Plaintiff v Defendant by Counterclaim

2 In 2005, subsidiaries of Nylex Ltd wished to sell three established businesses and the three properties on which the businesses were conducted: (1) the 'Mills Elastomer' business, conducted in Dandenong, Melbourne; (2) the 'Nylex Frankston' business, conducted in Frankston, Melbourne; and (3) the 'Empire Rubber' business, conducted in Bendigo, Victoria. Each of the businesses manufactured components for use in the automotive industry; but some valuable supply contracts were expiring during 2006, as the business had been lost to Chinese competitors. There were significant contingent and potential liabilities for employee entitlements in connection with the businesses, especially if new work could not be found to replace work under the contracts due to expire.

3 In addition to being paid for the assets, Nylex wished to shed itself of the employee liabilities after sale, by passing some or all of the liabilities to the purchaser of the three businesses.

4 Nylex was a keen seller. It was undergoing financial difficulties and was involved with its bankers in a structured asset realisation program with a view to reducing its overall debts. In an eleven month period, Nylex sold 26 businesses and assets for prices up to $180 million.

5 John Schulz, through companies to be incorporated, wished to purchase the three businesses and the three properties. He commenced negotiations with Nylex in April 2005. A total price of $17 million was agreed for all of the assets. In evidence, Mr Schulz referred to this as the 'headline price'.

6 In summary, companies owned and controlled by Mr Schulz entered into the following sale and purchase agreements with subsidiaries of Nylex:

(1) Huon Corporation Pty Ltd purchased the three businesses for a total price of $3.75 million;

(2) Liam Property Pty Ltd purchased the Dandenong property for $2.5 million;

(3) Huon Property Holdings Pty Ltd purchased the Bendigo property for $4 million; and

(4) Mail Property Pty Ltd purchased the Frankston property for $6.75 million.

For convenience, I will refer to the three companies which purchased the three properties as the 'property companies'.

7 Mr Schulz owned all of the issued shares in Huon Corporation and the property companies. Huon Corporation was the trustee of a Unit Trust. Each of the property companies was the trustee of a family discretionary trust, of which Mr Schulz was one of the principal beneficiaries. Mr Schulz and his financial advisor, Liam Hunter, were the directors of Huon Corporation and each of the property companies.

8 Prior to execution and completion of the sale and purchase contracts, Mr Schulz engaged advisors to assist him and his associated companies in the negotiation and documentation of the various components of the transaction. His accountants were Pitcher Partners. His lawyers were Mills Oakley Lawyers Pty Ltd, the plaintiff in this proceeding. At an early stage, Pitcher Partners advised Mr Schulz that he should purchase the businesses through one company and the properties through a separate company or companies. The purpose of such a structure was to protect the properties from the risks of the businesses to the extent legally appropriate. Mr Schulz accepted this advice and incorporated Huon Corporation to purchase the businesses and Huon Property Holdings to purchase the properties. Later, Liam Property and Mail Property were incorporated, so as to divide the ownership of the properties between the three property companies. Mr Schulz referred in his evidence to this structure as 'shielding' the properties from the risks of the businesses. In other words, he wanted to protect any equity which the property companies had in the three properties from claims by a liquidator or other external controller of Huon Corporation in the event it became insolvent.

9 There was, however, a fundamental problem with this strategy. Mr Schulz was only prepared to invest $250,000 of his own money in the overall transaction,[1] and this was only because Huon Corporation's financier required him to contribute 'skin money' of $500,000 to the acquisition of the three businesses. The remaining $250,000 'skin money' was borrowed by the property companies on the security of the properties, and advanced to Huon Corporation to satisfy Mr Schulz's skin money obligation. Further, the property companies contributed nothing to the purchase of the properties beyond the amount advanced by their financier. That amount was less than 50 per cent of the value of the properties and was secured by first mortgages over the properties.

10 As appears below, the Frankston and Bendigo properties were purchased with funds provided wholly by Huon Corporation. Within months of settlement of the transactions, Huon Corporation became insolvent and administrators were appointed. The administrators sued the property companies, Mr Schulz and Mr Hunter, claiming beneficial ownership of the Frankston and Bendigo properties on the basis of resulting trust. They also claimed other remedies based on breaches by Mr Schulz and Mr Hunter of their duties as directors of Huon Corporation. For a short while, Mills Oakley represented the property companies, Mr Schulz and Mr Hunter in that proceeding. New lawyers were then appointed. As a result of their advice, the properties were surrendered to the administrators as part of a commercial settlement.

11 This proceeding commenced in the Magistrates' Court with Mills Oakley as plaintiff. Mills Oakley sought to recover professional fees for work done in connection with issues arising after settlement of the transactions, in respect of the administrators' proceedings. In response, the property companies counterclaimed for loss suffered by them as a result of Mills Oakley's negligence in failing to warn them of the risks arising from the use of Huon Corporation funds to pay the purchase consideration for the Frankston and Bendigo properties. A counterclaim by Mr Schulz was stayed upon his bankruptcy.

12 In order to better understand the issues arising on the counterclaim, it is necessary to recount some relevant facts in more detail.

13 Pitcher Partners were engaged in early June 2005. In an internal Pitcher Partners memorandum dated 3 July 2005, a Pitcher Partners representative summarised instructions given by Mr Schulz at a meeting on 27 June 2005. In summary, the note records Mr Schulz informing Pitcher Partners that his aim following completion of the transactions was to sell the Mills Elastomer business at Dandenong, continue the Empire Rubber business at Bendigo and, following expiry of supply contracts with the Frankston business, to develop or sell the Frankston property. In connection with the Frankston property, Mr Schulz referred to the possibility of its development as an aged care facility. As to the group structure, the note records Mr Schulz's intention to hold the three properties in separate discretionary trusts, with borrowings 'to follow the use of property (appropriate proportions)'. The note also records Pitcher Partners view concerning the prices to be attributed to the three properties:

Better to maximise value of land on purchase to reduce future capital gains (estimated current value of $14.2 million).

14 On 7 July 2005, Pitcher Partners provided Mr Schulz with a detailed due diligence report concerning the proposed acquisitions. This report is referred to in detail below.

15 Mills Oakley was engaged in early July 2005. There was much evidence concerning the initial meetings between Mills Oakley representatives and Mr Schulz, and concerning the terms upon which Mills Oakley was initially engaged. As the trial progressed, it became apparent that most of this evidence was of little relevance to the determination of the principal issues in the proceeding. For present purposes, it is sufficient to note that Mills Oakley was initially retained to prepare a 'legal due diligence' report concerning the implications of proceeding with the proposed acquisitions, in particular with respect to the key legal issues concerning employment and employee entitlements, the proposed acquisition of the three properties, environmental issues and the key contracts which supported the three businesses. The Mills Oakley partner who was principally responsible was Martin Checketts. He was assisted by a senior associate, Jeanette Thompson. Another partner, Alan Stockdale, provided advice concerning employment issues, in particular redundancy entitlements consequent upon the expected closure of the Frankston business following expiry of existing major supply contracts with Holden and Mitsubishi.

16 At some stage there was a disagreement between Mr Checketts and Mr Schulz over the failure of Mills Oakley to deliver some documents at an expected time. Mr Schulz expressed his disappointment and there was an argument. Mr Checketts said that he is not a person who tends 'to fire up by nature', but he did 'fire up a little' on this occasion. From this time, after settling the final due diligence and negotiating the key terms of the transaction documents, Mr Checketts gave more responsibility to Ms Thompson. Subject to his supervision, he left completion of the transaction predominantly in her hands. He was copied in on some emails, but not all. In particular, he was not copied into the critical emails referred to below concerning the funding flow at settlement of the transactions.

17 Mills Oakley was informed at an early stage that it was proposed that Huon Corporation would purchase the businesses and Huon Property Holdings, and perhaps also other companies, would purchase the properties. In their draft due diligence report dated 17 August 2005, Mills Oakley agreed that this was an appropriate structure, for both goods and services tax ('GST') purposes and, additionally, for 'limitation of liability' reasons: to shield the property companies from the risks of the businesses.

18 The negotiations initially proceeded expeditiously. By late August 2005, the headline price of $17 million, and other significant issues, had been agreed. Accordingly, it became necessary to apportion that total price between the assets being acquired by Huon Corporation and the property companies. In this context, Mr Schulz was advised by Pitcher Partners that the properties should be acquired at market value - principally in order to maximise each respective purchaser's cost base for capital gains tax ('CGT') purposes, with the balance of the $17 million headline price to be attributed to the three businesses. The solicitors acting for Nylex (Clayton Utz) proposed price allocations in accordance with this advice. Those proposed prices were included in drafts of the sale agreement dated 1 September 2005.

20 The total of the prices for the three properties was $13.25 million.

21 At this stage, there was only one draft agreement for the whole of the transactions. Later, separate sale agreements were prepared. However, the price allocations contained in the 1 September 2005 drafts of the agreement were never altered. Those prices were reflected in the final transaction documents. Mr Schulz knew of these price allocations and agreed to them.

22 Further, in the context of avoiding possible GST liabilities, Mills Oakley advised that the vendors of the three properties should enter into formal leases with the relevant Nylex business-owning entities, on commercial terms, so that the property sales would be on a 'going concern' basis and thus attract an exemption from GST on the sale contracts. Mr Schulz accepted this advice and the transaction documents were amended so as to oblige the relevant Nylex subsidiaries to enter into lease agreements prior to completion of the property sales.

23 By mid-September, Mr Schulz had secured funding for the purposes of the transactions:

(1) First, by commitment letter dated 17 August 2005, GE Commercial Finance offered finance of up to $20 million to Huon Corporation to assist it to purchase the assets (and assume certain liabilities) of the three businesses. The facility could be drawn down according to a formula relating to the outstanding book debts of Huon Corporation from time to time. The facility was to be secured by a first ranking fixed and floating charge over all of Huon Corporation's assets, including its book debts; but excluding fixed plant and equipment - over which Nylex was to hold a first ranking fixed charge until the repayment of $1.5 million vendor finance. Importantly, GE's security was not to include any mortgage or charge over the three properties. Further, it was a condition of the GE facility that a lender acceptable to GE provide acquisition financing of not less than $5 million to the property companies to assist with the acquisition of the three properties. This financier was to have no recourse to Huon Corporation.

(2) Second, by a letter dated 14 September 2005, National Australia Bank ('NAB') offered finance to the property companies in the total sum of $5.25 million, to assist them in the purchase of the three properties. As events transpired, only $4.25 million was available to complete the purchase of the three properties. NAB held back $1 million. $750,000 was held back for stamp duty and other fees; and $250,000 was advanced to Mr Schulz and, at his direction, paid to Huon Corporation as part of the $500,000 'skin money' which GE required him to invest as a condition of its finance facility. As security for this funding, NAB required a first mortgage over each of the three properties, a first ranking mortgage debenture over each of the property companies and a guarantee and indemnity from Mr Schulz.

24 On the available funding, it was obvious that the property companies did not have sufficient funds to complete the purchases of the three properties. The amount required at settlement was $13.25 million. The available funding was only $4.25 million. This left the property companies $9 million short. On the other hand, Huon Corporation had access to significantly greater funds than were necessary to complete the purchase of the three businesses for a total sum of $3.75 million. Although the amount of this funding depended upon the application of the GE lending formula to the total of the book debts of the three businesses at settlement of the transaction, there was no reason to doubt from this time that Huon Corporation would have more than enough funds to complete the purchase of the businesses. In fact, as appears below, at the time of settlement of the transactions, Huon Corporation had an entitlement to draw down approximately $13.78 million against the GE facility. Accordingly, Huon Corporation had available funding of approximately $10 million more than it needed to complete the purchase of the three businesses.

25 Further, as appears below, a few days before settlement, Nylex agreed to bring forward a substantial cash adjustment due by Nylex to Huon Corporation under the sale of business agreements. That amount was approximately $4.8 million (the 'net cash adjustment'). Nylex agreed to pay the net cash adjustment to or at the direction of Huon Corporation at settlement. The money belonged to Huon Corporation. However, rather than apply it towards satisfaction of its liability for the purchase price of the businesses ($3.75 million), and receiving a cheque from Nylex for the balance, Huon Corporation directed that the $4.8 million net cash adjustment be paid by Nylex to Mail Property, to assist it with completing its purchase of the Frankston property. This still left the property companies short at settlement; by approximately $4.2 million after taking account of the NAB funding of $4.25 million.

26 The available NAB funding was not, however, all used towards completing the property purchases. Instead, at settlement of the transactions, there was a mixing of the funds available to Huon Corporation and the property companies as follows:

(1) Huon Corporation paid the total adjusted purchase price payable by Mail Property for the Frankston property (by the $4.8 million net cash adjustment and the balance of approximately $1.925 million in cash drawn down under the GE facility);

(2) Huon Corporation paid the total adjusted purchase price payable by Huon Property Holdings for the Bendigo property (by approximately $4 million cash drawn down under the GE facility);

(3) Liam Property paid the total adjusted purchase price due by it for the Dandenong property (by approximately $2.5 million drawn down under the NAB facility); and

(4) the property companies paid approximately $1.75 million of the price payable by Huon Corporation for the Empire Rubber and Nylex Frankston businesses (with funds drawn down under the NAB facility).

27 The net effect of this funding flow at settlement was that Huon Corporation paid approximately $9 million towards the prices payable by the property companies for the three properties. In particular, Huon Corporation provided all of the moneys used to purchase the Frankston and Bendigo properties. There were no documents prepared to record the formal basis upon which Huon Corporation provided these funds.

28 Mr Schulz was an unimpressive witness. His evidence as a whole must be viewed through the prism of his unshakeable beliefs that the failure of the businesses (and of his strategy of 'shielding' the properties from the risks of the businesses) was caused by Mills Oakley's negligence, that his business strategies were sound, and that he was entitled to structure the acquisitions to promote his own personal and family interests without any regard to the separate duties which he owed to each of Huon Corporation and the property companies. His evidence disclosed a complete lack of insight into these duties and the conflicts of interest which they placed him in at relevant times, and was replete with refusal to accept any personal responsibility for the consequences of his own decisions and actions. Further, Mr Schulz's evidence was evasive, argumentative and was laced with non-responsive answers in which he often volunteered evidence with the intent of blaming Mills Oakley.

29 Furthermore, it is apparent that Mr Schulz was untruthful in either his evidence in this case or in an affidavit sworn by him in the administrators' proceedings. In his evidence in this case, Mr Schulz said that he did not intend the moneys paid by Huon Corporation towards acquisition of the properties would be treated as loans by Huon Corporation to the property companies, as he did not turn his mind to the basis on which the funds were provided. In his affidavit in the administrators' proceeding, he swore to the contrary; contending that the moneys were intended to be advanced as loans. Taking the evidence as a whole, I prefer his evidence before me in this case. But it matters not. The direct conflict between the two sworn versions demonstrates that Mr Schulz is a man who is prepared to give evidence according to a version of events which best suits the current purpose. For the reasons appearing below, however, little turns on my view as to Mr Schulz's general credibility.

30 It is trite law that a solicitor owes a client a duty to exercise reasonable skill in the performance of the solicitor's retainer. The duty derives from both contract and tort.[2] The scope of the duty includes a duty to warn the client of material risks inherent in implementing a proposed transaction in a particular way.[3]

31 The relevant representative of Mills Oakley who advised Mr Schulz and his companies at relevant times leading up to and at settlement was Jeanette Thompson.[4] By this time, it appears that any supervision of Ms Thompson by Mr Checketts had become passive. Mr Checketts was available to advise Ms Thompson if she requested his assistance, or if Mr Schulz approached Mr Checketts directly. Although a senior associate, Ms Thompson was relatively young and inexperienced, and her evidence as a whole indicated that she was out of her depth in completing the transactions without any active supervision. Mr Checketts ought to have appreciated this and actively supervised completion. He was negligent in not doing so. Had he exercised adequate supervision, the relevant risks would probably have been explained to Mr Schulz. If so, Mills Oakley would probably have fulfilled its retainer to give competent legal advice, by recognising and warning of those risks.

32 As the solicitor with principal carriage of the matter for Mr Schulz and his companies, it should have been apparent to Ms Thompson that there was a problem. Mr Schulz's objective of 'shielding' the property companies, and thus the properties, from the risks associated with the conduct of the businesses could not be achieved in the context of the pricing structures in the transaction documents and the available funding. Put simply, the only way that the property companies could complete the purchase of the three properties was to use Huon Corporation's money.

33 If Huon Corporation's money was to be used to purchase the properties, there ought to have been documented arms-length loans from Huon Corporation to the property companies, under which the property companies agreed to repay the total amount provided by Huon Corporation together with interest. Those loans ought to have been made on the basis of second ranking securities behind NAB, and a guarantee from Mr Schulz. In the absence of such loans, it ought to have been obvious to any competent commercial lawyer, who turned his or her mind to the issue, that the flow of funds at settlement would have the result that the Frankston and Bendigo properties were held on a resulting or constructive trust for Huon Corporation.

34 In these circumstances, Mills Oakley ought to have advised Mr Schulz that the proposed funding flow at settlement of the transactions would expose the property companies to the risk that, if Huon Corporation failed and an administrator, receiver or liquidator was appointed, Huon Corporation would claim an interest in the Frankston and Bendigo properties on the basis of resulting or constructive trust. On the basis of such advice, Mills Oakley, in turn, ought to have advised Mr Schulz to consider restructuring the transactions so as to achieve his desired result, to the extent that the law and the available funding permitted, of shielding the properties from claims by Huon Corporation. In that context, Mills Oakley ought to have advised Mr Schulz (and also Mr Hunter) that, as a director of Huon Corporation, he owed duties to Huon Corporation as a whole to act in good faith and in its best interests,[5] a duty not to improperly use his position as a director of Huon Corporation to gain an advantage for himself or the property companies,[6] and a duty not to improperly use his position as a director of Huon Corporation to cause detriment to it.[7] Accordingly, any re-structuring of the transactions would need to avoid Mr Schulz breaching any of those duties.

35 None of these risks occurred to Ms Thompson. She frankly conceded that she did not turn her mind to any of these issues. They should have been apparent to her. She was negligent in not recognising the risks, consulting Mr Checketts as her supervising partner, and (together with Mr Checketts) advising Mr Schulz of the risks and discussing possible alterations to the structure and funding of the transactions to minimise those risks to the extent possible having regard to Mr Schulz's directors duties. In my opinion, the risks and resulting structural issues should have been brought to Mr Schulz's attention by Mills Oakley by no later than 9 November 2005 when Ms Thompson received an email from the relevant lending officer at GE. That email highlighted the lack of available funds from NAB to complete the property purchases, and indicated that the property purchases could only be completed if GE funding to Huon Corporation was used. This email implied that GE had no objection to the funding provided by it being used to complete the acquisition of the three properties, notwithstanding that the GE facility documents appeared to limit the permitted uses of GE funds to the acquisition of the businesses. In fact, GE knowingly permitted approximately $9 million of the funds advanced by it to Huon Corporation at settlement to be used to enable the property companies to complete the purchase of the properties.

36 Further, there were subsequent occasions before settlement of the transactions when the risks and consequent need for restructure should have been apparent to Mills Oakley. First, on 14 December 2005, two days before settlement, Ms Thompson learned that Nylex were prepared to bring the payment of the net cash adjustment forward to settlement. This had the effect of reducing the headline price of $17 million by $4.8 million. As that amount was due by Nylex to Huon Corporation under the terms of the business sale agreements, it should have meant that Huon Corporation had no need to pay Nylex anything to purchase the businesses. To the contrary, if applied to the purchase price for the businesses ($3.75 million), it should have led to Nylex paying Huon Corporation $1.06 million at settlement. This should have brought into sharp focus the risks discussed above and the obvious need to discuss restructuring of the transactions with Mr Schulz. That was not done. Ms Thompson frankly admitted that, in her mind, she always 'regarded it as a single "all-in" transaction'. Accordingly, she only considered the net cash adjustment in the context of its effect upon the headline price of $17 million.

37 Second, in the afternoon and evening of the day before settlement, Ms Thompson discussed the necessary payments to be made at settlement the following day with legal representatives for Nylex. She received an email from Nylex's solicitors at 6:51 pm on 15 December 2005 confirming those discussions and making suggestions as to the cheques, directions and other documents required to effect settlement. The funding flow which was suggested in the email highlighted the fact that, if implemented, there would be a mixing of funds available to the property companies with funds of and available to Huon Corporation, without regard to the individual liabilities and entitlements of Huon Corporation and the property companies. Later in the evening, at 9:02 pm, Ms Thompson prepared an email containing a table which further highlighted this position and sent it to Mr Schulz, Mr Hunter, Mr Taylor of GE and Mr DiPietro of NAB. In her email, Ms Thompson stated:

We have the payout figures for completion. The figures are worked out having regard to the adjustments required in respect of each property purchased. In order to accommodate the net cash adjustment without having to ascribe proportions of it to all payments, Clayton Utz has suggested (John [Schulz], John [DiPietro] and Brett [Taylor] have all confirmed they are happy) that Huon [Corporation] provide to Nylex a direction to pay the net cash adjustment to Mail Property in respect of the purchase of Frankston, thus reducing the purchase price of that property accordingly. Rather than cheques being drawn and exchanged in regard to the Net Adjustments, Nylex have agreed to accept a lesser figure for the purchase price of Frankston to accommodate that adjustment. This is my table below...

38 In the absence of knowledge of the risks and advice as to possible ways to avoid or minimise them, Mr Schulz instructed Mills Oakley to proceed and settle the transactions in accordance with the funding flow set out in Ms Thompson's email at 9:02 pm on 15 December 2005. It is not to the point that Mr Schulz knew of the purchase price allocations, knew of the funding shortfall from NAB to the property companies and approved the mixing of the funds to enable settlement to be effected. He is a businessman and not a lawyer. In the absence of him receiving an appropriate warning as to the risks of proceeding in that fashion, together with suggested ways in which the transactions might be restructured or better documented in order to avoid those risks, he lost the opportunity to act in a manner which best accorded with his intention and instructions to Mills Oakley that, to the extent legally permissible, the properties would be 'shielded' from the risks of the operating businesses.

39 By 30 June 2006, Huon Corporation had become insolvent and failed. Mr Schulz appointed administrators on that day. Within weeks, the administrators appreciated that Huon Corporation funds had been used to fund the acquisition of the Frankston and Bendigo properties by the property companies. The administrators brought a proceeding in this Court against the property companies, Mr Schulz and Mr Hunter. They claimed that the Frankston and Bendigo properties were held on a resulting trust for Huon Corporation. They also claimed equitable compensation against Mr Schulz and Mr Hunter for breach of their duties as directors of Huon Corporation; and alleged further that each of the properties was held on a constructive trust for Huon Corporation. In the face of these claims, the property companies, Mr Schulz and Mr Hunter settled the proceedings. They surrendered the three properties to the administrators on the basis that they would be sold in an orderly manner. In apparent consideration for the surrender of the Dandenong property, over which no claim for a resulting trust was made, the administrators agreed to pay its owner, Liam Property, the sum of $425,000 in respect of its equity in that property.[8]

40 In its pleadings and for much of the trial, Mills Oakley maintained the position that the scope of its retainer by the property companies did not include a duty to warn them of the relevant risks. Negligence was denied. That position was always untenable. It ought not to have been adopted. The duration of the trial was extended as a result.

41 When Mr Checketts gave evidence, he frankly stated that, if he had seen the 9 November email, it would have 'set alarm bells ringing' in his mind. As a result, he would have warned Mr Schulz of the risks and had a discussion with him about how Huon Corporation's funding of the property purchases should be characterised. In particular, he said there should have been a discussion with Mr Schulz as to whether the Huon Corporation funding should have been characterised as debt or equity. He also said that he would have discussed issues such as how the debt would be repaid by the property companies.

42 Later, Mr Checketts gave the following evidence as to how he would have broached the subject with Mr Schulz:

And as you can imagine, I have thought about this a lot following the event. It's somewhat hard to put myself back in the time and the context but I believe that I would have raised with him the fact that Huon Corporation was funding the property purchases. It had to based upon the funding that had been obtained. That was just how it had to happen. I would have raised with him and asked him to consider how that funding should be characterised; debt, equity or perhaps a gift. I would have explained to him the characteristics of debt and equity funding and the upsides and downsides. On the debt side I would have said that the loan must be on arm's length terms and there must be appropriate interest and other commercial terms for the loan and I would have asked him to consider whether from a serviceability perspective that was possible or desirable for him. I would have explained that equity funding wouldn't have required interest payment and the like but it would have meant that Huon Corporation had a proprietary interest in the trusts and based on that advice, I would have asked him to make a decision.

43 Further, Mr Checketts acknowledged that the provision of funding by Huon Corporation to the property companies raised issues concerning Mr Schulz's duties as a director of Huon Corporation, and the consequent need to ensure that the characterisation of the funding was cognisant of those duties. In that context, he said he would have advised Mr Schulz that any loan arrangement between Huon Corporation as lender and the property companies as borrower would need to be negotiated and documented on arms-length commercial terms.

On what basis should the property companies' claims for damages be determined?

44 Negligence having been established, the remaining issue for consideration is whether any or all of the property companies suffered loss and damage caused by that negligence. The property companies contend that they suffered loss because Mills Oakley's negligence deprived them of the opportunity to take legal and accounting advice and, as a result, to restructure the transaction so as to maximise the prospect that the equity of each property company in the property owned by it would be 'shielded' from the risk that Huon Corporation became insolvent. In that regard, the property companies pleaded and maintained at trial two alternative cases. As appears below, there is overlap between the alternatives.

45 First, the property companies contend that Mills Oakley should have advised them to restructure the transactions so that the prices for the three properties totalled $4.25 million (which was the available funding from NAB to the property companies) instead of $13.25 million (which was market value of the properties in accordance with advice received from Pitcher Partners in the context of avoiding CGT liabilities on sale). The property companies contend that the $9 million reduction in the purchase prices for the three properties should have been added to the total of the purchase prices for the three businesses, and paid by Huon Corporation from the net cash adjustment, the Nylex vendor finance and the funds advanced by GE.

46 Second, the property companies contend in the alternative that Mills Oakley ought to have advised them to record and document the flow of funds at settlement, so as to reflect arms-length inter-company loans on commercial terms (including security over the three properties) from Huon Corporation to the property companies.

47 As I have said, there is some overlap between these two cases. In the discussions which would have transpired between Mr Schulz, Mills Oakley and Pitcher Partners, it is likely that a range of possible structures and revised price allocations would have been considered. It is unlikely that it would have been an all or nothing discussion, between either reducing the purchase prices for the three properties to equal the net funding available from NAB on the one hand, or leaving the price allocations unaltered and negotiating arms-length loans from Huon Corporation to the property companies on the other hand. On the available evidence, there would have been a variety of possible scenarios in between these two extremes.

48 Mills Oakley denies that any loss has been established. It contends that any opportunity which the property companies may have had to restructure the transactions, consequent upon it giving a warning of the relevant risks and providing advice in that regard, was so speculative that it should be regarded by the Court as a negligible prospect. Accordingly, Mills Oakley contends that the property companies have failed to establish loss of a commercial opportunity which had any value.

49 The legal principles to be applied in determining whether a loss of commercial opportunity is compensable have been stated by the High Court. In Sellars v Adelaide Petroleum NL & Ors,[9] Mason CJ, Dawson, Toohey and Gaudron JJ distinguished between proof of causation and proof of damages, stating that proof of causation is to be determined on the balance of probabilities as to whether a plaintiff has sustained some loss or damage,[10] and, if that hurdle is crossed, that the amount of that loss or damage is to be ascertained by reference to the Court's assessment of the degree of probabilities or possibilities.[11] These conclusions were expressed in the following terms:

...we consider that acceptance of the principle enunciated in Malec requires that damages for deprivation of a commercial opportunity, whether the deprivation occurred by reason of breach of contract, tort or contravention of s. 52(1), should be ascertained by reference to the court's assessment of the prospects of success of that opportunity had it been pursued. The principle recognized in Malec was based on a consideration of the peculiar difficulties associated with the proof and evaluation of future possibilities and past hypothetical fact situations, as contrasted with proof of historical facts. Once that is accepted, there is no secure foundation for confining the principle to cases of any particular kind.

On the other hand, the general standard of proof in civil actions will ordinarily govern the issue of causation and the issue whether the applicant has sustained loss or damage. Hence the applicant must prove on the balance of probabilities that he or she has sustained some loss or damage. However, in a case such as the present, the applicant shows some loss or damage was sustained by demonstrating that the contravening conduct caused the loss of a commercial opportunity which had some value (not being a negligible value), the value being ascertained by reference to the degree of probabilities or possibilities. It is no answer to that way of viewing an applicant's case to say that the commercial opportunity was valueless on the balance of probabilities because to say that is to value the commercial opportunity by reference to a standard of proof which is inapplicable.

The conclusion which we have reached on this question finds support in other considerations. The approach results in fair compensation whereas the all or nothing outcome produced by the civil standard of proof would result in the vast majority of cases in over-compensation or under-compensation to an applicant who has been deprived of a commercial opportunity. Furthermore, it is an approach which conforms to the long-standing practice of taking into account contingencies in the assessment of damages.[12]

50 Brennan J delivered a separate judgment in Sellars. He summarised the principles in this way:

Provided an opportunity offers a substantial, and not merely speculative, prospect of acquiring a benefit that the plaintiff sought to acquire or of avoiding a detriment that the plaintiff sought to avoid, the opportunity can be held to be valuable. And, if the opportunity is valuable, the loss of that opportunity is truly "loss" or "damage" ...

...

However, a causal relationship between the loss of such an opportunity and the defendant's contravening or tortious conduct must be proved before any issue of the assessment of the amount of the loss arises.[13]

51 These principles were summarised by Winneke P in Price Higgins & Fidge v Drysdale,[14] in the following terms:

Where it is alleged that, as a result of negligent conduct, a plaintiff has lost a valuable opportunity, the courts have required the plaintiff to prove, in making good his or her claim, that the negligence has caused the loss of an opportunity of 'some' value as distinct from 'a negligible prospect' ...

While the plaintiff is required to prove to the appropriate standard of proof the existence of a valuable loss of opportunity and the fact that it was caused by the defendant's negligence, the plaintiff is not required to prove, on the balance of probabilities, the value or extent of the loss because of the difficulties associated with proof of past hypothetical fact situations; in those circumstances the value or extent of the loss is to be ascertained by reference to degrees of possibilities or probabilities...

...

Such principles appear to me to be well settled. But it is apparent from their statement that the existence of the relevant loss, be it a lost commercial-opportunity or a prospective physical injury, must be proven by evidence. It seems to me that one cannot simply assume that a plaintiff has lost a valuable opportunity because events supervening upon the defendant's conduct might suggest that such a loss has occurred. To prove that the loss has, to the requisite standard, occurred and that it has been caused by the defendant's contravening conduct, the plaintiff is required to demonstrate by evidence not only that the prospect had a real value but also that, if the true position had been disclosed, he or she would have acted to secure the benefit...[15]

Would the property companies have exploited the opportunity?

52 Mr Schulz said that if Mills Oakley had warned him of the relevant risks he would have taken legal advice and, if necessary, accounting advice. He said that he would have sought advice as to how to proceed with the transaction in a restructured form so as to achieve his purpose of shielding the properties from the risks of the businesses, to the maximum extent possible while acting consistently with his director's duties:

If someone had told you at or prior to 16 December 2005 that by mixing the funds in the way they were mixed you would be breaching your director's duties would you have done anything differently? --- Absolutely.

What would you have done? --- I would have ensured that there was absolutely no breach of either the duties as a director or any other duty.

How would you have done that? --- One option would be to ensure that only NAB funds were applied to the real properties and GE funding was applied to the businesses.

How could you have achieved that if the price for the properties was more than the money being lent by the National Bank? --- Changed the face value of the contracts.

How would you have done that? --- The face value of the contracts would be reduced for the real properties.

When you say "the contracts", what contracts do you mean? --- The real property contracts. That is for Liam, Mail and Huon Corporation and their respective trusts and the reduction in the purchase price achieved for the land sale contracts would then be reflected in an increase ...

...

Going back to what you said a couple of minutes ago about reducing the face value of the properties, if you had done that what would the purchase price for the three properties have been? --- It wouldn't have exceeded the available funds less the stamp duties required and other expenses.

How would you calculate that? --- I would have to rely on my advisors but I would suggest that stamp duty could be calculated at the market value and the expenses, if there were outgoings for the properties, they should be known and any additional fees and charges, they would be known. The aggregate of all of those would be then aggregated up and reduced from the available funds from the National Australia Bank and the net of those two figures would then be reflected in the land sale agreements, face value.

Whom would you have had to speak to to renegotiate that aspect of the transactions? --- Nylex.

Who would you have spoken to at Nylex? --- Sorry, I may have been a little preemptive there. I would have sought advice in the first instance. In the second instance it would have been Nylex.

From whom would you have sought those? --- Glen Casey.

At Nylex? --- Correct. He was the CEO and managing director at the time.

Do you think you would have discussed it with anybody else? --- At Nylex?

Anywhere? --- Well, I certainly would have discussed it with my lawyers. I would have gone to them in the first instance because it's they who in that scenario would have raised the issues that are now before me.

53 Later, Mr Schulz was asked what he would have done if Mills Oakley advised him that re-allocating the prices to accord with the NAB funding may be a breach of his director's duties:

Mr Schulz, what if ... you received some advice to this general effect: that simply changing the face value of the contracts of sale may itself be a breach of director's duties, what would you have done in that circumstance? --- I would have sought further advice as to how to settle in a manner in accord with the instructions and the advice received up until that time.

So if I understand that correctly, you would have explored all the possibilities to achieve your commercial aim of shielding the companies from the business losses? --- Absolutely.

You would have done that in consultation with your lawyers and if necessary, your accountants, having regard to both commercial matters or impacts and also taking into account, as you must, your individual director's duty to each of the individual corporations? --- Absolutely.

And done the best you could in the circumstances to achieve the maximum result? --- Yes, your Honour, and in the event that I couldn't do that and I couldn't [do] that because of a conflict, for whatever reasons, then we would have had to stay and review the whole transaction.

54 On the basis of this evidence, I find that the property companies have satisfied their obligation to prove that they would have endeavoured to secure the benefit of the opportunity to restructure the transaction, to the extent legally permissible having regard to Mr Schulz's director's duties, to maximise the prospect of protecting the properties from the risks of the businesses.

55 I will deal first with the highest case put forward by the property companies. It was contended by the property companies that, if Mills Oakley had warned them of the relevant risks and their effect upon Mr Schulz's intention to shield the property companies from the risks of the businesses, they would have sought to re-negotiate the price allocations so as to match the available funding. As I have said, this would have required the total prices for the three properties to be reduced from $13.25 million (market value) to $4.25 million, a reduction of $9 million; with the total prices for the three businesses being correspondingly increased by $9 million, from $3.75 million to $12.75 million. It was submitted on behalf of the property companies that this was an opportunity which had some value. They contend that the value of this lost opportunity is approximately $11 million; represented by the difference between the current values of the three properties and the amounts for which they could have acquired them if the price variations in the first hypothetical scenario had been implemented. They claim damages equal to the Court's assessment of the degree of likelihood that this opportunity, or the alternative below, would have been successfully pursued.

56 It was later submitted on behalf of the property companies that, as an alternative highest case, it was open to the property companies, on the valuation evidence, to have negotiated adjusted prices of $5.25 million for the properties and $11.75 million for the businesses.

57 In support of the highest case alternatives, counsel for the property companies submitted that it was open to Mr Schulz to seek to negotiate a re-allocation of the purchase prices to this effect, and that there was a significant prospect that Nylex, GE and NAB would have agreed. Further, it was submitted that this result would not, if achieved, have involved Mr Schulz in any breach of his duties as a director of Huon Corporation. For the reasons appearing below, I accept the first proposition but not the second.

58 I accept that it would have been open to Mr Schulz to re-negotiate the prices, and that there was a more than negligible prospect that Nylex, GE and NAB would have agreed. In his evidence in chief, the chief executive of Nylex, Mr Casey, who was involved in direct negotiations with Mr Schulz, said he could not think of any objection by Nylex to the suggested alterations to the price allocations within the headline price; although he would have sought tax and legal advice, and the approval of Nylex's bankers, before recommending the changes to the Nylex board. If no issue was raised by them, he said: 'I doubt there would have been a problem'.

59 Mr Casey acknowledged, however, that sales of the three properties for $4.25 million would have created capital losses, as they were being carried in Nylex's accounts at approximately $13.25 million,[16] and that this would have had some tax and accounting consequences. On that issue, he said in re-examination that Nylex had a number of tax losses in various group companies, some of which were able to be transferred into the consolidated Nylex accounts and some of which were not.

60 Mr Casey said that Nylex's initial asking prices of $14.2 million for the three properties and $26 million for the three businesses were based on valuations obtained by Nylex for internal purposes: by CB Richard Ellis for the properties and KPMG for the businesses. He agreed with the proposition that Mr Schulz negotiated a 'good deal' at $17 million for all the assets, but continued:

Look, I don't think it was a great deal less than what they were worth. It was an automotive industry. There were issues in the automotive industry and John had to back himself to make it successful. So there was clearly an element of risk on both parties.

61 In cross-examination, Mr Casey adhered to his evidence. He said that Mr Schulz was a good and persistent negotiator, even after agreement was reached on issues. He said that he allowed Mr Schulz to keep negotiating because Nylex was keen to finalise the transaction in circumstances where:

The situation was there were no other parties interested in the property and in the businesses and we were on a structured workout program with the banking syndicate and our desire was to finalise this transaction and move on to the next business for divestment.

62 In re-examination, Mr Casey said that he thought the initial asking prices by Nylex were fair at the time the assets were put on the market in October 2004. This shows that Mr Casey's view about the value of the businesses must have decreased very significantly over the period that the businesses were on the market. In particular, issues such as the high level of employee entitlements in the context of major contracts of the businesses coming to an end in 2006, problems in the automotive industry with increasing overseas price competition and like matters would have been considered by Mr Casey. There was no reason to suppose that Mr Casey changed his view on the value of the three properties to any significant extent, except perhaps to consider a possible reduction in value due to the increased likelihood of the properties being offered with vacant possession if one or more of the businesses ceased trading. In that regard, it is relevant to note that CB Richard Ellis revised its valuation of the three properties from $13.31 million in November 2004 (for Nylex accounting purposes) downward to $11.6 million in late July and early August 2005 (for NAB on a vacant possession basis for mortgage purposes).

63 Taking the evidence on this issue as a whole, I find that there was a real prospect that Nylex would have agreed to a $9 million price reduction for the three properties and a consequent increase in the price for the three businesses. In reaching that conclusion, I have taken into account matters including that Nylex was in a structured workout program with its banking syndicate, that Nylex wished to finalise the transaction and move on to the next business divestment, that there were no other parties interested in these assets, that Nylex was facing significant payments for employee entitlements, and that Mr Casey's view as to the value of the businesses obviously decreased after they were put on the market.

64 I am also satisfied on the evidence that there was a real prospect that NAB and GE would have agreed to the prices being altered in this fashion. NAB intended to lend on the security of the land and had obtained valuations which, in its view, justified making the loans and providing the other facilities which it provided. Its security position would be unchanged by the alteration to the purchase prices. In the hypothetical scenario under consideration, Huon Corporation would have continued to pay market rental of an amount more than sufficient to service the NAB debt. Further, in that regard, I accept the evidence of Mr Bishop, a finance broker who gave expert evidence on behalf of the defendants. Mr Bishop said that NAB would likely have continued to provide the same level of funding if the purchase prices of the three properties had been reduced to $4.25 million in total.

65 As to GE, it knew that it was lending against the cash flow of the three businesses and decided to lend without seeking any security over the three properties. Its lending commitment was governed by the application of a formula to the outstanding debtors of the three businesses from time to time, and the price which Huon Corporation paid for the businesses, provided the headline price of $17 million remained unaltered, was not relevant to it in deciding to lend. Indeed, GE had issued its commitment letter to Huon Corporation before the price allocations within the headline price had been agreed. At the time of this commitment, there was a headline price covering all of the three businesses and the three properties, and GE's only condition concerning the three properties was that NAB or another financial institution would lend a minimum of $5 million towards completion of the transaction, on the basis that NAB would have security over the properties.

66 In my opinion, however, the suggested re-allocations would have involved Mr Schulz in significant and obvious breaches of his duties as a director of Huon Corporation, and he would have been so advised by Mr Checketts in the hypothetical scenario under consideration.

67 The applicable legal principles are not in doubt. As a director of Huon Corporation, Mr Schulz owed it fiduciary and statutory duties. In summary:

(1) The relationship of director and company is an accepted fiduciary relationship.[17] As a fiduciary, Mr Schulz owed Huon Corporation a duty to exercise his powers as a director in its best interests.[18]

(2) By s 180(1) of the Corporations Act 2001 (Cth) ('the Act'), Mr Schulz owed Huon Corporation a duty to exercise his powers and discharge his duties with the degree of care and diligence that a reasonable person would exercise in his position. Subject to the limited 'business judgment' exception in s 180(2), compliance with this duty must be assessed objectively: 'one must ask what an ordinary person, with the knowledge and experience of the [director] might be expected to have done in the circumstances if he or she was acting on their own behalf'.[19] Where the transaction involves an actual or potential conflict between the interests of the company and the director's personal interests, the duty to exercise reasonable care and diligence must be exercised with 'special vigilance, calling for scrupulous concern ... to ensure that ... safeguards [are] put in place.'[20]

(3) There is a 'business judgment' exception in s 180(2) of the Act. However, that exception cannot apply in a case such as the present, where Mr Schulz had a material personal interest in the subject matter of the judgment he would have been exercising.[21]

(4) By s 181(1) of the Act, Mr Schulz owed Huon Corporation a duty to exercise his powers and discharge his duties as a director in good faith and in the best interests of Huon Corporation and for a proper purpose.

(5) By s 182(1) of the Act, Mr Schulz owed Huon Corporation a duty not to improperly use his position to gain an advantage for himself or someone else or to cause detriment to Huon Corporation.

68 Of course, in acting as a director of the property companies, Mr Schulz owed similar duties to each of them. For example, this required him to ensure that Huon Corporation paid rent for the properties on an arms-length commercial basis.

69 The duties under ss 181(1) and 182(1) of the Act will be breached where a director: 'promote[s] his personal interest by making or pursuing a gain in circumstances where there is a conflict or a real or substantial possibility of a conflict between his personal interests and those of the company'.[22] This is not to say that a director cannot act with some personal interest in mind: 'provided that this personal interest was not the actuating motive rather than some bona fide concern for the benefit of the company as a whole'.[23]

70 In assessing whether a director has breached the duties under the abovementioned sections of the Act, an objective test must be applied.[24] Where, as here, there are a number of companies with common ownership and control, the directors of each company must exercise their powers and discharge their duties in the interests of each individual company.[25] In some cases, there may be justifiable benefits of a derivative kind if one company in a 'group' provides assistance to another company in the same group, especially where there are interlocking shareholdings.[26] But in such circumstances, the directors must nevertheless exercise their powers and discharge their duties in the interests of the relevant company which is providing assistance. In this case, there were no interlocking shareholdings between Huon Corporation and the property companies, and the only reason for the conflict arising between their respective interests was Mr Schulz's desire to benefit himself and his family by placing the three properties under separate ownership from Huon Corporation, for the dominant purpose of protecting any equity in the three properties from the creditors of Huon Corporation in the event that it became insolvent. Accordingly, his personal interest was 'the actuating motive'.

71 In this case, there was an obvious conflict between Mr Schulz's interests and those of Huon Corporation. Any decrease in the purchase prices of the three properties would be for his benefit; and any increase in the purchase prices of the three businesses would cause detriment to Huon Corporation. Accordingly, the circumstances called for Mr Schulz to exercise 'special vigilance' in the exercise of his duties as a director of Huon Corporation.

72 It was submitted on behalf of the property companies that the benefit to the property companies of reductions in the purchase prices for the properties would not result in any corresponding detriment to Huon Corporation, for two reasons. First, because the low headline price of $17 million, in the context of an asking price of $40 million for all of the assets, meant that 'everything [was] being sold below valuation', with the consequence that the suggested price variations would have the effect that the property companies on the one hand and Huon Corporation on the other were each purchasing assets at a roughly equivalent rate of discount to actual value. This submission depends upon the contention that the evidence justifies the conclusion, or at least points to circumstances indicating a prospect which was not negligable, that the three businesses were worth substantially more than the $3.75 million sale price.

73 Second, it was submitted that there was no corresponding detriment to Huon Corporation because it 'would be in exactly the same position on either scenario'. Counsel submitted that this was so because, although paying $9 million more for the three businesses on the suggested re-allocation of the prices, Huon Corporation would be:

borrowing the same amount of money from the same lender on the same security and [would own] the same assets. So if you look at the two different situations there is no difference to Huon Corporation's position.

74 I will consider the second submission first. I do not accept it. On the scenario as implemented, the property companies acquired the three properties for their market value, which had been independently and objectively assessed. The only way that the acquisitions could occur was with the aid of $9 million paid by Huon Corporation. By these payments, Huon Corporation paid the whole of the purchase prices of the Frankston and Bendigo properties. As a result, it had an unarguable interest in those properties as beneficial owner under a resulting trust.[27] Accordingly, on the scenario as implemented, Huon Corporation did not 'own the same assets'. It was also the beneficial owner of the Frankston and Bendigo properties. Put simply, Huon Corporation would have lost $9 million if the price for the three businesses was increased by that amount.

75 As to the first submission, that the prices as implemented had the effect that the property companies paid full market value for the properties and Huon Corporation paid a substantially reduced price for the three businesses, thus justifying re-allocation of all of the prices within the $17 million headline price to reflect a sharing between the property companies and Huon Corporation of the discount provided by Nylex for the combined assets as a whole, consideration must be given to the evidence as to the likely value of the three businesses at the time of settlement on 16 December 2005.

76 It was submitted on behalf of the property companies that there was credible evidence that the three businesses had been valued by KPMG at the request of Nylex in or about October 2004 at approximately $26 million. This submission was based upon a document prepared by the business brokers acting for Nylex in the proposed sale of the three businesses and the three properties. The document is dated 5 October 2004, and comprises a schedule of asking prices for each of the assets being offered for sale ('the schedule'). Mr Casey said that the asking prices in the schedule were based on valuations provided by KPMG:

KPMG managed the program and provided valuations according to their expertise for each divestment and the bank also required an indication of the potential funds or the proceeds from the divestments. So KPMG and our internal advisors put together a valuation that included valuation of properties, lands and life of contracts, EBITDA and a combination of all those factors went into providing a valuation or a price for the market.

When you put the initial price on the market, that was based on a KPMG valuation of the business; is that what you are saying? --- Yes.

And also the CB Richard Ellis valuations of the properties? --- All which would have been considered in the final valuation, yes.[28]

77 The schedule attributes prices totalling $14.2 million to the three properties. That is more than the total of the valuations given by CB Richard Ellis for the three properties in the following month, November 2004. The CB Richard Ellis valuations were prepared on the basis of: 'Fair Value for company accounting purposes (previously Market Value - Existing Use apportioned between land and buildings).' Those valuations totalled $13.31 million for land and improvements. Mr Casey said that these values were likely to have been incorporated into the Nylex accounts for the year ended 30 June 2005. There is no evidence of any valuations totalling $14.2 million. The CB Richard Ellis valuations approximate the values apportioned to the three properties in the final contracts ($13.25 million).

78 The schedule attributes prices totalling $26 million to the three businesses. In attributing those prices, the schedule states that employee entitlements then totalled $7.2 million and that this amount had been deducted from values attributed to goodwill, plant and equipment and stock/inventory of the businesses; thus arriving at an asking price of $26 million. It was submitted that this was probative evidence to support a net business valuation of $26 million at acquisition in December 2005. On this basis, it was contended that Mr Schulz would not have breached his director's duties if he negotiated a re-allocation of the purchase prices to reflect a pro-rata sharing of the discount provided by Nylex against the total value of the assets being sold. The following calculations were relied upon:

Percentage allocation of $17 million purchase price

79 In my opinion, reliance on the CB Richard Ellis mortgage valuation of $11.6 million was unjustified in the context of these calculations. The calculations assume the highest possible value for the businesses (the asking price) yet choose the most conservative and lowest valuation for the properties. This does not compare like with like. It would have been a breach of Mr Schulz's director's duties to proceed on that basis. However, as appears below, adoption of the $14.2 million asking price, or the CB Richard Ellis market valuation of $13.25 million, as the value of the properties does not change my analysis and conclusions in respect of the first, and highest, hypothetical scenario relied upon.[29]

80 On the basis of the calculations in the above table, the property companies would have needed to borrow only $1 million from Huon Corporation in order to fund the acquisition of the properties; as NAB agreed to lend $4.25 million at settlement. On that scenario, the market rentals which NAB insisted Huon Corporation pay to the property companies would have been more than sufficient to enable the property companies to enter into formal loan agreements to repay Huon Corporation the $1 million finance and commercial interest on second mortgage security over the three properties.[30]

81 I accept that this scenario would, if there was a more than negligible prospect that it could have been achieved, have had some real value. However, for the reasons appearing below, I find that the prospects of this scenario being achieved were negligible. In summary, this is because the evidence does not support any valuation of the businesses which exceeds the $3.75 million paid for them; while the evidence establishes that the $13.25 million paid for the three properties was fair value consistent with the valuations independently arrived at by CB Richard Ellis in November 2004.

82 For the following reasons, the schedule and so-called 'KPMG valuation' provide no safe guide to the net value of the businesses at settlement in December 2005. It would have been wrong for Mr Schulz to have adopted the asking prices for the businesses in the course of exercising his director's duties in the hypothetical circumstances postulated. Such an approach would have involved him giving equal weight to the CB Richard Ellis valuations on the one hand, and the Nylex asking prices on the other; in circumstances where there were many indications from the facts known to Mr Schulz that the businesses were worth far less than the Nylex asking prices.

83 First, Mr Schulz said that the three businesses were initially offered to him by the business brokers acting for Nylex for a 'sell price of circa $20 million' in about March or April 2005, and that he received a draft contract from Nylex for $18.5 million 'for the businesses only' between a week and a month later. Later in his evidence, Mr Schulz repeated his understanding that these initial prices did not include the three properties, and that the three properties were only later included in the proposed sale for, in his words, 'zero dollars'. I accept Mr Schulz's evidence about the amount of the initial offers, and that the first draft contract of sale refers only to the three businesses. However, I reject his evidence that the initial offers did not include the three properties. However keen Nylex may have been to sell the three businesses and transfer the looming redundancy obligations to a purchaser, it is wholly implausible that the three properties were offered for no consideration. Mr Casey said that the three properties were always included in the proposed sale transactions, and I prefer that evidence. I find that it is probable that the three properties were always intended by Nylex to be included in the sale transaction, and that Mr Schulz understood that was so.

84 Second, there is no KPMG valuation in evidence. The only evidence of it having been prepared, and of it forming the basis of the asking prices for the businesses and the properties, is the evidence of Mr Casey; based on his general recollection of events six years before in the context of a sale program involving 26 businesses. He described it as 'a valuation or a price for the market' which 'KPMG and [Nylex's] internal advisers put together.' This evidence does not describe an independent market valuation by KPMG.

85 Third, there is no evidence of the basis upon which any KPMG valuation was performed or its purpose. There is no evidence of any instructions given by Nylex to KPMG. Mr Casey said that, unlike the CB Richard Ellis market valuations, which were incorporated into the Nylex statutory accounts: 'The KPMG valuations were more for accounting purposes as opposed to accounting standard valuations, so they are quite different.'

86 Fourth, the property companies had a case to prove. It was for them to adduce evidence establishing that, on the balance of probabilities, they have lost an opportunity of some value. In the circumstances of the first hypothetical scenario relied upon, that required the property companies to adduce evidence as to the value of the businesses at relevant times. They did not do so. The only valuation evidence put forward on behalf of the property companies concerned the value of the properties; to the effect that the properties had a market value of $13.8 million at the time of settlement. This evidence supported the CB Richard Ellis market valuations prepared in November 2004. No attempt was made by the property companies to place independent valuation evidence before the Court as to the market value of the businesses at the time of settlement.

87 Fifth, the schedule was not prepared by KPMG, or indeed Nylex. It was prepared on Nylex's behalf by a business broker engaged to assist Nylex in its divestment program. The schedule contains the disclaimer:

Disclaimer* The information contained in the document has been prepared in good faith with due care by Johnsons Business Brokers Pty Ltd (A.B.N. 41 617 195 871) trading as Johnsons Corporate Business Sales Strategists and The Club, International Corporate Sales Strategists (Johnsons) from information supplied by the Vendor. Neither Johnsons nor any of its principals or staff have carried out any verification or audit procedure on any information contained herein. The recipient, its employees and advisors should rely on their own enquiries and investigations regarding all matters in relation to these businesses.

88 The combination of the disclaimer, the fact that it was prepared by business brokers, the fact that it contains an asking price of $40.2 million for the properties and the businesses, and the fact that Nylex ultimately agreed to a price of $17 million for all of the assets, indicates that the schedule was an aspirational document designed for use in negotiations. It did not purport to contain independent values which had been objectively assessed by expert valuers.

89 Sixth, there is no basis to suggest that the asking prices take any account of the numerous risks, other than employee entitlements on redundancy, facing the businesses in the immediate future following settlement in December 2005. Mr Schulz was well aware of these risks as a result of his own investigations and the information provided to him by Pitcher Partners in their financial due diligence report. He described the risks and liabilities of the businesses, from which he intended to protect the property companies, in the following terms:

The liabilities within the businesses were obvious business liabilities in addition to the employee entitlements which is one that we became very conscious of and also the markets that the businesses operated at that particular time, that is the automotive industry.

What was the issue about that? --- The automotive industry at that time was considered to be a fickle industry and the prospects in that industry for some were regarded as high risk.

When you talked about the liabilities in the business including the employee entitlements did you have an estimate of how much they were at the time? --- I believe by the time that we had negotiated all of the [conditions precedent] in the business sale agreements which were, in effect, settled on or around early December, the vast bulk of those had been remediated, save and except for a gap that would not exceed $7 million at the time.

Who would have been liable for that after the purchase? --- Huon Corporation.

What else had you done to provide for the potential employee entitlements liability? --- We put in a unique bond for the benefit of the employees.

How much was that for? --- $7 million.

90 Mr Casey also recognised the risks. As stated above, it is obvious that he had a decreasing view of the value of the businesses. Although he thought that Mr Schulz negotiated a 'good deal' at $17 million for all the assets, he continued:

Look, I don't think it was a great deal less than what they were worth. It was an automotive industry. There were issues in the automotive industry and John had to back himself to make it successful. So there was clearly an element of risk on both parties.

91 Seventh, the bare price break-up in the schedule stands in stark contrast with the later detailed analysis by Pitcher Partners of the unreliability of Nylex's accounting information and the risks facing the businesses. The Pitcher Partners financial due diligence report is dated 7 July 2005, nine months later than the schedule. The Pitcher Partners report comprises 137 pages of detailed analysis and comment, together with 16 appendices.

92 Pitcher Partners performed their review pursuant to an engagement letter dated 6 June 2005 which was counter-signed by Mr Schulz to accept the scope of the retainer and its terms and conditions. In the engagement letter, Pitcher Partners described the scope of their retainer as 'a financial and taxation due diligence' of the businesses, with the objective of assisting Mr Schulz in 'the assessment of the risks and opportunities of the proposed acquisition'.

93 The review conducted by Pitcher Partners was extremely thorough. In the Pitcher Partners report, they expanded upon the scope of the work undertaken by them. They noted that they had full access to an electronic data room set-up by Nylex, and that they had discussions with Nylex senior management and with the divisional financial controllers of each of the businesses.[31] In relation to the last three reporting periods of the businesses, to 31 December 2004, Pitcher Partners reviewed Nylex's external auditors' working files, historical trading performance, historical financial position, historical cash flow generation, and also reviewed management reporting systems with a view to assessing the accuracy of information generated in reports and presented in the data room. At a more general level, Pitcher Partners conducted:

(1) 'A review of the forecasts prepared by Nylex Automotive Group for the period to June 2006, comparing with historical results and commenting on the assumptions made with reference to historical trends for revenue, gross margin, salaries and wage claims, EBITDA, working capital and [capital expenditure].'

(2) 'A review of the terms and conditions attaching to all disclosed legal agreements from a commercial point of view (note this is not a legal due diligence) ...'

(3) 'A review of customer and supplier contracts and terms and conditions with respect to [costs and sales] ...'

(4) 'A review of the IT environment and related risk management procedures ...'

94 Pitcher Partners noted that they had not conducted an audit and, accordingly, did not express an opinion on the achievability of the Nylex cash flow forecasts.

95 In their report, Pitcher Partners noted that the Nylex accounting information was of poor quality: 'as a general rule the quality of the information obtained was poor and supporting documents and reconciliations consistently did not agree to the accounts under review.'

96 The schedule states asking prices for plant and equipment of the businesses. In their report, Pitcher Partners were unable to reconcile the Nylex fixed asset register for the Empire Rubber business at Bendigo, and noted provision for capital expenditure and write downs. For the Mills Elastomer business at Dandenong, Pitcher Partners noted that the Nylex 2006 forecasts did not include required capital expenditure of approximately $100,000 to ensure compliance with workplace safety requirements. For the Nylex Frankston business, Pitcher Partners noted that the plant and equipment valuation in the Nylex accounts could not be relied upon because of the imminent likely closure of that business upon the expiry of the Holden and Mitsubishi contracts in June and September 2006. They recommended that:

The 'break up' value of the plant & equipment should be evaluated, in addition to the existing going concern valuation, in light of the ability to not only sell the plant & equipment, but also, if necessary, to transport the assets and reconstruct them intact and the impact this will have on their disposal value.

97 The schedule states fixed prices for inventories/stock of the businesses. In their report, Pitcher Partners noted 'significant issues surrounding the valuation of inventory' in the Nylex accounts for Empire Rubber, a significant decrease in the inventory/stock for Mills Elastomers since 2003, and a slight increase in inventory/stock for Nylex Frankston since 2004. Obviously, the value of inventory/stock changes from time to time and, in addition, there were valuation issues noted for Empire Rubber.

98 The schedule contains a fixed amount of $7.2 million for employee entitlements. For Empire Rubber, Pitcher Partners noted the unexplained increase in the provision for annual leave entitlements, the fact that future redundancies could cause significant future cash flow issues and an under-provision in the Nylex accounts for long service leave entitlements. For the Mills Elastomer business, Pitcher Partners noted that any possible redundancies would have significant cash flow implications, and an under-provision for long service leave entitlements. In respect of Frankston, which was predicted to close in 2006 due to the expiry of the Holden and Mitsubishi contracts, thus giving rise to significant redundancy entitlements, Pitcher Partners noted:

There have been no redundancies incorporated within the 2006 forecast as a result of the Holden work ceasing. Nor has any provision been made for redundancies in respect of the Holden contract as at April 2005. Management have not provided a schedule of proposed redundancies as a result of the impending loss of the Holden contract. We recommend that these redundancy costs be taken into account in the purchase price.

99 Further, in respect of the Frankston business, Pitcher Partners again noted an under-provision for long service leave entitlements.

100 Eighth, it was not only Pitcher Partners which raised concerns at this time concerning the Nylex provisions for employee entitlements. In his initial review of the Nylex provisions, Mr Stockdale identified $7.631 million of employee entitlements as at December 2004/January 2005 based on acceptance of the available Nylex information. Mr Stockdale asked Nylex for more up to date information. On 20 July 2005, after receiving some further information, Mr Stockdale informed Mr Schulz in an email that he and Pitcher Partners had collated the results of the further information. He noted that the Nylex provisions at June 2005 were described as 'estimates rather than actuals' and advised Mr Schulz that he could argue for further price reductions based on under-provision for redundancies:

• It seems to me that the arguments are:
  • their records do not seem reliable
  • the liabilities for annual leave and LSL (especially LSL) are likely to exceed their provisions
  • they have made no provisions for RDOs and sick leave
  • there are likely to be redundancies in excess of those for which they have provided
  • the EBA position leaves you exposed because they have implemented wage increases in the EBAs without getting the protection of a certified agreement
  • you face a significant cost in upgrading and probably replacing their record systems in a context where the businesses are no longer part of the overall Group they are in now
  • these costs are likely to be very substantial and will erode the EBIT on which multiples are based

101 Ninth, the concerns expressed by Pitcher Partners and Mr Stockdale as to the accuracy of Nylex's provisions for employee entitlements were well placed. Following liquidation of Huon Corporation, some of the employee entitlements were transferred to the purchasers of the Empire Rubber and Mills Elastomer businesses. The remaining entitlements totalled $19.3 million, a figure which far exceeded the $7.2 million provision contained in the schedule.

102 The liquidators' annual report, dated 29 November 2007, notes the following in connection with employee entitlements:

(1) The Frankston business ceased trading on 31 August 2006. [At that time, I infer that all of the employees were made redundant.]

(2) Upon the sale of the Empire Rubber business in May 2007, the purchaser offered continuing employment to 100 existing employees, and assumed liability for their accrued entitlements. The remaining Empire Rubber employees were made redundant on sale of that business.

(3) Upon the sale of the Mills Elastomer business, the purchaser offered continuing employment to 27 employees, and assumed liability for their accrued entitlements.

(4) The employee entitlements which were unable to be transferred totalled $19.3 million. Huon Corporation was able to pay only $3.9 million from its own funds. This left a deficiency of $15.4 million.[32]

(5) Pursuant to cl 10.8.1 of the Nylex Frankston business sale agreement, Huon Corporation had a right to reimbursement from Nylex of 50 per cent of the redundancy costs incurred and paid by Huon Corporation in respect of employees of the Frankston business who were made redundant as a consequence of the termination of the Holden supply contract. At the date of the liquidators' report, Nylex's liability to contribute was not crystallised, as the liquidators lacked the necessary funds to pay all of the ex-Frankston employees' redundancy claims in full. In their report, the liquidators proposed making formal application to GEERS to seek funding to pay the shortfall, thus crystallising Nylex's obligation to contribute under this clause. The evidence does not disclose whether or not this occurred. However, whether or not it did, the fact remains that the employee entitlements were grossly understated in the schedule.

(6) A $7 million insurance bond in favour of the employees was not able to be recovered by the liquidators. I infer that the insurance bond was recoverable by the relevant unions representing the employees or by some other representative body.

103 Tenth, the liquidators' report is inconsistent with attributing any value in excess of $3.75 million to the businesses in December 2005, or with attributing a lesser value to the properties. To the contrary, the liquidators' report provides strong evidence that the prices allocated in the contracts, and paid at settlement, represented market values and were fair to both Huon Corporation and the property companies. The liquidators' report discloses the following material facts:

(1) Following acquisition on 16 December 2005, the businesses rapidly encountered financial difficulties and Huon Corporation became insolvent. In large part this was because of the financial assistance provided by Huon Corporation to the property companies, which had the effect of severely depleting Huon Corporation's working capital reserves. Further, the rapid decline into insolvency arose from the failure of Huon Corporation to replace lost customer contracts, and declining sales to customers in the automotive industry.

(2) The liquidators sold the three properties for a combined net amount of approximately $15.23 million. This provided strong evidence that the CB Richard Ellis market valuations in November 2004 (for $13.31 million) and the agreed sale prices ($13.25 million) were not understated.

(3) The liquidators sold the Empire Rubber and Mills Elastomer businesses, and the plant, equipment and stock at Frankston, for a total sum of approximately $3.42 million. They also recovered some Government grants attributable to the businesses totalling $267,600. In total, sales of the businesses yielded a gross value of approximately $3,687,000:

(4) The total sale price for the businesses and the Government grants were less than the $3.75 million price paid by Huon Corporation in December 2005.

(5) Huon Corporation incurred a consolidated trading loss for the three businesses of $3.4 million in the period 16 December 2005 to 30 June 2006, when the administrators were appointed by Mr Schulz. This ignores any liabilities for redundancy entitlements. The businesses were clearly unprofitable and could not withstand such losses given the depletion of Huon Corporation's working capital arising from the financial assistance provided to the property companies.

(6) Further, the liquidators reported that in its short life under Mr Schulz's control, Huon Corporation provided an unsecured loan of $240,755 to a company associated with Mr Schulz. The company defaulted. The Huon Corporation liquidators made a statutory demand and placed the Schulz company in liquidation. A proof of debt filed by them yielded only $18,725 from the liquidation, a return of 7.78 cents in the dollar.

(7) Given that there were insufficient funds to pay all of the employee entitlements, which are priority debts in the liquidation, there were no available funds for unsecured creditors. The secured creditors, GE and Nylex, were paid in full, as was the State Revenue Office for stamp duty in respect of the overall purchase transaction.

104 In his evidence, Mr Schulz blamed Mills Oakley for the businesses failing. He said that it was part of Mills Oakley's due diligence task to review all of the existing Nylex contracts and bring any material matters to his attention. In that context, he said that Mills Oakley failed to advise him that a contract for the Empire Rubber business to supply a component for Holden expired in September 2006. He said that he knew of the expiry of the Frankston contracts for Holden and Mitsubishi but not of the expiry of the Empire Rubber contract with Holden. He contended that Mills Oakley breached its duties to Huon Corporation by failing to inform him of this fact. He said that he discovered the impending loss of the Empire Rubber contract with Holden in January 2006, and that the loss of that contract caused Huon Corporation to lose $15 million per annum in revenue and $5 million per annum in profit. Mr Schulz asserted that it was the loss of this contract, unknown to him because Mills Oakley did not advise him of it, that caused the businesses to fail.

105 Mr Schulz's evidence in this regard was irrelevant to claims by the property companies. Claims by Huon Corporation and Mr Schulz were made in other proceedings in this Court. Those claims were made prior to the appointment of administrators, and have in any event been discontinued.

106 In any event, I do not accept that there is any merit in Mr Schulz's complaint against Mills Oakley on this basis because:

(1) the businesses failed before expiry of the Empire Rubber contract to supply the Holden components.

(2) the issue was raised generally by Pitcher Partners in their financial due diligence report. They said:

Holden have contracted Empire to supply products for the new Commodore model (VE), however a lower level of components than for the existing VZ model. The VZ product variants, to which Empire currently supply components (i.e. utes and Holden Statesman) have had their existing lives extended. Dana who Empire also supply Holden components, have not been awarded the suspension contract for the VE model. This was [awarded] to a contractor that manufactures its own rubber.[33]

(3) Mr Schulz was the businessman. A businessman in his position exercising any reasonable care would have paid particular attention to the maintainable earnings of the businesses being acquired, particularly under the principal supply contracts. This is an example of Mr Schulz refusing to accept responsibility for having made a poor business deal. In truth, the transactions were the subject of nearly 100 per cent funding, with no significant equity being contributed by him or his companies. Unless the businesses were being acquired for a significant undervalue, which they were not, they were high risk businesses which would likely fail if any significant business risk materialised. That is what happened.

107 Further on this topic, if the first hypothetical scenario had caused Mr Schulz to commission a valuation of the businesses with a view to justifying an alteration of the price allocations, it is likely that a competent valuer would have discovered that the Empire contract to supply Holden components was to expire, and advised Mr Schulz accordingly. For that reason also, there would have been no justification for attributing a higher value than $3.75 million to the businesses.

108 There is one further submission made on behalf of the property companies which may conveniently be dealt with in considering the first hypothetical scenario. It was contended that Mr Schulz would have been justified in allocating lower prices to the properties because of identified risks that they may have been contaminated as a result of the conduct of the businesses by Nylex over many years. This risk was especially apparent for the Frankston property, as the business at that property was likely to be closed in 2006 following termination of existing contracts - with the consequent need to change its use to a more a sensitive one. The CB Richard Ellis valuations noted the existence of contamination risks, but did not take them into account in valuing the properties. For the following reasons, I do not accept that the contamination risks would have justified Mr Schulz in significantly reducing the prices allocated to the three properties, so as to accord with the first hypothetical scenario.

109 First, there was no expert evidence called as to the extent of the risks arising from possible contamination, or as to the effect of such risks upon the values of the three properties. The valuer called by the property companies simply noted the existence of possible contamination risks.

110 Second, Mr Schulz negotiated warranties from Nylex in the transaction documents, requiring Nylex to indemnify the property companies against the cost of compliance with any clean-up notice by an environmental authority in respect of contamination existing at settlement date. Those warranties did not, however, cover any clean-up notice consequent upon a change of use of any of the three properties, as was proposed in respect of the Frankston land.

111 Third, the later sales of the three properties by the liquidator show that the contamination risks had no adverse effect upon their market values as determined by CB Richard Ellis. Indeed, the Frankston property which had the greatest risk of requiring clean-up in the context of a changed use, was sold by the liquidators for $8.63 million, a price which significantly exceeded the CB Richard Ellis valuation of $6.75 million, prepared for Nylex in November 2004.

112 Finally, in addition to the above matters, the first hypothetical scenario ignores the capital gains tax ramifications of purchasing the properties at a significant undervalue. It was these capital gains tax issues which caused Pitcher Partners to advise that the properties be acquired for market value.

113 In summary, the evidence does not establish that, if Mr Schulz received appropriate legal advice and acted in accordance with his director's duties, he had any realistic chance of altering the price allocations from those contained in the transaction documents and upon which the transactions settled: $13.25 million for the properties and $3.75 million for the businesses. A director in the position of Mr Schulz, exercising special vigilance given his conflict of interest position, would have readily appreciated that this was so. On the balance of probabilities, I am not satisfied that the first hypothetical scenario had any value.

114 I turn to consider the alternative claim made by the property companies. If the price re-allocations put forward in the first hypothetical scenario cannot be maintained, the property companies contend that, as a result of Mills Oakley's negligence, they lost the opportunity to record and document the flow of funds at settlement; so as to reflect arms-length inter-company loans by Huon Corporation to the property companies on commercial terms (including second-ranking security behind NAB over the property companies and the three properties). In submissions, both parties canvassed possible variants to this scenario, incorporating some alteration in the price allocations between the properties and the businesses. On behalf of Mills Oakley, these variants were put forward to demonstrate that, even accepting that some price variations may have been permissible in light of Mr Schulz's director's duties and the CB Richard Ellis mortgage valuation of $11.6 million, the property companies would nevertheless not have been able to fund repayment to Huon Corporation of inter-company loans made on commercial terms. For the property companies, the price variations were put forward so they could contend that they had the ability to fund interest payments on inter-company loans and that, as a result, the second hypothetical scenario represented a valuable lost opportunity.

115 On its highest case, the property companies contend that the value of this lost opportunity is approximately $2.6 million; represented by the difference between the current values of the properties and the contract prices paid for them. They claim damages equal to the Court's assessment of the degree of likelihood that this opportunity, or one of its variants, would have been successfully pursued.

116 The second hypothetical scenario depends upon the market rental for the properties. This is because Mr Schulz could not have complied with his director's duties to Huon Corporation if he allowed it to lend money to the property companies on anything other than arms-length commercial terms. The rentals payable by Huon Corporation to the property companies were their only source of income. They had no assets other than the properties. Accordingly, in order to establish that the property companies could pay a commercial rate of interest to Huon Corporation on the loans, the amount of market rental was the critical determining factor. In order to establish that the second hypothetical scenario was of some value, the property companies had the onus of proving that, after paying interest due to NAB on its first mortgage loans, there would be sufficient cash available to the property companies to pay commercial interest to Huon Corporation. On this issue also, the property companies must overcome the hurdle that they have failed to adduce valuation evidence to support their case.

117 As part of its security requirements, NAB insisted that the property companies lease the properties to Huon Corporation at arms-length commercial rentals. The leases would provide income to the property companies, from which they would be able to pay interest due to NAB on its loans. The leases would also provide a formal covenant from Huon Corporation to pay rent, which NAB could enforce in the event that the property companies defaulted in paying interest and NAB moved to enforce its mortgages over the properties and debentures over the property companies.

118 For this purpose, Mr DiPietro ensured that NAB obtained fair market rental valuations from CB Richard Ellis. CB Richard Ellis valued the rentals at $810,000 in total for the three properties. Mr Schulz and Mr Hunter were advised of this valuation at a meeting, and this advice was confirmed by email dated 7 September 2005 from Mr DiPietro of NAB to Mr Hunter:

Jeanette [Thompson] also asked me what rentals are required on the Leases for the three properties. She stated that you and John preferred that the amounts should be equal to the amount the bank requires in interest and for the sinking fund. As per our last meeting/discussion (you, me, John [Schulz] and Bass) and our Letter of Offer, the rental amounts were to be as per sworn valuation completed by CBRE ie ... Frankston $363K, Dandenong $153K and Bendigo $297K. We agreed that this was to be further discussed, we can perhaps reduce the rentals by say 5% - 10% but any further would cause an issue with NAB. Please advise.

119 Following this email, these rentals were adopted in the draft lease agreements and the issue appeared to have been settled. In time, however, Mr Taylor of GE learned of NAB's insistence on market rentals being paid by Huon Corporation. In an email dated 8 December 2005 addressed to Mr Schulz and Mr Hunter, he expressed his displeasure from GE's viewpoint, on the basis that he thought market rentals would create 'leakage' of Huon Corporation funds to the property companies, over which GE had no security:

Regarding the rentals ... for the first time I am now aware of what the rentals are, but my point is that the total of $810,000 is at least twice what I would expect the debt service requirements to be to the NAB (ie $5.0 million @ say 8% -= $400,000).

I recall early discussions with John where it was intended that the rentals would be set at levels equal to the debt serving requirement. This position appears to have changed.

As the rent represents a leakage of cash from my borrower to entities over which I have no recourse, I need to understand what will happen to the surplus cash held by the Property Purchasers (being the excess between the rent received and the interest paid to the NAB) - perhaps the Property Purchasers could loan the funds back to Huon?

Please advise.

Brett[34]

120 Mr Schulz and Mr Hunter discussed this issue with Mr Taylor at a meeting in Sydney. An arrangement was struck, under which no more than $100,000 would be taken out of the property companies each year, from the balance of annual rentals remaining after deducting moneys paid to NAB in that year.

121 The difficulty which the property companies face is that the evidence establishes that CB Richard Ellis valued the fair market rental for the properties on an annual basis at $810,000. The parties agreed that, for the purpose of assessing the hypothetical variants of the second scenario, the annual amount due by the property companies to NAB was approximately $390,000. This left a surplus of $420,000 to pay interest to Huon Corporation on the hypothetical inter-company loans.[35]

122 On any of the variants put forward by the parties under the second hypothetical scenario, $420,000 was insufficient to cover arms-length commercial interest payable by the property companies to Huon Corporation on the hypothetical loan amount.

123 In order to meet this situation, it was contended on behalf of the property companies that it would have been open to Mr Schulz, acting consistently with his duties as a director of Huon Corporation, to have obtained valuations of market rental for the properties which exceeded $810,000 by a sufficient amount to place the property companies in the financial position to pay commercial interest to Huon Corporation. There were two aspects to this submission.

124 First, it was submitted that the evidence does not establish that CB Richard Ellis in fact provided NAB with a formal valuation of the fair market rental for the properties. It was submitted that no such valuation was produced by NAB in response to a subpoena of sufficient breadth to have required production of any such valuation. On this basis, it was submitted that the reference by Mr DiPietro in his 7 September 2005 email to the $810,000 annual rental being 'as per sworn valuation completed by CBRE' should be taken as no more than an informal indication of market rental based on a 7 per cent yield on the $11.6 million CB Richard Ellis mortgage valuation. I do not accept that submission. Mr DiPietro was not cross-examined to that effect, and neither Mr Schulz nor Mr Hunter gave any evidence to support it. I accept the statement in Mr DiPietro's email as meaning what it says.

125 Second, it was submitted that the property companies adduced evidence which established, or at least pointed to a significant prospect, that the market rentals for the properties at December 2005 significantly exceeded $810,000. In support of that submission, reliance was placed upon a letter dated 31 July 2006 from CB Richard Ellis to Mr Schulz containing an opinion as to alternative market rentals for the properties in December 2005 and July 2006 ('the 31 July letter').

126 It is necessary to set out the 31 July letter in full:

[omitting formal parts]

Dear John,

44-80 Sinclair Rd Dandenong valuation 27th July 2005

300 Frankston Dandenong Rd Frankston valuation 27 July 2005

48-86 Powell St Bendigo valuation 1st August 2005

Further to our telephone conversation, I have reviewed our valuations of the above properties all undertaken by CBRE at this time last year and I can confirm that in my experience as a specialist Industrial agent of over 10 year experience, the majority of which was in the south east industrial market, the rents established for both Dandenong and Frankston are conservative, my analysis is as follows;

Dandenong;

Assessed rent as per the above Valuation $205,793 per annum net

Actual rent $153,000 shortfall $52,793 per annum.

Achievable rent at arms length in current Market; $250,000 per annum plus outgoings.

Shortfall on current assessment $97,000 Per annum

Frankston

Assessed rent as per valuation $363,906 per annum net

Actual Rent $363,000 shortfall $906 per annum.

Achievable rent at arms length in current market $450,000 per annum plus outgoings.

Shortfall on current assessment $86,094 Per annum

Bendigo

Assessed rent as per valuation $352,913 per annum net

Actual rent $297,000 shortfall $55,913 per annum

Achievable rental unknown due to lack of comparable current data, assume Valuation amount.

Total Shortfall as at 2005 Valuation $109,612 per annum

The shortfall highlighted immediately above is based only on the assessed rentals from our valuations set one year ago, and in the absence of concrete rental evidence for the Bendigo site, and adopting the valuation amount, plus the estimated current market rental for Frankston and Dandenong,

I estimate the actual rental shortfall from the rent paid to true assessed market rental to be in the order of an additional $187,000, this is without any allowance for what Bendigo may be underlet by.

Total shortfall on current 2006 assessment $296,000 Per annum

In my experience, it is unusual for a property owner to underlet assets where they are the owner of both the business and the real estate, in this case, the properties are underlet in my estimation by at least $296,000 per annum, in addition to the fact that the rents are based on the building areas alone and make no allowance for each of the properties being underdeveloped.

To illustrate this, a common approach to assessing rentals is to base them as a percentage of the total capital value, which in this case, as per the above valuations is a total combined amount of $11,600,000 a conservative investor would be happy with a return of 11% for older style facilities, which would calculate at $1,276,000 per annum net.

The total rent paid under the current leases is $810,000, which represents only a 6.99% yield on the capital value of the real estate.

I am available to clarify any of the above if required.

Yours sincerely

CB Richard Ellis (V) Pty Ltd

[signed]

Ralph Paruit

Senior Manager | Industrial Services

We draw your attention to the fact that this correspondence is not a statutory valuation, the opinions, estimates and information given herein or otherwise in relation hereto are made by CB Richard Ellis (V) Pty Ltd to their best judgment, in good faith and as far [as] possible based on data or sources which are believed to be reliable. CB Richard Ellis (V) Pty Ltd, its officers, employees and agents expressly disclaim any liability and responsibility to any person whether a reader of this document or not in the respect of anything and of the consequence of anything done or omitted to be done by any such person in reliance whether wholly or partially upon the whole or any part of the contents of this document.

127 Based on the 31 July letter, it was submitted on behalf of the property companies that there was a significant prospect that Mr Schulz could have obtained valuation advice in late 2005 that the properties would be under-let at a combined rental of $810,000 per annum; and that he could have increased the rentals to accord with that advice without breaching his director's duties to Huon Corporation. On this basis, a number of schedules were put forward to demonstrate the ability of the property companies to pay commercial interest to Huon Corporation, on the basis that it received rental from Huon Corporation in accordance with the figures contained in the 31 July letter. In making this submission, counsel for the property companies described the 31 July letter as a 'valuation' of market rentals for the properties based on the CB Richard Ellis mortgage valuations totalling $11.6 million.

128 For the following reasons, I do not accept that the 31 July letter provides any safe guide to the market rentals for the properties at the time of settlement of the transactions on 16 December 2005. Put another way, the 31 July letter is in my opinion wholly insufficient to satisfy the onus on the property companies to prove that the second hypothetical scenario has a value which is more than negligible.

129 First, the 31 July letter is not a valuation. It contains a disclaimer to that effect.

130 Second, the property companies called valuation evidence in respect of the properties. However, the valuer gave no evidence as to market rentals for the properties in or about December 2005.

131 Third, the author of the 31 July letter was not called to give evidence; notwithstanding his concluding statement that he was 'available to clarify any of the above if required'. No explanation was given for the failure to call him as a witness. I infer that the author of the 31 July letter would not have given evidence on this issue which advanced the case for the property companies.

132 Fourth, most of the opinions expressed in the 31 July letter are mere assertion, unsupported by any detailed analysis:

(1) no basis is given for the 'Assessed rent as per the above Valuation' in respect of any of the properties;

(2) no basis is given for the 'Achievable rent at arm's length in current Market' for any of the properties;

(3) no basis is given for the 'true assessed market rental ... in the order of an additional $187,000 ... without any allowance for what Bendigo be underlet by ...';

(4) no basis is given for the estimation that the properties are underlet 'by at least $296,000 per annum ...';

(5) no evidence is put forward to support the assertion that 'a conservative investor would be happy with a return of 11% for older style facilities [such as the properties], which would calculate at $1,276,000 per annum net.'

133 Fifth, the failure to call the author of the 31 July letter meant that neither his specialised knowledge and experience to express his opinions, nor the basis and substance of his opinions, could be tested by explanation in evidence in chief or by cross-examination. If expert evidence of this kind was to be relied upon, it should have been the subject of an expert report filed in advance of trial under O 44.[36] In that regard, it is important to note that the 31 July letter was not a contemporaneous document available to Mr Schulz at the time of settlement. It was sought and obtained by him after the administrators had sued to recover Huon Corporation's interest in the properties.

134 Taking all of these matters in combination, although no objection was raised to the admission of the 31 July letter in evidence, the letter is in my opinion of insufficient weight to persuade me that there was a real and not insignificant prospect that Mr Schulz could have obtained valuation evidence which would have justified him in increasing the rentals to an amount enabling the property companies to pay commercial interest to Huon Corporation.

135 Finally, in support of the above analysis, the submissions made on behalf of the property companies concerning the second hypothetical scenario ignored the need for Mr Schulz to consider whether it was in the interests of Huon Corporation to lend money to the property companies on an interest only basis and, if so, for what period of time. None of the variants suggested addressed this issue. Given that Huon Corporation was to be a trading entity with working capital needs, and the loans to the property companies would obviously deplete it of available working capital, Mr Schulz needed to consider whether it was in the interests of Huon Corporation to lend any significant amount to the property companies. This issue highlights, once again, the essential flaw in Mr Schulz's business strategy. In circumstances where he contributed no funds to the purchase of the properties, and where he cannot demonstrate to the Court by evidence that the companies under his control were acquiring assets for any significant undervalue, his strategy of quarantining any equity which the property companies may in the future have in the properties placed him in a position of conflict of interest.

136 In all the circumstances, I conclude any opportunity available to the property companies to restructure the transactions so as to protect them from the risks of the businesses was of negligible value. However, having established that Mills Oakley breached its contractual duty to exercise reasonable skill and care, the property companies are entitled to an award of nominal damages in the token sum of $100.

Can the property companies recover damages for unnecessary legal fees? Can Mills Oakley recover the unpaid fees?

137 I turn to consider Mills Oakley's claim for unpaid fees and the property companies' claims for legal costs paid by them to new solicitors in defending and compromising the claims in the administrators' proceeding.

138 Mills Oakley claims $18,641.32 for unpaid fees in respect of work performed between 13 July 2006 and 21 July 2006. On 13 July 2006, Mr Schulz consulted Mills Oakley about threatened claims by the administrators against him and the property companies. He engaged Mills Oakley to act on behalf of himself and the property companies with respect to the administrators' claims. The administrators' claims were commenced on 17 July 2006 in the Commercial List of this Court. Mills Oakley acted for Mr Schulz and the property companies for a few days, until their retainer was terminated on or about 21 July 2006. At that time, new solicitors took over the conduct of the defence of the administrators' proceedings. The new solicitors assisted Mr Schulz to negotiate a settlement of the administrators' proceedings, and a formal deed of settlement was executed on 2 August 2006. Mr Schulz and the property companies paid the fees of the new solicitors and counsel, in the sum of $100,860.90.

139 In summary, the effect of the deed of settlement was that the property companies surrendered the three properties to the administrators, to enable them to sell the properties for the benefit of the creditors of Huon Corporation. In return, the administrators agreed to pay Liam Property a commercial settlement of $425,000 and, if certain contingencies occurred, a further contingent sum. Nothing was paid in respect of the contingent sum, as the contingency did not arise. The parties to the administrators' proceeding gave mutual releases to each other. On this basis, the administrators' proceedings were struck out with no order as to costs.

140 As appears above, the property companies claim damages from Mills Oakley for loss of opportunity on two alternative hypothetical scenarios. For the reasons given, I have decided that those opportunities had only negligible value. However, the property companies' claim for their legal costs of defending the administrators' proceedings and Mills Oakley's claim for the unpaid fees, remain for determination. Each of these claims raises the same threshold question: were the fees incurred as a result of Mills Oakley's negligence?

141 In my opinion, Mills Oakley's negligence caused the legal costs to be incurred. As appears above, Mr Schulz said that, if he had received advice that his strategy of shielding the property companies from the risks of the businesses was in conflict with his duties as a director, he 'would have had to stay and review the whole transaction'. I accept that evidence. Further, no variant of the hypothetical cases put forward by the property companies involved Mr Schulz investing further equity beyond the $250,000 'skin money' which he invested in the transaction. Taking the evidence as a whole, I find that if Mills Oakley had given Mr Schulz advice about the inherent risks of proceeding with the transactions as structured, priced, documented and settled, and concerning his duties as a director of Huon Corporation and each of the property companies, it is likely that the transactions would not have proceeded. In that circumstance, the administrators' claims would never have been made and the legal costs would never have been incurred or paid in connection with those proceedings.

142 In my opinion, however, the legal costs paid to the new solicitors cannot be recovered by the property companies. This is because the property companies profited from the transactions. The property companies contributed nothing but loan funds to the acquisition of the properties. The $250,000 'skin money' they lent to Mr Schulz or Huon Corporation was also borrowed. All borrowings were repaid from the proceeds of sales of the properties by the liquidator. The property companies also received $425,000 from those sale proceeds, as a commercial settlement of the claims in the administrators' proceeding. Taking full account of the $100,860.90 fees paid to the new solicitors, they were still approximately $324,000 better-off than if the transactions had not proceeded.

143 I turn to consider Mills Oakley's claim for its unpaid fees. Although arising out of the transactions at issue, the unpaid fees are claimed in respect of work done by Mills Oakley as a result of a separate retainer by Mr Schulz and the property companies in respect of the administrators' proceeding. As appears above, Mills Oakley acted for a short while, before their retainer was terminated. Mills Oakley issued a tax invoice for the unpaid fees on 21 July 2006. Mr Schulz and the property companies refused to pay it. Neither Mr Schulz nor the property companies applied to have the unpaid fees reviewed within the time prescribed by the Legal Profession Act 2004 (then 60 days) and no application has been made to extend the time for review.

144 The property companies raise two defences to the claim for unpaid fees.

145 First, they contend that Mills Oakley failed to make disclosure to them in accordance with s 3.4.9(1)(c) of the Legal Profession Act. Read together with s 3.4.11(1) of that Act, s 3.4.9(1)(c) required Mills Oakley to disclose to the property companies, before or as soon as practicable after the retainer, an estimate of the total legal costs to be incurred or, if that was not reasonably practicable, to give -

(i) a range of estimates of the total legal costs; and

(ii) an explanation of the major variables that will affect the calculation of those costs ...

146 Further, by s 3.4.9(1)(g) of the Act, Mills Oakley were required to disclose an estimate of -

(i) the range of costs that may be recovered if the client is successful in the litigation; and

(ii) the range of costs the client may be ordered to pay if the client is unsuccessful ...

147 Final submissions were made on the basis that this issue should be resolved by an interpretation of the disclosure statement made by Mills Oakley dated 18 July 2006. In that disclosure statement, Mills Oakley made the following disclosures:

(1) in respect of its obligation to disclose under s 3.4.9(1)(c):

At this early stage of the proceeding it is not reasonably practicable for us to provide you with an estimate as to the likely costs of the proceeding. As soon as we are in a position to give you an estimate of the likely fees we will do so.

If the claims in relation to the Bendigo and Frankston properties are resolved at a relatively early stage, it may cost between $50,000 to $80,000 to advance the remainder of the proceeding to the mediation stage.

At this point the fees incurred are approximately $15,000.00 plus Counsel's fees.[37]

(2) in respect of its obligation to disclose under s 3.4.9(1)(g)(i), Mills Oakley estimated that the property companies may, in the event of success in the litigation, 'recover up to approximately 50% of [their] costs when calculated on the Court scale' and made other relevant disclosures concerning the prospects of in fact recovering against the unsuccessful party.

(3) in respect of its obligation to disclose under s 3.4.9(1)(g)(ii), Mills Oakley gave an estimate of between $100,000 to $200,000 as the range of costs which the property companies may be ordered to pay to the administrators in the event that they were unsuccessful in their defence.

148 It was submitted on behalf of the property companies that these disclosures did not comply with the Act, principally because the disclosure under s 3.4.9(1)(c) did not, even accepting that it was not then reasonably practicable to give an estimate of total legal costs at that time, disclose a range of estimates and an explanation of the major variables. I do not accept that submission. The disclosure statement was made on the day after the administrators' proceeding was commenced. It was not then practicable to provide an estimate of the total legal costs to be incurred, or to give a range of estimates. Mills Oakley expressly noted this and stated that they would give the necessary estimate as soon as they were in a position to do so. In my opinion, given the early stage of the administrators' proceeding, the time by which Mills Oakley was required to make the disclosure under s 3.4.9 had not then arrived. Within days, Mills Oakley's retainer was terminated; thus depriving them of the opportunity to make the relevant disclosures within the time required by the Act.

149 Further, although conditional upon an early resolution of claims in respect of the Bendigo and Frankston properties (where there was no arguable defence on any view), the estimated range of between $50,000 to $80,000 to advance the remainder of the proceeding (concerning the Dandenong property) to a mediation was sufficient disclosure in all the circumstances. The defence based upon non-disclosure under the Act fails.

150 Second, it was submitted on behalf of the property companies that they ought not to be required to pay the unpaid fees, because the fees would not have been incurred in the absence of Mills Oakley's negligence in failing to advise about the inherent risks of proceeding with the transactions. That defence fails. As I have said, the unpaid fees relate to a separate retainer to advise in relation to the administrators' proceeding. There is no evidence that Mills Oakley's advice concerning that retainer was negligent, useless or unnecessary. To the contrary, the only evidence indicates that Mills Oakley gave sound advice to Mr Schulz, to the effect that the Bendigo and Frankston properties should be surrendered to the administrators because they were obviously held on trust for Huon Corporation. Mr Schulz did not accept that advice and, in consultation with his wife, determined to terminate Mills Oakley's retainer and engage new solicitors. Mills Oakley are accordingly entitled to be paid. The position would have been different in the absence of a commercial settlement for an amount exceeding the total legal costs paid or incurred by the property companies in connection with the administrators' proceeding.

151 For the above reasons, there will be judgment for Mills Oakley against the property companies for the amount of the unpaid fees. There will be judgment for nominal damages of $100 on the counterclaim. I will hear the parties as to interest and costs.

[1] In fact, the money was not Mr Schulz's. He borrowed it from his wife, who obtained the funds by a further advance under the mortgage over the family home which she owned.

[2] Astley v Austrust (1999) 197 CLR 1, [44]-[48].

[3] Heydon v NRMA Ltd [2000] NSWCA 374; (2000) 51 NSWLR 1, [145].

[4] Ms Thompson has since married and changed her name. I will refer to her by her unmarried name for convenience, as that name appears on relevant documents. It was also the name attributed to her in the evidence of others.

[5] Corporations Act 2001 (Cth) s 181(1)(a).

[6] Corporations Act 2001 (Cth) s 182(1)(a).

[7] Corporations Act 2001 (Cth) s 182(1)(b).

[8] Further, the settlement deed gave Liam Property the prospect of receiving a further amount of up to $575,000, according to a formula to be applied to any gross sale proceeds of the three properties exceeding $15.5 million. As the three properties were sold for a gross price of $15.35 million, no amount was paid to Liam Property under this contingent entitlement.

[9] [1994] HCA 4; (1994) 179 CLR 332.

[14] [1996] VicRp 22; [1996] 1 VR 346.

[15] Ibid, 354 (citations omitted and quotations from Sellars omitted).

[16] The actual figure was probably $13.31 million, in accordance with the CB Richard Ellis valuations in November 2004.

[17] Hospital Products Ltd v United States Surgical Corporation [1984] HCA 64; (1984) 156 CLR 41, 96.

[19] Re HIH Insurance Ltd; Australian Securities and Investments Commission v Adler [2002] NSWSC 171; (2002) 41 ACSR 72, [372](4) per Santow J (citations omitted).

[21] Section 180(2)(b).

[22] Re HIH Insurance Ltd; Australian Securities and Investments Commission v Adler [2002] NSWSC 171; (2002) 41 ACSR 72, [735](1).

[23] Ibid, [735](3) (citations omitted).

[24] Mernda Developments Pty Ltd (in liq) & Anor v Alamanda Property Investments No 2 Pty Ltd & Ors [2011] VSCA 392, [32]-[33].

[25] Walker v Winborne [1976] HCA 7; (1976) 137 CLR 1, 6.

[27] Calverly v Green [1984] HCA 81; (1984) 155 CLR 242, 246-7, 266-7.

[29] A If $14.2 million is adopted, the percentages are 66.25 per cent and 33.75 per cent, and the resulting prices are $11.25 million for the businesses and $5.75 million for the properties.

B If $13.25 million is adopted, the percentages are 64.65 per cent and 35.35 per cent, and the resulting prices are $11 million for the businesses and $6 million for the properties.

[30] If either $14.2 million or $13.25 million is adopted as the value of the properties, and the amount borrowed from Huon Corporation is increased to either $3.6 million or $1.65 million, the rentals would still have been sufficient to service interest on borrowings of those amounts.

[31] However, Pitcher Partners noted some restricted access to 'local management' during the course of their review, as the Nylex external auditors were on site conducting preliminary year end audit work. CB310.

[32] A Commonwealth Government scheme called GEERS provided payments totalling $9.6 million to employees.

[35] If the $100,000 'leakage' allowed by Mr Taylor of GE was implemented, the excess available to pay interest to Huon Corporation would be reduced to only $320,000. However, for the purpose of the analysis, the parties appeared to accept that the Court could approach the second hypothetical scenario on the basis that the full $420,000 would have been available to the property companies for the purpose of paying interest to Huon Corporation.

[36] Supreme Court (General Civil Procedure) Rules 2005.