M T Associates Pty Ltd v Aqua-Max Pty Ltd

Supreme Court of Victoria|2000-03-14|Before: Gillard J

M.T. Associates Pty Ltd v Aqua-Max Pty Ltd & Ors (No. 2)

CORPORATIONS - Orders pursuant to s.246AA of the Corporations Law - valuation of shares on a capitalisation of earnings method - compensatory nature of jurisdiction

The two general issues now before the court for consideration and determination are first, what is the value of the shares in the company Aqua-Max Pty Ltd ("Aqua-Max") as at 17 July 1998 and secondly, what amount should the majority shareholder in Aqua-Max, Sietel pay to M.T. Associates for its shareholding in the company?

It is necessary to briefly summarise the progress of the proceeding.

The dispute in the proceeding arose out of a joint venture agreement which was entered into on 21 November 1988 between, inter alia, M.T. Associates and Sietel. The joint venture vehicle was the company Aqua-Max. Sietel held 80% of the issued shares, namely, 1,600 shares, and M.T. Associates held the balance of 400 shares.

Thereafter the various parties to the joint venture agreement designed, developed and manufactured a gas storage hot water heater. It became known as the Aqua-Max G200 heater.

It had two features which made it one of the best storage hot water units on the market. First, it had a five star energy efficiency rating and secondly, its water container, namely, the cylinder, was made of stainless steel. These two features were at the time unique in the gas storage hot water heater market in Australia. Recently another gas storage hot water service has come onto the market which has a five star energy efficiency rating. However, its storage cylinder is not stainless steel.

Aqua-Max commenced selling the product in 1992. The inventor of the unit was Mr John Massey Trihey who was a party to the joint venture agreement as were companies associated with him. The other party to the joint venture agreement, Sietel, is a public company controlled by interests associated with Mr Richard Rees and his family. The Rees interests own approximately 80% of the issued shares in Sietel.

The parties fell out in about April 1993 and a proceeding was instituted in the Federal Court by M.T. Associates in November 1993. The proceeding was transferred to this court. The plaintiff is M.T. Associates and the two defendants are Aqua-Max and Sietel. A third defendant, Cook's Body Works Pty Ltd, was added at the end of the trial of the proceeding.

The primary claim was relief from oppression by Sietel as majority shareholder.

Eventually the proceeding came on before me on 2 February 1998 and after a 53 day trial I reserved my judgment which I delivered on 18 June 1998.

The court held that Sietel through its directors was guilty of conduct proscribed by s.260 of the Law, i.e. oppressive and unfairly prejudicial conduct contrary to the interests of the minority shareholder.

By reason of the provisions of the joint venture agreement and the occurrence of certain events the shareholding in Aqua-Max was altered.

As at the date of the court order, 18 July 1998, the shareholding in Aqua-Max was Sietel, 1819 shares and M.T. Associates 400 shares, ie 81.974% and 18.026% respectively.

The court ordered that the majority shareholder, Sietel, purchase the minority shareholding of M.T. Associates in Aqua-Max and the parties were invited to make submissions on the question of valuing the shares.

Various proposals were put forward and discussed. 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 53 of the Rules of Court.

On 17 July 1998 I ordered that the valuation be referred to a special referee and the court appointed Mr C.T. Daley of PriceWaterhouseCoopers as special referee.

On 9 October 1998 the referee delivered his report to the Prothonotary. A question arose over his fees which were eventually paid in February 1999 and thereafter the parties obtained a copy of the report.

On 19 March 1999 M.T. Associates and the defendants to the proceeding, namely, Aqua-Max, Sietel and Cook's Body Works Pty Ltd filed summonses in the proceeding, the defendants seeking an order the report be adopted and the plaintiff seeking an order that the court decline to adopt the report.

The two summons came on before me on 2 August 1999 and after a four day hearing I delivered a reserved judgment on 20 August 1999 ("the August 1999 hearing").

In my reasons for judgment I determined that there were certain features about the referee's report which I was not prepared to adopt but in the interests of justice which is the final determinant as required by Rule 50.04 of the Rules of Court, I adopted parts of the report and excluded other parts.

I informed the parties that the court would value the shares with those parts of the referee's report which were adopted forming the basis of the calculation, permitting the parties to place further evidence before the court with respect to other issues which were identified and make submissions in respect thereof.

The referee after considering a number of valuation methods selected the capitalisation of future maintainable earnings as the appropriate method to value the shares.

The parties agree that this is the appropriate method of valuation in the circumstances.

After hearing further submissions on 27 August 1999 I ordered that the court adopt part of the report of the special referee.

The excluded parts of the report were the amount of expense for research and development in the future maintainable earnings (FME), the expense calculated for leasing and hiring of plant and equipment and also personnel charges, the amount of the debt owed by Aqua-Max to Sietel as at 17 July 1998, the referee's reasoning in respect to the value of tax losses, his reasoning and determination of the range of capitalisation rates and the use made by the referee of the notional debt in valuing the shares.

In my reasons for judgment I stated that the only item in the future maintainable earnings calculation which I was not prepared to adopt was the research and development item but Mr Kennon QC submitted to the court that once I had excluded the capitalisation rates fixed by the special referee this had an effect upon the items of leasing of plant and equipment and personnel costs and accordingly I excluded those items also. Mr Kennon QC also submitted that the valuation of the tax losses was wrong. He submitted that it was in the interests of justice that these items be the subject of further evidence and submission. I acceded to the submission.

Taking into account the stance taken by Sietel on the application to adopt the report, on reflection Sietel was fortunate to be given the opportunity to later argue, contrary to its earlier submission, that the referee was wrong. On its application to adopt the special referee's report Sietel had submitted that his approach reasoning and decision were correct and ought to be adopted. Three expert witnesses were called to support the approach of the special referee and his determination by the defendants. The same three experts were called on the present proceeding and have to some extent adopted different views concerning the referee's report to what was put in evidence at the August 1999 hearing. The changes are matters relevant to the credit of the witnesses called by Sietel.

I ordered the following issues to be considered and determined on the adjourned hearing -

(i) In calculating future maintainable earnings:

(a) What necessary and appropriate adjustments for leasing and hiring of plant and equipment should be made?

(b) What necessary and appropriate adjustments should be made for personnel charges?

(c) What necessary and appropriate adjustments should be made for research and development?

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

(iii) What is the appropriate capitalisation rate to apply in determining the valuation of the company using the capitalisation of future maintainable earnings based on:

(a) earnings before interest and tax? ("E.B.I.T.")

(b) earnings before interest, tax, depreciation and amortisation? ("E.B.I.T.D.A.")

(iv) What is the amount of the surplus asset being the tax effective value of the tax losses, if any, to include in the calculation of the value of the shares in Aqua-Max as at 17 July 1998 referred to by the referee in paragraphs 202-209 of the referee's report?

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

(vi) Having determined the value of the shares in the company what price should Sietel Ltd pay to the plaintiff for its shareholding under an order made pursuant to s.246AA of the Corporations Law?

It is observed there are two general issues to be determined, namely, the value of the shares as at 17 July 1998 and what should Sietel pay for Aqua-Max's shareholding?

Counsel for M.T. Associates contended that there were certain factors not taken into account in the valuation process which must be taken into account on the second part of the determination to fully compensate Aqua-Max for its loss as a shareholder, caused by the oppressive conduct of the majority shareholder. The authorities support the claim for compensation. The court directed M.T. Associates to supply particulars of the matters relied upon, which it did. It will be necessary to refer to the particulars later.

This is the continuation of the proceeding and accordingly the evidence at trial, the referee's report and the evidence adduced at this hearing constitute the factual material before the court. The evidence adduced at the August 1999 hearing of the cross-summons concerning the referee's report is not part of the evidence in this hearing. However, I informed the parties that if any of the evidence called on that occasion is relied upon it would be open to a party to prove it in this part of the proceeding.

At this hearing Mr Trihey gave further evidence and was cross-examined.

Since the conclusion of the hearing in 1998 Aqua-Max introduced into the market a new storage hot water system called the Kwikot G40 ("G40"). It sells at a lesser price than the Aqua-Max G200 ("G200"). It came onto the market in June 1998.

The G40 heater has a four star energy efficiency rating and Mr Trihey is of the opinion that although the two water heaters are very similar the G40 heater is not as efficient as the G200 water heater. However, the G40 has a superior recovery rate to the G200. It has the stainless steel storage tank like the G200.

At the August 1999 hearing Mr Rees gave evidence that the G200 was to be phased out by the end of that year. Before the referee the contention was that it would be phased out in early 1999. It is noted that when this statement was made the G40 had just been launched on the market. Now the evidence is that it will not phased out until some time in this year. It is asserted that the G40 has not been a success. It is now uncertain how long Aqua-Max will continue to sell the G200. But on one version of the evidence of Mr Rees it may be years because of the G40's inability to capture the Aqua-Max market. This continual change of position by Aqua-Max through Mr R. Rees raises considerable doubts concerning the assertion that the G200 is to be phased out and replaced by a "completely new model".

The sales summary shows that in the year 1 October 1998 to 30 September 1999 Aqua-Max sold 18,605 G200 units and 5,466 G40 units (total 24,071 units) compared with a total of 25,797 units for the previous year. In that year Aqua-Max sold 23,578 G200 for the year and 2,219 G40 units for the four month period after its launch. The G40 unit has a number of features different to the G200. It has a superior recovery rate, the water delivery valve is better and it is a more attractive unit. It is to be noted that in the market place it directly competes with the G200. It will be necessary to consider these facts when determining what the future holds for the company. It is not good business practice to have two similar products on the market. Not only is it necessary to have two production lines but in the market Aqua-Max is competing with itself. The difference in price is in the order of $40.

Mr Rees gave evidence at the August 1999 hearing that the G200 would be phased out in a matter of months. In November 1999 he swore an affidavit in which he gave evidence which leads to the inference that that the G200 will be marketed for the foreseeable future and that was the thrust of his evidence at this hearing. However, his evidence is confusing. He gave evidence that the G200 would be phased out in 2000 but in a vague way suggested that the G40 was a flop and may have to be replaced. He then said a completely new model would have to be designed over four years at a cost in excess of M$7 to replace the G200. This would mean the G200 would have to continue.

The change in the G200's fate from July 1998 (referee's exercise), to August 1999 to November 1999 to this year cannot be put down to error or changing circumstances. The sales figures to August 1999 demonstrate that Mr Rees could not honestly have told the court at the August hearing that the G200 was to be phased out within six months. It was selling at a rate which would defy commercial common sense to take off the market. Nothing was said about the G40 in August that it was a flop. Yet by December 1999 the defendants' counsel asserted it was a flop. Mr R. Rees did not quite embrace that view. But his position is confusing and has all the hallmarks of recent invention to support the argument that Aqua-Max is now experiencing problems in the market place. This reflects on his credibility.

Mr Trihey also gave evidence with respect to matters raised by Mr Rees in his affidavit and in particular relating to the ownership of the plant and equipment used by Aqua-Max.

The plaintiff also called John Selak who is an expert valuer employed by Ferrier Hodgson Corporate Advisory (Vic) Pty Ltd.

He prepared a report which was tendered, gave evidence in respect to it, and was cross-examined.

Mr Selak's assistant, William Davidson, gave evidence of the difficulties he experienced getting information from Mr Rees concerning the accounts and records. He was cross-examined at length to demonstrate that the difficulties were either due to his own carelessness or an unfortunate misunderstanding.

I am satisfied on the evidence that Mr Rees, continuing his approach as evident in the first hearing, was being less than helpful and was being obstructive.

Every investigating accountant employed by M.T. Associates and the referee's staff have had trouble understanding the accounts and records of Aqua-Max and experienced difficulties in getting reliable information and records from Mr Rees.

Mr Richard Rees who is chief executive officer and a director of Aqua-Max and the managing director of Sietel swore an affidavit on 18 November 1999 in which he covered a number of topics concerning the ownership of plant and equipment and the future of the business of Aqua-Max. He was cross-examined at some length.

In addition, the defendants called Mr Michael Sloan of Taylor Lockwood Pty Ltd who is a valuer with respect to the valuation of plant and equipment owned by Aqua-Max and Sietel as at 15 September 1998 and as at November 1999. The defendants also called Mr Brian Edward Cazaly, a consultant, who gave evidence with respect to the issue of research and development, and Mr Roland Wettenhall, a chartered accountant, who gave valuation evidence. Professor Robert Officer gave evidence as did Michael Humphris, a chartered accountant in support of the methodology and approach of Mr Wettenhall. Both gave further viva voce evidence on the critical issue of the capitalisation rate. It is noted that their additional evidence was not the subject of a written report and was given without notice to the M.T. Associates lawyers. The evidence could and should have been the subject of exchanged reports. All witnesses were cross-examined.

In final address an issue arose concerning the findings made by the Court concerning Mr Rees' credibility at the trial and the use to be made of the findings at this hearing.

The evidence amply supports the conclusion that Mr Richard Rees is Sietel Ltd and Mr Richard Rees is Aqua-Max Pty Ltd. He solely controls both companies, he makes all decisions of any importance on their behalf and is the one who is responsible for the accounting records, the only one who fully understands them and controls their production to the plaintiff and the Court.

In his address in reply, Mr Kendall QC amplifying a submission he had put in final address that Mr Rees lacked credibility referred the court to statements made in the reasons for judgment I delivered on 18 June 1988 in the oppression proceeding and submitted that the court should not accept any evidence of Mr Rees unless it was corroborated in some satisfactory way.

He referred the court to pp.15 - 17 and p.139 of the reasons in which I did make strong criticisms of the honesty and credibility of Mr Richard Rees.

Mr Kennon QC objected to the court taking into account the findings I had made on that occasion and submitted that if the court was to take into account those matters the court should disqualify itself from deciding the issues in the present hearing.

I did make strong criticisms of the honesty of Mr Rees and opined the view that "I should view R. Rees' evidence with suspicion and scrutinise it very carefully."

The findings made were necessary in order to resolve the factual issues in the oppression trial.

At no stage prior to the matter being raised in final address (the 22nd day of the further hearing) did counsel on behalf of the defendants object to me determining the issues in the further hearing. Further, at the August 1999 hearing Mr Rees gave evidence on that occasion and was cross-examined and no objection was made to me hearing the applications. Indeed on that occasion I rejected some of the evidence of Mr Rees.

Any question of perceived bias, has been waived by no objection being taken at this further hearing but in any event if objection had been taken in my opinion the court would have been duty bound to continue with the hearing.

This part of the hearing is concerned with the question of the appropriate order to make under s.246AA after the court had made findings as to the oppression issues in the first part of the hearing, and is a mere continuation of the same proceeding. The issues now before the Court are different to the earlier issues and I am bound to approach the issues, which I do, with an open mind.

The question that now confronts the court is what use if any, can the court make of the earlier findings stated in the reasons for judgment concerning the credibility of Mr Rees.

In my view they cannot be ignored. They were made after 53 days' trial and were necessary in order to determine the issues before the court. Indeed the credibility of Mr Rees was an issue of importance in that part of the proceeding.

The findings were made after a long trial during which time the court had ample time and opportunities to appraise the credibility of Mr Rees.

This part of the hearing involves different issues. The fact is that the court has formed a certain view of the credibility of Mr Rees which cannot be ignored and in my opinion leads to the conclusion that I must carefully examine and weigh the evidence of Mr Rees at this hearing and scrutinise it very carefully.

The earlier findings are to be taken into account as background but the main focus is on the evidence given by him and the way he gave evidence, at this hearing.

The facts are that he is in control of both companies and their accounting records, some of the accounting records are extremely confusing and he is the one who makes the decision to produce records and facts to the court. His obstructive attitude in the past cannot be overlooked and there is some evidence in the present hearing, of obstruction by him to produce documents and explain the records of both companies to the plaintiff's accountant.

The primary evidence relied upon by the defendants concerning research and development into the future is the evidence of Mr Rees. It is evidence which is difficult to contest. It behoves the court to closely and carefully consider it.

In regard to the question of perceived bias in the present circumstances I refer to the recent Court of Appeal decision of Locabail Ltd v Bayfield Properties [1999] EWCA Civ 3004; (2000) 1 All ER 65, especially at p.78 where the particularly strong Court of Appeal said -

"The mere fact that a judge, earlier in the same case or in a previous case, had commented adversely on a party or witness, or found the evidence of a party or witness to be unreliable, would not without more found a sustainable objection. In most cases, we think, the answer, one way or the other, will be obvious. But if in any case there is real ground for doubt, that doubt should be resolved in favour of recusal. We repeat: every application must be decided on the facts and circumstances of the individual case. The greater the passage of time between the event relied on as showing a danger of bias and the case in which the objection is raised, the weaker (other things being equal) the objection will be."

The point was raised very late in the present hearing.

The method selected to value the shares is the capitalisation of future maintainable earnings method. All parties agreed this was the appropriate method.

This 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 could 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 earnings and making a judgment as to the future of the business;

(iv) considering and determining an appropriate capitalisation rate for the shares;

(v) multiplying the future maintainable earnings by the capitalisation rate;

(vi) considering and determining whether there are any additional assets that should be taken into account and if appropriate added to the value;

(vii) Considering and determining whether any deductions should be made - e.g. debt owing by the business.

As has been said often in the past, and no doubt will be repeated often in the future, the exercise involves a judgment being formed based on the circumstances, the experience of the valuer and as to the future. One must take into account the risks involved in the conduct of the business. The past history does provide a basis for the future but it must be analysed with care before it is used as a factual basis to estimate the maintainable earnings for the future and the risks relevant to the capitalisation rate.

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

Valuation of shares in a private company which conducts a small manufacturing and distribution business is a difficult exercise and invariably provokes much argument as to each step of the valuation procedure.

Whilst there is much room for honest difference of opinion in respect to the valuation, one would expect that valuers honestly approaching their task and provided they are given all relevant and accurate information, should arrive at valuations which are similar.

However, experience in the courts shows that this is a forlorn hope in most cases and this case is no exception.

Mr Selak on behalf of the plaintiff concluded that the value of 100% of Aqua-Max's share capital would be in the range of $12.7M to $13.1M on an EBIT basis depending on whether the Sietel loan interest was to be calculated on a simple or compound basis.

In contrast the defendants' expert, Mr Roland Wettenhall, has valued the shares at $1,305,000 at the EBIT level.

When the court is confronted with such an enormous disparity in the results of a valuation, it is difficult to accept the view that the difference between the valuers' results can be put down to an honest difference of opinion.

It is an unfortunate fact that expert witnesses are too often motivated by satisfying their client's wishes rather than acting independently and honestly and carefully giving opinion evidence.

I may say that my observations are not new. See for example Phipson on Evidence 10th Edition (1963) para 1286 where the learned author stated -

"The testimony of experts is often considered to be of slight value, since they are proverbially, though perhaps unwittingly, biased in favour of the side which calls them, as well as over-ready to regard harmless facts as confirmation of preconceived theories; moreover, support or opposition to given hypotheses can generally be multiplied at will."

Difficulties in Valuation - Defendants' conduct

I have found the task of valuing the shares extremely difficult.

Not only is there the enormous disparity between the valuations but there are a number of other factors which have exacerbated the difficulties in resolving the issues.

First, the referee's determination of the value. The referee fell into error in valuing the shares. The defendants in the application before the court in August 1999 supported the valuation whereas MTA attacked it on a variety of grounds. I considered the grounds of attack and ruled that some of them were made out. Having published my reasons I informed the parties that I proposed to adopt parts of the referee's report and decline to adopt other parts.

Having informed the parties of that fact, defendants' counsel, contrary to the earlier approach, then informed the court that there were other aspects about the referee's report which they did not agree with and in the course of the discussions I was persuaded that certain other aspects of the referee's report should be excluded.

It was put to me by the defendants' counsel that this about change of approach by the defendants could be justified on the basis that the referee in valuing the shares had taken into account what he calculated as a notional debt. It was the accepted view of the valuers called at the August 1999 hearing that the actual debt was to be deducted and not some notional debt. I so ruled.

The defendants submitted that once the court reached that conclusion other findings were open to doubt.

I have some difficulty in accepting that once that error had been exposed and corrected that it necessarily followed that the matters raised by the defendants needed further consideration. However, I have given the opportunity to the defendants to call evidence and make submissions in relation to the additional issues.

This inconsistent approach by the defendants raises doubts about their case.

Secondly, the difficulties encountered by the M.T. Associates expert in getting information has meant that their expert's report in some respects is not complete and in other respects proceeds on inadequate and uncertain information. It is put by M.T. Associates that the defendants were obstructing the valuer and making it difficult for him to obtain relevant information.

Mr William Davidson, the assistant to Mr Selak, was called as a witness by MTA to show the obstruction and he was cross-examined at some considerable length in relation to the assertion. Mr Davidson was seeking records and information from Mr Rees.

I listened with interest to the cross-examination and the proffered explanations put by cross-examining counsel as to difficulties that had been encountered and the suggestion that they were due to either error, misunderstanding or a failure by Mr Selak's assistant to follow up matters.

Mr Richard Rees is the Managing Director of Sietel Limited, the majority shareholder in Aqua-Max and is the Managing Director of the latter. On any view the companies operate very closely.

Mr Rees gave evidence at the trial in 1998 and I found him an unsatisfactory witness who was prepared to mislead and obstruct the gathering of information.

Mr Rees is responsible for the accounting systems of both Sietel and Aqua-Max. His background is accountancy and he has worked as an auditor. The accounting records of both Sietel and Aqua-Max are difficult to comprehend and according to Mr Rees, in some instances, do not mean what they convey to the reasonable reader.

Louis Carroll wrote the following through the mouth of Humpty Dumpty in "Through the Looking Glass" -

Humpty Dumpty - "There's glory for you!" Alice - "I don't know what you mean by glory". Humpty Dumpty - "I meant, 'There's a nice knock-down argument for you'." Alice - "But 'glory' doesn't mean 'a nice knock-down argument'." Humpty Dumpty retorted, in a rather scornful tone - "When I use a word it means just what I choose it to mean - neither more nor less". (Emphasis added.)

Mr Rees somewhat like Humpty Dumpty's attitude to language has his own modus operandi in respect to the accounting records of his companies. He is the only person who understands them. Documents and records are kept in a way which attracted much criticism at the original trial and the criticism continues. One can only be suspicious as to the accounts and records of both companies and whether those records truly reflect the facts.

It is so easy in this day and age with computers to re-arrange accounts, records and the like without trace and if records are kept in that way one loses confidence in their accuracy.

Mr Rees was slow to produce some documents and in some circumstances did not produce any documents until the trial commenced.

There is no excuse for what Mr Rees does. In this day and age with computers, well managed manufacturing companies of the size of Aqua-Max should have in its records all the information which could be retrieved very quickly to satisfy a request.

One of the big issues at the present hearing was the contention by Mr Rees that Aqua-Max did not own a large proportion of the plant and equipment even though it had been leasing or hiring it and using it over many, many years. The value of the plant and equipment is put at in excess of M$3.3.

The issue is who owns the plant and equipment? It is the contention of the defendants that it is wholly owned by Sietel, that the plant and equipment is presently being used by Aqua-Max on a monthly hire basis and Aqua-Max has no proprietary interest in any of the plant and equipment. M.T. Associates contends that the bulk of the plant and equipment is in fact owned by it.

The evidence of Mr Rees is that there is no documentation evidencing the arrangement between Sietel and Aqua-Max and he asserts there never has been. This has caused the plaintiff and its advisers to view the assertion with considerable suspicion which taking into account a number of other factors which I will refer to hereafter is well grounded. Not surprisingly Mr Selak and his assistant, Mr William Davidson, spent time trying to determine from the records the basis for the defendants' contention. Mr Selak requested the records to show who owned the plant and equipment and in the end documents called lease registers and asset registers were produced. One of them is headed "Aqua-Max - Lease Register". It is a print-out from a computer. One's immediate reaction is that it evidences Aqua-Max's entitlement to certain property which has been leased to it. However, when it was forwarded to Mr Davidson, Mr Rees in a covering fax referred to it as the Sietel lease register. This is despite the fact that there is such a print-out which is headed Sietel Lease Register.

This is but one of a number of examples where documents are produced which convey a certain conclusion but which Mr Rees asserts is not a correct conclusion.

I accept the evidence of Mr Davidson of the history of his attempts to obtain information and documents from Mr Rees concerning the very important issue of who owned the plant and equipment used by Aqua-Max. The responses by Mr Rees were unsatisfactory and obstructive. The information should have been readily available. It took an inordinate time to be provided.

The directors' reports and annual returns of both Sietel and Aqua-Max are in certain respects ambiguous and vague. When cross-examined on the entries Mr Rees invariably asserted that the auditors required that part of the document to be expressed in that way.

The records of Aqua-Max revealed a debt of $755,000 owing by it to Sietel as at 30 June 1998. However, it is the case of Sietel that because it has subsidised Aqua-Max over the years the loan account should be adjusted to reflect that fact. Indeed, the referee was induced by representations made on behalf of Mr Rees that the loan should be adjusted to reflect the alleged subsidy.

Mr Rees in evidence in the present hearing reiterated the contention. The court asked him was there any legal basis for the contention. He gave evidence that there was no documentation which supported his contention but he knew that Sietel had provided subsidies over the years, it had not been properly reimbursed and now the loan account should be adjusted to reflect the subsidy which he asserted was in the order of in excess of M$2.

When it was pointed out by the court that there was no documented legal basis for the adjustment and that Mr Rees was seeking to re-write the history of the relationship the court asked the following question which Mr Rees answered -

"Mr Rees, we've got to come back to whether there's a legal basis for this. It's all very well to talk generally but if Sietel was wanting to look after its interest it could have entered into an agreement, there could have been a resolution at the level of both boards that in the event of certain things happening Aqua-Max would reimburse Sietel to the extent of. But you can't point to anything that occurred in that way and what you're really saying to me is, 'Look, in the wash up it would be now fairer if Sietel was to get more back'?---No, no, no. Sietel didn't - didn't - we didn't have an arrangement like that and there was reasons why that wasn't put in writing, significant reasons because that could cause some tax implications by going around registering those sort agreements. Understandings are one thing, registered agreements, the tax department might look that up registered agreement and say 'Well, hey, hey fellows, I want to get in on this little show', so that's why there's an understanding. But the legal, the legal standing is that the legal ownership and the assets was never passed to Aqua-Max." (Emphasis added.)

Later the court asked the following questions and Mr Rees answered -

"Mr Rees, this is the vice of running a business in the way that you do, where you don't believe in having too many formal documents?

---I have - I'm the most documented person in this case. Just listen to me, Mr Rees. One might think that in relation to operating a business, from the interests of Sietel and Aqua-Max, there'd be some document which would be evidence of the relationship between the parties concerning the hiring of the plant and equipment, there's absolutely nothing and after a while one starts to think why not, a well conducted business would have such a document, with some evidence of the hiring arrangement?

---It is, it's the - I'm a very well documented person and I wouldn't like to dispute, but if you look at the other party, he had nothing, I am very well documented, I've thousands of files, I've got a reputation for documenting things, I'm very meticulous in the way I document things. Let me just continue the point. I put that point to you, you then say well look, there's nothing in writing about this understanding of

what - - - ?---No, I didn't - I explained why we didn't put it in writing. What Sietel would be expected to get back on its loan account, well, again - - - ?---No, because it retained - see, you don't - if we could put that in writing, we could say Sietel agrees to pass all this asset ownership over, agrees to a long term lease and agrees to the personnel, Sietel would have to agree to that on the basis that it gets the subsidies back, we could have put that in writing, or I put it as an understanding for some good reason, it wasn't just because I forgot about it, it it's thought through, people have in the past documented things, understandings, and got into trouble with tax, and I'm thinking well, I've got to be careful by - by thing, so.we'll keep it as an understanding, the directors are all there, we're quite entitled to have an understanding and we haven't got a tax liability. To put it down in black and white registered document, there is a risk of a significant tax liability, would send both companies broke maybe, so we have an understanding, but it's supported, Sietel's support is they retain the employment of the personnel, they retain the ownership of the assets, and that's well documented, I've put all vouchers out to support that and they retain the ownership of the building with no future lease commitment on it, no long term lease, they could do it, that is - that's how I get Sietel to agree to it, so the Sietel directors say, I say to the Sietel directors, this is the security I'm giving you in this understanding, I'm giving you very good support, you control the personnel that control this business, you control the building and control the assets. On Aqua-Max side I say, well, Aqua-Max, yes, you've missed out on those things, they were all controlled by Sietel but I'm giving you survival, I'm giving you subsidies and if you've got a better alternative, we've got a better alternative, we'll go elsewhere." (Emphasis added.)

The statement by Mr Rees of the concern that if matters are documented there may be problems with the Taxation Department amply supports the criticism of Mr Rees that he keeps records in such a way as to enable him to make assertions of fact to meet the particular circumstances in question. There are absolutely no documents that document the relationship between Sietel and Aqua-Max with respect to the use of the plant and equipment by Aqua-Max. However, there is ample evidence to which I will refer hereafter which supports the contention of M.T. Associates that at the end of a lease period the property was to vest in Aqua-Max.

Equally there is absolutely no evidence of any agreement between Sietel and Aqua-Max which would justify Sietel in increasing the loan account between them. Despite this lack of records Mr Rees is firmly convinced that Sietel should receive from Aqua-Max a sum in excess of M$2 for the loan account because of what he called "subsidies".

It emerged in the course of this hearing that neither Sietel or Aqua-Max had lodged income tax returns for the years 1992-1998 until July 1999 when they were filed as a bundle. No satisfactory explanation was given for this. Yet the auditors in those years did prepare drafts but they were never completed and then Mr Wettenhall had to finalise them in 1999. This conduct exacerbates the suspicion about the records of both companies, records in the sole control of Mr Rees.

In the circumstances the court must view the accounting records of both Aqua-Max and Sietel with suspicion.

There is no lease or any other document evidencing the use of plant and equipment by Aqua-Max which allegedly is owned by Sietel.

The difficulties in tracking down records in relation to this issue supports the submission that Mr Rees was being not only obstructive but also raises doubts as to the accuracy of documents produced.

It is very easy to adopt the Humpty Dumpty approach and say that when I produce an account it means what I say it means but without any supporting evidence, the assertion must be viewed as practically meaningless and on any view with scepticism. All these matters support the conclusion that Mr Rees is a witness whose evidence should not be accepted unless supported by credible independent evidence.

Thirdly, the expert for the defendants, Mr Wettenhall who was retained to assist the Rees interests in the valuation exercise before the referee and also to give evidence on the applications in August 1999 was engaged by Sietel and Aqua-Max to prepare their income tax returns and lodge them as a tax agent which he did on the 17th day of August 1999. He does not fit into the category of an independent expert. He spent considerable time with Mr Rees at the premises of Aqua-Max in 1998 preparing submissions to be made to the special referee. During this period he had opportunities to talk at some length with the special referee's assistants. He also escorted the special referee around the factory premises in the absence of any representative from M.T. Associates and his reason for doing so was specious nonsense. He stated in cross-examination in the proceeding in August last year that the reason why he went around the factory with a special referee was because he had an interest in factories. He maintained that the reason given last year was true at the present hearing. The fact was that he had already had a tour of inspection of the premises on a previous occasion for which he charged Aqua-Max as his alleged client a fee and he also charged for his time when he escorted Mr Daley the special referee around the premises. I do not accept his reason.

I am satisfied that Mr Wettenhall falls into that category of the expert witness who is extremely aware at all times of his brief and who is paying the bill. He plays the advocate and his evidence was coloured by his retainer. He was cross-examined as to the importance of independence and honesty of expert witnesses which he readily accepted were essential but in my opinion he has compromised his independence in this proceeding by his close involvement with Mr Rees, and his work lodging the tax returns for both companies for which he charged a substantial fee.

Further, he changed his evidence between the hearing in August 1999 and the present one in some respects. He also changed a draft report prepared by him which was provided to the defendants' legal team and their other two experts, after consultation and before giving evidence in the present hearing. The changes were significant and not satisfactorily explained. He also was prepared to use the referee's approach in respect to some of the issues when logic dictated otherwise, and then in viva voce evidence used a different approach. He was very aware of his client's interests when giving evidence. These matters reflect upon his credibility.

Another matter which made the court's task difficult and which reflected on the credibility of the defendants' case was the change in approach apparent in the present hearing.

Mr Kendall QC who appeared with Mr A. Phillips for M.T. Associates attacked the credibility and honesty of the defendants' case. He pointed out that at the hearing of the applications concerning the referee's report, the defendants did not criticise any part of the referee's approach, calculations or determination. In particular evidence was given by three experts to the effect that what the referee had done was correct and that he had arrived at the correct result. It was only during cross-examination of two of the experts that concessions were made that the referee had made an error in relation to the notional debt and its deduction. The three experts called on that occasion were Mr Wettenhall, Professor Robert Officer and Mr Michael Humphris. The approach on that occasion was for Mr Wettenhall to prepare a report and for the other two to comment on his methodology. The same three experts were called at the present hearing. They adopted the same approach.

In particular at the August 1999 hearing no attack was made on the referee's assessment of the research and development in the FME calculation or the referee's treatment of the plant, machinery and equipment used by Aqua-Max as being the subject of financial leases.

After the court held that the research and development item was incorrectly calculated and that the referee had wrongly determined a notional debt owing to Sietel which he had deducted, the defendants' case did a remarkable about turn.

After the court had published its reasons which effectively set aside the referee's notional debt deduction, the research and development item and the capitalisation rate, counsel on behalf of the defendants submitted that justice required the defendants be given an opportunity to question the leasing and hiring of plant and equipment, the amount for personnel charges made in respect of the Sietel employees and the value of the tax losses. The court was persuaded to exclude the referee's determination in respect to the items and give the parties the opportunity to adduce evidence and make submissions in relation to them.

Now the defendants say the research and development item determination by the referee was wrong and having embraced the figure at about $353,00 per annum now put a case that Aqua-Max is under siege from a competitor and will have to design, develop and manufacture a new product at an annual research and development amount of $750,000 for eight years.

If this argument is accepted it would have a substantial effect upon the FME.

As Mr Kendall QC correctly points out, at the August hearing last year not one mention of the need to develop a new product was put forward. Last year the evidence was the phasing out of the successful G200 unit and its replacement by the G40.

Now the evidence at this hearing is that the G40 has failed to live up to expectations, the G200 has run its course and has recently experienced problems and hence there is a need for a new product. Mr Kendall submits that this is a new case which is inconsistent with the stand taken last year and when analysed has very little substance. He also points out that having failed in supporting the notional debt deduction which was substantial (M$7.6) from the value, the defendants looked around for an item to support a large deduction and alighted on the ownership of the plant, machinery and equipment used by Aqua-Max. As I have stated, the referee treated the equipment as subject to financial leases giving Aqua-Max an interest in the plant and treated the balance owing under the leases as a commitment to Sietel.

I may say the deduction of the notional debt by the referee had an enormous impact on the valuation.

At the August 1999 hearing Sietel supported this approach but when the court set aside the deduction for the notional debt the defendants put a case that the plant, machinery and equipment in question were wholly owned by Sietel or would be wholly owned by Sietel, that Aqua-Max hired the equipment from month to month and there was no question of Aqua-Max ever having an interest in any of the plant and equipment it used which was supplied by Sietel. It is noted that Aqua-Max does own some equipment but this is treated separately.

The defendants' argument was that this equipment was valued at M$3.8 and this would have to be purchased by Aqua-Max in order to sell the business. Hence this would have to come off the value because Aqua-Max would have to purchase the plant from Sietel.

Mr Kendall QC submitted this was wholly inconsistent with the stance taken last year and it also reflects on the honesty and credibility of the defendants' case.

In a nutshell, having failed to have the notional debt deducted, Sietel through Mr Rees looked for another substantial deduction and ran the case that Sietel owned all the plant and equipment (save for a quantity of not great value owned by Aqua-Max), that Aqua-Max would have to purchase it in order for hypothetical sale to occur and the amount should be deducted from the purchase price.

In my opinion there is much substance in the submission and when the evidence is analysed in respect to the issues it will reveal much support for Mr Kendall's submission. I will return to this question hereafter.

Mr Kendall QC then submitted that when one considered the evidence as to how the new case was developed in relation to research and development, ownership of equipment and determination of the capitalisation rate it is clear that a plan was devised which not only involved Mr Rees and Mr Wettenhall but also the other two experts to establish bases for the new case. The evidence revealed that Mr Wettenhall prepared a draft report some time in October/early November 1999 which addressed the issues that were to be decided at the further hearing. Professor Officer and Mr Humphris were retained but with a limited brief which was to consider the report of Mr Wettenhall and to confine their evidence to whether or not the methodology used by Mr Wettenhall, the principles upon which he relied and his conclusions were based on proper valuation principles.

The evidence revealed that having prepared the draft report it was then considered in conference by the legal team, Mr Rees, Mr Wettenhall, Professor Officer, initially Mr Humphris and later his assistant.

Professor Officer prepared his report based upon the draft of Mr Wettenhall as did Mr Humphris. It is an inference from the evidence that as a result of the discussions involving the legal team, Mr Rees and the experts that Mr Wettenhall was prompted to re-think parts of his report and as a result he made a number of substantial changes, changes of significance to his original draft.

Professor Officer and Mr Humphris believe that before they signed their reports which were filed with the court they had seen the version signed by Mr Wettenhall.

An expert who spends considerable time with the legal team and other experts in the case considering and discussing the report which is to be the main report relied upon by a party and it is then changed in a significant way compromise his independence and his credibility as an expert.

Mr Humphris and his assistants apparently attended some three or four meetings and Professor Officer attended at least two meetings and had telephone conversations with members of the legal team.

Whilst both Professor Officer and Mr Humphris from time to time in their respective reports and in giving evidence emphasised that they were not really looking at the base figures used or any results but only were concerned with the methodology and logic of Mr Wettenhall's approach, nevertheless, in viva voce evidence, expressed views which were not in their written reports and further contradicted what they had said in their reports.

In my opinion the three experts called by the defendants compromised their independence and their credibility and it will be apparent from my consideration of their evidence in relation to particular issues that I was unimpressed with parts of their evidence.

All these matters combine to make reliance on the financial records, the evidence of Mr Rees and the defendants' experts precarious and fraught with risk and uncertainty.

The task of valuation has been difficult because of the uneasiness due to records which raise so many questions and because of the considerable doubts the court has about the evidence of Mr Rees.

I was impressed with the evidence of Mr Selak who was called by the plaintiff M.T. Associates and who in my opinion did seek to preserve his independence and to assist the court honestly and carefully. He was somewhat handicapped by the fact that he did not have all the information he wished to get from Mr Rees. However, I was impressed with his evidence and I was impressed with the evidence of his assistant, Mr William Davidson.

The obstruction by Mr Rees and the difficulty in understanding the financial records did not make the task of Messrs Selak or Davidson an easy one.

The starting point is the tables of the special referee which are comprised in Appendix H to his report.

There are three documents and first is the referee's exercise considering the accounts of Aqua-Max for the years ending 30 September 1993 through to 1998. In respect of the year 1998, the last three months are estimated.

His second document sets out the adjustments that should be made to the accounts, and the third document is the adjusted summary.

This adjusted summary is the starting point in the proceeding before me.

None of the documents in or attached to the referee's report include the profit and loss statement for the year ending 30 September 1998. In the present proceeding the profit and loss statement and balance sheet to the 30 June 1998 were tendered and it contains the items which the referee must have taken into account in assessing the accounts for the year ending 30 September 1998 which when adjusted are the basis for the future maintainable earnings assessment. The accounts are not easy to understand.

The parties accept that the special referee had the accounts which became Exhibit MTA 9.

The calculation by the referee showed future maintainable earnings at various levels including earnings before interest and taxation (EBIT). It is common ground between the parties that that is the appropriate level at which to value the shares. This was the view expressed by all of the experts.

The level above the EBIT level is the earnings before interest, taxation, depreciation and amortisation (EBITDA). It is at that level that one can determine what might be called the cash flow of the business. This level determines the gross profit less expenses resulting in the net profit.

The step between the EBITDA and the EBIT level involves consideration of research and development, depreciation of plant and equipment and amortisation in relation to depreciation in the past.

At the outset it must be emphasised that the object of the exercise is to determine what a reasonable but not over-willing purchaser would be prepared to pay and what the reasonable willing vendor but not over-anxious to sell, would be prepared to accept.

The second point that must be made is that the court is seeking to value the shares in Aqua-Max. The evidence clearly demonstrates that the assets of Aqua-Max are its ability to manufacture and sell hot water units i.e. its business. Its main area is the manufacture and sale of storage hot water systems but it also imports and sells an instantaneous hot water service.

The ability of Aqua-Max to derive income comes about because of its intellectual property, its know-how, the fact that it has designed a very good storage hot water unit and has established a healthy niche in the market, especially in this State.

Although counsel on behalf of Sietel was anxious to draw a distinction between the business of Aqua-Max and the value of the shares the reality is that the shares are to be valued on the basis of the value of the business.

The assets of the business which would be sold comprise the plant and equipment used to manufacture and sell the storage hot water services, the stock in hand, the intellectual property and know-how and the good will of the business. In addition there would be motor vehicles and office equipment. It also has the asset in the form of accumulated tax losses.

The sale will be effected by the transfer of the shares.

The third observation I wish to make concerns the question of Sietel and its attitude to a sale. The court is concerned to determine, inter alia, what a reasonable, willing but not over anxious vendor is prepared to accept for the business. In my opinion the court must proceed in this exercise on the basis that Sietel will put its "best foot forward" to achieve the best price. Sietel owns nearly 82% of the shares in Aqua-Max. Clearly it is in its commercial interests to obtain the best price. Accordingly it will take all reasonable steps consistent with its commercial interests to facilitate the sale and not obstruct in any way the successful completion of it. I proceed on that assumption.

I make this observation because from time to time, implicit in the defendants' evidence and submissions made, that because Sietel owned the real estate where the units are manufactured, that Sietel employs a number of key employees who work for Aqua-Max and that Sietel allegedly owns the plant and equipment which is used to manufacture the units that Sietel may be difficult in facilitating the sale and make demands that would jeopardise the sale. By way of example, that if it does own the plant and equipment it would expect to be paid the valuation of Taylor Lockwood which amounts to a considerable amount of money. But the reality is that there would have to be a degree of compromise because if Sietel could not sell the plant to Aqua-Max its value would drop substantially.

I find the defendants' approach unrealistic and I expressed it so a number of times during the course of the trial. The fact is that this sale would be with the full co-operation of Sietel.

Another matter that was highlighted by the defendants was that there was no certainty that those Sietel employees who were so important to Aqua-Max's success would necessarily go with the sale of the business. The argument was put that this decreased the capitalisation rate for the risk that these personnel may not pass with the business. Again I find this an unrealistic argument. Sietel would encourage these employees to go with the business for the obvious reason that it will increase the sale price. Realistically Sietel would not wish to place any obstruction in the way of these employees being employed by the new owner. Their expertise is best used in the business of Aqua-Max. It would be expected they would transfer their employment with the business.

That is not to say that Sietel is not entitled to a commercial return for any items of plant and equipment owned by it or that its commercial interests are not to be taken into account. But the reality is that it is the majority shareholder in the reasonable willing but not over anxious vendor and it would do all that was necessary to ensure the best price is obtained on a sale.

Sietel, as the majority shareholder, contends that the majority and the most valuable part of the plant and equipment used to manufacture the unit is owned by it and accordingly any value of the business must take into account that the purchaser of the business would need to purchase the plant and equipment from Sietel. It is suggested that the most practical course to adopt would be for Aqua-Max to purchase the plant and equipment. Hence it is contended that having arrived at the value of the business one must take off the value of the plant and equipment which would be paid for by Aqua-Max.

M.T. Associates has strenuously contended that Aqua-Max owns most of the plant and equipment which is used in the manufacturing business.

In determining the value I am of the opinion that the sale of the business would be effected by the sale of the shares in Aqua-Max and that it would be in the commercial interests of both vendor and purchaser that the sale would include all the necessary plant and equipment so that the purchaser obtains complete control of the manufacturing process. This means that Aqua-Max has to purchase all equipment owned by Sietel and it was common ground between the parties that the amount comes off the purchase price i.e. the debt owing to Sietel is increased.

The first step is to determine the items that made up the future maintainable earnings calculation arrived at by the referee.

The next step is to exclude the items of leasing and hiring of plant and equipment, the personnel charges levied by Sietel for its employees used by Aqua-Max and research and development.

It will be then necessary to consider what adjustments should be made in calculating the future maintainable earnings for each of the said items.

Having carried out that exercise it will be necessary to calculate the future maintainable earnings, determine the capitalisation rate and thereby value the company's business.

Once having arrived at that sum it is necessary to value the present value of the tax losses and add them to the calculation.

The court must then determine what actual debt is owed by Aqua-Max to Sietel Limited and deduct that from the amount. This comprises the debt owing at the relevant date and any amount that Aqua-Max has to pay for plant and equipment it has to purchase.

The date is 17 July 1998. That is the relevant date to determine the value of the business.

It is necessary to identify in the referee's calculation of the FME the amounts he allowed for leasing and hiring of plant and equipment, for personnel charges, that is, the provision of labour by Sietel to Aqua-Max and research and development.

I reproduce the special referee's summary set out in appendix H to his report. I have made a number of changes of no consequence.

AQUA-MAX - adjusted FME (Referee's Determination)

Earnings before interest taxation depreciation and amortisation (EBITDA)

The referee selected a capitalisation rate for the EBIT calculation at between 4.5-5.0 times. This results in a value - M$8.946 to M$9.940 according to the special referee.

The referee added the value of tax losses - M$1.075 to M$1,167 and subtracted debt to Sietel - M$7.613 - M$7.773 (this included the notional debt).

The items marked * in the FME are open to adjustment or exclusion and substitution in the present proceeding. The totals and value will as a result have to be amended.

The capitalisation rate, the value of the tax losses and the amount owing to Sietel were also very live issues at the present hearing.

The special referee took the actual figures of the company to the 30 June 1998 and estimated the last three months to 30 September 1998. The actual sales revenue to 30 September 1999 was substantially greater than the amount he estimated to the same date.

The first step is to determine what amount or amounts were included in the referee's FME calculation for the personnel charges, leased plant and equipment and research and development.

These items must be valued and then removed from the referee's calculation which will result in an increase in the FME.

The next step in the exercise is to determine what amount should be included as an expense in the FME for each of the said items.

The first step in the exercise has proven difficult. The referee's report comprises his report and appendices A - L (inclusive). Appendix H comprising three pages is the summary of the accounts for Aqua-Max for the company's financial years from 30 September 1993 to 1997 and the nine month period to 30 June 1998. The referee chose the nine month period because it was close to the relevant date which was 17 July 1998 but having done that he then annualised the accounts for the last three months. In other words he did not take into account actual income and expenses for that period. Counsel for M.T. Associates criticised that approach at the August 1999 hearing and I dealt with the criticism in my reasons.

The second page is a summary of adjustments of the accounts and the third page is the adjusted summary but as I have stated he annualised the figures for the final year ending on 30 September 1998.

The special referee took the final year as the FME.

In order to understand what he did, it is necessary to consider Appendix H, and some of the other appendices in his report. Unfortunately it is not entirely clear what items he included for what he described as costs i.e. expenses. He has lumped a number of costs together under the heading "other operating costs".

The evidence reveals that he had a print-out supplied by Mr R. Rees of the Aqua-Max accounts for the nine months to 30 June 1998 being Exhibit MTA 9. The parties accept that the referee had this document and worked from it.

It comprises a balance sheet, a profit and loss statement for the manufacturing division, a profit and loss comparison report for the same division, and a balance sheet profit and loss statement and profit and loss comparison sheet for the research and development division.

At a glance

Court

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Before

Source

Judgment (748 paragraphs)

Parties

Cases Cited (5)