Stanilite Pacific Ltd. (In Liq) & Anor. v. Seaton and Ors. [2005] NSWCA 301

7 December 1994 letter 175. A central plank in the appellants' case on this issue is a letter dated 7 December 1994 from Mr Seaton to the appellants [TB 1/423] {BB 22/5800}: see appellants' written submissions, [108]-[109], [129]-[132]. However, as was established at first instance, by its very terms that letter does not assist the appellants and is not relevant to the issue in the proceedings.

176. The analysis of the evidence with respect to this letter begins with the first report of Mr Shanahan, in which he approached the question whether total revenues to be received under the Russia contract could be reliably estimated with some timidity, and solely by reference to this letter of 7 December 1994. In paragraph 52 of his first report {BB 13/3286}, Mr Shanahan made reference to that letter and commented that its terms 'cast doubt' upon whether the total contract revenues to be received under the Russia contract could be reliably estimated [Shanahan, para 53 {BB 13/3287J]; and see Judgment, [213] {RB 1/191-192}. Mr Shanahan's evidence rose no higher than this query.

177. It is apparent from the face of the letter of 7 December 1994 that it was prepared by Price Waterhouse for the purpose of undertaking an independent review on the Stanilite group's forecast of timing of cash receipts and payments over a particular period: It was not concerned with estimating contract revenues under the Russia or any other contract.

178. Mr Seaton's evidence was that, having reviewed the cash flow forecast from the Russia contract in late 1994, he was not in a position to independently assess the reasonableness of the projected timing of the receipts. The receipts were the subject of monthly projections in the forecasts, and, as at 7 December 1994, Mr Seaton did not have the level of information that was required in order to assess whether the apportionment of receipts between particular months in the cash flow forecast was reasonable. One of the sources of cash flow - was payment under the Russia contract. For these reasons the Price Waterhouse letter said: 'We have been unable to independently assess Techinfo's ability to generate the revenues within the timeframes assumed and accordingly we are unable to determine whether the assumptions in respect of these receipts provide a reasonable basis for the forecast.' [Emphasis added.] [TB 1/423] {BB 22/5800}

179. The use of the words 'within the timeframes assumed' and 'receipts' in that letter makes it abundantly clear that Mr Seaton's qualification concerned only the timing of the receipts. It was not concerned to estimate revenues under the Russia contract. Mr Seaton makes this clear in paragraph 158 {BB 11/2833} of his statement. This was re-inforced during the course ofMr Seaton's cross-examination [Seaton, T569.39-570.11 {BkB 3/569.39- 570.11}, T572.43 {BkB 3/572.43}, T576.5 {BkB 3/576.5}]. The trial judge set out that evidence in the Judgment at [213]-[214] {RB 1/191-194}, without any criticism or disagreement with it.

13 March 1995 report to directors 180. The appellants submit that Mr Seaton's report to directors of 13 March 1995 set out concerns he had with respect to the bringing of revenue and profit on the Russia contract to account (para [113] of their written submissions). That submission is made without any regard to Mr Seaton's and Mr Robertson's evidence as to the purpose of that and other similar reports to directors, and is a good example of the appellants' misuse of such reports in an attempt to fill the evidentiary gaps in their case (as to which see paragraphs 50-53 above). Mr Seaton's evidence, as described at various points during these submissions, was that he did not have concerns about bringing revenue and profit on the Russia contract to account.

Other circumstances 181. The 7 December 1994 letter and 13 March 1995 report to directors aside, the appellants also submit that Mr Seaton had knowledge of various matters concerning the potential to be paid or recover payments due under the Russia contract, and that by reason of his knowledge of those matters revenues could not be reliably estimated. Those factors were as follows: (a) guarantees and charges to be provided by Techin under the Russia contract, and export insurance to be provided by EFIC, both designed to secure payment of moneys to Stanilite, had not been perfected [Seaton, T621.20-37 {BkB 3/621.20- 37}, T666- 7 {BkB 3/666- 7}; CB 4/945 {BB 24/6197}]; (b) the actual cash receipts under the Russia contract had, by early 1995, slipped behind what had been scheduled in the Russia contract (Attachment 11) and previously forecast by Stanilite [Seaton, T625.35] {BkB 3/625.35}; (c) Stanilite had suspended deliveries of product to Russia in December 1995 because of a failure by Techin to provide the appropriate security [Seaton, T654 {BkB 3/654}, T667.2 {BkB 3/667.2}]; (d) Stanilite was experiencing technical difficulties in installing the network. Mr Seaton understood these difficulties to be minor, and typical of the sorts of difficulties experienced in the early stages of contracts of this kind [Seaton, T662.38 {BkB 3/662.38}; TB 24/7770 {BB 24/6393}]; (e) Techin was experiencing some cash flow problems [TB 24/7770] {BB 24/6393}. As Mr Seaton understood it, those problems were caused in part by Stanilite not having successfully installed the network, and in part by problems at Techin's end associated with obtaining a licence from the local authorities, so that Techin could make sales to subscribers [Seaton, T663.38 {BkB 3/663.38}, T664.7 {BkB 3/664.7}, T672.36 {BkB 3/672.36}]; (f) Techin was in dispute with its US lawyers with respect to payment of their accounts [CB4/1158 {BB 25/6619}; TB24/7770.8 {BB 24/6393}]; (g) Stanilite's lawyers had not been able to assure it that the retention of title provisions in the Russia contract could be enforced in Russia [CB 4/945] {BB 24/6197}.

182. It was put to Mr Seaton, and accepted by him, that these were all matters to be taken into account by an auditor in determining whether the entity has a claim against an external party which was "likely to be satisfied" [Seaton, T670.29 {BkB 3/670.29}]; Judgment, [228] {RB 1/202-203}. That is not controversial, and is an entirely separate question from whether they are matters relevant to the determination of whether revenues can be reliably estimated and ought, therefore, to be recognised pursuant to AASB 1009. The trial judge accepted that submission at [228] {RB 1/202-203}.

183. Mr Seaton rejected the suggestion put to him that he was unable to reliably estimate revenues to be received by Stanilite under the Russia contract by reason of any of the above matters [Seaton, T579.34] {BkB 3/579.34}, and stated that: "I had no concerns at all about the revenues to be received under the Stanilite contract. I thought it was reasonably clear and set out in the contract, and the revenues to be received were $28 million US." [Seaton, T579.24.] {BkB 3/579.24}

184. The trial judge accepted Mr Seaton's evidence, in making the following finding at [230] {RB 1/204}: "The evidence establishes that as at March 1995 both the plaintiffs and the defendant were optimistic that the Russian Contract was going to be successful and that money would be received under it. The defendant gave evidence that there were a number of "hiccups" at that stage, but he expressed the view that there was nothing that he believed was going to put the contract 'off the rails'." [Seaton, T832] {B.kB 4/832}

Mr Shanahan's own evidence on the point 185. Mr Shanahan himself dealt with this issue in his statement in reply. He pointed to cash flow delays under the Russia contract and his understanding that 'Stanilite would only receive payment from Techin after Techin had received payment for the provision of terminals in Russia' (para 132) {BB 16/4034-5}, but he was not prepared to say that those facts meant that the condition in AASB 1009 concerning reliable estimation of contract revenues was not satisfied. The highest he put it was as follows: 'While it is clear that the quantum of maximum total revenue under the contract is clearly established, in my opinion whether the amount of those revenues that will be received can be reliably estimated is a much more difficult question.' [Emphasis in original.] (para 131) {DB 16/4034}

186. Mr Shanahan was therefore astute to distinguish between estimation of revenue under the Russia contract, on the one hand, and estimation of cash receipts, on the other. AASB 1009 is concerned with the former, not the latter; and Mr Shanahan conceded that the former was satisfied.

187. The trial judge referred to that evidence at [215] {RB 1/194} of the Judgment, and pointed out at [266] {RB 1/227-228} that Mr Shanahan's evidence ultimately supported Price Waterhouse's case. The latter finding was also based on Mr Shanahan's precise quantification and dissection of revenues referred to in the Judgment at [234] {RB 1/205-206} and [236] {RB 1/206}.

Credit and performance risk - NAB conditions of 12.1.95 188. The appellants also continue to submit that a letter dated 12 January 1995 from the NAB to the appellants [TB 28/9331] {BB 23/5992} and the state of the Russia contract operated to prohibit Stanilite Electronics from performing its obligations under the contract, and that for this reason total revenues to be received could not be reliably estimated.

This also is a matter which falls outside the Outline provided by the appellants during their opening, which was intended to define the issues clearly. The appellants called no evidence in relation to it, and there was no scope for the appellants to advance a case beyond that which was pleaded and particularised in the Outline. Accordingly, the Court should treat this matter as irrelevant. If, however, that submission is not accepted then Price Waterhouse make the following submissions.

Again this is a matter of credit and performance risk that is not relevant to clause .10(a) of AASB 1009. That aside, on the facts of the case as described below, the terms of the letter did not give Mr Seaton (and would not have given a reasonably competent auditor) cause to take a different approach to the recognition of profit on the Russia contract.

In its letter of 12 January 1995, NAB set out, inter alia, a series of special undertakings it required Stanilite to honour during the life of the temporary facility. The first special undertaking read as follows: '[W]ith regard to the Russia contract, the company will, from this day forward, restrict expenditure in relation to that contract to not exceed total actual receipts of revenue from that same contract. This constraint is to continue until the equity monies are received when we would consider a review of the arrangement in the light of circumstances then existing.'

The position as at March 1995 was that, contrary to Stanilite's cash flow forecasts, relatively little money (namely US$204,000) had been received from Techin under the Russia contract. On this basis, the appellants put to Mr Seaton that the position as from 12 January 1995 was that, unless and until moneys were received from Techin, Stanilite could not continue to expend money on the Russia contract, and therefore could not hope to make further money on the Russia contract.

For reasons explained by Mr Seaton, that proposition is incorrect.

First, as Mr Seaton read and understood the NAB condition, the prohibition related to the incurring of further expenditure. It did not prevent Stanilite from paying expenses that it had incurred prior to 12 January 1995, and it was Mr Seaton's understanding that, by that date, Stanilite had already incurred the majority of its expenditure on the Russia contract [Seaton, T615.28 {BkB 3/615.28}, T615.53 {BkB 3/615.53}, T616.35 {BkB 3/616.35}, T616.45 {BkB 3/616.45}, T617.38-57 {BkB 3/617.38-57}, T618.20 {BkB 3/618.20}, T766.19 {BkB 4/766.19}]. Mr Seaton's understanding is confirmed by Stanilite's response to NAB of 13 January 1995, particularly para (ix) at TB 28/9345 {BB 23/6010} to the following effect: 'As previously advised to the bank, should revenue not flow as expected and required under the Russian contract, no further commitments will be made and equipment is recoverable with EFIC cover underwriting any losses'.

In this respect, paragraph [151] of the appellants' written submissions misconstrues Mr Seaton's evidence. As is clear from the transcript references referred to above, when Mr Seaton spoke in his evidence of the majority of the money having been spent he was talking in terms of the expense having already been incurred. The fact that the incurred expenses were planned to be actually paid at some later date (as set out in cash flow forecasts) was not to the point.

Moreover, to construe the term 'expenditure' in NAB's letter as constraining Stanilite from making payments under existing contractual obligations would have involved NAB in unlawful interference with contractual relations -a result unlikely to have been intended by NAB.

In assessing the impact of the NAB condition, it should be remembered that there were two limbs to that condition. First, there was a restriction on expenditure save from actual receipts; and, secondly, that restriction was to continue until the equity monies were received. The cross-examination of Mr Seaton concentrated on the first limb and ignored the second.

In cross-examination on the first limb, Mr Seaton acknowledged that the strict effect of the 12 January 1995 special undertaking was that Stanilite could not ship further product to Russia, pay technicians to install the product, purchase additional equipment, or complete the construction of the partially built cellswitches unless and until either sufficient moneys were received from Techin or NAB gave its permission [Seaton, T618.35-619.30] {BkB 3/618.35-619.30}. There is no evidence of the quantum of these expenditures or their materiality.

The attitude of NAB with respect to this matter is therefore of significance. In that regard, Mr Seaton's evidence was that, whilst he did not know whether NAB had provided a formal written waiver of the special undertaking [Seaton, T763.9] {BkB 4/763.9}, he was aware that NAB was prepared for Stanilite to continue to do extra work on the contract, and extra work was done [Seaton, T619.34] {BkB 3/619.34}. In this respect, Mr Seaton stated that the matter had been discussed between NAB and Stanilite [Seaton, T655.52] {BkB 3/655.52} and NAB was well aware that work was continuing under the Russia contract notwithstanding payments had not been received [Seaton, T673.56] {BkB 3/673.56}. In fact, an NAB representative (namely the relationship manager, Mr Ferreira) was present at a meeting of the due diligence committee on 6 March 1995 at which Mr Wheatley of Stanilite gave a presentation about the Russia contract and the future activities to be undertaken by Stanilite under the contract [Seaton, T663.51 {BkB 3/663.51}, T674.3 {BkB 3/674.33}]. See also the following documents which indicate that NAB was aware, after 12 January 1995, that Stanilite was proceeding to complete the Russia contract: (a) Announcement to the Australian Stock Exchange on 3 March 1995 [TB2/831] {BB 24/637 L-N}. (b) Minutes of the due diligence committee of6 March 1995 [TB2/863] {BB 24/6396 N, 24/6397K}. (c) Notes of the due diligence committee of6 March 1995 [TB28/9397] {BB 24/6391J, 24/6393 R- T}. (d) NAB Report on business contact dated 14 March 1995 [TB5/1712] {BB 25/6474J-Q}. (e) Report on business contact dated 21 March 1995 [TB5/1721] {BB 25/6574}. (f) NAB Internal memorandum dated 2 May 1995 [TB 3/938] {BB 26/6859 S-T}.

All of these documents post-date the 9 February 1995 NAB memorandum upon which the appellants rely (see [153] of the appellants' written submissions).

Mr Seaton explained that he had received management representations to the effect that NAB knew that Stanilite was continuing to push on with the Russia contract in 1995 because that was the best way of assisting Techin to realise cash to enable it to pay the moneys it owed Stanilite [Seaton, T763.56] {BkB 4/763.56}. It was Mr Seaton's understanding that NAB was keen to see the contract continue because to do otherwise would not be in the interests of Stanilite or NAB [Seaton, T785.9] {BkB 4/785.9}. For this reason NAB had effectively waived compliance with the special undertaking, or as Mr Seaton colloquially described it, 'everyone was turning a blind eye' [Seaton, T764.33] {BkB 4/764.33} and the NAB was 'living with it' [Seaton, T764.40] {BkB 4/764.40}. The trial judge implicitly accepted that evidence at [225] {RB 1/201}. Further, the trial judge accepted without criticism Mr Seaton's evidence to the effect that the bank was prepared for Stanilite to continue to do extra work on the contract and that extra work was done: Judgment [224] {RB 1/200-201}.

There are two further reasons why the special undertaking in the bank's letter of 12 January 1995 is of no significance for the purpose of this proceeding. First, the bank was entitled, under the facility agreement [TB4/1450] {BB 20/5070}, to declare the moneys to be immediately due and payable only if an event of default occurred [TB4/1468 {BB 20/5088 K-M}, clause 14.2]. Relevantly, an event of default occurred if: 'The Company does not comply with the undertakings in Schedule 3, or does not observe any other obligation under any Document and, if the non-observance can be remedied, does not remedy the non-observance within 14 days.' [Clause 14.1, TB4/1466] {BB 20/5086 Q}.

The undertakings in Schedule 3 are the financial undertakings breach of which was subject to the bank's waiver of 15 March 1995. If there was a breach of an obligation under a Document (being this letter of 12 January 1995) that breach was capable of remedy and an event of default does not arise until the expiry of 14 days notice by the bank to remedy the breach and the same remains unremedied. The bank gave no such notice: on the contrary, according to the evidence, it acquiesced in the breach (as the trial judge implicitly found at [225]) {RB 1/201}. Hence, no event of default arose and the bank could not have called up the moneys in the circumstances.

Further, the relevant date for assessment of the impact of the undertaking is, of course, 3 May 1995, for that was the date of the alleged act of negligence on Price Waterhouse's part by consenting to the inclusion of the 31 December 1994 audit opinion. Now, by 3 May 1995 the following things had occurred: (a) On 28 April 1995, Stanilite Pacific had, through BBY, successfully placed 7 million shares to institutional investors and raised $11.7 million; (b) On 2 May 1995, NAB consented to the Stanilite's group's using the amount so raised for the purposes of its operations and thereby waived the undertaking that the raising be used to reduce the overdraft facility; and (c) BBY and CS First Boston underwrote the issue of 14.5 million shares to raise $23.2 million, subject to standard terms and conditions.

By 3 May 1995, therefore, the cash position of the Stanilite group had so fundamentally improved that the undertaking must be taken to have expired.

Mr Robertson's evidence in relation to this issue is important, and is referred to by the trial judge at [226]-[227] {RB 1/201-202}. His expert opinion is that a reasonably competent auditor would not be guided solely by the fact of the special undertaking to the NAB. Rather, a reasonably competent auditor considering the matter as at 3 May 1995 would be entitled to consider that, in light of the receipt of the placement funds and the activity surrounding the capital raising, the particular undertaking would be 'washed away by the capital raising' [Robertson, T952.20] {BkB 4/952.20}, and was therefore 'in [imminent] danger of being totally relaxed' [Robertson, T948.38] {BkB 4/948.38}. The appellants' contention that this is circular thinking and impermissible (see [157] of their written submissions) should be rejected as it is, in effect, a submission that the auditor should not have regard to a commercial circumstance relevant to the financial position of the company being audited.

Further, Mr Robertson stated that in deciding whether the undertaking was a concern from an audit perspective (whether at 3 May 1995 or at 16 March 1995) a reasonably competent auditor would be entitled to have regard to the way in which the relationship between NAB and Stanilite was being conducted [Robertson T949.19] {BkB 4/949.19} and any other relevant factors and information available to him or her [Robertson, T950.45 {BkB 4/950.45}, T952 {BkB 4/952}, T964.42 {BkB 4/964.42}]. For example, if the auditor perceived that NAB was turning a blind eye to any breaches of that undertaking, it would be easier for the auditor to conclude that 'the condition was there as a technicality rather than as a real live factor' [Robertson, T954.58] {BkB 4/954.58}.

Mr Robertson was asked whether the auditor would need to obtain formal confirmation from NAB that the undertaking would be waived. His evidence was that, in light of the receipt of the placement proceeds and the impending capital raising, it would not be necessary for the auditor to obtain such confirmation [Robertson, T948.47 {BkB 4/948.47}, T961.8 {BkB 4/961.8}]. The effect of Mr Robertson's evidence is that auditors would be likely to appreciate that, in the real world, a bank would be unlikely to surrender a covenant in its favour and any request for such a surrender would be futile [Robertson, T955.20) {BkB 4/955.20}, and that whether an auditor would need to make such a request would depend on the particular circumstances of the case and the way in which the relationship between NAB and the company was actually being conducted [Robertson, T979.27] {BkB 4/979.27}.

In seeking to undermine Mr Seaton's views on the likelihood of the capital raising proceeding and the effect that would have on the continued operation of NAB's letter of 12 January 1995, the appellants may take no comfort from the fact that the formal underwriting agreement with respect to the capital raising was not put in place until early May 1995. Mr Robertson's view was that an auditor could be in a position where he would have a range of information available to him upon which he could rely in determining whether the capital raising would proceed, notwithstanding that the formalities associated with the execution of the underwriting agreement had not been attended to [Robertson, T972.26 {BkB 4/972.26}, 973.26 {BkB 4/973.26}].

In light of this evidence, the argument advanced by the appellants with respect to the effect of the 12 January 1995 letter from NAB is untenable.

(v) Appellants' submission with respect to Mr Robertson's evidence 208. The appellants submit that the trial judge did not make enough of Mr Robertson's evidence that certain matters of performance and credit risk were "damning" (see [158] -[159] of their written submissions).

209. This submission fundamentally misstates the evidence of Mr Robertson and must be rejected. The cross-examination and evidence to which the appellants refer concerned matters relevant to the 1995 audit in late September 1995 [Robertson, T964] {BkB 4/964}. It is not, therefore, evidence directed to the provision of the 1994 audit letter in March 1995 or the giving of the consent on 3 May 1995. For example, the various matters identified in the question to which the relevant answer relates include an assessment of the actual payments received across the period from November 1994 to September 1995, and the fact that securities and EFIC insurance had not been effected by September 1995. It is not, therefore, possible to take Mr Robertson's answer as one applying as at March or May 1995.

210. In any event, Mr Robertson made it clear in his answer that in order to form a view on the question of how a reasonably competent auditor would have dealt with Russia contract revenues and profits in light of the matters to which he was taken, one would need to know precisely what factors and information were available to Mr Seaton.

211. One fact that Mr Robertson did not himself know was that NAB was not insisting on compliance with the terms of its 12 January 1995 letter. His evidence at T964 {BkB 4/964} must be read in this context. As noted above, when Mr Robertson was asked to assume the truth of that matter, his evidence was that it would be open to a reasonably competent auditor not to treat the terms of the 12 January 1995 letter as a "real live factor" and that in the assumed circumstances it would have been open to a reasonably competent auditor to allow revenues and profits on the Russia contract to be recognised [Robertson, T954-5] {BkB 4/954-5}. **********

14/09/2005 - Correction to name of Counsel appearing on coversheet - Paragraph(s) coversheet 16/09/2005 - Amendment to headnote - Paragraph(s) heading

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