Norco Co-operative Ltd v Pauls Trading Pty Ltd & Anor

[1] The plaintiff is a party to a written joint venture agreement with the defendants dated 27 June 1996 and a deed of variation dated 21 December 1998 (collectively, the 'JVA').

[2] The defendants are in default under clause 9.1 of the JVA. The circumstances of the default and its legal consequences appear in [2006] QSC 15 and [2006] QCA 128.

[3] The default triggered the operation of clause 9.2 of the JVA, whereby the defendants granted an option to purchase each of their respective 'Interest[s]'.[1] Further, the defendants on behalf of a related company, Gold Coast Milk Pty Ltd ('GCM'), granted to the plaintiff an option to purchase 'GCM's Goodwill'.[2] The JVA calls these two pieces of property 'the Offered Interest'.[3]

[4] The plaintiff has duly exercised the options granted under clause 9.2 of the JVA.

[5] As no agreement was reached between the participants, under clause 9.3(a) JVA as amended by clause 2.11 of the 21 December deed the price (the 'Transfer Value') payable by the plaintiff for the Offered Interest is the higher of $40,000,000.00 and 'the fair market value' of the Offered Interest in cash as determined by an expert in accordance with clauses 9.3(b) and (c).

[6] Clause 9.3(d) JVA provides that 'the determination of the expert as to Transfer Value will be final and binding on all Participants'.

[7] The participants appointed BDO Kendalls Securities Ltd ('the expert') to perform the exercise required by clause 9.3(a)(2) JVA as the 'Expert' to fix the 'Transfer Value' of the 'Offered Interest'.

[8] As to the 'Transfer Value' of the 'Offered Interest', clause 9.3(c) of the JVA provides:

'In making his determination of the Transfer Value the expert will adopt the same principles and time limits as an Expert appointed for the purposes of Clause 8 is required to adopt when determining the Fair Value of a Subject Interest. The Participants will provide the Expert with all reasonable assistance to allow him to determine the Fair Value of the Subject Interest including, when requested, providing all relevant documentation within the Participant's control.'

[9] 'Expert' means the person appointed to determine the Fair Value.[4] Clause 8.2 of the JVA extensively defines 'Fair Value'.

[10] On 6 February 2006, the participants gave a letter of instruction to the expert. Under the heading '3. The Assignment' they said:

'The process to be adopted in appointing the Expert and undertaking the required valuations is set out in the Joint Venture Agreement (as amended), a copy of which is provided. However, the agreed interpretation if these provisions is set out below. ...

Standard and basis of value[:] The Expert is to determine the "Fair Value" as defined in Clause 8.2, including applying the principles in ASIC Practice Note 43...'

[11] Under the heading 'Protocols' the participants acknowledged that:

'Under the Joint Venture Agreement,

• The expert may accept submissions from the Participants within 10 business days of the appointment;

• The Expert may consult with any Participants ... in its discretion.

• The Expert will use best endeavours to state its determination of value within 20 business days of appointment.

The Participants agree to the following protocols in respect of the valuation:

• The Expert will provide copies of any written submission received from one party to the other party ....

• Prior to finalisation of the Valuation, the Expert will provide a draft for factual correctness. The draft will contain a summary of facts for review by the Participants, but will not include the Expert's opinion in relation to value;

The Expert will act as an expert, not an arbitrator, in this assignment.'

[12] On or about 13 February 2006, the expert forwarded an engagement letter to each of the participants, each of whom accepted the terms of that engagement.

[13] On 5 April 2006, the expert sent a letter to the participants that relevantly provided:

'Please find attached a draft of our valuation report. In accordance with our instruction, we have removed all information relating to our valuation opinions from the text of the report when providing a copy for the Participants to review.

Our instructions to deliver our valuation report, including the requirement to deliver this draft report, are set out in full in the letter of instruction dated 6 February 2006 from the Participants and our engagement letter dated 14 February 2006 signed by the Participants. The Participants have not amended those instructions or our engagement and have not requested us to attend to any additional matters.

In accordance with your instruction, we require the Participants to review the attached draft report and confirm to us in writing the following:

1. The factual information contained in the draft report, which has been provided to us by the Participants, the NPJV and its advisors, is accurate; and

2. There is no additional information that we should have been provided in respect of this engagement and was not provided to us.

[14] This letter asked the Participant to provide any comment by 3 p.m. on 6 April 2006.

[15] Early on 7 April 2006, the expert provided its report dated 6 April 2006, which valued the 50% interest at $52,098,000.

[16] On 12 April 2006, the defendants wrote to the expert complaining of factual errors which they asserted appeared in the first valuation. The directly relevant complaint in the schedule attached to the defendant's letter is item 3 (which relates to Table 12 at p 39 of the first valuation).

[17] By letter dated 13 April 2006, the plaintiff wrote to the expert disputing the defendants' allegations, asserting that the first valuation was final and binding, and denying that there was any basis for the expert to reconsider it.

[18] On 13 April 2006, the expert sent an email to the defendants which included the statement that:

'Item ... 3 ... in your schedule provide[s] us with some information which is directly contrary to that provided to us by the management of the NPJV. We will ... go back to the NPJV to understand and resolve the conflicting information. ...'

[19] On 13 April 2006 the expert sent an email to the defendants which rejected most of their complaints but stated:

'We have started to consider the final issue (number 3) you have raised. We won't be able to continue any further work until Tuesday.'

[20] On the same day, the defendants sent an email to the expert asking that 'what ever is the cause of the factual error in the Generic volume, please ensure the same error does not exist in the gross margin for other Table 11 or 12 products...'

[21] On 18 April 2006, the expert sent an email to the defendants which referred to the defendants' complaint about item 3 and stated:

'...We have been speaking to the NPJV to clarify that information and to ensure that we have the most reliable information available in our report. ...

Our letter of instruction requires that our valuation be based on factually correct information. If the new information materially effects [sic] our valuation, we intend to issue a revised valuation report promptly after we receive your comments on the new information...'

[22] On 19 April 2006, the plaintiff responded to those assertions by email to the expert, stating that regardless of the valuer's right under its engagement to amend its valuation '... the parties are bound by the valuation of 6 April.' The plaintiff added that, if the valuer believed that there was a need to amend the valuation, it sought an opportunity to make its own submission.

[23] Also on 19 April 2006 the expert wrote to the participants stating relevantly:

'We have made further enquiries regarding item 3 .... In response to those enquiries, we have been provided with information that is materially different to the information set out in Tables 11 and 12 of our report. The information can be classified into two categories ...

The first category relates to the gross margins of TLA branded, non TLA branded and generic sales detailed in Tables 11 and 12 ... . The revised gross margins set out in the attached tables have come directly from Management of the Joint Venture.

The second category relates to the volumes of the TLA branded, non TLA branded and generic sales to national account customers detailed in Tables 11 and 12 of the report. On re-examination of the gross margin details, better information regarding volumes became available. This was also provided directly from the Management of the Joint Venture.'

[24] On 20 April 2006, the expert issued a further report that valued a 50% interest at a much higher amount than in the first valuation.

[25] The plaintiff contends that the first valuation is binding. The defendants contend that it is not binding. The defendants contend that the second valuation is binding. The plaintiff admits that, if (contrary to its contention) the first valuation is not binding, then the second valuation is binding.

[26] Accordingly, the matters in issue concern only the defendants' allegations impugning the first valuation.

[27] The parties are agreed upon the applicable legal principles. They are conveniently set out in Legal & General Life of Aust Ltd v A Hudson Pty Ltd,[5] McHugh JA said:

'In my opinion the question whether a valuation is binding upon the parties depends in the first instance upon the terms of the contract, express or implied. This was pointed out by Sir David Cairns in the Court of Appeal in Baber v Kenwood Manufacturing Co Ltd (at 181). ... As Sir David Cairns pointed out, it is easy to imply a term that a valuation must be made honestly and impartially. It will be difficult, and usually impossible, however, to imply a term that a valuation can be set aside on the ground of the valuer's mistake or because the valuation is unreasonable. The terms of the contract usually provide, as the lease in the present case does, that the decision of the valuer is "final and binding on the parties". By referring the decision to a valuer, the parties agree to accept his honest and impartial decision as to the appropriate amount of the valuation. They rely on his skill and judgment and agree to be bound by his decision. ... But as between the parties to the main agreement the valuation can stand even though it was made negligently. While mistake or error on the part of the valuer is not by itself sufficient to invalidate the decision or the certificate of valuation, nevertheless, the mistake may be of a kind which shows that the valuation is not in accordance with the contract. A mistake concerning the identity of the premises to be valued could seldom, if ever, comply with the terms of the agreement between the parties. But a valuation which is the result of the mistaken application of the principles of valuation may still be made in accordance with the terms of the agreement. In each case the critical question must always be: Was the valuation made in accordance with the terms of a contract? If it is, it is nothing to the point that the valuation may have proceeded on the basis of error or that it constitutes a gross over or under value. Nor is it relevant that the valuer has taken into consideration matters which he should not have taken into account or has failed to take into account matters which he should have taken into account. The question is not whether there is an error in the discretionary judgment of the valuer. It is whether the valuation complies with the terms of the contract.' [Emphasis added]

[28] The critical question in the litigation is whether the 'draft' valuation prepared by the expert and given to the parties on 5 April 2006 was in accordance with the contract by which it was engaged.

[29] If it was, the defendants concede that the first valuation of 6 April 2006 is binding on them, even though it contained errors of fact or of valuation methodology. In the event that the draft did not accord with the contract the defendants do not so much 'impugn' the draft or the subsequent valuation of 6 April as contend that the valuation process was not complete until the valuer had produced a draft that accorded with the contract and the parties had had an opportunity to argue that it contained errors of fact. The defendants submit that the valuation process contracted for was only complete when the expert disseminated the valuation on

20 April 2006. It is said that 'that document is the only valuation issued after the process agreed to by the parties had been followed, complying with the contract, and is the one binding on the parties.'

[30] The dispute falls within a narrow confine and comes down to one point. It is whether the draft valuation complied with the protocol that the expert would 'provide a draft for factual correctness. The draft will contain a summary of facts for review by the participants, but will not include the ... value.' If it did the contract was adhered to and the defendants may not complain about the first valuation. If it did not the first valuation was not prepared in accordance with the contract.

[31] The draft valuation set out, in s 5.3, the expert's understanding of the business the assets of which were to form the offered interest. Under the heading 'Business Relationships with Participants' it was said:

'The primary business relationships between the Joint Venture and the Participants include the following:

• Under the TLA, the rights to use the Pauls brands in the Territories;

• The administration of national account customers by Parmalat;

...'

[32] 'TLA' is an acronym for the Trade Mark Licence Agreement. The 'Territories' were the areas in which brands of milk the subject of the TLA could be sold. Parmalat is the ultimate owner of the defendants. In s 7.3 it was said:

'Management have provided us with a forecast statement of financial performance for the year ended 30 June 2006 ... .

...

Management have forecast that the EBITDA of The NPJV for the 2006 financial year is expected to be approximately $12.413 million.

The assumptions upon which the forecast is based include the following:

• The joint venture continues to operate in its current form;

...'

'EBITDA' means earnings before interest, tax, depreciation and amortisation.

[33] In two important respects the joint venture will not continue to operate in its present form after the plaintiff acquires the defendants' interest in it. As a result of the construction put upon the TLA by the Court of Appeal the plaintiff will not have the right to sell milk products branded with the 'Pauls' trademark. Nor will the plaintiff be able to sell to 'national account customers', which are in effect nationwide supermarket chains, which will continue to be customers of the defendants.

[34] The expert conventionally valued the offered interest on the basis of its capacity to generate income. To derive the income likely to be produced by the offered interest the expert had to adjust the forecast income to account for the fact that some of its business would be lost, relevantly profits from the sale of Pauls brand milk products and the loss of national account customers.

[35] These adjustments appeared in the valuation of 6 April as Table 11 and Table 12 respectively.

Average gross margin of Pauls branded products (cents/litre)

2006 Forecast volume of Pauls branded sales (000s litres)

2006 Forecast gross margin for Pauls branded sales ($000s)

[37] Table 12 set out the expert's calculation for the adjustment of the loss of sales to national account customers:

Average gross margin - generic product ($/litre)

2006 Forecast volume - generic sales (000s litres)

2006 Forecast gross margin - generic sales ($000s)

Average gross margin - non TLA Pauls products ($/litre)

2006 Forecast volume - non TLA Pauls sales (000s litres)

2006 Forecast gross margin - generic sales ($000s)

Total gross for non TLA branded sales - national accounts

Loss of national account non TLA branded sales ($000s)

[38] Table 10 set out the adjustments which the expert had made to the forecast EBITDA. The adjusted income figure was capitalised to arrive at the valuation of the offered interest. The adjustment included the 'bottom line' figures from Tables 11 and 12. Those figures (with others) had the result of reducing the forecast EBITDA from $12,413,000 to $10,539,000.

[39] By their letter of 12 April 2006 the defendants set out their 'view of the factual errors in the report which have resulted in the point valuation being misstated ...'. The relevant item appears in the enclosure to the letter as item 3. It was in these terms:

3. In Table 12 - Loss of National Customers, gross margin on Generics is 26.36 cents per litre, gross margin for Generics to National accounts in NPM budget for 2005/6 is 9.95 cents per litre. (Details below)

Average Gross Margin on Generic Products

$'s/Ltr

ASP - Gross Selling Price of Housebrand

Volume as per Brand Sales data ex NPM 0.7982

Rebate per litre on Generic Volume included

In Discounts & Rebates in the NPM Budget -0.1648

Cost of Milk ingredient for Generic volume

as per NPM Budget -0.3540

Average Packaging cost per litre included in

COGS from NPM Budget -0.1249

Distributor Cartage rate per Litre included in

NPM Budget Distributor Allowance

(Generics only) -0.0550

Gross Margin as per the NPM Budget for

Generic Products to National Accounts 0.0995

No allowances have been made for Manufacturing Labour or Other Manufacturing costs. Therefore $0.0995 should be used, not $0.2636 in table 12.

$6,103,000

[40] The expert's response of 19 April 2006 is set out in para 23 of these reasons.

On 20 April 2006 the expert delivered its second valuation under cover of an email which read:

'Subsequent to the issue of our report on 6 April 2006, the Participants have questioned the accuracy of some facts.

We have considered factual information and where appropriate made amendments to facts in our report.'

[41] The adjusted figure for Table 11 became $1,733,000 and for Table 12 $1,416,000. As a result of the defendants' complaint about the profit margin which formed the basis of Table 12 the expert re-examined the basis for Table 11. In that case the consequence of the examination was an increase in the amount of the downward adjustment to EBITDA. This adjustment favoured the plaintiff. The adjustment to Table 12, however, resulted in a substantial reduction in the amount of the downward adjustment to EBITDA. The consequent changes to Table 10 in the second valuation produced an adjusted EBITDA of $11,614,000, up from $10,539,000 which appeared in Table 10 of the first valuation. The net change made a substantial difference to the valuation. In the valuation report dated

6 April 2006 the transfer value was assessed at $52,098,000. In the subsequent valuation of 20 April the transfer value was assessed at $57,419,000, a difference of $5,321,000.

[42] The dispute turns upon what the protocol required of the draft to be submitted as a preliminary to the issue of the valuation. The protocol formed a term of the contract between the parties and the expert pursuant to which it was to effect the valuation. The debate comes down to the extent to which facts had to be revealed in the draft to allow the parties to correct any factual error.

[43] It will be appreciated that the contents of Table 12 did not appear in the draft valuation. When they appeared in the first valuation of 6 April they elicited the defendants' immediate response which the expert, having made further enquiries, accepted as substantially correct.

'... the 6 February letter did not require that the draft report be "a complete draft, excluding only the expert's opinion in relation to value". Rather, it required that the Expert provide "a draft" containing "a summary of facts for review" and that it not include the Expert's opinion "in relation to value". Plainly there may be differences of opinion as to what is required to constitute "a summary of facts for review". That term does not require a comprehensive statement of all of the facts relied upon. It is submitted that the draft does contain a summary of facts for review, particularly in sections 4-7 of the draft. On the face of the draft it complies with the "protocol" in the 6 February letter.'

'[The draft valuation] plainly summarised the facts - ... the existence of the business arrangements and the prospect that they may or may not continue. [The expert] summarised both historical and prospective financial information, describing them explicitly as summaries. [It] has identified very clearly the sources upon which [it] has relied and ... has given only a summary of them. But ... [there was] incorporation by reference to the source documents ...'

[46] The submission goes on that Table 12 is merely an expansion of the earlier summaries and contains 'an exercise of valuation expertise by assessing the quantum of the projected loss of income which led to the adjustment to EBITDA.

[47] Accordingly the plaintiff submits that the expert did provide a draft for factual correctness which contained a summary of facts for review.

[48] The defendants' submissions focus on the omission from the draft valuation of the figure which appeared in Table 12 of the valuation of 6 April for the gross average profit margin for generic milk products, 26.36 cents per litre. It was this figure which formed the basis of the projections and forecasts which, estimated and adjusted, led to the valuation of the loss of national account business as

$2.837 million per year. The defendants contended in their letter of 12 April that the profit margin was slightly under 10 cents per litre. After further enquiry this contention was accepted by the expert as substantially correct.

[49] The defendants submit that the profit margin of 26.36 cents per litre was a fact which was wrong. The defendants' case is that the figure should have appeared in the draft to have allowed the defendants to correct it.

[50] The short question is whether the protocol required that figure to be inserted in the draft. If it did the draft did not comply with the contract and the subsequent valuation of 6 April was not binding on the parties.

[51] What did the protocol require? Clearly not every fact which might impact upon the valuation. That I think is clear from the requirement that the draft contain a summary of facts. The purpose of the protocol is clear. The valuation, which is to be binding on the parties, was to be based on accurate facts. To enable the valuer to get the facts right it was to set them out in a draft valuation so that the parties could correct any apprehended error.

[52] It is, I think, significant that the protocol, and therefore the contract, required the expert to provide a draft valuation to allow for the correction of error. A valuation is a process of reasoning. From facts which are identified by inquiry and search the valuer applies his judgment to arrive at his opinion of value. It is obvious that the facts must be correct if the opinion is to be worthwhile. But not all facts which a valuer may ascertain in the process of his examination of value are critical or even important to the final opinion.

[53] What the protocol required was a draft valuation, not a recitation of the facts which the expert had encountered. Some of those he would have discarded. Others would have been analysed and adjusted and combined with others to form the facts which comprised the factual basis for the valuation. By placing a 'summary of facts' in a 'draft for factual correctness' the protocol required the expert to reveal the reasoning which underpinned the valuation and showed the facts which were of material importance to the conclusion.

[54] It is likely that the 'average gross margin' of 26.36 cents per litre is not a primary fact but a conclusion of fact akin to an ultimate fact found by a court or tribunal. It will be the product of information and evidence appearing in financial records and books of account. Some element of judgment was no doubt required to derive the amount of the margin. In that sense the figure, 26.36 cents per litre, is a summary of fact resulting from the expert's sifting of the evidence in support of it.

[55] But that fact seems to have had a substantial effect on the valuation. It was an integral part of the process of reasoning displayed in the valuation. The forecast earnings of the joint venture had to be adjusted for the loss of revenue from sales to national account customers. The figure inserted for the downward adjustment appears in Table 10 but the starting point for that adjustment was the margin which is the foundation for the determination of the figure which appears in Table 12. The 'bottom line' figure in Table 12 which appears as the adjustment figure in Table 10 is clearly a critical fact to the valuation but it depends, in turn, upon the margin which is the starting point for the inquiry in Table 12.

[56] The draft, to be effective for its purposes, had to reveal the factual basis for the adjustments to EBITDA. It would not otherwise allow for the process of correction. Unless the profit margin appeared in the draft the process of reasoning, which led to the final downward adjustment figure, it could not be challenged.

[57] It cannot be doubted that the figure for gross margin was material to the valuation. When corrected it led to a very substantial change to the valuation. It was, I think, a summary of fact which the protocol required to be included in the draft.

[58] This conclusion is reinforced by the terms of ASIC Practice Note 43. It will be recalled that the expert was to determine the fair value of the offered interest by, inter alia, applying the principles of that practice note. Part of the note provided:

'[PN 43.42] The expert should carry out sufficient enquiries or examinations to establish reasonable grounds for believing that any profit forecasts, cashflow forecasts and unaudited profit figures ... have been prepared on a reasonable basis. ...'

[59] The projected lost income following from the loss of national account customers was a cashflow forecast. A principal ground for that forecast was the profit margin on milk sold to those customers. The practice note required the expert to make sufficient enquiries to establish that ground. That would seem to make that ground, or fact, material to the valuation and of significance to it. It is therefore a fact which should have been disclosed in the draft.

[60] The parties are agreed that if I should conclude the expert's draft valuation of

5 April contained a sufficient summary of the facts to satisfy the protocol the valuation of 6 April was contractually binding upon the parties and the plaintiff would be entitled to the declaration it sought to that effect. They are also agreed that if I should conclude that the draft valuation did not accord with the protocol, and therefore the contract, the valuation of 20 April is the binding determination and the defendants would be entitled to the declaration they seek on their counter-claim.

[61] It follows from my opinion that the valuation of 6 April did not accord with the contract, that the later valuation is binding. I therefore give judgment on the counter-claim and declare that the valuation by BDO Kendalls Securities Ltd dated 20 April 2006 is final and binding upon the plaintiff and the defendants. I dismiss the plaintiff's claim.

[1] 'Interest' is defined in cl 1.1 of the JVA and amended by clause 2.4(a) of the deed of variation dated 21 December 1998.

[2] See clause 9.2 of the JVA as amended by clauses 2.12(b) and 2.14(b) of the 21 December deed. 'GCM's Goodwill' is defined in cl 1.1 of the JVA.

[5] [1985] 1 NSWLR 314 at 335-6, upheld by the Privy Council without expressing any view on the question here under consideration (1986) 61 ALJR 280.