McKensey v Hewitt

CASES CITED : Kirkpatrick v Kotis (2004) 62 NSWLR 567 Rogers v Wentworth (unreported NSWCA 18 April 1988)

Hugh Stanley McKensey (First Plaintiff) PARTIES : Victor John Lewis (Second Plaintiff) Peter Charles Hicks (Third Plaintiff) Christopher Michael Hewitt (Defendant)

COUNSEL : Mr T Alexis SC (Plaintiffs) Mr M Ashhurst (Defendant)

SOLICITORS : Harris Wheeler (Plaintiffs) Hewitts Commercial Lawyers (Defendant)

• 9 - IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION

1585/95 HUGH STANLEY MCKENSEY & ORS V CHRISTOPHER MICHAEL HEWITT JUDGMENT 1 This judgment deals with a notice of motion filed on 7 August 2006 on behalf of Mr Hewitt, the first defendant. The action has had a tortuous history arising out of a dispute between persons who were, at various times, members of an accounting partnership in Newcastle, known as Forsythes. 2 On 10 September 1994 the then partners of Forsythes entered into what has been called a separation agreement setting out terms under which Mr Hewitt and another partner, Phillip Anthony Nelson, would retire from the old partnership (Forsythes (Old)) and under which the remaining partners of Forsythes (Old), namely Messrs McKensey, Lewis and Hicks, would carry on a new partnership of Forsythes under the same name (Forsythes (New)). 3 An earlier dispute involving an earlier Forsythes partnership in which a Mr Page was a partner was also subject to much litigation in this court. The only matter of relevance here is that when Mr Page left the firm taking certain clients with him it became necessary to value the firm to establish his interest in it. Mr Page took certain clients of the firm with him when he left, so that the goodwill attributable to those clients was deducted from the figure otherwise payable to him as his share in the partnership. In that case there was only one valuation done, that being for the whole partnership, with the value attributed to the goodwill of those clients taken by Mr Page being the proportion the maintainable earnings attributed to them bore to the earnings of the whole partnership. 4 Clauses 10 and 16 of the separation agreement are as follows: 10. On or before 31 December 1994, the parties jointly engage, and pay in the proportions of their interests in Forsythes (Old) at 28 August 1994, the services of Rob Knights of Rob Knights & Co, Chartered Accountants of Sydney, or in the event of him being unable or unwilling to so act, a valuer appointed by the NSW State Chairman of the Institute of Chartered Accountants in Australia, to value the goodwill of the accountancy practice and associated entities of Forsythes (Old) excluding the HMC Unit Trust, Forsythes Computer Systems Pty Ltd and Back to Basic Business Services Pty Ltd. The basis upon which the valuation is to be conducted is that of a willing but not anxious buyer and a willing but not anxious seller, with the seller being prepared to enter into reasonable covenants not to compete. The above valuation will be based solely upon the trading results of Forsythes (Old) for the year ended 30 June 1994. Settlement for the amount owing to the Retiring Partners, representing their share of the goodwill, will be in accordance with the Settlement Payment. … 16. An interim schedule of 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, is attached hereto as Schedule G. On final determination of those fees, the value of the goodwill attributable to them is to be determined by the same valuer in accordance with 10. The value so determined will be due to Forsythes (New) by the Retiring Partners and will form part of the Settlement Payment. 5 It was and is accepted that the interests of the retiring partners in Forsythes (Old) would be paid out by the remaining partners, but that the goodwill value of the clients taken away by the retiring partners would be set off against this amount. It is not necessary to decide whether this was logical or not. Before me counsel accepted that this was the basis of the agreement. 6 The proceedings between the remaining partners as plaintiffs and the retiring partners as defendants were heard before Einstein J in September 1997 and determined on 15 October 1997. One of the issues was the proper construction of clause 16. The contention of the defendant retiring partners apparently was that there was a need for only one valuation to cover clause 10 and clause 16, as the goodwill attributable to the maintainable earnings of clients taken away by the retiring partners would be a proportionate amount of the whole of the goodwill of Forsythes (Old) being the proportion those earnings bore to the total earnings of Forsythes (Old). As I explained, that was the basis upon which Mr Page's share in goodwill of the original partnership was determined when that partnership was terminated. 7 At an early stage of the proceedings before Einstein J an offer was made and accepted which resulted in the settlement of a substantial part of the proceedings before him. As a result of this agreement an order by consent was made in the following terms: 1. The Court now declares that upon the proper construction of the settlement agreement made on 10 September 1994 between Hugh Stanley McKensey, Victor John Lewis, Peter Charles Hicks, Christopher Michael Hewitt and Phillip Antony Nelson, the words "in accordance with 10" which appear in cl16 of that agreement mean: (i) that the valuation is to be by a valuer jointly engaged by the parties; (ii) that the basis upon which the valuation is to be undertaken is to be that of a willing but not anxious buyer and a willing but not anxious seller, with the seller being prepared to enter into reasonable covenants not to compete and; (iii) that the valuation is to be based solely upon the trading results of Forsythes (Old) for the year ended 30 June 1994. 8 Pursuant to these orders, and after certain vicissitudes because Mr Knights, the named valuer, had died and there were difficulties with the method of appointing a valuer in his place, Mr Vella was appointed by court order as valuer to carry out the clause 10 and clause 16 valuations in accordance with the consent orders. 9 By valuation dated 21 April 2006, Mr Vella has valued the goodwill of Forsythes (Old) at $880,000 and the goodwill attributable to the fees parcel taken by the retiring partners at $221,200. The valuations are separate; that is the latter figure is not a percentage of the former calculated rateably to the proportion of fees taken by the retiring partners to the total fees of Forsythes (Old). The total valuation of Forsythes (Old) consisted of a composite of figures, calculated on differing bases depending upon the component of the business. The general accounting value component was arrived at by "deducting from the value of goodwill determined on a capitalization of maintainable earnings methodology, the fair market value of the net tangible assets devoted to the practice" based on a multiple of 6. The clause 16 valuation was done on a "rule of thumb basis", determining the figure in the dollar a purchaser would pay for a parcel of fees of that type. 10 The motion which I am dealing with seeks declarations and an order as follows: 1. A declaration that the valuation of Trevor Vella on 21 June 2006 and pursuant to the Settlement Agreement between the parties dated 10 September 1994 in proceeding numbered 1585 of 1995 is not a final and binding determination. 2. A declaration that the valuation pursuant to the Settlement Agreement between the parties dated 10 September 1994 in proceeding numbered 1585 of 1995 is to be a valuation performed in accordance with the Consent Orders made the 17th day of September 1997, that is to say, there is to be one valuation only carried out on the same basis for goodwill generally under clause 10 and goodwill attributable to the fees referred to clause 16 of the Settlement Agreement.

3. An order that the parties instruct Mr Vella to determine the true value of the two parcels of fees identified in clauses 10 and 16 of the Settlement Agreement between the parties dated 10 September 1994 in accordance with the Consent Orders made 17th day of September 1997 and declaration 2 herein. 11 The issue is whether the valuation of Mr Vella of the goodwill taken by the retiring partners is one made in accordance with clause 16 as interpreted by the consent orders. There is no longer any challenge to the clause 10 valuation of the goodwill of Forsythes (Old). 12 Sub-paragraph (i) of order 1 of the consent orders has little bearing on the dispute. It is, I think, obvious that the agreement contained in (i) as to the meaning of "in accordance with 10" in clause 16, namely "that the valuation is to be by a valuer jointly engaged by the parties", is not what clause 10 provides. The agreement is one as to a construction which I consider contrary to the clear terms of clause 10. Paragraph 1 (ii) of the consent orders is clear enough and accords with clause 10. It is important as I will explain later. However, the majority of the dispute concerned the effect of the words of 1 (iii) of the consent orders on the valuation to be prepared under clause 16. 13 As a matter of commonsense one would think that the reason for prohibiting consideration of earlier years for clause 16 was because the parties thought that in the circumstances which then existed, earlier years provided no reliable guide for the estimation of future earnings or perhaps future costs. 14 The question then is whether the proper construction of clause 16 as interpreted by the consent orders means that no separate valuation of goodwill attributable to the parcel of fees taken by the retiring partners is now to be made under clause 16, so that the goodwill attributable to those clients is to be calculated as the proportion of the total goodwill value, the fees charged to those clients bears to the earnings of Forsythes (Old) for the 1994 year; and not calculated in isolation by reference to the "maintainable fees" listed in Schedule G. 15 When the matter was first before me and certain material was tendered, particularly the transcript of proceedings before the trial judge, I rejected the material tendered on the basis the wording to be construed was not ambiguous. Later when considering the matter I found that when the construction of court orders, even consent orders, is under consideration, evidence of surrounding circumstances, but not of intention is admissible: Kirkpatrick v Kotis (2004) 62 NSWLR 567; Rogers v Wentworth (unreported NSWCA 18 April 1988). The matter was then relisted for further evidence and submissions at which stage the transcript and pleadings were put into evidence. This additional evidence established that the case of the defendants in the 1997 proceedings, brought in their cross-claim as finally amended, was that only one valuation was required; and that the clause 16 valuation was to be at the same rate and on the same basis as the clause 10 valuation. This case was put in various ways including proper construction and implied terms, rectification as a result of unilateral mistake, and misleading and deceptive conduct. The additional evidence also established that the consent orders were made after Mr McKensey had been under cross-examination for some time about the basis upon which the interest of Mr Page in the partnership and the value of goodwill attributable to the clients that he took with him, were determined and adjusted on his departure. However, the consent orders were not made minutes after that evidence was given. An open offer was made after the luncheon adjournment and it was accepted the following morning, the acceptance bringing about the orders made by consent. As a result of those consent orders other orders were agreed including an order that the balance of the cross-claim be dismissed. There was no reference in the consent orders or other orders on the cross-claim to the terms upon which the Page interests in the former partnership were adjusted. 16 The additional evidence also established that at the commencement of the hearing before Einstein J the defendants abandoned their claim pleaded up to that time that the valuation of the fees parcel taken by the defendants was to be at the same rate as that attributable to the Forsythes (Old) valuation. The claim was altered to one that it was to be on the same basis as the valuation of Forsythes (Old) but not the same rate probably because the Forsythes (Old) business had a number of components apart from the general accountancy component. 17 This concession seems to me to be contrary to the proposition that there was to be one valuation only. For instance, if the valuation of the goodwill of Forsythes (Old) were $880,000 then that could bring about a rate of cents in the dollar attributable to the income or earnings for the 1994 year. The same rate could then have been applied to the fees parcel taken by the defendants. Once the same rate claim was abandoned yet the "same basis" claim maintained, in my view that could only have meant that the basis was upon the trading results of Forsythes (Old) for 1994 which is what was achieved by the consent orders. 18 I would have thought that if the intention and construction of the consent orders was to bring about the position that only one valuation was required, then either the orders could have provided that what was to be done pursuant to the separation agreement was what was done when Mr Page left the partnership, or it could have been expressed in the following way: Valuation of Goodwill of Forsythes (Old) (Clause 10) x Schedule G 1994 fees (taken by retiring partners) Clause 16 value = ___________________________________________ Total 1994 fees of Forsythes (Old) 19 Mr Vella in his valuation said that he considered the words in order 1 (iii) prescribed facts or matters to be taken into account, or in his words restricted matters to be taken into account in determining the valuation but that they did not determine the methodology. He gave convincing reasons for adopting different methodologies, specifically the different nature of the components of the Forsythes (Old) business to be valued, only parts of which were of the same nature as that represented by the clients being taken by the departing partners, as well as the size of Forsythes (Old) compared with the parcel of fees attributable to clients going to the Hewitt interests. 20 It was argued by Mr Ashhurst for the applicant that as the Schedule G fees were based on fees applicable to the 1994 year the words "to be based solely upon the trading results of the Forsythes (Old) for the year ended 30 June 1994" added nothing. I do not accept that as correct. A list of the fees, the goodwill attributable to which was to be valued, would not have prevented consideration of past earnings or future expected earnings being considered by the valuer. What Mr Vella regarded as the restriction did prevent consideration of such material. 21 The most significant reason given by Mr Vella for his view that separate valuations were required, and that the consent orders set out the defined grounds for the valuation but not the methodology was that order 1(ii) would be meaningless if the "one valuation" or "proportional" approach were adopted. I agree with that statement. Order 1(ii) requires that the valuation under clause 16 is to be determined as the fair market value which is the willing but not anxious buyer and seller basis but this provision becomes otiose and contradictory if no separate valuation is to be made. I consider the entire consent order must operate on its terms. Order 1 (iii) must then be considered having regard to 1 (ii) as a restriction placed on the valuer. The parcel of fees was part of the trading results of Forsythes (Old) for 1994. Earlier years or future forecasts relevant to the clients who produced those fees could not be taken into account. 22 I can only conclude by saying that it is very unfortunate that the consent orders were not expressed more clearly as it is the lack of clarity which has brought about the continuance of the battle between two sides to the separation agreement. However, it is usually lack of clarity in expression which gives rise to construction issues as each side may have legitimate arguments about meaning of words and objective intentions. That is the position here, but the fact there are two clauses 10 and 16 which on their face each require a separate valuation as well as the requirement to give meaning to order 1(ii) as well as 1(iii) in my opinion carry the day. 23 The notice of motion should be dismissed with costs. **********

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