The negotiation and execution of the Letter Agreement
3 The applicant is a wholly-owned subsidiary of Zwanenberg Food Group BV ("ZFG"), a Dutch company which specialises in the production and sale of processed meat products and chilled meat products. Included in ZFG's range of chilled food products are "processed snack products", which can be offered for sale at supermarkets, for instance. In about October 2010, ZFG decided to explore the potential for the production and sale of snack food products in Australia, and the general manager of the applicant, Hendrik Willem ("Dick") Koops, was instructed by the executive chairman of ZFG, Aldo van der Laan, and the chief executive officer of ZFG, Ronald Lotgerink (both of whom were then in Australia for other reasons), to investigate the relevant market. This he did over the next six months or so, and it appears that, on the production side, his focus was on finding a suitable chicken processing facility in Victoria.
4 Mr Koops' inquiries brought him to the respondent, a manufacturer of cooked and fresh poultry products from its premises in Bendigo. On 6 June 2011, Mr Koops travelled to Bendigo and met with Dean Russell, the sole shareholder and director of the respondent. They undertook a tour of the respondent's manufacturing plant, exchanged Powerpoint presentations relevant to their respective businesses, and discussed generally the proposal for the respondent to produce snack food products for the applicant, for sale into the Australian market. Both parties were attracted to that proposal. They met again (at Mr Koops' office in Surrey Hills) on 23 June 2011. On 24 June, Mr Koops sent an email to Mr Lotgerink attaching some brief notes of what had been discussed at the meeting, and noting that "the impression on both sides was once again highly positive". By return email, Mr Lotgerink said that he agreed with Mr Koops' proposal (ie to do business with the respondent), adding "please go ahead".
5 On 12 July 2011, Mr Russell sent Mr Koops an email which contained the following text:
Key Issues:
1. Can the principals establish trust and empathy?
2. Are the products appealing to the Australian consumer?
3. Is there enough profit in snack foods to provide margin for two enterprises working the one project?
4. Are key customers in Australian retail and food-service prepared to commit to snack foods?
5. Is there a market beyond Australia?
6. Will a collaboration be more productive than each business working independently?
My thoughts:
1. A meeting in Australia with Aldo or Rodney and myself asap.
2. Prepare 6 test kitchen samples of both Entertaining (3) and Snacking (3) style products for consumer testing.
3. Develop cost models on 6 proposed lines, include margins for both Moira Mac's and Zwanenberg / Plumrose.
4. Present 6 products to Coles, WW, Aldi, Bidvest, PFD and a mix of independent distributors.
5. Consult with Austrade on opportunities in Vietnam, S. Korea, China, India, Hong King, Singapore and Japan.
6. Suck it and see, one step at a time.
Mentioned in this email, "Aldo" was Mr van der Laan, and "Rodney" was probably a reference to Mr Lotgerink. "Plumrose" was a brand name under which the applicant already sold some (non-snack) food products in Australia.
6 On 27 July 2011, Mr Koops sent Mr Russell an email to which were attached four diagrams showing factory layout options for the production of snack foods at the respondent's plant at Bendigo. Much of the specialised machinery to be used in the production of snack foods was to be supplied by ZFG which had experience of the kind of industrial operations that were contemplated. The diagrams had been prepared by Twan Peters, a production manager employed by ZFG who had been responsible for the operations of one of its processing factories in The Netherlands. In the email, Mr Koops indicated which of the four was Mr Peters' preference. However, Mr Koops noted that, in every option, it was necessary to make use of some space in the corridor, including, under the preferred option, for packaging of final product. This was, it seems, an early indication of issues that might arise due to space limitations at the respondent's factory.
7 On 13 and 14 September 2011, Messrs Koops and Peters met with Mr Russell and Shannon Simpson, the respondent's factory manager, at Bendigo. The four men inspected the factory, and observed the respondent's existing operations. Amongst the things that Mr Russell told Mr Koops was that the respondent's production line was designed to produce 40,000 kg per week, based on 1½ shifts per day of eight hours each. They had discussions with the respondent's landlord, Leon Scott, on the subject of alterations to the factory that might be needed to accommodate a snacks production line. They also looked at an adjacent area under the control of a concern identified as "Pasta Master" (but, it seems, part of Mr Scott's freehold) which was not being used at that time and which, therefore, might have been available for the snacks line if it could not be installed within the respondent's existing tenanted area. Mr Peters prepared a report for the applicant on these two days of meetings and inspections, and, while the detail of it is now of no particular importance, it was, to say the least, encouraging as to the prospects of the respondent being able to undertake the kind of production operation which the applicant had in mind.
8 On the business, as distinct from the operational, side, Mr Russell had, on 12 September 2011, prepared a schema on a computer program called "Mindjet" which he showed to the representatives of the applicant when they were at Bendigo over the following two days. It set out what was one idea as to how the parties' relationship might be structured, and (at a high level) how it might operate. The proposal was for there to be a joint venture company in which the applicant and the respondent would have equal shareholdings, and that the respondent would second staff to that company at cost. The following was proposed on this schema:
Structure: 1 ZA and MM enter into a 50/50 Joint Venture, by issuing 2 shares in a new company (1 each). 2 Partnership Agreement needs to be drawn up and signed off. 3 Capital Plant and Equipment supplied by ZA to partnership at cost, with repayments, by JV, starting after 12 months. 4 MM takes on head lease of rental space. 5 JV subleases on 12 monthly basis.
9 On 26 October 2011, Mr Lotgerink sent Mr Koops an email in which he noted that he had had "feedback" from Mr Peters (presumably including the report to which I have referred) and from the applicant's technical expert in factories of this kind, Willem Versantvoort. Mr Lotgerink's email continued:
Our position is now as follows:
1. Moira Mac's is potentially a strong candidate.
2. The line appears to be readily installable, they have the basic know-how required.
3. We're prepared to commit to a transfer of knowhow and start-up support.
4. However we're not in favour of a shared factory
a. In a single factory there can only be one boss
b. Constant discussion on investment, rent costs, maintenance, etc.
5. The way forward has to lie in a preparedness on MOIRA'S part to invest in renovation and the line.
6. We will then provide him with a sales guarantee, on the basis of which he can (partly) run the operation.
7. We will also set down what has been agreed in a co-packers agreement.
So the core question is, is MOIRA prepared to invest in expansion and the line on the basis of a sales guarantee and a co-pack agreement.
Can you discuss this with MOIRA?
This email contained a clear indication, to Mr Koops, that ZFG was not interested in a joint venture as such, but preferred some arrangement under which it would purchase the produce of the proposed undertaking from the respondent, coupled with a "sales guarantee". As will be apparent from what follows next, however, the prospect of such a guarantee was not part of the applicant's discussions with the respondent.
10 By November 2011, Mr Koops and Mr Russell were exchanging financial models for the proposed snack production operation. The court knows that Mr Koops sent a model to Mr Russell on 8 November, but the copy of the spreadsheet on which the details of it were set out tendered (by the respondent) in the case had, by the time of its reproduction for that purpose, been altered by Mr Russell in his response to Mr Koops of 22 November 2011. A focus of Mr Russell's concerns was the level of sales which the respondent would be likely to achieve, particularly in the early days of what would be a new offering on to the Australian retail market. In that response, Mr Russell said that he had put in some "very conservative figures" for sales in the first two years, namely of 250 t and 500 t respectively. In years 3, 4 and 5, Mr Russell had used the figures previously suggested by Mr Koops, which were based on sales of 1000 t/year. In his response of 22 November, Mr Russell referred to the risk of a slow take-up of the new snacks product by retailers, saying "clearly it would have a major impact on cash-flow". He continued:
Perhaps to mitigate this risk, we need some pre-commitment from the retailers. O & G would need to investigate at the strategic management level.
Moira Mac's won't be able to fund equipment and cash flow losses - we would need some certainty to take to the bank.
I need to get the financial viability clear before I can get the Memorandum.
There is no evidence of whether, and if so how, Mr Koops responded to Mr Russell's concerns. "O & G" was a reference to a company affiliated with the applicant called "Orange & Green" which conducted a number of services for the applicant including "administration, supply chain [and] quality assurance".
11 Whether or not prompted by Mr Russell's concerns, the fact is that, by about November 2011, the applicant had secured in-principle understandings with two of the larger retailers, Coles and Woolworths, that they would, in Mr Koops' words, "stock and trial the snack products".
12 On 19 December 2011, Mr Koops sent Mr Russell a first draft of a memorandum of understanding to articulate the parties' intentions in the period prior to them entering into formal contractual relations. After identifying the parties, the memorandum proceeded in the following terms:
Purpose
The parties agree to work together on the planning, development, operation and management of a snacks operation to be built in the facilities of Moira Mac's.
This memorandum merely constitutes a statement of the mutual intentions.
Moira Mac's and Zwanenberg Food Group acknowledge the following are intentions vital to a successful partnership:
a) Both parties intend a long-term business relationship
b) Both parties need to work together in good faith
c) Confidentiality
Key Principles
a) Moira Mac's will invest in machinery and any specific building upgrade requirements
b) Zwanenberg offers Moira Mac's a guaranteed minimum value of contract
c) Zwanenberg and Moira Mac's share knowledge and experience
d) Zwanenberg and Moira Mac's work exclusively together in this production facility
e) Both parties work on basis of "open cost calculations", with regards to
- Recipe costs
- Direct labour costs
- Overhead
- Interest, depreciation/write offs and profits
Objectives
The project opens a window of opportunity for Moira Mac's to start up production in a wide range of products. These must not compete with Zwanenberg's range.
Zwanenberg offers Moira Mac's security by offering guaranteed compensation for volume or investment.
With respect to item e) under "Key principles" in this passage, Mr Koops gave the following evidence in chief:
Mr Russell said in the early stages that he questioned or was wondering if there's a profit in it for both parties and we agreed in the early stages to share information and make all our calculations open to each other, have no secrets, and that only had the purpose to make calculations more accurate and transparent to each other, but that requires a level of trust as well, which was important for both parties as well.
In a return email sent to Mr Koops on 20 December 2011, Mr Russell placed the following comment alongside the passage which would preclude the respondent from competing with the applicant's "range": "Define range".
13 Under Mr Koops' draft memorandum, the anticipated contract would have a term of five years. The memorandum dealt with the subject of intellectual property, and continued:
Financials
Estimated investment in Machinery $1,500,000
Estimated investment in building $500,000
Write off period 5 years
Moira Mac's invests in machinery and building upgrade requirements.
Should the project fail or was to be terminated prematurely, Zwanenberg will buy the machinery back from Moira Mac's at the residual fiscal value at that point in time.
The investment in the building is at Moira Mac's risk.
Proposal
Variable fee per kilo TBC
Minimum value of contract $400,000 per annum
Non Competition
During the contract period Moira Mac's will not use any of the snacks production equipment or Thermopack/MAP equipment for contractors other than Zwanenberg Australia.
Moira Mac's will not manufacture products in the snacks facility, whether branded or private label, for any retailer in the same categories as Zwanenberg is active in.
Zwanenberg will not enter the foodservice industry with snacks products. Moira Mac's will have exclusive access to the industry.
If volume grows over the expected volume production of 20 Mt per week (and free production capacity becomes more scarce), Moira Mac's will prioritize Zwanenberg production up to 25Mt per week (10 week average) at agreed rates.
Moira Mac's is allowed to produce non conflicting products on the production line. Moira Mac's will be charged a contribution rate that will be deducted from the Zwanenberg fee.
Again, in his reply of 20 December 2011, Mr Russell inserted a number of comments into the text set out above, including the following alongside the passage "40 Mt per week": "Assume 20 ton per 40 hour shift with notional capacity of 40 ton per week".
14 Over the period 15-19 January 2012, Mr Russell visited the ZFG operations at Corby in the United Kingdom and at Aalsmeer, Borculo and Almelo in The Netherlands, where he observed snack food production of the kind that was anticipated for Bendigo, should the proposed arrangement go ahead. Accompanied by Mr Koops, Mr Russell met, and had discussions with, Mr van der Laan, Mr Lotgerink, and Sjoerd van der Laan, Mr Aldo van der Laan's son, being Mr Koops' direct report in the management of ZFG. In the course of those discussions, Mr Lotgerink said that he wanted to develop a business based (and here I refer to the evidence of Mr Koops) on "additional costs", that is costs which were "additional to the existing business" of the respondent. Mr Koops referred to this approach as "incremental costing". Mr Russell agreed with that approach. In his evidence in chief in this case, Mr Russell said that, at the conclusion of this trip, he was "very interested in pursuing the arrangement with ZFG".
15 During the next few months of 2012 the applicant was, it seems, occupied in what Mr Russell described as "extensive due diligence" on the respondent. The applicant was provided with the respondent's profit and loss statements, and with its balance sheet as at 31 December 2011. According to Mr Russell, the applicant "was interested in analysing [the respondent's] financial position and costs of producing its own products". I would add that this level of interest in such matters arose because of two principles embodied in the parties' then understanding: first, that of "open cost calculations", which meant, in effect, that the respondent would be completely open with the applicant about its current level of costs, and secondly, that of "incremental costing", as referred to in the previous paragraph. The applicant would know how much it would cost the respondent to produce one additional unit of output, a circumstance which, of itself, would give the relationship between the parties a feature which would normally not be found in conventional buyer/seller price negotiations.
16 In early May 2012, the applicant had its Melbourne solicitors prepare a first draft of what would have been the written contract which governed the parties' relationship for the production of snack foods by the respondent at Bendigo. Although, ultimately, nothing came of that draft, the facts that it was sent to Mr Russell and, I infer, that it was on his solicitor's desk when he (the solicitor) prepared the first draft of the agreement which the parties executed later in 2012 are important, even if only very high-level, aspects of the background.
17 The applicant's draft proposed that, for the manufacture of products in accordance with the contract, the respondent would be paid a "fee" made up of the sum of three "components": a "standard manufacturing cost price", an amount to cover interest and repayments payable by the respondent for the acquisition and establishment of the capital infrastructure which would be used to make snack products for the applicant, and a profit margin of 3%. As to the first of these components, the draft contract provided as follows:
Zwanenberg will pay the Manufacturer the manufacturing cost price for Products manufactured pursuant to a Purchase Order.
Principles:
- Initial manufacturing cost price based on preproduction costing
- Corrections to manufacturing cost price based on postproduction costs
Manufacturing cost price consists of:
- Materials (raw materials and packaging) - at cost
- direct labour - at cost
- Overhead (indirect costs for snacks production, excluding depreciation and interest):
• Total sum overhead to be maximized
• Based on preproduction estimates overhead is maximized at $700,000 per annum over a volume of 1,000 Mt produced product
• Correction based on postproduction costs
It was also provided as follows:
For the avoidance of doubt, other than the Fee no monies are payable by Zwanenberg to the Manufacturer in respect of the manufacture or delivery of the Products.
Although nothing further was seen of a provision in terms like those just set out, it is useful to note its existence in this early draft provided on behalf of the applicant, as it demonstrates the starting position, as it were, from which the applicant commenced negotiations with the respondent.
18 When Mr Russell received this draft from the applicant, he did not favour it. In his view, the draft did not reflect the memorandum of understanding prepared in the previous December. It was "written very much in legal language and [Mr Russell] wanted the deal to be expressed more in language that [he] was comfortable with." Under cross-examination, Mr Russell was challenged on the genuineness of this explanation for his reservations about the draft, but nothing turns on the matter. The fact is that, because of those reservations, the draft was taken no further.
19 Instead, on 17 May 2012, Mr Russell forwarded his own draft to Mr Koops. This was written on the respondent's letterhead, and was in the form of a letter addressed to the applicant. Between the parties, it came to be referred to as the "letter agreement", and I shall follow that convention. After the greeting, the letter was headed "Australian manufacturing arrangements for Zwanenberg snack products". The letter was over the hand of Mr Russell, but not at that stage signed by him: indeed, it was transmitted to Mr Koops electronically, and referred to in the covering email as a "draft". The letter concluded by inviting the addressee, the applicant, to sign in the space provided at the foot of the last page if it agreed with the terms and conditions set out in it. In point of content, the letter agreement owed much to the applicant's draft contract referred to in the previous paragraph, but a number of provisions had been introduced to protect the respondent's interests. In his covering email, Mr Russell said, rather optimistically as matters turned out, that there were "some small revisions needed for this draft, but should finalise in the morning".
20 The first section of Mr Russell's draft was headed "Background", and served as a kind of preamble to the letter agreement. Clause 1.4 was as follows:
Under this arrangement:
(a) Moira Mac's agrees to invest in new machinery and building upgrades required to manufacture the products;
(b) Zwanenberg will purchase the manufactured products based on an "open cost calculation" plus agreed profit margin;
(c) Zwanenberg agrees to order minimum quantities of the manufactured products;
(d) each party agrees to make available their respective know-how on a non-exclusive basis solely for the purpose of the manufacture of the products under this letter agreement and not for any other purpose;
(e) Moira Mac's agrees to exclusively manufacture products for Zwanenberg,
on the terms and conditions of this letter agreement.
Alongside para (c) of this subclause, Mr Russell himself had inserted the electronic comment: "pay a minimum fee based on the cost of principal and interest financed for machinery and factory set-up".
21 Section 3 of Mr Russell's draft was headed "The deal". Clauses 3.1 and 3.2 provided as follows:
3.1 (Term) This letter agreement shall commence on the date of this letter agreement and continue for a period of seven (7) years unless terminated earlier in accordance with this letter agreement (Term). This letter agreement may be extended by mutual agreement of the parties.
3.2 (Investment in Machinery) Moira Mac's agrees to invest in the machinery (Machinery) and building upgrade requirements relating to the Machinery (Building Upgrades) as set out in Annexure A. Moira Mac's shall finance the purchase of the Machinery and Building Upgrades with its financiers.
The remaining provisions of section 3 dealt with knowledge sharing, confidentiality and non-competition. Section 4, headed "Manufacturing", ultimately lay at the centre of the letter agreement, but the only further thing which needs to be said about it here is that it contemplated that there would be an Annexure A to the letter agreement, dealing with product specification. That annexure was not then included.
22 The provision, ultimately agreed, which was based on section 5 of Mr Russell's draft is, however, most controversial. The whole of the section as it appeared in that draft provided as follows:
Financial matters
5.1 (Fees) From the Commission Date, Moira Mac's shall invoice a fee for each delivery of Products based on a variable fee per kilo (Fees). Zwanenberg agrees to pay the Fees to Moira Mac's. The Fees shall consist of three components:
(a) manufacturing costs (including materials, packaging, labour and overhead) as set out in Annexure B to this letter agreement (Manufacturing Costs). Manufacturing Costs shall be calculated at the commencement of each calendar quarter;
(b) capital costs (comprising principal and interest on the loan for Machinery (including any commission costs) and building upgrade requirements) (Capital Costs). For the avoidance of doubt, the Capital Costs include any payments on the loan prior to the Commission Date required for pre-commissioning activities. Any government grants for the manufacturing using the Machinery shall be used to reduce the Capital Costs. Capital Costs shall be forecast at the commencement of this letter agreement until 30 June 2013 (and, thereafter, each financial year ending 30 June) based on the forecast finance costs divided by the forecast production volume for that period. At the end of each period, the Capital Costs shall be adjusted against the actual finance costs paid by Moira Mac's in that period and Moira Mac's shall be entitled to invoice an adjustment equal to this adjustment amount; and
(c) an agreed profit margin of five percent (5%) applied to all of the above;
5.2 (Payment terms) All payments are due within 30 days of the end of the month in which the products are manufactured an delivered;
5.3 (Minimum Fees) At the end of each calendar month, Moira Mac's shall be entitled to invoice an adjustment to Zwanenberg equal to the amount of the actual Capital Costs for that calendar month (regardless of the quantity of Products ordered and invoiced in that month) less the total cumulative Capital Costs component of the Fees invoiced to Zwanenberg for Products during that calendar month.
5.4 (Security) Zwanenberg's parent company must provide, within 7 days of request by Moira Mac's, an irrevocable letter of credit from a reputable bank in favour of Moira Mac's financiers as security for the financing required for the machinery (Letter of Credit). The investment in the Building Upgrades is at Moira Mac's risk.
5.5 (Charge) Zwanenberg shall be entitled to a charge over the specific Machinery provided that the charge shall be released when the Letter of Credit is released by Moira Mac's financiers.
5.6 (Purchase of Machinery) If Zwanenberg terminates this letter agreement under clauses 8.1 or 8.2, Zwanenberg may purchase the Machinery from Moira Mac's at the residual fiscal value at that point in time.
5.7 (Insurance) Moira Mac's shall maintain adequate insurance to cover general (product) liability they may incur in regards to the agreement.
In his draft, Mr Russell had placed an electronic comment alongside para (c) of cl 5.1, as follows: "2% will be set aside to reinvest in capital improvements during the term, allocated annually with both parties' agreement. Any surplus capital would be split equally at the end of the term or carried over into a new term." Nothing further came of that suggestion, the profit margin having been agreed, at a fairly early stage, at 3%. The controversial aspect of section 5 was cl 5.3, which became a frequent subject of the correspondence subsequently passing between the parties. It should also be noted, at this stage for the sake of the narrative only, that cl 5.1(a) contemplated that there would be an Annexure B to the letter agreement, dealing with the matter of manufacturing costs.
23 On 21 May 2012, Mr Russell sent a further email to Mr Koops, attaching what he described as "some formats that could be attached" to the proposed agreement. One of the attachments was a schedule of the "annual estimated cost", as the heading to the schedule stated, for each item of expense that would be involved in the production of snack products for the respondent. Each item of cost had been converted into a "per kg" figure, based on the assumption that annual production would be 1,000,000 kg, ie 1,000 t. The total came to $10.97 per kg, including the 3% profit margin. The respondent's evidence-in-chief was that this schedule was a "template [which] estimated a cost of $10.96 per kg to produce a processed meat product". Under cross-examination, Mr Russell said that the schedule was merely "a copy of our general ledger ... as it was at that time", that he was not "attempting to estimate cost", that the schedule was "the logical total for those items", and that he was "merely reflecting a template as it appeared within the Moira Mac's business".
24 Mr Russell's schedule was not well received by ZFG in The Netherlands. In an email sent to him on 22 May 2012, Mr Koops said that the schedule had "caused quite a bit of commotion", adding that "your cost model is very different to what we have worked with thus far". One of the matters to which Mr Koops drew specific attention was "factory overhead", which he said was "much higher". He said that total overhead was $1.7m, "where we advised earlier that overhead should be maintained at 880K". Mr Koops concluded his email by proposing that he and Mr Russell should have a telephone or video meeting the following day.
25 They did have a meeting on 23 May, but it was face-to-face, at a cafÉ somewhere in Tooronga. At that meeting, Mr Koops informed Mr Russell of the poor reception which his (Mr Russell's) email sent the previous day had received in The Netherlands. According to Mr Koops' evidence, Mr Russell's response was in the following terms:
You were not supposed to send that through to The Netherlands. That was just for you to understand what I think … the costs incurred in that snacks operation would be. So it was more a - an example of a costs model rather than the cost that I think would be incurred.
Mr Koops then reminded Mr Russell that he (Mr Koops) worked for the applicant, and that it should be expected that he would send any document he received on to The Netherlands. Mr Koops attempted to explain to Mr Russell what he meant by "incremental costs", namely, "the additional out-of-pocket costs to [the respondent's] business by setting up that snacks factory" but, still according to Mr Koops' evidence, Mr Russell did not "give [him] the opportunity to finish [his] explanation". Mr Russell said that Mr Koops did not have to lecture him on accounting, to which Mr Koops responded that, if Mr Russell got his numbers right, he would not have to lecture him. Mr Koops described this as a very unpleasant meeting. Taken to the meeting in cross-examination, Mr Russell was unable to recall it with anything like the detail given by Mr Koops. He said that he did not recall the use of the word "incremental", but I accept Mr Koops' evidence that the word was used; and I accept his evidence generally about the meeting, in preference to the very limited, uncertain, evidence given by Mr Russell.
26 On 25 May 2012, there was a video conference involving Mr Russell for the respondent and Mr van der Laan, Mr Lotgerink, Mr Baan, Mr Koops and Mr Sjoerd van der Laan for the applicant. Although Mr Sjoerd van der Laan's presence at the conference was not clearly recalled by Mr Koops, an email from the latter to Mr Russell on 26 May 2012 makes it clear that he was there. At this conference, Mr Russell first outlined his reasons for not wanting to use the manufacturing agreement that had been prepared by the applicant's Melbourne solicitors. The representatives of the applicant said that they were happy to work with Mr Russell's letter agreement.
27 It was at this video conference that Mr Russell and Mr Baan first met. Mr Lotgerink said that he proposed to have Mr Baan involved in developing the cost model for the proposed snacks operation on behalf of the applicant, because he had a lot of experience in that field. Mr Baan, who had recently seen Mr Russell's schedule of estimated costs of 21 May 2012, and been told by Mr Koops (subsequent to the unpleasant meeting at Tooronga) that the figures in that schedule had "no substantive value", told Mr Russell that he would "rather use [his] own cost pricing model to calculate a proper cost price". Mr Russell had no objection to that. Mr Koops recalls Mr Baan asking Mr Russell: "Are you willing to open your books so we can have a good look and develop a cost model that we are all happy with?"
28 The importance of getting the cost model right, of course, lay in the circumstance that the proposed arrangement was, on one view of it, to be a hybrid of a conventional arms-length contract and a joint venture. The respondent was to produce goods for sale to the applicant, but the agreed price for those goods was to be such as would cover the costs involved in their manufacture. The "costs" in question - under a firm requirement of the applicant which was accepted by the respondent - were to be the additional costs incurred by the respondent in running the snack foods operation alongside its existing business. In order to determine what those costs were, the applicant considered it to be necessary for the respondent to accept an "open books" approach to the parties' negotiations on the subject, and that was accepted by the respondent. From this point forward, the calculation of the unit price of the goods to be produced by the respondent was effectively driven by Mr Baan. The experience of the few days leading up to this video conference on 25 May 2012 had left neither him nor his colleagues in The Netherlands with any great confidence in Mr Russell's capacity to handle, unassisted, the concepts or the detail involved in calculations of the kind that would be required.
29 Those attending the video conference on 25 May 2012 also discussed various amendments to the draft letter agreement which Mr Russell had sent to Mr Koops on 17 May 2012. In Mr Koops' email to Mr Russell of 26 May 2012 to which I have referred, the former asked the latter for confirmation that he would send an updated version of the letter agreement, with all the additions which had been discussed with Mr Sjoerd van der Laan and Mr Lotgerink at that conference. That was necessary, he said, because a signed manufacturing agreement was a condition of the guarantee which the applicant's bank proposed to provide in relation to the debt the respondent would incur for the purchase of the machinery to be used in the snacks production line at Bendigo.
30 On 28 May 2012, Mr Russell sent Mr Koops an electronic copy of his then draft of the letter agreement. The draft contained some changes compared with the 17 May version, and Mr Russell also had inserted more marginal comments which, he said in his covering email to Mr Koops, related to the "Friday discussion" (ie, I infer, the video conference). Mr Russell said that he would send the draft to his solicitor "for a re-write", he asked Mr Koops to "comment asap", and he added: "Please don't forward until we discuss." The draft of 28 May 2012 contained what were, in effect, no more than blank placeholders for the foreshadowed Annexures A and B.
31 Mr Koops responded to Mr Russell's draft letter agreement on the same day. He made a number of comments on the draft, one of which was headed "Costprices" and read:
Both parties will make a list of cost components that make up the cost price.
Comparison will show the differences which both parties will discuss.
Mr Russell's response by return included the comment that "my next cost model will have to be compared against yours before it is ready to [be] put on the table for negotiation".
32 That next cost model was in fact sent by Mr Russell to Mr Koops at 6 pm that very day, 28 May 2012. It was a development of the so-called template sent by Mr Russell on 21 May 2012. The original figure of $10.97 per kg had come down to $10.82. Some additional cost items were included, as were Mr Russell's explanations, in some cases, of items on the list. Of particular present significance was the inclusion of a new column setting out the respondent's "annual fixed" costs. These were stated as annual, not unit, figures. The items concerned were superannuation and wages for direct staff, electricity, gas, audit fees, cleaning/rubbish removal, rent, accountancy, bank charges, computer supplies, consultant fees, insurance, laundry, licence fees, minor equipment under $100, pest control, printing and stationery, council rates, water rates, machinery consumables, samples, staff amenities, staff training, telephone, internet, mobiles, and travel. The total of these annual fixed costs was $644,150. Mr Russell's endorsement alongside that total was "MM LIKELY COSTS REGARDLESS OF VOLUME". A note made by Mr Russell at the head of the table read: "Fixed costs per kg are vulnerable to sharp increase with low volumes".
33 Mr Koops sent Mr Russell's cost model to Mr Baan in The Netherlands. Mr Baan re-arranged, but did not alter, Mr Russell's figures to make them comparable with the costs incurred by ZFG in the production of a Dutch snack product, chicken satay. He calculated that the overhead cost shown in Mr Russell's figures was $1.76 per kg, based on an annual production of 1,000 kg, whereas the corresponding Dutch figure was $1.50. Mr Baan sent his cost comparison to Mr Koops, but there is no suggestion that it was sent on to Mr Russell.
34 Mr Baan found, however, that true comparability as between Australian and Dutch costs was difficult to achieve. In his witness statement, Mr Baan said:
For this reason, I knew that the next stage of analysis of the feasibility of the Moira Mac's proposal would require me to analyse Moira Mac's financial information, such as its payroll records, rent costs, and accounts. I understood from Mr Koops that Mr Russell had told him that he had over 30 years experience in the industry and had been the CEO and financial controller of Moira Mac's. I therefore expected that he would have a detailed knowledge of his business and of the costs incurred in conducting it. I relied heavily on this knowledge and what he told Zwanenberg, because no one from the Zwanenberg side knew the conditions in Australia. For this reason, the cost model that I intended to create to determine if the proposed arrangement would be profitable would involve a combination of Zwanenberg and Moira Mac's input.
Mr Baan was taken to this passage in cross-examination, but not in any way that involved a substantial challenge to what he said.
35 The parties' objective had been to execute the letter agreement in May 2012 and, with that in mind, Mr van der Laan and Mr Lotgerink came to Australia in late May, with a view to participating in a formal signing at the respondent's premises at Bendigo. They did come to Australia on 29 May 2012, but the parties' agreement had not matured to the extent that would be necessary for the execution of a written document at that stage. In the result, these men, accompanied by Mr Koops, used the occasion to discuss unresolved issues with Mr Russell, and to inspect the Bendigo factory. As to the latter aspect, it was in May 2012 that it became apparent to Mr Russell that the Pasta Master area would be available to rent if he wanted it, and thenceforth the applicant and the respondent formulated their plans on the assumption that that area would be used for the proposed snacks operation. It seems to have been resolved during Mr van der Laan's visit that the Pasta Master area would be used.
36 In the days following the visit of Mr van der Laan and Mr Lotgerink, Mr Peters and Mr Versantvoort visited Bendigo to deal with engineering and technical arrangements for the installation and later operation of the required equipment and machinery in the former Pasta Master area. It was, it seems, during the visit of Mr Peters and Mr Versantvoort that the subject of the remuneration to which the respondent would be entitled for the labour costs involved in meat preparation was first raised, and discussed as between them and Mr Koops and Mr Russell. The "meat preparation" phase of the operation would take place after the meat had been received from the respondent's supplier, but before the commencement of the snacks process as such. I shall return to this subject in due course.
37 On 7 June 2012, Mr Koops wrote to Mr Russell informing him that Mr Lotgerink had asked Mr Baan "to make a full, detailed analysis of the cost model". The analysis would proceed conformably with the following "starting principles":
• Open cost information
• Open cost calculation, based on incremental costs
• Look for opportunities for cost savings for Moira Mac's based on benchmarking with Zwanenberg
Mr Koops proposed a "cost type analysis", suggesting a classification of costs by direct costs (recipe and labour), indirect factory costs (overheads of different kinds), lease and rent, depreciation and indirect financing costs (interest). He asked Mr Russell to provide his costs, based on his financial statements for 2011 and 2012, by reference to that classification. He asked: "Can you give me your estimate on incremental costs to run the snacks production?" He added that Mr Lotgerink would like this information "asap". In a number of tranches, Mr Russell provided at least some of the information requested over the period 11-12 June 2012.
38 On 15 June 2012, Mr Baan sent an email to Mr Koops, identifying the financial information that Mr Russell had not supplied to that stage, stating that the respondent's average overhead rate was $2.60 per kg (which Mr Koops, in an email to Mr Lotgerink on 18 June 2012, considered to be "reasonably in line with [the applicant's] figure of EUR2.15/kg for snacks") and attaching his "calculation model". That model indicated that the incremental overhead cost to the respondent for having to produce an additional 1000 t of products would be $709 (ie $0.71 per kg). Over the ensuing fortnight or so, Mr Baan continued to refine his calculations as more information became available from Mr Russell. Save to provide information as requested, and to clarify things from time to time, Mr Russell was not part of this process.
39 On 4 July 2012, Mr Russell sent Mr Koops a revised version of the draft of the letter agreement. The draft of 17 May had been amended in a number of respects, including by the insertion of the passage "plus the fixed component of the Manufacturing Costs (Annexure B)" after the words "actual Capital Costs" in cl 5.3. Annexures A and B, as such, remained blank. On 5 July 2012, Mr Koops replied to Mr Russell, noting, in relation to the amendment to cl 5.3:
Speaks of "plus the fixed component of the Manufacturing Costs (Annexure B)"
Albert has finished his pre production cost calculations which he'll share with us soon. We need to make sure this fixed component is described carefully in this overview as well.
40 As to what happened next, Mr Russell gave the following evidence-in-chief:
Following Koops' email I spoke to him about the subject of fixed costs. I said to Koops that I had made it clear to he and Aldo during their visit to Australia in May that Moira Mac's could only proceed with the joint venture of [sic] Zwanenberg would guarantee our monthly costs for operating the snacks business. I said that clause 5.3 would need to be amended. I said to Koops that Moira Mac's would only proceed if it was entitled to recoup its fixed costs (bank principal and interest, fixed component of its manufacturing costs, such as rent and insurance regardless of the amount of product that [Zwanenberg] ordered. Where volumes of product were of sufficient quantity to cover Moira Mac's costs, there would be no issue. However, if the volume of orders was small, Moira Mac's would not recover its fixed costs and would end up subsidising [Zwanenberg's] sales to its customers. I said to Koops that clause 5.3 had to be amended to address that situation.
The "Aldo" referred to was Mr van der Laan. I take it that the missing closing parenthesis in about the middle of this passage was intended to come after the word "ordered".
41 By email of 10 July 2012, Mr Koops accepted the amendment to cl 5.3 of the letter agreement proposed by Mr Russell on 4 July. He added that he had discussed the matter with Mr Baan, and that his (Baan's) estimate for the total costs, per annum, was, approximately, $384,000 by way of interest and repayment fee, $50,000 for rent and $50,000 for insurance, which Mr Koops proposed might be rounded off at $500,000 pa. He said that, if that was in line with Mr Russell's thoughts, they could "add these estimated costs to Annexure B". By return email the same day, Mr Russell told Mr Koops that he had "a much broader view of what comprises 'fixed components'", and that he would send Mr Koops "a list of what [he thought] should be included".
42 Also on 10 July 2012, Mr Koops sent an email to Mr Russell and Mr Peters, to which was attached a cost price model prepared by Mr Baan, on which he had been working for a number of weeks. For each of several product/size categories, the model stated the price, per kilogram, that the applicant would pay the respondent for producing the items in question; and it gave a breakdown of the components in that price. Taking the 600 g pack of meatballs as an example, the model showed the following:
MEATBALLS Bulk Pack 600 gr
Meat
Prod Loss
Spices
Oil
Packaging
Labour 0.51
Overhead 0.81
Interest and repayment fee 0.25
Copackers margin 0.05
1.62