McKensey v Hewitt

McKensey v Hewitt - [1999] NSWCA 426 - NSWCA 1999 case summary — Zoe

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Facts: The appellants were employees of Deloitte Haskins & Sells ("DH&S") in Newcastle, which in October 1987 decided to cease operations in the Newcastle area. The appellants agreed to take over the business of DH&S and formed a new partnership called Forsythes Chartered Accountants ("Forsythes"). A transition agreement called the "Deloitte's Retirement Agreement" was drawn up. The purpose of this document was to facilitate such things as the transfer of clientele, business equipment and technical material to the new partnership. Clause 14 detailed an annual payment of $30,000 for ten years to be made by all Forsythes partners to DH&S in consideration for clientele and referred work. The respondents became partners in the new business and made contributions to the DH&S payments during 1988, 1989 and 1990. In September 1994 the respondents endeavoured to retire from Forsythes and dissolve the partnership. The Deloitte's agreement provided mechanisms for doing so. The respondents argued they were unable to comply with these provisions as the appellants had failed to disclose to them the terms of the retirement agreement, and the true nature of the $30,000 per annum liability to DH&S. The appellants brought action against the respondents, alleging a breach of fiduciary duty against the other Forsythes partners in failing to settle the financial accounts. They also sought an order for specific performance to complete the retirement agreement, an order for an account of profits, an injunction restraining the respondents from further access to Forsythes' documents, damages, interest and costs. In their cross-claim the respondents argued the appellants' failure to disclose details of the Deloitte's agreement meant the firm was unable to organise all elements necessary to facilitate the retirement of certain partners. The trial judge, in allowing the cross-claim, held the appellants had acted unconscionably in failing to disclose the true nature of the Deloitte's agreement. He found the payments were not in consideration only for the acquisition of DH&S clients, but as a personal benefit to the appellants. This constituted a breach of fiduciary duty. He ordered the appellants pay equitable compensation to the respondents The appellants appeal against this decision. On appeal it was argued the trial judge erred in finding the payments to DH&S were for the appellants' personal benefit. The appellants also submitted that there was no requirement for them to disclose details of the agreement to incoming partners, and so there had been no breach of fiduciary duty.

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In consideration of the foregoing, the new firm will pay an annual fee of $30,000 for a period of ten years." 4 His Honour found that the payments contemplated by clause 14 of the agreements were, or at least substantially were, in consideration for " benefits" personally obtained "by the appellants", whose existence was withheld from the respondents. The duty to disclose the nature of the payments was, according to his Honour, on the appellants, and their failure to do so constituted a breach of fiduciary duty. 5 This, with all respect to his Honour, vergers on the absurd. It might make some sense of the various benefits derived from the agreement were enjoyed only by the appellants and had been dissipated before either of the respondents had joined the partnership. But the respondents did not prove these facts, or even endeavour to make that case. In commercial terms, the bulk of the $30,000 payable by Partnership 1 was in consideration for taking over the Newcastle clientele of the old Deloitte's partnership. This clientele could hardly have vanished overnight. It, or the bulk of it, must have been there a month after the formation of Partnership 1 when Mr Nelson joined it, and , one imagines, still there eighteen months later, when Mr Hewitt joined. It would therefore seem that there were no "benefits" flowing from the agreement which was enjoyed exclusively by the appellants. In fact, it seems virtually certain that whatever "benefits" flowed from that agreement were enjoyed at all times by both the appellants and the respondents. 6 In truth, one of the assets of Partnership 1 was that clientele, and one its liabilities was the liability to pay for its purchase. It is no stranger that such a liability should exist than it would be, as Gills JA put in argument, that a liability existed in relation to a photocopier purchased on hire purchase by the partnership. 7 Although there was, apparently, no suggestion that any of the respondents had actually seen a copy of the agreement, neither is there any suggestion that they had asked to see it and been denied it. 8 For some years the agreement was performed, and the new partnership paid the annual tribute of $10,000 to the old partnership; this involved a payment by each of Messrs Hewitt and Nelson of the annual sum of $1,500 for the years 1988, 1989 and 1990. It is on this basis that I have calculated the maximum payable to the respondents to be $10,000, even if every single allegation made by them were correct. (Each side agreed with this calculation). 9 What his Honour's judgment in effect means is that the appellants are being crucified for daring to suggest that the respondents should pay their fair share of the partnership liabilities. 10 Two other points call for mention. The first is to note that counsel for the appellants submitted that the word "the foregoing" in clause 14 of the agreements referred only to clauses 2 and 3. No rational basis for this submission was advanced, and there is no reason for supposing the "the foregoing" has other than its usual English meaning and refers to every clause from 1 to 13. 11 The other is to note the principal order made by his Honour. His Honour expressed it thus: "The appropriate order will be to refer it to the Master to inquire into and certify the amounts which were charges to the accounts of Messrs Nelson and Hewitt over the lives of Partnerships 2 to 5 inclusive being referable to payments to Deloittes pursuant to the Deloittes' retirement agreement." 12 But why have an inquiry when everyone knows what amounts were charged? They were $4,500 in respect of each respondent. It should be noted that the respondents did not seek to sustain this order. 13 I agree with the orders proposed by Justice Giles. 14 GILES JA: There were a number of issues in the proceedings before Einstein J, all flowing from the breakdown of the last of the chartered accountancy partnerships known as Forsythes. This appeal was directly concerned with one only of the issues, although indirectly with other issues. 15 The succession of partnerships is described in the reasons of Meagher JA. They began with the retirement of the first partners from Deloitte Haskins & Sells ("Deloittes") and the Deloittes Retirement Agreement, the terms of which are set out in his Honour's reasons. I do not repeat those matters. 16 The issue directly the subject of the appeal was the claim by the respondents, Messrs Nelson and Hewitt, that the appellants, Messrs McKensey and Lewis, should pay equitable compensation for breach of fiduciary duty. The breach alleged was that the appellants failed to advise the respondents of "the true nature" of the obligation under cl 14 of the Deloittes Retirement Agreement to pay an annual fee of $30,000 for ten years. 17 Einstein J held -

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The holding as to consideration 21 The appellants submitted that "the foregoing" in cl 14 of the Deloittes Retirement Agreement related only to the matters in cll 2 and 13, the "friendly firm" arrangement and the best endeavours to refer audit work to the new partnership. So, it was submitted, the payment of the annual fee of $30,000 was not consideration for the taking over of the clients of the Newcastle office to which cl 3 referred, as was underlined by cl 6 in its provision that the retiring partners would not be requested to pay any sum for goodwill. 22 I do not think that the submission should be accepted. Clause 14 identified that for which the annual fee of $30,000 was payable in general terms, "the foregoing", and the expression on its natural reading encompassed all matters the subject of the preceding thirteen clauses. There is no reason to limit the consideration to the matters the subject of cll 2 and 13, and cl 6 meant only that a further sum specifically referable to goodwill would not be required. 23 There was nothing wrong, indeed it made good sense, for the parties to the Deloittes Retirement Agreement to stipulate for an annual sum payable by the retiring partners in addition to some specific payments ( for example in cl 12), in return for the package of benefits falling to those partners. I do not think that the appellants' reference to the principles by which a contract should be construed so as to make commercial sense and avoid commercial inconvenience (eg Upper Hunter County District Council v Australian Chilling and Freezing Co Ltd (1968) 118 CLR 429; Port Jackson Stevedoring Pty Ltd v Salmond and Spraggon (Aust) Pty Ltd (1978) 139 CLR 231; Hide & Skin Trading Pty Ltd v Oceanic Meat Traders Ltd (1990) 20 NSWLR 310) provides any support for the submission. 24 The appellants sought to go to the evolution of the Deloittes Retirement Agreement in aid of the submission. I doubt that it was permissible to do so (see Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337 at 352), but even if it was again I do not think that the submission is supported. Without setting out the evolution, I do not think that it demonstrated that the provision arguably the ancestor of cl 14 was related only to subsequently referred audit work the subject of cl 13, let alone that, as was argued, the later changes to the clauses left that sole relationship. Indeed, the sole relationship, and so the significance of the evolution of the Deloittes Retirement Agreement, was denied by the appellants' acknowledgment that the consideration for the annual fee of $30,000 included the benefit of the "friendly firm" agreement pursuant to cl 2. 25 Although I would prefer not to describe it as a parameter, in my opinion Einstein J was correct in holding that the payment of the annual fee of $30,000 was in part in consideration for the new partnership taking over Deloittes' Newcastle practice.

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Personal benefits and breach of fiduciary duty 26 The respondents knew that annual payments of $30,000 were being made to Deloittes. Neither of them was provided with a copy of the Deloittes Retirement Agreement. Nor was either told that the payments of $30,000, to which he contributed in that the payments were made from partnership funds prior to distribution of profits to the partners, were in consideration of a package which included that the appellants as the partners retiring from Deloittes would take over the clients of the Newcastle office. 27 Whatever may have been the case at the trial, on appeal the respondents' position was that the duties to disclose arose and the disclosure of "the true nature" of the Deloittes Retirement Agreement should have been made after the respondents became partners, as distinct from in the communications prior to their becoming partners. Accepting that the appellants owed fiduciary duties of good faith and disclosure to the respective respondents, I do not think that it was necessary that there be the disclosure for which the respondents contended. 28 It is evident that Einstein J considered that disclosure in relation to the Deloittes Retirement Agreement was called for because, in his Honour's view, the payments made and to be made pursuant to cl 14 were "in part consideration for benefits personally obtained by Messrs McKensey and Lewis, before Mr Nelson and later Mr Hewitt joined the partnership". Central to this was that the appellants obtained what were described as personal benefits, it seems from later parts of the judgment being contribution by the respective respondents towards discharge of what were described as their "personal obligations" to pay Deloittes for inter alia the Newcastle clients. The appellants then had to pay equitable compensation to the respondents to restore to them the amounts contributed. 29 When each of the respondents became a partner he became entitled to enjoy the use of and profits from the partnership assets, and became obliged to bear partnership liabilities, as between himself and the other partners in proportion to their agreed partnership interests. The Newcastle clients, at least in the case of Mr Hewitt no doubt excluding some who had ceased to be clients of the partnership since 1987, were in a practical sense a partnership asset, in just the same way as all other benefits from the Deloittes Retirement Agreement (including, for example, the "friendly firm" arrangement). The annual fee of $30,000 was in a practical sense a partnership liability, even though if Deloittes had sued for the fee it would have sued the appellants. As between themselves and the other partners the respondents became entitled to the benefit of the asset and became obliged to bear the burden of the liability, and there was no need for the appellants to explain to them, in discharge of fiduciary duties, either the source of the partnership liability or that they were contributing to meeting the partnership liability. 30 I do not think it correct to regard the payments made and to be made pursuant to cl 14 as in part in consideration for benefits personally obtained by the appellants before the respondents respectively joined the partnership. Payment of the annual fee after a new partner joined the partnership was payment for the partnership asset, the Newcastle clients or such body of them as remained, to the benefit of which the new partner became entitled. The annual fee was no different from a periodical payment for an item of office equipment purchased by the existing partners on time payment. There was no question of the appellants keeping an asset for themselves but having it paid for out of partnership funds. 31 It follows that in my view his Honour was incorrect to make the declaration as to the fiduciary duties and their breach, and the declarations and orders directed to payment of equitable compensation should be set aside.

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The orders as to costs 35 Separate orders stating the same costs percentage were made in relation to the costs of the statement of claim and the first cross-claim, on the one hand, and the costs of the second cross-claim, on the other hand. The issues concerning breach of fiduciary duty, which did not involve Mr Hicks, were amongst the issues raised by the second cross-claim, and it follows from what has already been said that the order for costs in relation to the second cross-claim should be set aside. The respondents did not maintain or failed on the other issues raised by the second cross-claim, principally to do with a sale of furniture and equipment, and they should be ordered to pay the costs of that cross-claim. 36 The challenge to the orders as to costs in the appeal involved the costs of the statement of claim and the first cross-claim. Mr Hicks was involved in the issues raised in those pleadings. 37 By the statement of claim the appellants and Mr Hicks claimed specific performance of an agreement ("the Settlement Agreement") made with the respondents by which the latter retired from the last of the partnerships in September 1994. The agreement called for steps to complete accounting matters for the partnership and for payment between the former partners, and there was an issue of construction as to the basis or bases on which valuations were to be made. There were other issues going to enforceability of this part of the Settlement Agreement. By the first cross-claim the respondents claimed specific performance and equitable damages in relation to another part of the Settlement Agreement by which the appellants and Mr Hicks were to purchase certain units in unit trusts, the issues coming to be whether the purchase of the units was to be completed irrespective of completion of the Settlement Agreement by the payment for which it called and, if it was, whether the appellants and Mr Hicks had otherwise been entitled to refuse to complete the purchase. 38 In the course of the hearing before Einstein J agreement was reached resulting in consent orders declaring a construction of the Settlement Agreement as to valuation and making an order for specific performance of that agreement. The issues as to the purchase of the units were determined by his Honour in favour of the respondents, and an order was made for an enquiry into the damages suffered by them; their claim to specific performance of the Settlement Agreement was said to be embraced by the order made on the statement of claim. 39 When dealing with costs his Honour referred to what he described as "an important concession … made by Mr McKensey in cross-examination", setting out a passage from the cross-examination. He then said - "It seems to me that the defendants by achieving order 1 of the consent orders made mid-hearing achieved the result which the plaintiffs had steadfastly from late November 1994, refused to accept. Insofar as the first cross-claim is concerned the cross-claimants Messrs Nelson and Hewitt sought and achieved declarations in relation to the transaction described in clause 23 of the settlement agreement. The cross-claimants did not succeed in obtaining an order that the transaction described in clause 23 of the Settlement Agreement 'be specifically performed forthwith'. This was because an order had already been made by consent that the whole of the Settlement Agreement be specifically performed and carried into execution and it did not seem to me that there was utility in, or that it was appropriate for, an independent order to be made for the specific performance of the transaction provided for in clause 23. The cross-claimants to the first cross-claim did, however, succeed in making good their claim to equitable damages in respect of the money which they would have received had the transaction provided for in clause 23 of the Settlement Agreement been completed on or before 31 December 1994. … Standing back from a minute examination of the way in which the proceedings had been first commenced, pleaded and repleaded, opened during the hearing, settled in part by the mid-hearing consent orders and then pursued to finality on the issues adjudicated upon in the principal judgment, it seems to me that quite probably the principal issue which had divided the parties for a number of years was fairly and squarely ultimately conceded by the plaintiffs and Mr McKensey in his cross-examination. It cannot, however, be suggested that the defendants/cross-claimants won on all remaining issues. They did not. The cross-claimants did, however, succeed and succeed to a substantial extent to those sections of the cross-claim pursued. It does not seem to me that the amount of time involved in the proceedings which related to the furniture and equipment issue was in any sense substantial and I do not consider that there should be some difference in the approach taken by the Court as to costs as between Mr Nelson and Mr Hewitt. In all of the circumstances it does appear to me that the appropriate order with respect to costs is an order that the plaintiffs pay 70% of the defendants' costs of the whole of the proceedings. That is to say of the statement of claim and of the two cross-claims and I propose to so order."

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40 The appellants submitted that his Honour had misapprehended the significance of the cross-examination of Mr McKensey and the consent orders made during the hearing. In truth, it was said, the basis of valuation as declared in the consent orders was as Mr McKensey had instructed the valuer, a basis which he maintained in the cross-examination in question. So the consent orders did not reflect a victory for the respondents on what his Honour described as the principal issue which had divided the parties for a number of years, but rather a victory for the appellants, and in exercising his discretion as to costs under this misapprehension his Honour had erred. 41 The issue arose over the construction of cll 10 and 16 of the Settlement Agreement. By cl 10 there was to be a valuation of the goodwill of the accountancy practice and its associated entities. By cl 16 there was to be a valuation of the goodwill attributable to "the maintainable fees earned by Forsythes (Old) from clients taken over by the Retiring Partners jointly, based on fees applicable to the year ended 30 June 1994", made by the same valuer "in accordance with 10". The two valuation figures were used in arriving at the payment between the former partners. 42 His Honour initially described the issue as that the respondents contended that there was to be one valuation only carried out on "the same basis" for goodwill generally and goodwill attributable to the fees referred to in cl 16, but the appellants and Mr Hicks contended that the two valuations were to be on different bases. However, it seems clear enough that there was more, and that beneath these different positions was that the appellants and Mr Hicks instructed the valuer that the cl 10 valuation was to be 'based on the trading results of Forsythes for the year ended 30 June 1994", but did not say the same about the cl 16 valuation. Mr Kensey maintained this in the cross-examination to which his Honour referred. The appellants and Mr Hicks were wrong. The instruction to the valuer reversed the restriction to trading results for the year ended 30 June 1994, and the consent declaration made express that the cl 16 valuation was to be restricted in that way. The respondents won on the substance of the issue, and there is no reason to disturb his Honour's exercise of discretion in relation to the costs of the statement of claim and the first cross-claim. 43 Neither the appellants nor the respondents adverted to the fact that Mr Hicks was not a party to the appeal. Where the challenge to the costs order affecting him has failed, this can be overlooked. 44 The appellants have had partial success on the appeal, but have failed as to the consideration in the Deloittes Retirement Agreement and as to costs: the latter was of greater pecuniary significance between the parties. In my opinion the parties to the appeal should be left to bear their own costs. 45 I propose the following orders -

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(4) Make no order as to the costs of the appeal. 46 FITZGERALD JA: The circumstances giving rise to this appeal are summarised in the judgment of Meagher JA. 47 As I understood the argument ultimately presented to this Court on behalf of the respondents, it accepted that the appellants did not have any obligation to disclose the "Deloittes Retirement Agreement" in their discussions with each respondent before he joined the partnership. However, because of the fiduciary duties which partners owe one another, it was argued that the appellants were obliged to disclose to each respondent after he became a partner that the annual fee of $30,000 payable under clause 14 of the Deloittes Retirement Agreement was, wholly or partially, a payment for the clients "acquired" by the appellants under clause 3 of that agreement. According to the respondents' attempt to uphold the judgment of the trial judge, had that been disclosed they would have been able to avoid paying their contributions of $1500 per year (based on their respective proportions of the partnership) to the annual fee of $30,000. The legal basis of their entitlement to withhold those contributions did not emerge. 48 The respondents' case did not depend upon a premise that each paid an amount to join the partnership which was influenced by an understanding that one of its liabilities, the annual fee of $30,000, did not have any relationship to the acquisition of one of its assets, its clients, and, as I have already mentioned, it was not submitted in this Court that the non-disclosure complained of occurred in discussions prior to the respective entries of the respondents into the partnership. Nonetheless, the basic premise seemed to be that the annual fee of $30,000 was a personal liability of the appellants or, alternatively, related to the acquisition by the appellants of a personal asset, the clients. However, the clients were plainly a partnership asset, and the annual fee was plainly a partnership liability. Each respondent obtained the benefit of the former and the financial disadvantage of the latter upon his entry into the partnership. 49 The weakness of the respondents' position is highlighted by the position of one of them, Nelson. He joined the appellants as a partner within two months of the Deloittes Retirement Agreement. The only benefit the appellants obtained from the clients acquired under the Deloittes Retirement Agreement which Nelson did not obtain were any benefits which accrued within that period of two months. 50 I have found it impossible to identify a legal foundation for the respondents' claim for equitable compensation. In my opinion, the appeal should be allowed. 51 On the other issues, I agree with Giles JA. I also agree with the orders which his Honour proposes. **********

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