Smith Martis Cork & Rajan Pty Ltd v Benjamin Corporation Pty Ltd

REASONS FOR JUDGMENT THE COURT Introduction 1 This is an appeal against orders made by a judge of the Court (Carr J) in an oppression suit brought under s 232 of the Corporations Act 2001 (Cth) ("the Act"). 2 The first appellant, Smith Martis Cork & Rajan Pty Ltd, ("the Company") was established in 1991 by four individuals ("the founding members") to carry on the business of financial planning and investment advice. The founding members were Mr GH Smith, Mr JRS Martis ("Mr Martis"), Mr PN Cork and Mr S Rajan. In about 1992 or 1993, the founding members transferred their shareholdings to their family trusts. The Company carried on business successfully for more than 10 years but in early 2002, Messrs Smith, Cork and Rajan excluded Mr Martis from management of the Company. 3 The learned primary judge found that there was an agreement or understanding between the founding members that the Company was to be conducted as a quasi-partnership: see the principles stated by Lord Wilberforce in Ebrahimi v Westbourne Galleries Ltd [1973] AC 360. 4 His Honour also held in accordance with the principles referred to by the High Court in Wayde v NSW Rugby League Ltd (1985) 180 CLR 459 ("Wayde"), that the exclusion of Mr Martis from management was commercially unfair and hence oppressive to the respondent, Benjamin Corporation Pty Ltd ("Benjamin Corporation"), the family trust through which Mr Martis held his shares in the Company. This was because Messrs Smith, Cork and Rajan, or their associated entities, had not offered to acquire the shares at fair value. 5 Accordingly, the learned primary judge ordered that the trustees of the family trusts of the remaining founding members purchase the shares held by Mr Martis' family trust at a price ($737,000) which his Honour determined to be the fair value of the shares. 6 The Company and the trustees of the family trusts of Messrs Smith and Rajan have appealed against his Honour's order. The trustee of Mr Cork's family trust has not joined in the appeal. 7 The appellants do not challenge his Honour's finding of oppression. The only issue in the appeal is whether the primary judge erred in principle in his approach to the determination of the fair value of the shares. The appellants accepted that the determination of the fair value was an exercise of his Honour's discretion and that it is necessary for them to establish that the discretion miscarried, within the well known principle stated in House v The King (1936) 55 CLR 499 at 504-505. 8 The essence of the appellants' argument is that his Honour erred in principle in his approach to the calculation of value because he accepted the opinion of an expert valuer that, in valuing the shares, it was appropriate to make an assumption that effected an adjustment to the way in which the Company actually distributed its income to the shareholders and certain senior employees. The adjustment had the effect of notionally reducing the Company's outgoings thereby increasing the sum attributable to the Company's earnings in the calculation of future maintainable earnings ("FME"). 9 The relevant adjustment was to the amounts payable to the Company's "authorised representatives". The Company was a licensed securities dealer and investment adviser under the Act. Each of the founding members held a proper authority from the Company and was appointed as an authorised representative under a written securities representative agreement. In addition, the Company entered into securities representative agreements with Mr Martis' brother, Mr VJ Martis ("Andrew") and three other employees ("the three employees"). 10 Andrew, through his family trust, became the holder of ordinary shares in the Company. The three employees did not hold ordinary shares in the Company. However, the founding members, Andrew and the three employees each held, through their family trusts, differential dividend shares in the Company. 11 As the name suggests, the differential dividend shares were used as a means to pay differential dividends to the holders of those shares. Throughout the relevant period payments were made by way of differential dividends to the holders of that class of shares as a reward for fees earned by the relevant securities representative in his or her capacity as an authorised representative for the Company. 12 The formula for remuneration of authorised representatives which was adopted for the whole of the period was that each authorised representative, or his or her family trust, was paid 80% of the gross fees earned by him or her from servicing his or her own clients, less a deduction for direct expenses. The balance of the Company's revenue was paid out to the shareholders by way of salaries or expenses. No dividend was ever declared or paid on the ordinary shares. 13 The evidence before the primary judge was that the payment of 80% of gross fees earned by authorised representatives exceeded the industry norm. Indeed, the evidence was that payments of this magnitude were virtually unknown in the industry. The unchallenged evidence was that the industry standard was for authorised representatives to receive payments in the order of 40% of gross fees earned, less direct expenses, with the balance appropriated to the owners' pool of profits for distribution to the benefit of the owners. 14 Mr Edwards of Price Waterhouse Coopers, who gave evidence for Benjamin Corporation based his calculation of FME on the assumption that it was appropriate, for that purpose, to reduce the remuneration payable to all of the authorised representatives to the industry norm of 40% in lieu of the 80% which was actually paid. This had the effect of increasing the amount which was attributable to the owners' pool thereby providing a corresponding increment in the value of the goodwill attributed to the ownership of the ordinary shares. 15 This adjustment, which was accepted by his Honour, formed the basis of the appellants' attack on the method of calculation of the price which his Honour determined as the fair value of the ordinary shares owned by Benjamin Corporation. 16 The approach which his Honour took was to determine the value of the shares in the Company in accordance with the well established principle in Spencer v The Commonwealth (1907) 5 CLR 418 ("Spencer's case"). That is to say, his Honour determined the price which a willing but not anxious buyer would pay to a willing but not anxious seller of Benjamin Corporation's ordinary shares in the Company calculated upon the basis of the Company's FME, an element of which was the adjustment of the payments made to the authorised representatives to 40% of fees earned. 17 The appellants attacked this determination in three different ways. First, it was said that this assumption departed from the long standing arrangements under which the founding members, Andrew and the three employees shared the costs of carrying on business but retained 80% of whatever he or she earned. It was said that his Honour's approach to valuation was not open to him because there was no prospect that the long standing arrangements would be altered. 18 It was said that a sale by one of the founding members to the others of his ordinary shares would be calculated on the basis of an 80% payment to authorised representatives. This would produce a lower payment to the owners' pool and, consequently, a lower valuation of the whole of the ordinary shares in the Company. 19 Second, it was said that the valuation method adopted by his Honour valued the Company upon the basis of a sale by all of the holders of ordinary shares, that is to say, of the whole of the Company, to a willing third party. This was said to be contrary to the understanding between the founding members that if one of them wished to depart from the Company his shares would be purchased by the continuing parties who would then carry on the business in his absence. 20 Thus, it was said that a sale by one of the founding members to the others of his ordinary shares must be calculated on the basis of the existing arrangements of an 80% payment to authorised representatives. This, it was said, would produce a lower valuation than a sale of the whole of the ordinary shares in the Company. 21 It was also said that the approach to valuation on the footing of a sale of the whole of the Company to a third party was contrary to Benjamin Corporation's case as pleaded in the statement of claim. 22 Third, it was submitted that his Honour erred by determining the value of Benjamin Corporation's shares by reference, in part, to the benefits derived by Mr Martis personally through the distribution to him of differential dividends calculated on the basis of an 80% share of his individual earnings. This benefit was said to arise not from Benjamin Corporation's ownership of the ordinary shares in the Company but from an agreement between the Company and Mr Martis as to how the differential dividends were to be distributed. 23 Counsel for Benjamin Corporation, apart from taking issue with each of the three grounds of attack, said that the second and third grounds were not open because they were contrary to the way in which the trial was conducted before the primary judge. 24 In particular, counsel submitted that no distinction was drawn at trial between the position of Mr Martis and Benjamin Corporation, the latter being treated for all relevant purposes as Mr Martis' alter ego. 25 Counsel for Benjamin Corporation also drew attention to the provisions of s 232(e) of the Act which empowers the Court to make an order where the affairs of a company are being conducted in a manner which is oppressive to or unfairly prejudicial to a member "whether in that capacity or in any other capacity". This is a wider test than was available under earlier legislation which provided that the relevant acts of oppression must be against the member in his, her or its capacity as a member of the Company. The Legislation 26 Section 232 of the Act relevantly provides: "The Court may make an order under section 233 if: (a) the conduct of a company's affairs; … … is either: (d) contrary to the interests of the members as a whole; or (e) oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a member or members whether in that capacity or in any other capacity. …" 27 The following provisions of s 233 are relevant:- "(1) The Court can make any order under this section that it considers appropriate in relation to the company, including an order:- … (d) for the purchase of any shares by any member or person to whom a share in the company has been transmitted by will or by operation of law;" 28 Section 234(a) provides that:- "An application for an order under section 233 in relation to a company may be made by: (a) a member of the company, even if the application relates to an act or omission that is against: (i) the member in a capacity other than as a member; or (ii) another member in their capacity as a member … " The background facts 29 These are set out at [2] to [46] of his Honour's judgment. We will summarise the facts for convenience of reading. 30 As his Honour observed at [3], although the parties to the proceedings were various corporations or individuals acting as trustees of family trusts, the proceedings were mainly concerned with the affairs of the founding members. 31 The Company was acquired by the founding members in November 1991 for the purchase by the Company of the investment advisory and securities dealing business of another company ("JCLD"). All of the founding members had been employees of JCLD until it went into receivership in mid-November 1991. 32 Initially, each of the founding members took 25% of the issued ordinary shares of the Company. In late 1992 or 1993 those shares were transferred to the respective trustees of the founding members' family trusts. 33 In late 1995, the trustees of the founding members' trusts each sold a small percentage of their shares to Andrew's family trust. From that time up to and including the hearing, Benjamin Corporation and the other trustees of the founding members' family trusts each owned 22.5% of the Company's ordinary shares. Andrew or his trust owned 10% of the ordinary shares. 34 There were 80 differential dividend shares. The family trusts of the founding members each owned 10 differential dividend shares. Andrew's trust owned 10 as did each of the three employees or his or her family trust. 35 The founding members, through their associated entities, also owned shares in a unit trust which provided office and administrative services to the Company. The primary judge assessed the value of the whole of Benjamin Corporation's interest in the business including the ordinary shares, the differential dividend shares and the units in the unit trust. No complaint was made about that course being taken. 36 The Company's business was very profitable. In each of the financial years ending 30 June 2000 to 30 June 2002 the Company derived income from commissions and fees of well in excess of $2m. Fee income was derived from one-off commissions for investment advice and there were also recurring commissions on clients' investment portfolios. 37 The primary judge said at [25], that the Company's income was divided by way of salary and differential dividends under a "profit sharing arrangement". The remuneration payable was, as his Honour said at [28], calculated and paid to each authorised representative at the rate of 80% of the revenue received by the Company from clients serviced by that particular authorised representative, less an amount representing the representative's cost base plus an amount for "notional superannuation". The residue was paid to "the owners' profit pool". 38 The primary judge observed at [30] that:- "The owners' profit pool was distributed among the four individuals and Mr Andrew Martis in proportion to their holdings of ordinary shares in the Company, but not as dividends payable in respect of those shares." 39 His Honour detailed, at [33] and following, the steps taken by Messrs Smith, Cork and Rajan to remove Mr Martis as a director of the Company. He found that matters came to a head between the parties in March 2002. There was a legally ineffective resolution to remove Mr Martis in late March. Messrs Smith, Cork and Rajan effectively exercised their voting rights to remove Mr Martis as a director at a meeting held on 10 May 2002. 40 On 6 August 2002, the Company gave notice to Mr Martis of the termination of his employment as an authorised representative with effect seven days later. 41 In September 2002, Mr Martis filed applications in the Industrial Relations Commission of Western Australia seeking, inter alia, compensation for the termination of his employment as an authorised representative. The primary judge's finding of oppression 42 His Honour referred at [49] to the claim made by Benjamin Corporation in its pleading that there was a common assumption among the founding members and their related entities that each of the founding members would remain as directors of the Company and would participate in the Company's management. His Honour concluded by referring to what was said in the pleading, namely the common assumption that:- "…if, as a result of a breakdown of the relationship between them, one of them was removed as a director of the Company, or was excluded from such management, the remaining directors would arrange the purchase of the shares held by that person's related entity at a fair value or on reasonable commercial terms" 43 His Honour found at [64] that there was an agreement between the founding members and their related entities as pleaded by Benjamin Corporation. He said at [81] that, alternatively, there was an understanding between them to the same effect. 44 His Honour then said at [82]:- "The facts of this matter give rise, in my view, to a strong inference (and I so find) that the Company was taken off the shelf by the four individuals as a means of forming and continuing an association on the basis of a personal relationship, involving mutual confidence. There was an agreement or understanding that all of them would participate in the conduct of the business and that there would be restrictions upon the transfer of their individual interest in the Company, so that if confidence were lost, or one member was removed from management, he could not take out his stake and go elsewhere. I am, of course, tracking the words of Lord Wilberforce in Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 at 379. As Lord Hoffman observed in O'Neill v Phillips (again at 1102): 'In such a case it will usually be considered unjust, inequitable or unfair for a majority to use their voting power to exclude a member from participation in the management without giving him the opportunity to remove his capital upon reasonable terms.'" 45 At [84] and following the primary judge detailed the circumstances in which Mr Martis was removed from management and had his employment terminated. His Honour said at [85] that he searched in vain in the evidence for anything which disclosed dissatisfaction by the other founding members with Mr Martis' performance as a manager or as managing director, until shortly before March 2002. 46 The primary judge also referred at [126] to minutes of a meeting which recorded that there was no allegation of impropriety against Mr Martis. 47 The primary judge recounted, at [134] and following, that two offers were made by the other parties to purchase Benjamin Corporation's shares. These offers were made in "without prejudice" correspondence. 48 His Honour was of the view that the letters were inadmissible but, in case he was wrong, he examined the two offers which were made. One was for an amount in excess of $737,000. However, the offer was heavily conditional. His Honour found at [146] that Benjamin Corporation was justified in rejecting it. The other offer was for an amount of $100,000. 49 The primary judge referred to Wayde and other well known authorities on the law of oppression. He said at [158] that the exclusion of Mr Martis from management was unfair and gave rise to the exercise of the discretion conferred by ss 232 and 233 of the Act. 50 His Honour found at [284] - [287] that none of the thirteen separate matters put forward by the defendants to justify the removal of Mr Martis had been made out. The primary judge's finding of fair value 51 The primary judge determined the value of the shares at 10 May 2002, which was the date on which Mr Martis was excluded from management; see at [295] - [296]. 52 His Honour referred at [299] and following to the expert evidence called by the parties. The principal experts were Mr Edwards of Price Waterhouse Coopers for Benjamin Corporation and Mr Calder of KPMG who gave evidence for the defendants. 53 There was a large measure of agreement between Mr Edwards and Mr Calder. They agreed that the shares should be valued on the basis of FME. They also agreed on the figure of total revenue to 30 June 2002 that should be adopted for the purposes of calculating FME. They agreed that, if the assumption were made that authorised representatives would be paid at industry rates, the appropriate after tax multiple for the purpose of calculating the capital value of the shares was between 5.7 and 7.1. 54 His Honour referred to the two essential differences between Mr Edwards' calculation and Mr Calder's calculation at [304] - [305] as follows:- "Mr Edwards' calculation of FME was on the basis that each Authorised Representative would be paid at "industry rates". But Mr Calder prepared his calculation of FME on the basis that after the notional sale of the shares in the Company to a purchaser had taken place, each of the four individuals and the employed Authorised Representatives would continue to receive the 80% net margin, referred to earlier in these reasons. Another basic disagreement was that Mr Edwards valued the business on the basis of assuming a sale of the business as a going concern. Mr Calder's valuation was based on the future earnings from the owners' profit pool." 55 His Honour said at [317] that he preferred Mr Edwards' evidence to that of Mr Calder. This was because Mr Calder's valuation was based on assumptions which his Honour did not regard as valid. 56 One of those assumption was that the founding members were free to leave the Company and take their clients with them. 57 This led Mr Calder to value the shares not on the basis of adjusted FME but only on the basis of the owner's existing profit pool calculated on the assumption of 80% remuneration to authorised representatives. 58 His Honour pointed out at [319] that Mr Edwards adjusted the amounts payable to authorised representatives down to the industry standard of 40% in order:- "…to recognise the profit which the four individuals derived as owner operators, but which formed part of the payments to them as Authorised Representatives." 59 The reason why the primary judge rejected Mr Calder's assumption that the founding members were free to leave and take their clients with them was that they were precluded from soliciting the Company's clients under the terms of their employment agreements. The agreements contained restraints upon the authorised representatives from soliciting, canvassing or counselling clients to leave the Company. 60 His Honour referred to the principles stated in cases such as the decision of the NSW Court of Appeal in Mordecai v Mordecai (1988) 12 NSWLR 58 ("Mordecai"). He observed that the cases indicated that if the founding members attempted to take away the Company's clients, the Company could obtain injunctive relief and compensation for any loss. 61 There was a further reason why his Honour accepted the assumption that it was appropriate to adjust the remuneration of the authorised representatives down to the industry standard. As he said at [329], a fair valuation assumed a willing seller and, to obtain the best price, the sellers would enter into such agreements as were necessary to ensure that the full value of the goodwill passed to the purchaser. 62 The primary judge accepted the evidence that 40% remuneration was a reasonable commercial rate to apply as the industry norm for remuneration of authorised representatives. 63 The primary judge noted that one of the employee authorised representatives gave evidence that if his remuneration was changed from 80% to 40% he would leave the Company's employment. However, his Honour discounted the effect of this evidence because the employee's remuneration had in fact fallen to below 40% in 2003 but he had not left the Company. 64 His Honour accepted a multiple or capitalisation rate of 6.4 which was midway in the range agreed between Mr Edwards and Mr Calder. He did not discount the figure produced by the application of that capitalisation rate, notwithstanding that Benjamin Corporation held a minority interest in the Company. His Honour said that it was appropriate not to discount for the reasons referred to by a Full Court in Dynasty Pty Ltd v Coombs (1995) 59 FCR 122 ("Dynasty"). No complaint was made about this on the appeal. 65 His Honour said at [350]:- "I think that the plaintiff should be compensated for being deprived of what would have been the benefits of continued ownership and participation in the management of the Company. In terms of s 233 of the Act, I think that it would be appropriate for an amount equivalent to interest to be awarded to the plaintiff on the above amount." 66 The rate of interest which his Honour fixed as the rate payable on the assessed value of Benjamin Corporation's 22.5% shareholding, that is to say $737,000, was 7% per annum calculated from 13 August 2002 to the date of settlement. The pleading point 67 In order to make good his submission that the valuation of the shares upon the basis of a sale of the whole of the business was contrary to the case as pleaded, senior counsel for the appellants directed us to the following paragraphs of the Amended Statement of Claim:- "10. There was a common assumption amongst each of Messrs Smith, Martis, Cork and Rajan and from 1993, each of the Directors' Related Entities that and/or each of them had the reasonable expectation that and/or there was a conventional understanding that: 10.1 Messrs Smith, Martis, Cork and Rajan would remain directors of SMCR; 10.2 each of Messrs Smith, Martis, Cork and Rajan would participate in SMCR's management; and 10.3 if, as a result of a breakdown of the relationship between Messrs Smith, Martis, Cork and Rajan, one of them was removed as a director of SMCR, or was excluded from the management of SMCR, or ceased to be an employee of SMCR, the remaining directors would arrange the purchase of the shares held by the Director's Related Entity which was related to the excluded director at a fair value or on reasonable commercial terms. 11. The common understanding and/or reasonable expectation and or conventional understanding arose from, or is to be inferred from the following facts:- 11.1 prior to the purchase of the shares in SMCR each of Messrs Smith, Martis, Cork and Rajan was a financial planner (client adviser) employed by JCLD; 11.2 each of Messrs Smith, Martis, Cork and Rajan had, established a business relationship with a number of JCLD's clients and together were in a position to take their clients from JCLD had they wished to do so; 11.3 in the premises, Messrs Smith, Martis, Cork and Rajan shared the goodwill of JCLD's investment advisory and securities dealing business; … 11.8 from 1993 to 2002, each of the Directors' Related Entities: (a) retained equal ordinary shareholdings in SMCR; (b) was paid differential dividends as a reward for the fees each director earned as authorised representatives of SMCR; (c) were paid equal dividends from an owner's profit pool: particulars of the owners' profit pool are provided at paragraph 13 of an affidavit of JRS Martis sworn 22nd August 2002. 12. The common assumption and/or reasonable expectation and/or the conventional understanding continued down to and including August 2002. 13. Contrary to the common assumption and/or Mr Martis' reasonable expectation and/or the conventional understanding, Messrs Smith, Cork and Rajan:- … 13.4 at no time have offered to purchase or arrange the purchase of the Benjamin Trust's ordinary shares or differential dividend shares in SMCR: (a) at a fair value; or (b) on reasonable commercial terms". The 'inconsistency' point 68 As stated earlier, counsel for Benjamin Corporation submitted that it was not open to the appellants to contend that the valuation should be other than upon the basis of a sale of all the shares in the Company to a third party because this was inconsistent with the way in which the case had been conducted at the trial. 69 To make good this proposition, counsel took us to the following paragraph of a document entitled "State of Agreement between the Experts" which was Exhibit A41 before his Honour:- "Edwards and Calder do not agree on the question whether it is appropriate to calculate FME on the basis that each of the authorised representatives is to be paid 'normal industry remuneration' [normal industry remuneration for a corporatised financial planning practice]. Edwards' calculation of FME is on the basis that each authorised representative is paid at 'industry rates' whereas Calder prepares his calculation of FME on the basis that each of the present proprietors, and the employed authorised representatives, will continue to receive 80% of 'net margin' (revenue net of direct costs less cash expenses) after sale of all the shares in SMCR to a purchaser. Edwards values all the ordinary shares in the Company assuming a sale on a going concern basis: Calder values the future earnings from the owners' profit pool." (emphasis added). Legal principles 70 The authorities make it clear that once the discretion conferred by s 233 of the Act has been enlivened by a finding of oppression under s 232, the Court has a wide discretion as to both the appropriate remedy and, if it orders compulsory purchase of shares, as to the mode of valuation of the shares. The authorities are set out in a recent decision of Campbell J in United Rural Enterprises Pty Ltd v Lopmand Pty Ltd (2003) 47 ACSR 514 ("United Rural Enterprises") at [34] - [38]. 71 If the Court considers it is appropriate to make an order that the other members purchase the shares of the oppressed shareholder, its task is to fix a price that represents a fair value in all the circumstances; see Coombs v Dynasty Pty Ltd (1994) 14 ACSR 60 at 102 (von Doussa J) and on appeal Dynasty at 143 (Spender, O'Loughlin and Branson JJ). 72 As Davies JA observed in Shirim Pty Ltd v Fesena Pty Ltd [2002] NSWSC 10 ("Shirim")at [12], the purpose of an order that the oppressor purchase the shares at a fair price is to compensate the oppressed shareholder for the oppression which has taken place. His Honour noted that this principle has been regarded as established ever since the decision of the House of Lords in Scottish Co-operative Wholesale Ltd v Meyer [1959] AC 324.