McDonald's Australia Limited v Transport Infrastructure Development Corporation

McDonald's Australia Limited v Transport Infrastructure Development Corporation - [2006] NSWLEC 796 - NSWLEC 2006 case summary — Zoe

[11]

Legislation 5 As stated in s 54(1) of the Just Terms Act: The amount of compensation to which a person is entitled under this Part is such amount as, having regard to all relevant matters under this Part, will justly compensate the person for the acquisition of the land. 6 Section 55 of the Just Terms Act sets out the matters which must be considered in determining the amount of compensation to which a person is entitled: McBarron v Roads and Traffic Authority (NSW) (1995) 87 LGERA 238 at 244. 7 Section 55 of the Just Terms Act provides: In determining the amount of compensation to which a person is entitled, regard must be had to the following matters only (as assessed in accordance with this Division): (a) the market value of the land on the date of its acquisition, (b) any special value of the land to the person on the date of its acquisition, … (d) any loss attributable to disturbance, … 8 Section 56(1) provides: In this Act: "market value" of land at any time means the amount that would have been paid for the land if it had been sold at that time by a willing but not anxious seller to a willing but not anxious buyer, disregarding (for the purpose of determining the amount that would have been paid): (a) any increase or decrease in the value of the land caused by the carrying out of, or the proposal to carry out, the public purpose for which the land was acquired, and (b) any increase in the value of the land caused by the carrying out by the authority of the State, before the land is acquired, of improvements for the public purpose for which the land is to be acquired, and (c) any increase in the value of the land caused by its use in a manner or for a purpose contrary to law. 9 Section 57 provides: In this Act: "special value" of land means the financial value of any advantage, in addition to market value, to the person entitled to compensation which is incidental to the person's use of the land. 10 Section 59 provides: In this Act: "loss attributable to disturbance" of land means any of the following: … (f) any other financial costs reasonably incurred (or that might reasonably be incurred), relating to the actual use of the land, as a direct and natural consequence of the acquisition.

[12]

Market value 11 There is a fundamental disagreement between the parties as to whether a claim can be made for the market value of the business under s 55(a) in the circumstances of this case. 12 Both valuers agreed that the most conceptually sound basis for measuring the loss suffered by the Applicant on an extinguishment basis was to assess the net present value of the cash flows which it had lost for the remaining 11 years of the lease as a consequence of the compulsory acquisition of the premises. While the valuers disagreed in relation to the recovered cash flow and discount rate to be applied in that analysis they both agreed that was the appropriate methodology. That methodology assessed the loss of the business as the net present value of future profits. There does not seem to be any basis on which this claim can be regarded as market value under s 56(1) of the Just Terms Act. Given that the valuers jointly agreed that the net loss of cash flow was the appropriate methodology to apply it is difficult to relate the argument focussing on market value to the Applicant as representative of the appropriate measure of compensation. Both valuers have considered that the amount of compensation should be claimed as disturbance. 13 The basis on which the Applicant argued that it was entitled to the market value of the business was unclear to me. The Applicant argued that the correct approach was the primary alternative claimed so that the Court should combine a compensation claim under s 55(a) and s 57 to determine "what would McDonald's have paid for this site rather than lose it". The value of this business to the Applicant is one which has a "financial advantage in addition to the market value to McDonald's, which was incidental to the use by McDonald's of the Chatswood outlet". If the Court determines that there is such a financial advantage peculiar to the Applicant then special value should be applied. These arguments by the Applicant's counsel are unclear and do not reflect the provisions of the Just Terms Act. The Applicant's counsel argued that The Commonwealth v Milledge (1953) 90 CLR 157 was supportive of the approach he argued for in relation to market value. That case was not dealing with a loss of a business for a sublessee's interest in land. I do not consider it has much application to the circumstances of this case. It deals with market value in relation to the compulsory acquisition of freehold land on which a business is located. 14 TIDC argued that the interest in land acquired is a sublease resulting in the extinguishment of a business. The methodology for determining the market value of the lease involves a calculation of the profit rental. The profit rental is the difference between the value of the rental under the lease at the relevant date, and the value of the rental for the leasehold interest if it was leased on the open market at the relevant date. The two valuers in the case, Dr Ferrier and Ms Exner, have both calculated profit rental attributable to the sublease as part of their calculations and that figure has been subsumed into their overall calculations under the net present value of cash flow methodology. There is no separate calculation of market value undertaken by the valuers. 15 Further support for TIDC's position may be found in Douglas Brown, Land Acquisition: An examination of the principles of law governing the compulsory acquisition or resumption of land in Australia and New Zealand (5th ed.), LexisNexis Butterworths, Chatswood, 2004, in which the author considers the extinguishment of business loss as a result of acquisition. He states that compensation provisions in resumption statutes do not directly refer to situations where the active resumption causes, or partly contributes to, the extinguishment of a business. A claimant therefore needs to rely on the provisions governing disturbance, loss or damage.

[17]

22 I agree with TIDC's submission. There is no evidence that the premises had any particular financial advantage to the Applicant that could not be enjoyed by another operator on the same premises. The physical feature of the premises being in an area of high pedestrian traffic was a feature that any retail operator could have exploited. No claim for special value is maintainable. 23 It follows from my conclusions above that the only basis on which a claim for compensation for loss of business can be made by the Applicant is as a claim for loss attributable to disturbance under s 59(f) of the Just Terms Act. Valuation evidence 24 As outlined above at par 12, the two valuers called by the parties, Dr Ferrier (TIDC) and Ms Exner (Applicant), agreed on the appropriate methodology to adopt. The two major areas of disagreement between the experts in relation to this methodology are: (a) what is the amount of lost cash flow likely to be recovered through increases in sales of other McDonald's outlets, and (b) what is the appropriate discount rate to apply to lost cash flows. 25 The two valuers prepared their principal reports and also prepared a comprehensive and useful joint report (Exhibit C). 26 Separate to the net present value of cash flows lost as a result of the compulsory acquisition, TIDC also argued that there were two other possible bases for recovery of compensation which they had Dr Ferrier value. The primary alternative related to a net loss of cash flow attributable to "location goodwill". The second option argued by TIDC to apply in the alternative was a net loss of cash flow allowing for the possibility of further recovery of cash flow at a future time within the remaining 11 year term of the sublease held by the Applicant. The third alternative argued by TIDC was that adopted by the valuers as their primary approach in their evidence, being the net present value of cash flow ignoring the possibility of further recovery at a future time. I will now consider the first alternative argued by TIDC because if successful there is no need to consider any other alternative approach.

[22]

36 He concluded the following (a) There was a sales increase at St Leonards, Wynyard Ramp and Chatswood Westfield McDonald's when benchmarked to the Sydney Local Market (b) However, other factors occurred at the same time that have also impacted on the sales at these stores. Therefore, I cannot conclude that the sales increase is a result of the closure of Chatswood Railway. (c) It is my opinion that the increase in sales to Chatswood Food Court resulting from the closure of Chatswood Station Store is a maximum of 5.1% but this will only be temporary until the new station is built and another food court is available for train travellers. (d) My opinion is that a maximum impact of 5.1% is a generous allowance in the circumstances. 37 Dr Ferrier considered the increased sales of $6,935 per week at locations proximate to the premises showed an increase of 19.6 per cent ($360,620 per annum). He relied on the table at par 5 of Mr Lowe's affidavit to reach this conclusion. Dr Ferrier's opinion was that it would be reasonable to reduce the identified increase in sales by 15 per cent per annum ($306,000) representing approximately 17 per cent of the estimated annual sales of $1,843,018.00. 38 In oral evidence Mr Lowe sought to qualify the evidence in his affidavit to the effect that the total of likely recovered sales was in the order of 5.1 per cent taking into account all McDonald's outlets not just the Chatswood Food Court outlet. This opinion was not based on any particular market analysis but was his opinion based on experience. When pressed in cross-examination he was unable to attribute any particular percentage change to any market research or surveys undertaken, his view being a general one based on his experience. 39 Ms Exner assumed that the recovery of sales was 5.1 per cent of the gross profit of the business from increased sales of other outlets because she was instructed to adopt that figure. She criticised Dr Ferrier's analysis at 9.12 of the joint report because he assumes the amount of recovered sales will continue at the same rate until 30 January 2016. This is unlikely as Mr Lowe considers the increased sales will reduce once the new railway station is built with a new food court. Further, Mr Lowe is not able to conclude that the increased sales at other outlets are a result of the closure of the Chatswood railway outlet.

[24]

(ii) Discount rate 41 The valuers do not agree on the appropriate discount rate to apply. Ms Exner applied the weighted average cost of capital (WACC) as the appropriate discount rate. This was calculated using an established formula (see Sch 2 of her report, Exhibit B). She derived a discount rate of 14 per cent in part from the use of publicly available market data for McDonald's Corporation (US). She did not use data available for McDonald's Australia Ltd, the Applicant, because it is not a publicly listed company and therefore the necessary data was not available to her. Part of the approach required use of a figure known as the beta, which measures the "riskiness" of a business. McDonald's Corporation US has a beta of 0.95 according to Bloomberg financial analysts. A business with a beta less than 1 is considered less risky. 42 Ms Exner considered that the Applicant would not be willing to relinquish its rights under the sublease to operate a business at the site unless a third party was prepared to pay an amount at least equal to the value of the business of $2,383,743 applying a discount rate of 14 per cent for the remaining 11 years of the lease (as calculated in Sch 1 of her report, Exhibit B). 43 Ms Exner considered it was reasonable to adopt a discount rate equal to the WACC of McDonald's Corporation US as this reflected the risk associated with the assets being valued. This risk was different to and lower than the risk faced by a hypothetical franchisee operating a business which she considered was Dr Ferrier's approach. She considered a discount rate of 14 per cent was correct. To support her approach Ms Exner compared the WACC of three McDonald's competitors, Starbucks Corporation, Restaurant Brands NZ Ltd and Yum Brands Incorporated. All of these businesses yielded a similar result (Sch 12 of her report, Exhibit B). 44 Dr Ferrier did not agree with Ms Exner's approach in deriving the WACC because: (i) no prospective arm's length purchaser would have reasonably expected to generate the same cash flows without the use of the McDonald's system and name; (ii) even if a specific prospective purchaser could have expected to generate the same cash flows by using their own system and name (such as Pizza Hut, KFC or Subway), such a purchaser would not have reasonably been willing to pay for the goodwill attributable to the McDonald's system and name (which they would not acquire), but only for the goodwill attributable to the location; (iii) no prospective arm's length purchaser would be likely to have the same cost of capital as the Applicant; and (iv) McDonald's Corporation US WACC does not adequately allow for the risks associated with the expected cash flows of the particular business at Chatswood railway station. 45 Consequently Dr Ferrier's opinion was that a reasonable approach to determine the amount an arm's length purchaser would be prepared to pay for the business in light of the profitability of the site, was to assess the amount which the Applicant would reasonably pay for the business. Dr Ferrier applied the figures obtained from the McDonald's Franchise Accounting Manual 2005 in a section entitled "The sale and purchase of an existing restaurant". The manual identifies three types of transactions as follows: (i) Company sells store to an operator or registered applicant (ii) Operator sells store to the Company, or (iii) One operator sells store directly to another operator or to a registered applicant 46 The manual states that while the procedures are the same for each type of transaction, for the purposes of that section the focus is on one operator selling directly to another. In the sample borrowing guideline calculation a multiple of five is used as the relevant factor to apply. Dr Ferrier considered that it was apparent the multiple of five used by the McDonald's manual to assess the value of a business to a franchisee was applied to EBIDA (Earnings Before Interest, Depreciation and Amortisation) and not to EBIT (Earnings Before Interest and Tax). He therefore calculated that the equivalent cash flow discount rate should be 22.3 per cent based on a period of 11 years remaining in the lease, resulting in a value of $1,180,882. This was the amount likely to be paid by a prospective franchisee for the business before recruitment and training. 47 Ms Exner also undertook a calculation of the loss of profits on the basis of the cash flows generated to operate the business by a third party franchisee, Dr Ferrier's approach. Her revised calculations based on this approach was $2,047,177 (Sch 5(i) of her report, Exhibit B). 48 The approach of Dr Ferrier was criticised because it was not correct to apply the analysis in the manual which concerned the sale to franchisee. Dr Ferrier also failed to take into account the extra income derived by McDonald's from its franchisees in the form of ongoing rent and system fees and a royalty fee which amounted to $907,781 over 11 years (see Sch 5(ii) of her report, Exhibit B) which amount Ms Exner took into account hence the higher figure ($2,047,177). 49 Ms Exner stated (at par 9.18 of the joint report) that Dr Ferrier's approach assumed a capitalisation rate in perpetuity and was not limited to a finite period which ends on 30 January 2016. The corrected figure would be 17.7 per cent if the correct period was applied. Dr Ferrier disagreed that his figure was calculated incorrectly but rather related directly to the remaining lease period of 11 years.

[26]

52 The Applicant argued that Collex Pty Ltd v Roads and Traffic Authority of New South Wales [2006] NSWLEC 579 in which Talbot J considered the application of the discounted cash flow methodology in a compulsory acquisition of land supported the approach of Ms Exner. Talbot J considered the valuation evidence before him at [90] - [92] and the approach of the experts in that case included the calculation of the beta for the operations being valued. The valuers also considered the beta of companies carrying on comparable or related activities to the applicant in that case. Each case must be decided on its own facts. Collex is simply a case where the discounted cash flow approach was also accepted by the Court. It has no direct application to the analysis of the valuers using that approach in this case. I do not consider the case provides particular support for Ms Exner's approach. 53 I consider that Dr Ferrier's approach more accurately determines the discount rate likely to reflect the normal business risks associated with the cash flow of this business, which has been acquired. It is therefore more reflective of the risks to a purchaser that the cash flow from the business may not be maintained. The discount rate he derived from the McDonald's franchise manual is intended to apply beyond that of a franchisee purchase of a business and is also applicable to an arm's length purchaser situation. Further, an arm's length purchaser would be unlikely to have the same cost of capital as McDonald's Australia Ltd. 54 The Applicant's counsel argued strenuously in reply that another failure of Dr Ferrier's approach was that he had derived a capitalisation rate "in perpetuity" because it was not limited to an 11 year period identified by Ms Exner. His approach was said to be faulty compared to Ms Exner's because in her table in Sch 1 of her report she applied the discount rate of 14 per cent on an annual basis over the 11 year period. It was argued that Dr Ferrier had failed to do this. However on close examination of his first report it appears that he also undertook a similar analysis over an 11 year period, albeit with different figures, at the time his report was prepared. Information on which he now relies has since become available so that the figures applied have changed, but not the underlying methodology. It is also clear from the joint report at par 9.14 that Dr Ferrier's analysis commences with the valuers' agreed amount which a prospective franchisee would pay for the remaining 11 year period of the lease so that the limitation of 11 years is clearly factored in from the outset of his calculations. 55 I do not consider there is any validity to this criticism of Dr Ferrier's approach. Consequently I consider I should adopt Dr Ferrier's approach and the amount he calculates in relation to this alternative is $1,112,000 being the net loss of cash flow of the business. It is not relevant to add in the extra income the Applicant would derive from a franchisee through ongoing rent and system fees as that is not relevant to a hypothetical purchaser situation. 56 While the Applicant's counsel filed in Court a Fifth Further Amended Points of Claim which was said to reflect changes needed because of different figures adopted by the valuers in oral evidence in relation to the amount recovered for stock, plant and equipment, this was not agreed by TIDC and was contrary to figures provided by the two valuers jointly in Exhibit J. In the absence of that agreement by TIDC that the changes are necessary purely because of mathematics, I consider I should adopt the revised figure in the agreed evidence of the valuers in Exhibit J for Dr Ferrier, which is $1,112,000.

[27]

Possibility of further recovery of sales at future time 57 The second alternative argued by TIDC was that there was a likelihood that another McDonald's store would open in the Chatswood area within the remaining 11 year period of the lease. This would result in a recovery of sales within the remaining lease period which would reduce the amount of loss. 58 The Applicant relied on the evidence of Mr Gude, the New South Wales real estate manager for McDonald's, that if a property became available on the Pacific Highway at Chatswood suitable for a restaurant the Applicant would open a new outlet. In his affidavit sworn 31 May 2006 he detailed the investigations undertaken by the Applicant into the availability of alternative sites in the Chatswood business district. The Applicant concluded that there was no viable comparable site to the existing railway concourse site. He stated that McDonald's identified gaps in the market for its restaurants. A gap in the Chatswood market for a freestanding store along the Pacific Highway has been identified. In oral evidence Mr Gude stated it was highly unlikely and/or there was no possibility of a McDonald's outlet opening in the Chatswood area in the future. 59 Dr Ferrier's opinion was that the Applicant should be adequately compensated for the loss actually suffered. The Applicant should only be awarded the lost cash flows for the whole 11 year period up to 30 January 2016 if there was no reasonable possibility that it would not recover any of that lost cash flow. Dr Ferrier considered that there was a possibility of some recovery of lost cash flow in that period. He identified an additional ten per cent as an appropriate amount to allow. He accepted that this was an entirely subjective calculation because of the uncertainty about what may happen in the future. Because of additional information received Dr Ferrier revised his first estimate from ten per cent to five per cent as the appropriate discount rate which should be allowed. He therefore concluded that the appropriate discount rate was 27.3 per cent which reflects the possibility that the Applicant will recover additional lost cash flows by reopening or relocating the business sometime before 30 January 2016. This resulted in an amount of $832,000. 60 Ms Exner did not agree with this approach as she considered it was unreliable in the absence of an actual alternative scenario to consider. It is impossible for experts to determine with sufficient certainty when a restaurant may open and what cash flows would result from such an event.

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