M.T. Associates Pty Ltd v Aqua-Max Pty Ltd [1999] VSC 286

5. The court found that Sietel through its directors was guilty of conduct proscribed by s.260. The section is now s.246AA of the Law.

8. Having indicated that I proposed to make an order that the majority shareholder purchase the minority shareholding in Aqua-Max, I invited the parties to make submissions on the question of valuing the shares. Various proposals were put forward and discussed and in the end the parties agreed that the most appropriate method to value the shares was by reference to a special referee pursuant to Order 50 of the Rules of Court.

"8. Sietel Ltd purchase the 400 shares of M.T. Associates Pty Ltd in the company Aqua-Max Pty Ltd at a price to be agreed between the parties on or before 21 July 1998 and in the event the parties cannot agree, at a price to be determined by the court after it has received a report of a special referee pursuant to Order 50 of the Supreme Court Rules."

15. The upshot was that the parties could not agree on the price, they could not agree on the identity of the special referee and by order dated 24 July 1998 I appointed Mr C.T. Daley of PriceWaterhouseCoopers as a special referee to value the shares.

18. On 9 October 1998 the referee delivered his report to the Prothonotary of this court.

21. A problem arose as to the fees charged by the special referee and eventually the parties paid the fees and obtained a copy of the report in February 1999.

24. On 19 March 1999, the plaintiff and the defendants filed summonses in the proceeding.

27. The defendants seek an order that the report be adopted pursuant to Rule 50.04 of the Rules of Court.

30. The plaintiff for its part seeks an order that the court decline to adopt the report pursuant to the same sub-rule.

35. Order 50 of the Rules of Court is concerned with "References Out Of Court".

38. The Order gives jurisdiction to the court to refer any question in a proceeding to a special referee for decision or expression of opinion and the rules provide for the giving of directions for the conduct of the reference.

"The court may as the interests of justice require adopt the report of a special referee or decline to adopt the report in whole or in part, and make such order or give such judgment as it thinks fit."

45. Plainly, the court's jurisdiction is discretionary and is dictated by "the interests of justice".

51. In the unreported decision of Kilpatrick Green Pty Ltd v Leading Synthetics Pty Ltd delivered 5 June 1998, I considered the court's jurisdiction under Order 50 and traced the history of the provisions. After referring to what Brooking J said in Nicholls v Stamer [1980] VicRp 46; (1980) VR 479 at 495 concerning the lack of criteria to guide the court in the exercise of its discretion I went on to say this -

"When the new rules were passed in 1986, the framers of them did not take up the challenge to provide any criteria to guide the court on an application under Rule 50.04. It is pertinent to observe that there is no rule equivalent to s.16(2) of the old Arbitration Act and one can safely assume that under the present procedure the report is not to be treated as equivalent to the verdict of a jury. Clearly, the framers of the rule intended the court should have a wide and flexible discretionary jurisdiction. The exercise of it is fixed by what is in the interests of justice in all the circumstances. On the other hand, the jurisdiction is not unlimited and in my opinion a party who is dissatisfied with a referee's report or part thereof is not entitled as of right to require a judge to reconsider and determine all issues afresh. See In Super Pty Ltd v S.J.P. Formwork (Aust) Pty Ltd (1992) 29 NSWLR 549."

55. The rules do in fact set out some of the powers the court may exercise with respect to the report.

"(2) On the receipt of the special referee's report, the court -

(a) ...

(b) may by order -

(i) require the special referee to provide a further report explaining any matter mentioned or not mentioned in the report;

(ii) remit the whole or any part of the question originally referred to the special referee for further consideration by him or any other special referee;

(iii) vary the report."

65. In the Kilpatrick Green case I was dealing with an unusual situation. A judge of this court had referred all the issues in a building case to a Queen's Counsel as special referee. The special referee conducted the hearing in much the same way as a court proceeding. Accordingly, I decided that the interests of justice dictated that I should treat the application to decline to adopt the report as an appeal to this court and accordingly applied the principles and practice relating to an appeal from a single judge to the Court of Appeal.

68. But this case is entirely different. The court referred an issue in the proceeding to an expert to determine.

71. The Court of Appeal recently considered the principles in a similar reference in the case of Plumley v Adgauge Pty Ltd (1998) 29 ACSR 315.

74. Buchanan JA, speaking for the court, said at p.318 the following -

"It may be accepted that a judge ought not to adopt and act upon a special referee's decision on a question of law unless it appears to be correct. On the other hand, a decision as to a matter of fact is not to be reconsidered afresh, and in general should only be rejected if it is patently unreasonable or contrary to or against the weight of the evidence. Otherwise the reference will be no more than a rehearsal for the trial of the same issue before the court. In Super Pty Ltd v S.J.P. Formwork (Aust) Pty Ltd (1992) 29 NSWLR 549, the Court of Appeal was concerned with the adoption of a report of a special referee to whom proceedings had been referred for inquiry and report under a rule of court. Gleeson CJ said, at p.563-4: 'Insofar as the subject matter of dissatisfaction with a referee's report is a question of law, or the application of legal standards to establish facts, then a proper exercise of discretion would require a judge to consider and determine that matter afresh ... On the other hand, if the referee's report reveals some error of principle, some absence or excess of jurisdiction, or if some patent misapprehension of the evidence, that would ordinarily be a reason for rejecting it ... ' ... I do not intend to catalogue the grounds upon which a court may refuse to adopt a special referee's report. The court's discretion is confined only by the interests of justice, which will depend upon the circumstances attending particular cases ... In many, if not most, cases it will be appropriate to exercise a discretion by reconsidering any questions of law and applying legal standards to established facts. I consider no more is required in this case."

78. I respectfully agree and apply those principles in the present proceeding.

81. In giving effect to the dictate in Rule 50.04 to do what "the interests of justice require" it should not be overlooked the purpose of the reference to the special referee.

84. The court, after hearing the parties, ordered that the issue of the value of the shares to enable the court to make a final order pursuant to s.260 of the Law was to a referee who was an expert in the field and who after hearing submissions from the parties investigated the company and its accounts and reached a decision to avoid a protracted dispute in court between valuers and to save time and money.

87. It is not appropriate on an application such as the present to treat the report as the basis for a further contest.

90. As has been emphasised in the cases, the reference to a referee is an alternative to orthodox litigation, it is not an extra level to the hierarchy of decision making and is not to be treated as a rehearsal for a court hearing. Further, it has been emphasised that it would be entirely contrary to the object of the procedure if the report was treated as a starting point for a further hearing on contentious factual matters, although the broad flexible jurisdiction may require further consideration and where necessary the admission of further evidence.

95. The defendants submit that the report should be adopted. However, that would not be the end of the matter. The report gives a range of values in respect to the issued share capital in Aqua-Max. Even on adoption of the report the court has to consider two further issues, namely -

(i) What is the value of the shares in the company Aqua-Max as at 17 July 1998?

(ii) What amount should Sietel pay to M.T. Associates on the compulsory purchase of the shares in accordance with the provisions of s.260 of the Law?

101. M.T. Associates is dissatisfied with the valuation made by the special referee. Accordingly, it submits that the court should decline to adopt the referee's report.

104. In order to define the issues the court ordered M.T. Associates to file and serve a list of objections which it did and which were subsequently amended.

107. I will refer to the grounds relied upon hereafter.

112. The special referee in his report discussed various methods of valuing the shares.

115. In the end he selected the capitalisation of future maintainable earnings as the most appropriate method to value the shares.

118. There is no dispute between the parties to this being an appropriate method in the circumstances of the case.

121. That method requires a step by step procedure as follows -

(i) An historical survey of the accounts of the company over a number of years, the more the better;

(ii) Making an adjustment to those accounts to make allowances for unusual items and any items that can be attributable solely to the proprietor to determine the true profit in previous years;

(iii) After making all proper adjustments, considering and determining the likely future maintainable earnings of the company; this involves determining the present maintainable profits and making a judgment as to the future of the business;

(iv) Considering and determining an appropriate capitalisation rate for the company;

(v) Multiplying the future maintainable earnings by the capitalisation rate.

The referee's exercise

127. The exercise involves judgments being formed based on the circumstances and the experience of the valuer, reading of the future so far as is possible and the risks involved in the business. The past history of the company provides the basis for the future. But the past must be analysed with care before using it as a factual basis to estimate the maintainable earnings for the future.

130. Each step of the exercise is fraught with potential controversy and requires the valuer to carefully seek, analyse and weigh all relevant evidence and carefully and logically arrive at his decision.

133. In considering the past history of the company it must be steadily borne in mind that it is only of assistance when properly evaluated to provide a logical basis for the future. There may have been factors in the past which have influenced the profits of the business and when identified and carefully appraised can explain good or bad times in the past which may be ignored for the future.

136. Further, past accounts may need to be adjusted before the true profit can be determined. Examples of adjustments are remuneration to an owner which may be excessive compared with what a manager would be paid, goods consumed by the owner, income from assets normally not included in the business and non-recurring items which influenced one year's profits but were unlikely to re-occur in the future.

139. The judgment as to the future maintainable earnings is usually a difficult exercise and one which must be carefully and logically performed.

142. In determining the rate of capitalisation one must identify and evaluate the risks involved in the business. The type of business, its competitors, its stability, the backing of assets, its gearing and reputation in the market place are some of the factors which have to be evaluated.

145. Valuation of shares in a private company conducting a relatively small manufacturing and distribution business is a difficult exercise and invariably provokes much argument as to each step of the valuation method employed.

148. There is much room for honest difference of opinion in respect to the valuation. Provided the exercise is performed in accordance with proper principles of valuation, honestly and carefully it is nearly impossible to say that a valuer's decision is wrong. It may be said by another valuer that he does not agree with the result, but if the result is in accordance with proper valuation principles it is difficult to say the valuer's decision is wrong.

151. The object of the reference was to avoid all controversy and leave to an expert the method of valuation, and the task of determining the value after giving the parties an opportunity to place material before him.

154. Unfortunately, the referee's report has not put the arguments to rest and the plaintiff has submitted that the determination made by the referee is flawed and the report should not be adopted by the court.

157. Each party has placed evidence by affidavit before the court from various witnesses, including valuation experts. The defendants' witnesses were cross-examined.

165. The order made 17 July 1998 stated the question the referee was required to decide and also gave directions with respect to the conduct of the reference.

168. The referee was required to decide the following question -

"What is the value as at the date of this order of the total number of shares issued by Aqua-Max Pty Ltd after effect is given to the orders of the court made this day in this proceeding and in proceeding No. 5966 of 1993 -

(i) prior to making any adjustment for excess compound interest paid by Aqua-Max Pty Ltd to Sietel Limited;

(ii) after making an adjustment for the excess payment of compound interest?"

178. The reason why the referee was required to value the shares on two bases was that the evidence showed that Sietel lent money to Aqua-Max over a number of years and charged compound interest on the money lent. There was a dispute between the parties as to whether the interest charged should have been compound or simple interest.

181. In proceeding No. 5966 of 1993, Aqua-Max Pty Ltd and Sietel Limited sued M.T. Associates Pty Ltd, Malz Nominees Pty Ltd and John Massey Trihey.

184. The plaintiffs failed in the proceeding and judgment was entered for each of the defendants with costs. Each defendant obtained judgment against Aqua-Max on a counterclaim. The orders in that proceeding resulted in Aqua-Max having to pay out sums of money in the order of $465,000.

187. The orders made in the present proceeding with respect to the oppression claim were that certain share transactions were set aside, a further issue was ordered and the share register of Aqua-Max was to be amended to give effect to the orders. Further, Aqua-Max was required to pay Sietel the sum of $522,399 after the share register was amended and Aqua-Max was to pay Cooke's Bodyworks Pty Ltd the sum of $196.

190. The following directions were given to the referee -

"15. In determining the financial position and accounts of the company the special referee make such adjustments to the financial position and accounts of the company as he or she thinks are appropriate and supported by the evidence and without affecting the generality of the foregoing make an adjustment by excluding any legal costs paid or payable by the company in this proceeding and proceeding No. 5966 of 1993. ... 25. Sietel Limited, Aqua-Max Pty Ltd and Cooke's Bodyworks Pty Ltd by their directors servants and agents do all that is necessary to assist the special referee with the reference and to obey all reasonable questions asked by the special referee concerning the financial position and accounts of Aqua-Max Pty Ltd including without limiting the generality of the foregoing any transactions or dealings between Aqua-Max Pty Ltd and either Sietel Ltd or Cooke's Bodyworks Pty Ltd. 26. Subject to the requirements of the rules of natural justice and the following directions and any further directions which may be given by the court, the special referee may conduct the reference in such manner as he or she thinks fit. 27. The special referee is not bound by the rules of evidence. 28. By 11 August 1998 the special referee must conduct a preliminary conference with the parties to determine the manner of conducting the reference. 29. The special referee may where he or she considers it appropriate to do so, but always subject to paragraph 26 of this order - (a) conduct the reference in the absence of the party who has indicated that it is not interested in being heard on the reference; (b) conduct the reference in an investigative rather than an adversarial manner; (c) consider any documents submissions or thing or any part thereof or apply his or her professional expertise to the consideration thereof as is reasonably necessary for the proper conduct of the reference; (d) direct that there be no opening or final addresses by a party or that it be limited in subject or in time. If the special referee exercises any of these powers he or she must record this fact and the circumstances in the report. 30. The special referee may for the purposes of the reference investigate any matter or call for any document or explanation he or she considers appropriate and generally may make such inquiry and inspection of any document or thing and use such personal knowledge and expertise as is reasonably necessary for the purpose of the reference. 31. Each party must comply with any lawful direction of the special referee which he or she considers necessary for the reference."

194. Paragraph 32 went on to provide for the holding of a hearing to enable the parties to make submissions and present reports.

197. It is necessary to go back to paragraph 15 of the order. The purpose of this paragraph was to ensure that in determining the earnings of the company Aqua-Max any question of legal costs involved in any of the two proceedings was to be excluded. Some methods of valuation do require adjustments of accounts and the balance of the order was aimed at ensuring that an adjustment be made to the accounts as the referee thought appropriate and supported by the evidence. The reference to "appropriate" means appropriate according to proper principles of valuation.

202. The report comprises some 59 pages together with 13 appendices and is dated 9 October 1998.

205. The referee adjusted the accounts for the years ending 30 September 1993 to 1998. In respect of the year ending 30 September 1998 he took the actual figures to 30 June 1998 and estimated the accounts to 30 September 1998.

208. After considering the submissions with respect to the future earnings and relevant factors the referee expressed his opinion as follows -

"In view of those factors, it is suggested that future earnings growth may quite rapidly approach the levels experienced by the industry as a whole. On that basis, it is suggested that the adjusted results forecast for the year ending the 30th September 1998 should be used as the basis for an estimate of future maintainable earnings." - (See para.190.)

212. After discussing the various methods of valuation and indicating that the appropriate method was capitalisation of future maintainable earnings he stated -

"Based upon the above considerations, we have adopted, for the purposes of this report, the projected results for the year ending 30th September 1998 as the basis for the estimated FME (future maintainable earnings) of the company. In this regard, the maintainable earnings streams we consider it is appropriate to adopt for the purposes of this valuation are summarised as follows:

Earnings before interest tax depreciation and amortisation (EBITDA)

218. He is criticised by the plaintiff because he projected the figures for the last three months when he could have obtained actual figures for at least two months with respect to sales revenue. I will return to this criticism hereafter.

221. Having arrived at the FME figures he considered the capitalisation rate and after considering a number of factors he stated -

"After taking these factors into account, we have assessed the following ranges of FME multiples as being appropriate to apply to the FME of Aqua-Max:

227. He discussed the issue of surplus assets and opined the view that the surplus assets were between M$1.075 and M$1.167.

"In order to arrive at the value of the share capital, it requires that the market value of the company's debt be deducted from the value of the enterprise." (See para.212.)

234. He explained his approach in the following paragraph -

"The level of debt supported by the company is that which has been determined following adjustment to prior year results to reflect how the financial position of the company would have appeared as at 17 July 1998 had it always been operated on a stand-alone basis. For those purposes, we have adopted the adjusted balance sheet of a company as at the 30th June 1998. Assessed on this basis, the Sietel loan account becomes analogous to a line of credit from an independent financier. The quantum of this debt varies depending on whether interest on the outstanding balance is calculated on a simple or compound basis."

238. The reference to "Sietel" is to the parent company which holds the majority of the shares in Aqua-Max. From the very inception of Aqua-Max, Sietel has lent it money and there is no doubt that without the loans it would have been very difficult for Aqua-Max to have succeeded.

241. He calculated the "notional debt" at M$7.613 based on simple interest and M$7.773 based on compound interest.

244. He then turned to the calculation which he did on two bases with a cross-check based upon a number of methods.

247. For present purposes I set out the EBIT valuation which is -

251. It is noted that he has reduced the value by subtracting the notional debt.

254. In fact the actual debt at the relevant time was less than M$2.3 although there is some dispute about the accuracy of the loan account. At the date of the end of the company's financial year, namely, 30 September 1998 the debt according to the statutory accounts was in the order of M$2.28.

257. It is pertinent to observe at this stage that the prospective purchaser is concerned with the real debt and not some notional debt.

260. It is common ground between the parties that in order to determine the value of the shareholding it is necessary to deduct whatever the company owes by way of debt.

263. However it is submitted by the plaintiff that there was no basis whatsoever for reducing the value by the notional debt.

268. I raised the issue at the beginning of the proceeding and indicated that I would be assisted by any of the experts as to the basis upon which the notional debt should be deducted.

271. That invitation was not taken up even though the three experts retained by the defendants gave further evidence when called in addition to their affidavit evidence and were cross-examined.

274. The evidence also established that the expert retained by each party to submit a report to the referee did not contend that a notional debt should be calculated and deducted from the value.

277. Mr. Selak prepared a report on the referee's report. Mr. Selak is a director of Ferrier Hodson Corporate Advisory and a valuation expert.

280. He has critically analysed the referee's report and expressed the opinion that in some respects it is fundamentally flawed and wrong.

283. In regard to the notional debt he had this to say -

"(i) Part of PWC's approach which gave rise to PWC calculating additional notional debt of $4.97M owing by Aqua-Max to Sietel is fundamentally flawed. (ii) Having determined the unencumbered value of Aqua-Max, PWC then proceed to deduct this notional debt of $4.97M from the value when in fact no such debt actually exists."

287. The reference to PWC is to PriceWaterhouseCoopers.

"Having `normalised' the current earnings of Aqua-Max, PWC then attempt to reconstruct history by trying to work out what Aqua-Max would look like today, if it had operated as a stand-alone entity since its inception some ten years ago. The effect of this adventure (sic) is to create a notional debt of some $4.97M owing by Aqua-Max to Sietel which has no basis at law nor is it supported by generally accepted valuation practices." (My emphasis)

294. Mr. Selak's report was the subject of an affidavit by him. He was not cross-examined on his affidavit or report.

297. There is no doubt that the actual debt owing by Aqua-Max should be deducted from the value of the shareholding.

300. The controversy concerns the referee's deduction of the notional debt.

303. Professor Robert Officer, the Professor of Finance at the Melbourne Business School, University of Melbourne swore an affidavit on behalf of the defendants. He referred to the question of the deduction of debt. He said -

"Where the effect of financial structure is confounding the use of multiples, ie where the company that is to be valued has a different financial structure from those that have been recently sold or from which the earnings' multiple has been obtained, then it is acceptable to use an earnings before interest and taxes (EBIT) capitalisation rate on EBIT and then subtract debt to get the value for equity." See para. 11. (Emphasis added)

307. He did not comment in his affidavit on the referee's deduction of a notional debt.

310. In oral evidence he referred to deducting debt and informed the court that was actual debt.

313. Two other experts swore affidavits on behalf of the defendants. They are Roland Wettenhall, a chartered accountant, and Michael Humphris, also a chartered accountant whose main field of expertise was liquidation.

316. Each deponent referred to the question of adjusting the loan account between Sietel and Aqua-Max but did not expressly address the question that the notional debt should be deducted from the valuation based upon the capitalisation of future maintainable earnings method.

319. In final address Mr Kennon QC submitted that what the referee did was in accordance with proper valuation principles and produced a written summary justifying the deduction.

322. The summary is rambling and confusing. However, after some discussion it became apparent that the argument was that since the accounts for the past had to be adjusted to reflect the true earnings of the company the loan account should also be adjusted to reflect the true level of support provided by Sietel. In other words, if the operating costs were increased by the adjustments to the prior years to determine the maintainable earnings the loan account also had to be adjusted to truly reflect the financial support Sietel had given in respect of the operating costs which had been notionally adjusted.

325. The exercise is theoretical. No witness supported the contention that in order to determine the valuation a notional debt should be determined and be deducted from the final calculation.

328. It is contrary to the evidence of Mr Selak and Professor Officer. It has no support in any of the evidence of valuation principles which was before the court.

331. Mr Kennon QC was invited by the court to forward to the court any authority which justified the deduction of a notional debt instead of the actual debt. In response he and his junior forwarded a 15 page submission which canvassed the evidence, contained further submissions but no authority in the form of a decision or text book on the subject was produced to justify the deduction of the notional debt from the calculated value.

334. They referred to passages in the Valuation of Business Shares and other Equity - 3rd Edition, edited by Wayne Lonergan, but the quoted text does not support what the referee did.

337. Counsel for the plaintiff forwarded submissions in response.

340. I have considered the further submissions. The defendants' submission did not persuade me that what the referee did was correct.

343. In my opinion the special referee was in error in deducting a notional debt. It is contrary to proper valuation principles. He should have determined the actual debt at the relevant date and deducted it.

346. A consideration of the object of the valuation makes this clear. The referee stated the basis for the valuation as follows -

"For the purpose of our opinion, market value is defined as the price that would be negotiated in an open and unrestricted market between a knowledge, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length."

350. The adjustments to the past accounts are made to reflect what earnings are expected in the future. The exercise produces actual figures after considering and adjusting the earnings and expenses to establish the capacity of the company at the date of valuation to earn profits and its prospects of maintaining those profits in the future. Once the value is calculated on that method it is necessary to take into account the actual debt owing by the company to a lender. This can be treated in a number of ways but if the purchase was to proceed on the basis that the company would be debt free then the amount of the debt would have to be subtracted from the value. Notional debt is irrelevant to the prospective purchaser. He is concerned with actual debt.

353. I reject the defendants' submission that the level of support given by Sietel in the past or the fact that it owns the plant and equipment which is used by Aqua-Max to manufacture the units must be taken into account in valuing the shareholding at the relevant date.

356. Sietel is and has been well compensated for the support it has provided to Aqua-Max in the past. In this regard I refer to the substantial interest paid on the loans and the substantial lease payments made by Aqua-Max for the use of the equipment.

359. The question is the ability of Aqua-Max on the relevant date to generate profits.

362. It is said that the value of the shares is influenced by Sietel continuing to provide the plant and equipment to Aqua-Max. I accept that Aqua-Max needs plant and equipment to make the units. But the submission overlooks the reality of the situation and what the real issue is in respect to the valuation.

365. The reality is that Sietel owns over 80% of Aqua-Max and that it derives substantial income from leasing the equipment to Aqua-Max. It is in the interest of Sietel to continue to lease the equipment to Aqua-Max. Indeed, the plant and equipment would be of little value if sold independently of any business.

368. The fact is that the issue is concerned with a willing vendor and a willing purchaser. The reality is that Sietel if it sold its total interest in Aqua-Max would be concerned to obtain the best price and this would involve making sure the plant and equipment was available to the new purchaser either on a lease basis or on a sale basis.

371. The submission that because Sietel owns the equipment it is appropriate to determine the notional loan account and deduct it from the value in my opinion is wrong and irrelevant.

374. It follows that in arriving at the valuation the special referee should have deducted the actual debt.

377. The report cannot be wholly adopted because of the error made by the special referee.

382. I now turn to the other attacks made on the report by M.T. Associates.

385. Before considering the other grounds relied upon by M.T. Associates it is necessary to consider a submission made by it to the effect that the special referee should have considered the joint venture agreement between the parties, the reasons for judgment in the oppression proceeding, in particular the criticisms made of Mr R. Rees, and generally take into account the findings made concerning oppression.

388. Mr Kendall submitted that the valuation should take into account the fact of oppression.

391. He referred to the decision of E.S. Gordon Pty Ltd v Idameneo (No. 123) Pty Ltd 15 ACSR 536 at 540 at Rankine v Rankine (1995) 18 ACSR 725, 729-30.

394. In my opinion the matters raised by Mr Kendall are not relevant to the present applications before the court, which are concerned with the issue whether the court should adopt the referee's report in whole or in part according to the dictates of justice.

397. However, I do accept that such matters are relevant to what order should ultimately be made in the proceeding.

400. The reference to the referee was to obtain evidence as to the valuation of the shares as at 17 July 1998 and the report if adopted constitutes evidence of the valuation of shares. The report provided valuations on two different bases and gives a range of values. It will form part of the evidentiary material insofar as it is adopted and which the court will consider when determining the final orders.

403. It would in the circumstances of this case be inappropriate for the referee to read the reasons for judgment and seek in some way to give effect to the findings concerning oppression.

406. In the end the court will consider and determine what orders are appropriate under s.260 of the Law (now 246AA) and in doing so will give effect to the findings made in the oppression proceeding and referee's report insofar as it is adopted by the court. This approach in my view is supported by the Queensland Court of Appeal decision of Rankine v Rankine, supra.

409. Some of the grounds relied upon by the plaintiff assert that the special referee should not have accepted information, assurances and opinions given to him by Mr Rees without question and should have verified the accuracy of what he was told.

412. In performing his investigative and inquiring role to enable him to make his decision, the referee had to gather information from various sources which of course included personnel from Aqua-Max and Sietel and Mr R. Rees. He was required to use his own knowledge and experience in arriving at his decision. In his report the referee refers to gathering information and in the end it was a matter for him to evaluate and use as he thought fit in arriving at his findings and conclusion.

415. I am not persuaded that he erred in any way in performing the task he did in gathering and seeking information from a number of sources, including Mr R. Rees.

418. The plaintiff submitted that the referee erred -

(i) By denying natural justice to the plaintiff in that he -

(i) spoke to Mr Rees to gather information concerning the business, accepted it and did not give the plaintiff an opportunity to be heard in respect of it;

(ii) failed to consider and take into account a report sent to him by the plaintiff's expert, Mr Stout, dated 1 October 1998.

(ii) By estimating the value of the sales for the last three months of the year to 30 September 1998 when he had available the actual sales figures for two months which revealed that his estimate was incorrect.

(iii) By adopting an incorrect method of determining the appropriate salary rate for personnel employed by Aqua-Max which affected the operating expenses.

(iv) By accelerating the amortisation of research and development costs he failed to give effect to the circumstances and distorted the future maintainable earnings by allowing an excessive amount.

(v) In arriving at the capitalisation rate he failed to take into account various positive factors, and took into account the notional debt with the result that the capitalisation rate determined, was too low.

(vi) By failing to take into account or sufficiently take into account the value of the intellectual property.

(vii) By failing to properly adjust the outgoings for excessive charges for interest for plant and equipment leased by Sietel to Aqua-Max.

(viii) By incorrectly adjusting the warranty expenses which thereby increased the expenses.

424. At the outset it is necessary to state the nature of the task entrusted to the referee.

427. He was to value the shares as at 17 July 1998. The appropriate method of valuation was for his decision. He was bound to perform the task in accordance with the orders made. He was bound to apply the rules of natural justice, that is, rules which were applicable in the particular circumstances. His role was to investigate and ultimately make a decision as to valuation. He was not an arbitrator and he was not acting as a judge. He was to rely upon his own knowledge, experience and expertise.

430. He valued the shares in accordance with well established principles. He set out to determine the market value, namely, a price negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

433. He chose the method of valuation. He decided to value the shares on the basis of the stand alone company.

436. It is important to note that in the end he was to determine what the reasonable but not over-anxious buyer would be prepared to pay. The purchaser's paramount consideration was the return on his investment and essential to this was the earnings expected in the future. The focus is on 17 July 1998 and what the future holds.

439. The criticisms and attacks made on the referee's report must be examined in the light of the task entrusted to the referee.

444. I have set out above the directions given to the referee by the order made 17 July 1998.

447. Paragraph 26 of the Order required him to give effect to the rules of natural justice insofar as they applied to his reference but he was to conduct the reference in such manner as he thought fit and was not bound by the rules of evidence. Further, he was to conduct the reference in an investigative rather than an adversarial manner. He was to rely on his knowledge and expertise.

450. Natural justice is a common law concept to ensure that a fair procedure is followed in making a decision. It generally comprises a requirement that the decision maker give an opportunity to the person whose interests are affected to be heard and secondly, that the decision maker is impartial.

453. But the actual content of the obligation to accord natural justice will depend upon all the circumstances and in particular the nature of the powers and duties given to the decision maker.

456. There is no suggestion that the referee was biased.

459. The complaints concern speaking to Mr Rees, gathering information from him, not giving the plaintiff an opportunity to be heard in respect of the information got from Mr Rees and failing to consider the second report of the expert, Mr Stout.

462. Under the terms of the order made 17 July 1998 the referee was obliged to conduct a hearing and seven days prior to that hearing each party was entitled to deliver an expert report relied upon by that party. An opportunity was to be given at the hearing to the parties to make submissions for a limited time.

465. The evidence revealed that a preliminary meeting was held on 25 August 1998 at which the parties were represented by legal practitioners and experts. Subsequently reports were delivered by Mr Ken Stout of Ernst & Young on behalf of the plaintiff, and Mr Wettenhall of Wettenhall & Co on behalf of the defendants which included answering reports by each of these experts. A hearing was held on 23 September 1998 at which Messrs Stout and Wettenhall made submissions in relation to the issues.

468. The evidence revealed that prior to the hearing on 23 September 1998 members of the referee's staff spent a lot of time at the factory and office premises of Aqua-Max in Cheltenham to gather information. It is clear during this exercise that information was provided to them not only by Mr R. Rees but Mr Wettenhall who apparently spent a lot of time at the premises prior to 23 September 1998.

471. Mr Daly, the referee, after the hearing on 23 September conducted an inspection of the premises and Mr Wettenhall accompanied him on that inspection.

474. It was necessary for the referee to request further information from the company Aqua-Max.

477. Mr Daly wrote a letter to the solicitors for both parties on 28 September 1998 indicating that he sought an extension of time for the filing of his report and further stated that there had been delays in receiving information from Aqua-Max.

480. On 29 September 1998, Mr Stout was informed that additional material had been received from Aqua-Max. A member of Mr Stout's staff obtained copies of these documents and on 1 October 1998 Mr Stout forwarded a supplementary submission arising from the contents of two of the files of additional material.

483. The supplementary submission had not been requested by the special referee. Mr Stout gave evidence which was not contested that he did not receive any acknowledgment of the receipt of these submissions. It is noted that it is not shown in the list of documents which were referred to in the referee's report.

486. Mr Wettenhall was cross-examined as to his presence at the premises of Aqua-Max whilst the referee's staff was present during the period from 25 August 1998 up to the date of the hearing on 23 September 1998. He frankly conceded that he gave assistance to the staff, assisted them with their loan account deliberations and on occasions worked at the same desk as the special referee's staff. I reject the evidence of Mr R. Rees concerning the amount of contact between Mr Wettenhall and the referee's staff.

489. I think it was unfortunate that Mr Wettenhall had so much contact with the referee's staff and further that he accompanied the referee on the inspection in the absence of any representative from the plaintiff.

492. Nevertheless, the referee had an investigative role to perform and it was necessary to seek assistance from employees of Aqua-Max who were able to give information concerning the company, its business and the accounts. That was all part of the role that the referee had to perform.

495. The referee referred to the gathering of information which of course did include obtaining information from Aqua-Max, its staff and managing director, Mr Rees. This was part and parcel of the task the referee had to perform.

498. As has been said often, what the rules of natural justice require depend upon the particular circumstances of each case. See National Companies and Securities Commission v News Corporation Ltd [1984] HCA 29; (1984) 156 CLR 296 at 319.

501. As Rogers J said in Beveridge v Dontan Pty Ltd (1991) 23 NSWLR 13 at 21 -

"What natural justice demands, in the hearing of a reference, depends very much on the nature of the issues posed by the reference. The issues remitted may range across the spectrum from the entirety of issues to isolated issues calling primarily for the application of technical expertise."

508. In my opinion the referee did not fail to accord natural justice required by the reference to him taking into account his task, the rules of court and the provisions of the order made on 17 July 1998.

511. He had to gather information, he had to evaluate it and I am satisfied that he performed his task in this regard fairly.

514. This brings me to the question of the report of Mr Stout dated 1 October 1998.

517. First, it is noted that the plaintiff had no right to rely upon this report. It is said, however, that the reason for the report was because of the failure of the defendants to provide the necessary information prior to the hearing on 23 September 1998 to enable a report to be submitted by the plaintiff's expert. I agree.

520. The referee in my view was obliged in the circumstances to give consideration to matters that were raised in Mr Stout's report. However, I am not persuaded that he did not consider the matters that were raised by Mr Stout in his report. Although there is no reference to the report of Mr Stout in the referee's report I am not persuaded by a consideration of the latter's report that he did not consider and have in mind the matters raised by Mr Stout.

523. The topics raised by Mr Stout in his report of 1 October 1998, namely, the remuneration to the staff, sales and gross profits' margins, purchases of stock, the question of warranties, the Sietel loan account and value of intellectual property are all matters that have been considered by the referee.

526. I accordingly reject the attack made by the plaintiff on the report that the referee in some way denied natural justice to the plaintiff.

531. The referee had available to him the actual sales revenue for the period ending 30 June 1998, namely, a nine month's period. The amount was $13,369,000.

534. In performing his task the referee in determining future maintainable earnings took the whole 1997/1998 financial year for the company, that is, to 30 September 1998. He estimated the sales revenue and expenses for the latter three months which resulted in sales revenue estimated at $17,826,000 for the twelve months.

537. It is noted that the relevant date for valuation was 17 July 1998 but no criticism is made of the referee's approach in taking the year to 30 September 1998.

540. The criticism that is made is that he appears to have had access to information current to 31 August 1998 to enable him to quote unit sales but did not use it. It is said he should have used this information rather than figures to 30 June 1998 and then calculate the last three months by adding an additional 25%. Mr Stout put in his original submission estimated sales revenue of M$19.7 and the defendants' expert, Mr Wettenhall, submitted a sales revenue figure of M$18.6. However, the special referee arrived at a figure of M$17.8.

543. In fact, the audited financial statement for Aqua-Max Pty Ltd for 30 September 1998 show an actual sales figure of M$19.2.

546. Mr Stout has done a calculation which shows that the effect of an error in respect of the sales revenue had a marked effect upon the earnings before interest and tax calculation.

549. In my opinion proper valuation principles demand that the valuer where possible use actual figures rather than estimated figures.

552. The authorities support this approach. See Trustees Executors and Agency Company Limited v The Commissioner of Taxes [1941] HCA 18; (1941) 65 CLR 33.

555. In McCathie v Federal Commissioner of Taxation [1944] HCA 9; (1944) 69 CLR 1, Williams J at p.16 said -

"The accounts for the year ended 15 July 1941 would be admissible in my opinion, on the question whether the structural alterations had affected the trade in the years ended 15 July 1938 and 1939, whether these alterations would in the future lead to improved business, and whether the grave international situation was going to interfere with the trade of a retail store. These were matters existing and to be taken into account at the date of death, and the court should not be forced to speculate as to the future when the facts are known and can speak for themselves."

559. His Honour followed the decision of Trustees Executors and Agency Company Limited v Commissioner of Taxes, supra.

562. It follows that arguably the referee made an error in his approach to determining the sales revenue to 30 September 1998 but the important issue is the level of sales revenue for the future.

565. His calculation was that the future maintainable profits were based upon a sales revenue of $17,826,000.

568. The question is whether the plaintiff has established that the referee made an error in assessing this sum? It is clear from his report that the referee proceeded in the proper way to evaluate the past accounts to enable him to come to the conclusion as to what the level of profits would be for the future. In my view he had to weigh up all the various factors and I am satisfied that he properly carried out his task. I am not satisfied that any error he may have made in approach in any way affected his final result which is a matter of judgment based upon many factors some of which are subjective.

571. Further, the evidence of Mr Richard Rees based upon the revenue for the present year showed that the level of sales revenue estimated by the referee has been borne out by the sales for the present financial year.

574. Indeed, Mr Kendall challenged Mr Rees to produce the sales' documents which he did and in final address Mr Kendall conceded that the present level of sales tended to support the referee's estimate.

577. Accordingly, I reject this attack upon the referee's report.

582. In determining the true earnings after operating expenses the referee had to consider the charge for senior personnel some of whom were employed by Sietel and provided services to Aqua-Max. The referee started with the salary rates for 1997-1998 but instead of the actual salary rates, established a figure which was commensurate with the position held by the particular employee and the services rendered. Having commenced with that rate, the referee then determined the annual rates from 1993 to 1997 by discounting the 1998 rate by the rate of inflation.

585. The criticism that is made of that approach is that reference to actual payments for personnel such as production and design engineers would be a more appropriate and reliable approach to the determination of the past expense.

588. The experts, Professor Officer and Mr Humphris, agreed that it would have been more appropriate to look at actual results rather than some hypothetical calculation.

591. In my view that is correct. It was inappropriate to adopt the method which the referee did.

594. Whether or not that vitiates his finding depends upon the real issue which is what would be the expense for the future in respect to these senior employees?

597. Approaching it in this way I am satisfied that the amount which the referee allowed in the adjusted accounts to the year ended 30 September 1998 was appropriate in the circumstances. Whilst his calculation for the past may be flawed, the question is what would the cost be to Aqua-Max as a stand alone company in the future? That is the question that the prospective purchaser seeks to answer. That is what the referee determined.

600. Accordingly, I reject the attack made upon the referee's report in respect to this matter.

605. In his calculation for future maintainable earnings the referee has allowed the sum of $353,000 for research and development for the year ended 30 September 1998. That is the figure upon which he relies for future maintainable earnings.

608. The question then is whether in each year hereafter, Aqua-Max will spend the sum of $353,000 on research and development?

611. The referee after noting that the total research and development expenditure was M$1.6 associated predominantly with the development of the Aqua-Max G200 product, noted that of that amount M$1.4 was incurred prior to production in 1992 with the balance spread over five years to September 1997. He then said -

"Mr Rees has advised that in order to ensure that those costs are fully written off by the time the Aqua-Max G200 product is phased out, amortisation charges have been increased significantly in the financial years ended 30 September 1996 and 1997. In light of those facts the following basis has been adopted for calculating amortisation charges for the purposes of the adjusted operating results:"

- and he then sets out the basis. It is noted that the life cycle of the Aqua-Max G200 product was to the end of March 1999. This has proved to be incorrect. According to the evidence of Mr R. Rees it is most likely that the G200 product will be phased out by the end of February next year.

"Research and development costs have been amortised based on production in each year as a proportion of the estimated product life cycle."

620. The referee allowed the sum of $353,000 for research and development for the year ending 30 September 1998.

623. Mr Selak, the expert called by the plaintiff, said in his critique on the referee's report the following -

"The thinking behind this calculation is shallow and flawed."

627. He then goes on to say why. Aqua-Max has manufactured a new product which is now on the market. According to Mr Rees the very successful G200 product is to be discontinued. The evidence is that the new product, the Kwikhot G40, is very similar to the old model. It can be safely assumed that Aqua-Max expects it to be a better heater than the old model and be as well received in the market. Mr Selak notes that the new product is very much like the old product. He therefore opines the view that at most the annual charge for research and development should be $78,000. He further notes that in any event the charge of $353,000 is a non-recurring cost which should not impact on future revenues.

630. Professor Officer is also critical of the approach by the referee.

633. In my opinion the referee has made a fundamental error in relation to the research and development cost.

636. His approach does not seem to be based upon what was the likely level of research and development in future years. His reference to past research and development overlooks the fact that there were many features about the past which would not be replicated in the future.

639. The question is what is the likely level of cost of research and development by Aqua-Max in the conduct of its business into the foreseeable future? For present purposes I have before me a calculation of Mr Selak which puts the figure at about $78,000.

642. In my opinion the referee has erred in his estimate of the likely cost for research and development in the future and this error has a substantial effect upon the valuation of the shares.

647. In order to determine the capitalisation rate the referee analysed the price earnings multiples of certain listed public companies operating in the same industry as Aqua-Max both in Australia and overseas. The referee compiled a summary of the investigation. He then went on to say that in order to select the appropriate capitalisation rate for Aqua-Max he had to have regard to a number of factors which "suggest that multiples appropriate for Aqua-Max are significantly lower than those observed among the comparable companies analysed." - see paragraph 200.

650. The plaintiff submits that the factors which the referee thereafter referred to are all what might be described as negative factors reducing the capitalisation rate. Mr Kendall submitted that there were other factors that should have been taken into account such as the fact that Aqua-Max is a substantial company in its own right, and has an annual sales revenue of nearly M$20, with an earnings before interest and tax of somewhere around about M$2.7. Further, it employs some 150 people, has enjoyed a compound growth of something in the order of 20% over the past four years and has 27% of the Victorian market for its products. He also draws attention to the fact that although there are a number of large Australian companies who also make gas storage hot water services, the proportion of the market obtained by Aqua-Max and its unique product would attract a lot of interest from competitors.

653. Mr Selak for his part says that the proper capitalisation rate for earnings before interest and tax is 6 to 6.5 which compares with 4.5 to 5 calculated by the referee.

656. Professor Officer opined the view that the rate fixed by the referee was within range and he also was of the view that the rate fixed by Mr Salek was also in the range.

659. I am not prepared to conclude that the referee overlooked the positive factors in coming to his appropriate capitalisation rate. The referee discussed the company and its products and clearly took account of the uniqueness of its product and its prospects.

662. The plaintiff has not persuaded the court that in considering and determining the appropriate capitalisation rate that the referee made any error and clearly on the information stated in his report was within the range of an appropriate capitalisation rate.

665. However, it must be pointed out that there are two aspects which raise queries about the referee's final assessment. The first relates to the future maintainable earnings. It is clear that the issue of future maintainable earnings and the calculation of the capitalisation rate are inextricably intertwined. Having determined the future maintainable earnings rate the capitalisation rate takes into account the risks involved, one of which is the period the profits may be expected to continue. Other factors are the level of gearing and the debt which has to be carried by the company.

668. It follows that if the future maintainable earnings calculation is incorrect then this could have an effect upon the capitalisation rate. Further, the question of the debt that the company has to carry in order to conduct the business is also relevant to the exercise.

671. I have already found that the referee made an error with respect to research and development for the future which effects the earnings before interest and taxation. Secondly, I am uncertain as to how the referee used the notional debt calculation in arriving at the capitalisation rate. It would appear to me that he has taken the notional debt calculation into account in determining the valuation. This is made clear by what he said in paragraphs 231 and 232.

674. After stating his view of the value of the share capital he said this -

"231. Clearly this assessment of value has been fundamentally affected by the level of indebtedness attributed to Sietel as at the date of the valuation. With interest calculated on a simple basis, and including the Sietel lease commitment, this liability has been assessed at M$7.129. This is approximately M$4.97 greater than the liability to Sietel and related companies shown in the companies account as at 30 June 1998. 232. This difference of M$4.97 effectively represents our assessment as to the extent to which Aqua-Max has been subsidised by Sietel during the period from its inception to the date of the valuation."

678. Both Professor Officer and Mr Humphris accepted that the capitalisation rate would be affected by the level of the company's debt.

681. The referee's consideration of the choice of capitalisation rate found in paragraphs 199-201 of his report does not enable the court to say what effect if any the level of debt played in the assessment of his capitalisation rate. If he took into account the notional debt in arriving at the figure then clearly this was an error.

684. On any view, proper valuation principles require the consideration of the actual debt when determining the capitalisation rate.

687. Because the future maintainable earnings is affected by the error concerning research and development and because of the concern about the use if any of the debt in arriving at the capitalisation rate, in my opinion the court should not accept the range of capitalisation rates fixed by the referee.

692. The criticism that is made is found in the grounds of opposition which provide in ground 3 that the special referee "failed to make any or any sufficient allowance for the value of the intellectual property owned by Aqua-Max, and in particular failed to place any value upon the superior technology of welding 1mm stainless steel, which technology is kept confidential by Aqua-Max and is not available to its competitors."

695. The referee did refer to the product protection and considered the matter as can be seen from paragraphs 35-36 of his report. He obtained evidence from a patent attorney.

698. A Mr Michael John Grant, a patent attorney, gave evidence on affidavit in support of the defendants' case and he was not cross-examined.

701. I am satisfied from the summary in his report and the evidence that the special referee did make sufficient allowance for the value of the intellectual property in making his determination.

709. This has always been a contentious issue between the plaintiff and the defendants. Sietel over many years has provided most of the plant and equipment for the conduct of the business. It has charged certain rates for the leasing. The rates appear on one view to be high.

712. This was a matter that was raised by the parties before the referee. He had to consider the competing views and make a decision. In my opinion he has properly taken into account the outgoings which he had to decide after considering all relevant matters. I am satisfied that he made a proper assessment in order to determine the future maintainable earnings.

720. Each product sold by Aqua-Max Pty Ltd carries a warranty. The Aqua-Max G200 product carries a 10 year warranty.

723. The referee had to make some assessment of the future with respect to the number of warranty claims and the likely cost of same. He noted that Aqua-Max Pty Ltd up to the year 30 September 1997 had not provided for future warranty expenses. In that year a provision of $100,000 was created which was increased to the sum of $225,000 in the nine months to 30 June 1998.

726. He then went on to consider what was an appropriate basis to provide for future warranty expenses.

729. He closely analysed the relevant matters and came to a conclusion which he fixed at $122,000 for warranty claims.

732. In my opinion the plaintiff has not demonstrated any error in relation to this.

737. I am satisfied that the referee made two errors in determining the value of the shares. First, he determined a notional debt and subtracted this sum from the calculation made.

740. In order to overcome this error the level of valuations calculated by him could be increased by M$4.97.

743. The second error concerns the research and development expense which he has calculated for future maintainable earnings. The court is not in a position to make an assessment of what that amount should have been.

746. It follows that the capitalisation rate has been calculated taking into account an error with respect to future maintainable earnings, namely, the research and development component and most likely an error with respect to the risk factor concerning the level of the debt.

749. I should also add that the evidence revealed some doubt about the true level of the actual debt at the relevant time. According to the accounts, as at 31 October 1997 Aqua-Max was not indebted to Sietel and indeed, as at 31 March 1998 the accounts reveal that Sietel owed Aqua-Max $609,540.

752. In his report to the referee dated 16 September 1998 Mr Wettenhall, the expert retained on behalf of the defendants, stated at paragraph 8.9 the following -

"It is noted that the loan account between Seitel and Aqua-Max is paid out and that for FME purposes there is no difference in calculations when considering the compound interest/simple interest issue."

756. The referee prepared what he described as the original loan account spread sheet as at 30 June 1998 and it showed that in May 1998 Sietel owed Aqua-Max a sum of money whereas by the end of June 1998, Aqua-Max owed Sietel $718,817.48.

759. The statutory accounts filed by Aqua-Max Pty Ltd with the Australian Securities and Industries Commission reveal a debt of $2,280,930.

762. Because it is clear that the level of debt will influence the appropriate capitalisation rate and because it is unclear how the referee used the level of debt to determine the capitalisation rate, these combined with the uncertainty about the future maintainable earnings results in the court not being in a position to accept the range of capitalisation rates determined by the referee.

765. It now becomes a question of what the court should do? This is determined by what the interests of justice require.

768. It is clear that the court cannot adopt the referee's report. On the other hand, the purpose of the exercise was to obtain an expert's report with respect to the valuation of the shares and much time, energy and expense has been expended to reach that determination.

771. The interests of justice require in this case that the court should adopt that part of the report which the court considers is error free.

774. Accordingly, the court is prepared to adopt the referee's report dated 9 October 1998 excluding -

(i) the referee's reasoning and determination of the amount of $353,000 for research and development as an operating expense in the future maintainable earnings;

(ii) the amount of the actual debt owed by Aqua-Max Pty Ltd to Sietel Ltd as at 17 July 1998;

(iii) the reasoning and determination of the range of capitalisation rates;

(iv) the use made by the referee of the notional debt in valuing the shares.

780. Having adopted the report in part, subject to any submissions by counsel for the parties, the following issues will have to be considered and determined by the court -

(i) What was the appropriate amount for research and development in the future maintainable earnings of the company?

(ii) What was the actual debt owed by Aqua-Max Pty Ltd to Sietel Ltd on 17 July 1998?

(iii) What was the appropriate capitalisation rate for a calculation based on the EBITDA and EBIT results?

(iv) What is the value of the shares in the company Aqua-Max Pty Ltd as at 17 July 1998?

(v) What amount should Seitel Ltd pay to M.T. Associates Pty Ltd on the compulsory purchase of the shares in accordance with the provisions of the Corporations Law?

786. I will hear counsel on the form of orders and the question of costs.