Tomanovic v One Australia Pty Limited

Did the primary judge err in accepting the valuation methodology of GMEC which was adopted by Mr McGuiness?

1. Both valuers accepted that an earnings based method of valuing a company as a going concern is the methodology most commonly adopted.
2. This opinion is consistent with what has been stated in a number of cases in which the valuation of shares in a proprietary company has been considered.
3. In Perpetual Trustee Company (Limited) v The Federal Commissioner of Taxation [1942] HCA 4; (1942) 65 CLR 572, Williams J pointed out at 580 that the main items to be taken into account in valuing shares are the earning power of the company and the safety of capital assets in which the shareholders' money is invested. A similar approach was taken by his Honour in McCathie v The Federal Commissioner of Taxation [1944] HCA 9; (1944) 69 CLR 1 (McCathie). In that case Williams J made the following comments at 11: "…(3) In applying this test to a hypothetical purchase of shares in a company, the distinction must not be lost sight of between the acquisition by a purchaser of property which becomes subject to his sole control and the acquisition of shares in a company, which only confer on the holder those rights to which he becomes entitled from time to time under the constitution of the company and the general law. (4) A purchaser of shares in a company which is a going concern does not usually purchase them with a view to attempting to wind up the company. (5) A prudent purchaser, therefore, while taking care to see that his purchase money is well secured by tangible assets, would look mainly to the dividends which he could reasonably expect to receive on his shares, and such a purchaser would no doubt expect to receive such dividends as were appropriate to the nature of the business in which the company was engaged. It follows, therefore, that the real value of shares which a deceased person holds in a company at the date of his death will depend more on the profits which the company has been making and should be capable of making, having regard to the nature of its business, than upon the amounts which the shares would be likely to realize upon a liquidation." See also Abrahams v The Federal Commissioner of Taxation [1944] HCA 32; (1944) 70 CLR 23 at 31.
4. What was said by Williams J in McCathie may require some qualification where it was within the power of the purchaser to wind-up the company. However, in the present case there was no issue in the Court below that GMEC should be valued as a going concern.
5. In Commissioner of Succession Duties (South Australia) v Executor Trustee and Agency Company of South Australia Limited [1947] HCA 10; (1947) 74 CLR 358 (Commissioner of Succession Duties), Latham CJ, Rich and Williams JJ made the following comments at 362: "The main items to be taken into account in estimating the value of shares are the earning power of the company and the value of the capital assets in which the shareholder's money is invested. But a prudent purchaser does not buy shares in a company which is a going concern with a view to winding it up, so that the more important item is the determination of the probable profit which the company may be reasonably expected to make in the future, because dividends can only be paid out of profits and a prudent purchaser would be interested mainly in the future dividends which he could reasonably expect to receive on his investment. Further, a prudent purchaser would reasonably expect to receive dividends which would be commensurate with the risk, so that the more speculative the class of business in which the company is engaged the greater the rate of dividend he would reasonably require. In order to estimate the probable future profits of a company it is necessary to examine its past history, particularly the accounts of those years which are most likely to afford a guide for this purpose. In order to estimate the rate of dividend that a prudent purchaser could reasonably require on his investment it is necessary to examine the nature of the business and the risks involved and to seek the evidence of business men, particularly members of the stock exchange and experienced accountants, who can testify to the appropriate rate from the prices paid for shares in companies carrying on a similar business listed on the stock exchange or from private sales of shares in such companies or from their general business experience."
6. This passage was approved by Gibbs J sitting as a single judge of the High Court in Gregory v Commissioner of Taxation of the Commonwealth of Australia [1971] HCA 2; (1971) 123 CLR 547 at 565.
7. A somewhat similar problem to that which has arisen in the present case arose in Mallet v Mallet [1984] HCA 21; (1984) 156 CLR 605. In that case the primary judge valued the shares in a proprietary company at $334,600 in circumstances where the value of the assets of the company was close to $700,000. The High Court, by majority, upheld the decision of the trial judge. Gibbs CJ made the following remarks at 616-617: "It might at first sight seem surprising that the shares in a company whose assets are valued at close to $700,000 should have a total value of only $334,600, the value which the judgment of Bell J. would place on them. In determining the value of shares it is necessary to take into account both the earning power of the company and the value of its capital assets: Commissioner of Succession Duties (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd and see Gregory v. Federal Commissioner of Taxation. In many cases the real value of the shares will depend more on the former than on the latter item. Where, however, the company is merely a convenient means of holding the assets, and the person who owns the shareholding in question is able to put the company into liquidation at will, the real value of the shares will be likely to be the amount which the holder would receive if the company were voluntarily wound up. And since the purpose for which a valuation is made may affect the court's attitude (Commissioner of Succession Duties (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd), there is much to be said for the view that the court will be more ready to value shares on a liquidation basis in a case such as the present than in a revenue or even in a compensation case." (Citations omitted).
8. Gibbs CJ at 617 also referred to the difficulty of adopting an alternative methodology in the absence of evidence of whether the assets were capable of ready realisation, whether it would be prudent to realise them and the likely proceeds of realisation.
9. Mason J dissented. He made the following remarks: "What is the most appropriate method of estimating the value of shares in a proprietary company depends upon a variety of factors. They include the purpose for which the valuation is made, the nature of the shareholding, the character of the company's business, its capacity to earn profits and the net value of its assets. It has been said that a valuation based on earning capacity is generally most appropriate because the hypothetical purchaser of shares in a company which is a going concern is looking, not to a winding up, but to the profits which will ensue from the company continuing to trade: McCathie v. Federal Commissioner of Taxation; Abrahams v. Federal Commissioner of Taxation; Commissioner of Succession Duties (S.A.) v. Executor Trustee and Agency Co. of South Australia Ltd. But it has been recognized that valuation by reference to assets backing or a liquidation basis will be appropriate where earning capacity provides no real measure of the true share value (Commissioner of Stamp Duties (N.S.W.) v. Pearse) or presents overwhelming difficulties (Elder's Trustee and Executor Co. Ltd. v. Federal Commissioner of Taxation; Jekyll v. Commissioner of Stamp Duties (Q.)) or where the shareholding is such as to enable the holder to bring about liquidation of the company (New Zealand Insurance Co. Ltd. v. Commissioner of Inland Revenue): see generally the judgment of Gibbs J. in Gregory v. Federal Commissioner of Taxation. There is always the risk that in examining methods of valuation attention is diverted from the object of the exercise, namely the ascertainment of the real value of the shares, to the means by which the object is to be achieved. As a general proposition the valuation by means of capitalization of profits is appropriate to those cases in which the likely purchasers will be looking to the profits which the company will earn as a going concern. Where, however, the valuation of the shares as calculated by reference to their assets backing substantially exceeds their valuation as calculated on a capitalization of profits, the former is to be preferred, subject to a discount for the expenses of winding up and distribution, unless there is some good reason for preferring the latter, as, for example, where the shareholding to be valued is a minority of shareholding and those in control of the company intend to carry on its business because that course has advantages for them. Even in such a case it will be proper to take some account of the assets backing of the shares in order to reflect the possibility that those in control of the company might be minded in the future to sell their shares or to realize the value of the assets of the company." (Citations omitted).
10. In considering whether the primary judge erred in adopting the valuation method propounded by Mr McGuiness there is one further matter which should be borne in mind. The process of valuation may produce a range of results from different judges valuing in accordance with accepted principle and making no error of law. An appellate court is not justified in substituting its own opinion unless it is satisfied the court below acted on the wrong principle of law or its valuation was entirely erroneous: Commissioner of Succession Duties at 367, The Commonwealth v Milledge [1953] HCA 6; (1953) 90 CLR 157 at 159, Emerald Quarry Industries Proprietary Limited v Commissioner of Highways (South Australia) [1979] HCA 17; (1979) 142 CLR 351 at 356 and 374 and The Commissioner of Taxation of the Commonwealth of Australia v St Helens Farm (ACT) Proprietary Limited [1981] HCA 4; (1981) 146 CLR 336 at 363-364 and 381.
11. I do not consider that the primary judge erred in accepting that the approach adopted by Mr McGuiness was the appropriate methodology to determine the value of GMEC. The method of valuation adopted by Mr McGuiness is a well-accepted method of valuing a company as a going concern. Importantly, no suggestion was made that the company should not be valued on a going concern. Rather, the methodology that Mr McGuiness used was in dispute.
12. Ultimately, no submission was put that the primary judge misconstrued his task or misunderstood the Court of Appeal's Orders which directed the basis on which the valuation was to be undertaken. Further, the primary judge was correct in stating that Mr Meredith did not provide any academic or professional support for the proposition that a precondition to an earnings based valuation was stability of earnings or for the proposition that a precondition to a discounted cash flow analysis was ten year cash flow forecasts provided by persons having "stewardship" of the company.
13. Undoubtedly it is correct that stability of earnings and the availability of long term cash flow forecasts diminish the uncertainty inherent in the valuation based on an estimate of earnings or cash flows. So much was acknowledged by the primary judge. However, this does not mean the absence of such factors precludes the use of such methods of valuation if the valuer believes that he or she has sufficiently reliable material to undertake the task.
14. In the present case the evidence of Mr McGuiness, an experienced valuer, was that he had sufficient information to undertake the valuation using earnings and cash flow based methodologies. Mr Meredith, apart from the general assertion that the preconditions he said were necessary for the use of methodologies were absent, did not point to any material relied on by Mr McGuiness as being inaccurate or unreliable. Nor did he criticise any of the integers used by Mr McGuiness in carrying out his valuation.
15. In these circumstances it does not seem to me that the primary judge erred in principle in accepting that the methodology used by Mr McGuiness was appropriate. However, the question remains whether the result arrived at was self-evidently erroneous such that the valuation could not be accepted. This involves two questions. First, could the valuation be supported having regard to the differences between the result arrived at and the book value of the company as disclosed in the statement of financial performance for the year ended 30 June 2010? Second and aligned to this issue, did Mr McGuiness err in taking into account costs of between $6 million to $8 million in his estimate of earnings for the brokerage business? It is convenient to deal with the second issue first.

In valuing the brokerage business, did Mr McGuiness wrongly take into account costs of between $6 million to $8 million?

1. I have set out the method by which Mr McGuiness derived the operating costs in pars [38]-[39] above. Mr McGuiness relied in part on a loan book valuation model in that analysis. He was justified in doing so. Although Mr Meredith said he had lost faith in that model because of the different net present value of the trailing commissions derived from it, compared to the figures stated in the accounts, he failed to observe that this was due to a different discount rate. The primary judge was correct in rejecting Mr Meredith's criticism of the model in these circumstances.
2. The appellants' submissions focused on the proposition that there was nothing to suggest costs of the nature of $6 million to $8 million would be incurred in collecting the trailing commissions. The appellant submitted these costs related to the generation of new business and criticised the primary judge and Mr McGuiness for not identifying the costs said to be involved in their collection. They submitted that Mr Sayer did not identify such costs and an inference could be drawn that there were none.
3. The difficulty with that submission is that Mr McGuiness was not attempting to calculate the value of the trailing commissions in isolation. Rather, he was valuing the brokerage business as a going concern. Once that is understood, it is apparent that Mr McGuiness did identify the costs in question. The costs in question were the operating costs, after removal of the borrowing costs, which Mr McGuiness attributed to the lending and origination business. This was consistent with the evidence of Mr Sayer that other costs of the lending and origination business were covered in the management fee paid to Perpetual Trustee Company Limited (see par [11] above). It was also consistent with the budget for the 2009, 2010 and 2011 years, which identified such costs.
4. It follows that in valuing the brokerage business as a going concern it was necessary to take these costs into account. Indeed, had they not been attributed to the brokerage business but to the lending and origination business, as Mr McGuiness pointed out, the cash flow of that business would have been exhausted by 10% of those costs.
5. It was not suggested that the costs were unreasonable, rather they should have been ignored in the valuation as there was insufficient evidence that they would in fact be incurred. In my opinion they could not be ignored in the application of the methodology used by Mr McGuiness. Whether that methodology produced a result which could be said to be reflective of the value of the company is considered below.

Was the valuation plainly erroneous?

1. The primary submission made by the appellants was that having particular regard to the total equity of the company of $12,515,127, disclosed in the statement of financial position for the year ended 30 June 2010, a value of GMEC between $2.7 million and $3.1 million was plainly erroneous. As I indicated, senior counsel for the appellants referred to s 1305 of the Corporations Act, pointing out that the effect of that section was that the value of assets set out in the statement of financial performance was prima facie evidence of their value. He also pointed to the fact that the Director's statement accompanying the accounts said that they presented a true and fair view of the company.
2. However, in considering the accounts it must be borne in mind that they had been prepared on a going concern basis in circumstances where there was material uncertainty as to the ability of the company to continue as such. Both the notes to the accounts and the auditor's report expressed a concern as to whether in those circumstances assets would be realised in the amount stated in the accounts.
3. It is important to remember that Mr Meredith in his orderly realisation of assets model simply assumed that assets could be realised in their orderly fashion at book value and gave no consideration to the overall financial position of the company as at the balance date. The submissions of the appellants adopted the same approach.
4. There was no evidence to suggest that there was a market for the trailing commission, whether their disposal would result in a default either under the loan facility or the Senior Note Facility or for that matter how any orderly realisation could take place. As Mr McGuiness agreed in the joint report, if a company is to be valued on an orderly realisation of assets basis, the book value would need to be adjusted to reflect market value. In this context a prudent purchaser of the company as a going concern would consider whether in fact any of its assets could be realised without significant financial consequences to the company.
5. Acceptance of the appellants' proposition, that a willing but not anxious purchaser would pay an amount equivalent to the book value of the assets of the company for its shares, ignores the factors to which I have referred. It also ignores the fact that the company's profit to the 30 June 2010 financial year was $187,124 before tax and $130,987 after tax and that it had a negative cash flow of $133,860. In these circumstances it does not seem to me that the primary judge erred in declining to adopt the approach suggested by Mr Meredith or in concluding that Mr McGuiness' valuation was unreasonable.
6. As I indicated above at par [140], the appellants submitted that Mr McGuiness' valuation was flawed because it did not take into account future earnings from net trailing commissions. This submission was not put in the Court below, was not the subject of evidence from Mr Meredith, who did not criticise any of the integers in the valuation and Mr McGuiness was not cross-examined on it. In these circumstances it cannot be relied on in this Court.
7. Similarly, the submission of senior counsel that the increase in working capital to $26,878,129 in the discounted cash flow analysis used by Mr McGuiness as a secondary method of valuing the brokerage business was inconsistent with a business worth $3.7 million to $4.1 million was not put in the Court below. The figure for working capital was calculated by Mr McGuiness on the basis that working capital was 160% of revenue. He explained that this was unusually high but was the effect on the changes in accounting policy in 2010. He stated it was "applicable" to have regard to the high levels of working capital relevant to revenues in 2010 for determining estimates of expected future profit and in turn expected cash flows. This methodology was not disputed and it was not suggested to Mr McGuiness or for that matter put to the primary judge that it followed that the valuation arrived at by Mr McGuiness was erroneous for that reason.
8. It does not seem to me that the fact that Mr Sayer said he would not wind-up the company had any bearing on its value. It was not suggested to Mr Sayer that he believed the value of the company was in excess of $12,515,000. Even if it had been put and could be said to be relevant, it would have very little weight.
9. Nor do I think that the fact that Macquarie Bank sold its 10% shareholding for $750,000 in 2008 demonstrated that the valuation arrived at by the primary judge was erroneous. The appellants submitted that the financial position of the company had improved since that date. There was no analysis to demonstrate that this was the case. In fact the position of the company showed a marked deterioration in 2009 due to the writing off of bad debts of $7,468,248. For this reason alone the submission cannot be accepted. Further, the pre-tax profits for the 2009 year, adjusted as I have indicated in par [121] above, were $815,759, compared with $187,124 for the 2010 year, showing a decline in the position of the company rather than an improvement.
10. In these circumstances it cannot be said that the valuation arrived at by the primary judge, although significantly lower than book value, was erroneous.

Did the primary judge err in accepting the valuation of the AHQ and 9 AS Trust loans propounded by Mr McGuiness in his valuation?

1. The appellants were correct in submitting that the primary judge erred to the extent he relied on the fact that the accounts stated that the impairment provisions in the auditing standards had not been complied with. As the appellants submitted, the notes to the account and the Representation Letter signed by Mr Sayer indicated the loans were fully recoverable.
2. However, the hypothetical prudent purchaser for the purpose of the valuation would be considered to be fully informed as to all matters known as at 30 June 2010 which would affect the value of the shares in question: Spencer v The Commonwealth of Australia [1907] HCA 82; (1907) 5 CLR 418 at 441. That would include, in my opinion, information relating to the recoverability of the loans, which were a significant asset of the company.
3. Each valuer agreed that the loan receivables should be valued in accordance with the orderly realisation of assets methodology. The loans were shown in the accounts of GMEC in an amount of $6,718,464. Mr Meredith assumed them to be fully recoverable. It should be noted however that in valuing AHQ and 9 AS Trust, Mr Meredith indicated that the management of GMEC had instructed him that of the related party debts due to AHQ, shown in the balance sheet at a value of $4,799,626, only $1,327,522 was recoverable. However, Mr Meredith did not take the diminution of the value of AHQ and 9 AS Trust into account in assessing the recoverability of the loans due by those entities to GMEC.
4. By contrast, Mr McGuiness took those matters into account and as a consequence wrote down the recoverability of the loans from $6,718,464 to $2,256,193.
5. The adjustments to the loans due by AHQ and 9 AS Trust were consistent with the information provided by the Chief Financial Officer, which was tendered in evidence and admitted without objection.
6. It seems to me that this information would be taken into account by a prudent purchaser in assessing the value of GMEC. As I indicated, Mr Meredith did not contend to the contrary but stated there may have been other sources from which the loan could be repaid. It is unlikely that a prudent purchaser would rely on such speculation. Further, if what was being referred to by Mr Meredith were sources available to the existing owners of the entity, a prudent purchaser would not take them into account in considering the value of the receivables.
7. The other differences between Mr McGuiness and Mr Meredith in their treatment of AHQ and 9 AS Trust were not the subject of submissions on the appeal.
8. It follows that the primary judge did not err in accepting as correct the valuation of shares in GMEC arrived at by Mr McGuiness.

The application to amend the notice of appeal

1. Although it may be arguable that Order 4(b) of the Court of Appeal's Orders in the oppression proceedings (see par [4] above) was wide enough to encompass prejudgment interest and interest from 5 March 2010 to 30 June 2010 the matter was not raised below.
2. A consideration of the issue would involve, first, the construction of the earlier order of the Court and second, whether the loan to Mr Tomanovic was recoverable and the effect this would have on the calculation of the amount due pursuant to that order or for that matter the valuation of the shares in GMEC. The matter was not dealt with in the written submissions. It was quite inappropriate to raise it shortly prior to the hearing of the appeal and as the respondents point out, there at least would have been the possibility that evidence concerning the recoverability of the judgment debt could have been led had the matter been raised at the hearing. For these reasons the application should be refused.

Conclusion

1. In these circumstances leave to amend the notice of appeal should be refused and the appeal should be dismissed. The appellants should be ordered to pay the respondents' costs of the appeal.
2. BARRETT JA: In Gold Coast Selection Trust Ltd v Humphrey (Inspector of Taxes) [1948] AC 459 at 473, Viscount Simon LC said, "Valuation is an art, not an exact science"; and, "Mathematical certainty is not demanded, nor indeed is it possible". As the Chief Justice explains, the primary judge proceeded according to an objectively reasonable method of valuation and reached a conclusion that, having regard to the evidence before him and the submissions put to him, does not exhibit error. For the reasons stated by the Chief Justice, the appeal should be dismissed with costs.
3. EMMETT JA: This appeal is concerned with the valuation of shares in Global Mortgage Equity Corporation Pty Ltd (GMEC). The valuation was necessary for the purposes of determining the price to be paid by the first respondent, One Australia Pty Ltd (One Australia), to the second appellant, Australian Financial Services Corporation Pty Ltd (AFSC), in consequence of orders made in an oppression suit brought under s 232 of the Corporations Act 2001 (Cth). An order was made that One Australia purchase the shares owned by AFSC in GMEC at a price equal to 45 per cent of the net value as at 30 June 2010 of GMEC, plus an amount of interest minus the net value as at that date of other assets that had been transferred to AFSC by either One Australia or the second respondent, Mr Kenneth Sayer. A judge of the Equity Division concluded that the amount payable by One Australia for the purchase of the shares in GMEC owned by AFSC was $1,870,043.
4. AFSC and its principal, the first appellant, Mr Zoltan Tomanovic, appealed from the orders made by the primary judge. They contended that his Honour erred in arriving at a valuation of the shares in GMEC, and that his Honour should have determined a valuation in the order of $12,500,000, which would have resulted in a price payable by One Australia of 45 per cent of that sum.
5. I have had the advantage of reading in draft form the proposed reasons of the Chief Justice for concluding that the appeal should be dismissed with costs. The appellants sought leave to file an amended notice of appeal. I agree with the Chief Justice, for the reasons proposed by his Honour, that leave to amend should be refused. Accordingly, as the Chief Justice indicates, four questions raised in the appeal require resolution.
6. The first question was whether the primary judge was justified in accepting the valuation approach adopted by Mr McGuiness, the valuer called by One Australia, in preference to that of Mr Meredith, the valuer called by AFSC. I agree with the Chief Justice that the primary judge did not err in principle when accepting that the methodology used by Mr McGuiness was appropriate.
7. The second question was whether Mr McGuiness wrongly took into account costs between $6,000,000 and $8,000,000 in valuing the brokerage business of GMEC. I agree with the Chief Justice that in valuing the brokerage business as a going concern, it was necessary to take those costs into account.
8. The third question was whether, having regard to the shareholders' equity disclosed in the balance sheet of GMEC, the valuation by Mr McGuiness was plainly erroneous. I agree with the Chief Justice that, although the valuation arrived at by the primary judge was significantly lower than book value, it could not, in the circumstances, be said to be erroneous.
9. The final question was whether the primary judge erred in accepting the valuation propounded by Mr McGuiness in his valuation of certain loans made by GMEC. I agree with the Chief Justice that, while the primary judge erred to the extent that he relied on the fact that the accounts stated that the impairment provisions in the auditing standards had not been complied with, the hypothetical prudent purchaser of the shares in GMEC must be assumed to be fully informed as to all matters known as at 30 June 2010 that would affect the value of the shares, including information relating to the recoverability of the loans, which were a significant asset of GMEC. The adjustments to the value of the loans made by Mr McGuiness were consistent with information provided by the chief financial officer of GMEC, which was admitted into evidence without objection. Such information would be taken into account by a prudent purchaser in assessing the value of the shares in GMEC. Any error by the primary judge was therefore immaterial.
10. I agree with the Chief Justice, for the reasons proposed by his Honour, that the primary judge did not err in accepting as correct the valuation of shares in GMEC arrived at by Mr McGuiness. It follows, as the Chief Justice proposes, that the appeal should be dismissed and that the appellants should pay the respondents' costs of the appeal.

Amendments 06 May 2015 - Par [125] "$7,5000,000" changed to $7,500,000" DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 06 May 2015