high gross margin in or to November 2005 is explained by there having being purchases of stock in November 2005, not accounted for in that month but brought to account later. It entails the corresponding thesis that Admed paid for the stock later than November 2005 (most probably in December 2005).
178The Nicholases proffer an alternative explanation. They say that the stock figures and high gross margin for November 2005 are principally explained by the fact that there were, over the previous five months, taken into stock, at value, goods which had been returned free to Admed. This occurred most frequently where equipment (for example, a bed sold for the use of a retired veteran who passes away) was no longer needed and was returned to Admed for no consideration ("free stock"). Free stock was then available to be used again, usually as rental stock.
179They say that there is no necessary correlation between the Micronet cost of goods sold and cost of sales in the compilation reports. They say that Mr Potter's assumption that there is absent from the November compilation reports an accrued obligation to pay for stock reflected in them, is unsubstantiated. They say that Admed did not use Micronet stock reports to calculate cost of goods sold.
180Lyn Nicholas gave evidence of difficulties with the Micronet system, in particular in relation to its unreliability as a source of determining cost of sales. She identified a number of problems. Firstly, the system did not price and record non-standard items. A separate code "NINV" was set up to record these non-standard items but the prices of these items were not automatically recorded in the system. These were recorded manually and not automatically taken up in the creditors ledger for the month. The problem was compounded when the prices for non-standard items changed, and this was often overlooked. Secondly, when specialised items were ordered, suppliers at times did not know the prices and the goods were recorded as having no cost. This would be rectified later. Thirdly, where prices on invoices were incorrect, items would be recorded as having no cost until the price issue was resolved and the correct price recorded manually. Fourthly, Micronet would record the full cost of an item being rented although it had previously been paid for. Fifthly, Admed's invoices would include a cost for freight, for example in the Sydney metropolitan area freight was charged at $10 for a small item and at $25 for a large item. In the case of a nursing home installation, freight might be substantially more. Micronet incorrectly included this freight as a cost of sale although it involved no specific outlay by Admed, delivery simply being part of Admed's general overheads because it had its own transport fleet.
181Micronet included a stock ledger which was relied on as providing an accurate record of inventory from time to time but, as is self-evident, the particular shortcomings in the system would either cause the cost of that inventory to be overstated, or understated as the case may be.
182In his Second Supplementary Report in Reply, Mr Potter undertook a search of the November 2005 Micronet system sales report to identify invoices in relation to "Hire". He identified 67 invoices of which 3 incorrectly reflected cost of sale. His view was that the amounts involved were immaterial in the context of the total monthly sales and cost of sales. This examination was limited to only one month. Immaterial amount or not, the analysis demonstrates the unreliability of Micronet, in this instance entailing the overstatement by Micronet of the cost of sales.
183Mr Potter also identified "in the data available" to him three transactions using the NINV code having a total value of $382.50. His evidence was that the extent and effect the NINV code would have on his analysis and his report is unclear. This further demonstrates the unreliability of Micronet.
184There can be little doubt that Micronet is an unreliable source with respect to cost of sales. PWC identified its shortcomings generally in its due diligence report under the sub-headings Risks and System Issues extracted earlier. No one from PWC was called.
185Mr Ford's figure as at 31 January 2006, presumably derived from primary records of Admed, is $5,186,015 (as opposed to Mr Potter's $5,360,001), a not insignificant but unexplained variation of $173,986.
186The evidence reveals that the stock figures as at November 2005 were fixed after a physical take of closing stock by PWC during the course of the due diligence.
187PWC's work resulted in a closing stock adjustment increasing the value of stock on hand (excluding rental stock) then recorded in Admed's records as the figure of $3,158,491, to $3,511,742. This increase of $353,251 roughly approximates to the $397,356 shortfall assessed by Mr Potter. The actual combined closing stock figure in the November compilation reports is $3,513,981. The difference of $2,239 between the PWC figure and that in the November compilation reports was unexplained.
188To the extent that it related to free stock, the upwards stock adjustment would not have a corresponding increase in the cost of sales to acquire it. The evidence established that free stock was included, but not how much.
189The stock revaluation provides a plausible alternative explanation for the elevation of the closing stock figure (or at least a part of it) without any corresponding cost of sales. It also provides a plausible alternative explanation for at least some of the elevated gross profit percentage for November 2005.
190To compound the difficulties, in his Second Supplementary Report in Reply, Mr Potter observed a discrepancy between the stock figures in the November compilation reports and a figure shown in PWC's due diligence report which, according to him, indicated a possible overstatement of stock, which could explain a significant portion of the difference he identified between Micronet's cost of sales and that in the compilation reports. This possible explanation would be inconsistent with the plaintiff's primary thesis. I refer to it only because it underlines the difficulty in the way of finding a particular understatement in the absence of primary records. But the plaintiff did not challenge the opening or closing stock figures in those reports.
191No primary records were identified by the plaintiff as reflecting bought but unpaid for stock on hand as at November 2005 or the payment for it in December 2005 (or later) in accordance with Mr Potter's thesis. Admed's Bank Statements were in evidence but no payments of that character were identified.
192Lyn Nicholas' evidence was that December 2005 was a particularly bad trading month. This provides the possible explanation or partial explanation for the depressed gross margin figures for that month.
193Mr Potter's comparative analysis of percentage gross margins earned for different periods is consistent with his general thesis, but it is not inconsistent with the Nicholases' position, and it provides no foundation for the fixing of a specific amount.
194The letter dated 19 December 2007 from the Nicholases' solicitors, relied on as an admission, is of very limited weight. It refers to the alleged difference in gross margin between November 2005 and December 2005 and admits no more than the probability that this was due to purchases in November 2005 being paid for in December 2005. It also directly puts in issue the alleged December 2006 loss. Even if the letter is construed as an admission, it provides no assistance in the task of determining on the probabilities, with sufficient precision, the amount of any overstatement.
195In Jones v Dunkel (1959) 101 CLR 298 at 305 Dixon CJ said:
But the law ... does not authorise a court to choose between guesses, where the possibilities are not unlimited, on the ground that one guess seems more likely than another or the others. The facts proved must form a reasonable basis for a definite conclusion affirmatively drawn of the truth of which the tribunal of fact may reasonably be satisfied.
196I am not persuaded on the balance of probabilities that there was an overstatement, let alone a material one. Even if I were to have formed the view that an overstatement had been proved, fixing an amount would thrust the Court into the realm of impermissible guesswork. Justice does not dictate that a figure be plucked out of the air. There is no starting point for the plaintiff's valuation contentions.
197The facts proved do not form a reasonable basis for a definite conclusion as to the existence and amount of the overstatement affirmatively drawn of the truth of which I am reasonably satisfied.
198The result is that this claim fails.
199The claim for misleading and deceptive conduct fails for the additional reason that I am not persuaded that even if the PBT to 30 November 2005 was $663,085, and the plaintiff had known it, it would not have proceeded anyway.
200What the plaintiff would have done is to be assessed as at 1 February 2006, bearing in mind that the December 2005 accounts were not available until after that date.
201Neither party suggested that the transaction would have proceeded at a lower price. Accordingly, if the plaintiff had not paid the Nicholases' price it would have foregone the acquisition.
202The plaintiff has, throughout, contended that the overstatement was brought about by a failure to account for cost of sales in November 2005 which would have had a corresponding effect thereafter, predominantly in December 2005. This attitude and conduct reflects its state of mind. It follows that a November 2005 overstatement would have been counterbalanced by a belief that December 2005 would show an understatement.
203Moreover, the plaintiff would undoubtedly have taken into account such information as it had with respect to January 2006's performance. In her email of 25 January 2006, enclosing the November 2005 compilation reports, Lyn Nicholas referred to the fact that they were currently $100,000 up in January 2006 on last year with a number of days left to invoice. Paul Mirabelle accepts that the January 2006 performance was above the historical January position, although his concession was qualified with the words "as came out in March".
204In my view, these considerations are sufficient in themselves to displace the plaintiff's contention that the November 2005 overstatement would have deflected it from purchasing.
205There are, however, other objective factors inimical to the suggestion that the figures in the November compilation reports were causative of the plaintiff entering into the transaction, being the nature of the plaintiff's own investigations, the problems with Admed's accounts which were drawn to its attention (including that the accounts were not prepared on a full accruals basis), the significance of the transaction to the plaintiff's general strategy, the personal stake of Paul Mirabelle, Daren McKennay and Geoff Thompson in the transaction, the warranties which it took and particular provisions of the Agreement. These are dealt with in the context of the Budget Claim, to which they are also pertinent. Added to these considerations are the facts that:
a contrary to Admed's and Abbetta's accounts as at 30 June 2005, which were expressly incorporated into the Agreement, no other compilation reports were incorporated into the Agreement even though they existed before it was entered into. This is consistent with what Stewart Nicholas says he conveyed to Paul Mirabelle on 12 or 13 December 2005 that the negotiations had always been based on historic figures and he had never agreed to any forecast; and
b the November compilation reports contain the disclaimers referred to earlier.
206As at 20 January 2006 Paul Mirabelle had not looked at the November compilation reports though he had understood that they had been provided and were being looked at by Geoff Thompson.
207Given these conclusions, it is not necessary to consider whether the claimed overstatement (if it had been established) would nevertheless not have been misleading because of other information given to the plaintiff at the time. Additional information which threw doubt on the compilation reports would only reinforce my conclusion that the plaintiff would have proceeded anyway.
208Absent a finding (or the availability of one) that an overstatement has been established, it is neither feasible nor appropriate to proceed to consider the question of quantum. There are, however, a number of observations pertinent to the approach taken by the plaintiff which are warranted in the circumstances.
209Mr Potter was instructed to value the issued shares of Admed as at 1 February 2006. He did this by using the conventional Discounted Cash Flow (DCF) method to derive the present value of expected future returns of the business, on three possible scenarios relating to the continuation of the DVA contract.
210For each scenario, he took the revenue and expenses for July to November 2005, adjusting only for the cost of sales in the Micronet reports, and then annualised those figures to estimate Admed's net profit to 30 June 2006. He adjusted Admed's estimated net profit to 30 June 2006 for an increase in salaries and wages of $270,000 (covering an appropriately qualified financial manager and increasing owner and other management salaries to market level) and applied growth assumptions to project Admed's revenues and expenses for each year until 30 June 2012. Mr Potter converted these projected revenues and expenses to cash flows by making assumptions, based on Admed's historical performance, about inventory holdings and the time taken to receive payment from debtors and to pay creditors and then discounted those cash flows to a net present value, starting with the risk free rate and adjusting upwards for specific risks. To derive a total value, he added a terminal value, assuming particular revenue and expenses growth.
211The plaintiff puts that this was the true value of the shares it acquired on 1 February 2006.
212The first observation is that, as has been earlier mentioned, it was observed by the High Court in Campbell v Backoffice Investments that this is not self-evidently the correct approach where, as the plaintiff would have it, it gauged the purchase price on the basis of a multiple.
213Secondly, rather than using actual figures for 2006 (and thereafter), Mr Potter annualised the figures to November 2005 (and then made a forward estimation). He gave evidence to the following effect:
Q. And is there some reason why you have used an extrapolation rather than the actual?
A. My instructions were to base my valuation on information available as at the 1st of February 2006.
Q. And so your opinion as expressed in these documents takes a snapshot of how things stood as at 1 February 2006 and does not take into account the actual events that unfolded after that date?
A. The first part is correct, I do base it on information at 1 February 2006, but I did have regard to subsequent information to see if my estimates were wildly inaccurate.
214There is an obvious shortcoming with this approach. The Court should (if not must) take into account relevant events that occurred after the purchase of the business in determining its value as at the date of its purchase, particularly where the plaintiff had control of it for more than three years after buying it; see Kizbeau Pty Ltd v W G & B Pty Ltd (1995) 184 CLR 281 at 294.
215The shortcoming is exposed by the fact that Mr Potter's straight-line extrapolation of figures to November 2005 to reach a full year figure differs from the actual figures to June 2006. The absence of major inaccuracy does not provide a solid foundation for a finding.
216Thirdly, the evidence placed before the Court did not extend to permitting an understanding of how Admed and Abbetta performed after 2007 or what consideration was attributed to them when they were effectively disposed of, or to measure the benefits the plaintiff obtained by using the cash which the acquisition provided and which enabled it partly to pay for Taylor Bryant.