Brookteck Pty Ltd v Lumocol Australia Pty Ltd
[1996] FCA 919
•23 OCTOBER 1996
CATCHWORDS
TRADE PRACTICES - whether representations as to cash takings and profit margins were made in the course of the sale of a book business - reliance.
CONTRACTS - cannot rely on an exclusion clause where there has been a breach of the Trade Practices Act 1974 (Cth).
DAMAGES - how assessed - goodwill - valuation - difference between value of business and price paid.
Trade Practices Act 1974 (Cth) s 82
Corporations Law s 459E
Fair Trading Act 1987 (NSW) s 72
Clark Equipment Australia Ltd v Covcat Pty Ltd (1987) 71 ALR 367, cited.
Petera Pty Ltd v EAJ Pty Ltd (1985) 7 FCR 375, cited.
BROOKTECK PTY LIMITED (First Applicant) KRISTIAN BANT ROMULD, JILL CAROLYN ROMULD (Second Applicant) and LUMOCOL AUSTRALIA PTY LIMITED (First Respondent), ALBERT (BARRY) ALLERTZ (Second Respondent) and LUMOCOL AUSTRALIA PTY LIMITED (Cross Claimant) and BROOKTECK PTY LIMITED (First Cross-Respondent) and KRISTIAN BANT ROMULD (Second Cross-Respondent) and JILL CAROLYN ROMULD (Third Cross-Respondent)
No NG 501 of 1994
Tamberlin J
Sydney
23 October 1996
IN THE FEDERAL COURT OF AUSTRALIA )
NEW SOUTH WALES DISTRICT REGISTRY ) No. NG 501 of 1994
GENERAL DIVISION )
BETWEEN: BROOKTECK PTY LIMITED
First Applicant
KRISTIAN BANT ROMULD and
JILL CAROLYN ROMULD
Second Applicants
AND: LUMOCOL AUSTRALIA PTY LIMITED
First Respondent
AND: ALBERT (BARRY) ALLERTZ
Second Respondent
LUMOCOL AUSTRALIA PTY LIMITED
Cross Claimant
AND: BROOKTECK PTY LIMITED
First Cross-Respondent
AND: KRISTIAN BANT ROMULD
Second Cross-Respondent
JILL CAROLYN ROMULD
Third Cross-Respondent
CORAM: TAMBERLIN J
PLACE: SYDNEY
DATED: 23 OCTOBER 1996
REASONS FOR JUDGMENT
TAMBERLIN J:
In this application the applicants seek damages under the Trade Practices Act 1974 (Cth) ("the Act"). They also seek to set aside a personal loan agreement. Further, the applicants seek to set aside a Statutory Demand served on the first applicant pursuant to s459E of the Corporations Law ("the Law").
Against the second respondent damages are sought under s72 of the Fair Trading Act 1987 (NSW). Alternatively, an order is sought under s7 of the Contracts Review Act 1980 (NSW) to set aside the personal loan agreement.
There is a cross-claim by the first respondent against the first applicant under a sale agreement of 1 July 1992 and as against all applicants upon a loan agreement of the same date.
In final submissions the relief claimed by the applicants was for damages, interest and costs.
The Nature of the Claim
Essentially, the claim is that in the course of a series of meetings held between the second applicants ("the Romulds") and the second respondent ("Mr Allertz") which culminated in the sale of a technical book business, Mr Allertz misrepresented that the business had generated a substantial cash amount, in the order of $100,000, over and above the income disclosed in the books of account of the business, and that the gross profit margin of the business was substantially higher than it was in fact.
Background
In May 1992, Mr Romuld was interested in purchasing a business. He had a meeting with a Mr Golosky who was a business broker, in relation to certain businesses which were on the market.
On 29 May the Romulds met with Mr Golosky. He mentioned the business known as Northbridge Book Supplies ("NBS") which had just come onto the market and which he described with some enthusiasm.
Mr Romuld recollects having been given some sort of profit and loss statement from the owner of NBS, the first respondent, ("Lumocol"). Mr Romuld was also given a business summary.
The business summary showed that the business was the wholesale distribution of book supplies and that the takings July 1991/April 1992, a period of ten months, were $3.527 million. The gross profit was stated to be $817,767 and the nett profit was expressed to be $416,589. The stock was stated to be $389,692 as at 30 April 1992. The business was described as:
"TRADING AND REGISTERED AS 'NORTHBRIDGE BOOK SUPPLIES', BARCODED TEXT BOOKS, SOLD TO TAFE AND BUSINESS COLLEGES HALF EQUITY IN BUSINESS CONSIDERED. VENDOR WILL CONSIDER FINAL STOCK FOR PURCHASER."
The nominated price on the business summary was $650,000 plus stock at value.
On Monday, 1 June 1992, a meeting took place between Mr Allertz, Mr Golosky and the Romulds.
Before going to the meeting Mr Romuld prepared a list of eight questions. One of these questions read:
"7.What financial benefits have been extracted in the last three years."
The questions are dated 1 June. The answer given to question 7 as recorded on a note of Mr Romuld reads:
"7.$100,000 in cash (probable loss $50,000 to staff)"
At that meeting Mr Allertz indicated that he could stay on for the transitional period of one or two years. Mr Romuld asked about the management accounts and he was told by Mr Allertz that the year ended on 30 June, but there was not much activity in May and June. There was some discussion about the method of marketing and access to colleges. Mr Romuld alleges, (and this is denied by Mr Allertz), that Mr Allertz said he had extracted around $100,000 in cash each year from the business and that the business made more than $500,000. Mr Allertz is alleged to have said that it was an unbelievable business and that he had taken out over $100,000 per annum but some of this went to staff. Mr Romuld says that his interest increased immensely knowing that the business was grossing more than $516,000 per annum clear, particularly having regard to the asking price of approximately $650,000. It struck him as good value.
The following day Mr Romuld telephoned Mr Golosky expressing interest in the business and wishing to see one of the retail outlets. A meeting took place between the Romulds and Mr Allertz at North Sydney TAFE in the afternoon of 3 June 1992. Mr Romuld was handed a profit and loss statement of Lumocol and was told by Mr Allertz that these figures were correct and that he should disregard the previous figures. There was some discussion about selling only 50% of the business.
On 6 June 1992, Mr Romuld had discussions with his adviser, Mr Brian Steele, who was an accountant. They discussed the accounts of Lumocol for the years 1990 through to 30 April 1992. A meeting took place on 9 June 1992 between Mr Romuld and Mr Allertz. Mr Romuld took a list of twelve questions with him to the meeting and raised the issues with Mr Allertz. The questions were discussed. Mr Allertz is alleged to have said that the inventory at 30 April 1992 was correct. The figure shown in the accounts was $389,692. Mr Allertz is alleged to have said that he was basically looking for $400,000 for the business but in addition there was another $100,000 for cash taken out. Further, he is alleged to have said that he took out $130,000 in cash, in the previous year, but gave the staff $30,000, so that he received a nett amount of $100,000. He said that the assets were worth $100,000 and you could not replace them for less than that and Mr Golosky's fee had to be covered which would be around $30,000, giving a total figure of $630,000 for goodwill and assets and that stock would be around $300,000. It is claimed Mr Allertz also said, in relation to taking cash out of the business, that it was possible to take out as much as you like and that he had taken out $100,000 per annum and that had he so wished, he could have taken out $150,000. After paying staff $30,000 he retained over $100,000. The substance of this conversation is denied by Mr Allertz.
Contemporary notes taken by Mr Romuld on 9 June include the following note:
"Looking for 400
cash 100 (130 in, 30 out
assets .... 100
Golosky 30
630
Stock 300+ "
On 10 June 1992 Mr Romuld again met with Mr Steele and prepared lists of twelve questions in all, to be raised at a meeting with Mr Allertz on 13 June.
On 13 June 1992, Mr Steele and Mr Romuld met at the offices of NBS with Mr Allertz and a further fifteen questions were raised with Mr Allertz.
In the course of discussions Mr Steele is alleged to have said that the margin of 26% in the 1991/1992 year was a big improvement over the previous year. At this meeting Mr Romuld claims that he was handed a copy of a stock-take summary as at 30 April 1992. On the bottom left-hand side of this is a note of a figure of $389,692 and below that a figure of $489,692 showing an alteration and increase in the amount of stock as at 30 April 1992.
On 16 June 1992 Mr Romuld met with Mr Allertz and obtained a further bundle of current bank statements.
In the course of this meeting, Mr Allertz is alleged to have said that he took $130,000 out of the business but had to pay the staff $30,000, and that his accountant, Mr Somerville, did not know about that. This is denied. However, Mr Allertz agrees that he did say to Mr Romuld words to the effect that the business was a retail business like all other businesses around, "everyone takes cash out".
On 21 June 1992 there was a telephone conversation between Mr Allertz and Mr Romuld.
In the course of that conversation Mr Romuld says that he pointed out to Mr Allertz that when the profit for ten months to 30 April 1992 was first calculated it came out at $500,000 but was then reduced to $416,000 and he wished to know the true figure. Mr Allertz said that he should disregard the $500,000 because it had not taken into account some stock for
which payment needed to be made as it was on the forward charge account and that the true figure was $416,000.
At a meeting on 23 June 1992 between Mr Allertz and Mr Romuld, Mr Allertz is alleged to have confirmed that the original stock figure was $489,692 but it is shown in the 30 April accounts as $389,692. Mr Allertz is said to have confirmed that the figure of $389,692 was independent of the $130,000 cash which it is said was taken out, and of which it is claimed $100,000 was retained by Mr Allertz after payment of staff. Mr Allertz is said to have agreed that the rest of the accounts were genuine.
On 24 June 1992 there was a further meeting between Mr Allertz and Mr Romuld, in which there was further discussion of the taking out of a cash amount of $130,000 of which $30,000 was used to pay wages.
Mr Romuld produced a document to Mr Allertz, (Exhibit W) which is set out later. This had notes on it in which refer, in relation to profit, to an amount of $100,000, described as "cash in". There is also a reference under the heading "Sales" to "Cash 130".
Mr Allertz is said to have agreed that the true level of performance of the business was a profit of $477,000 on sales of $3,828,000.
Mr Romuld said in deciding to purchase the business he relied on what Mr Allertz said on 24 June 1992 and in the amendments to the document which he had shown to Mr Allertz, (annexure W). The Romulds entered into the personal loan agreement also on that basis. These documents were entered into on 1 July 1992 at the office of Mr Golosky.
During July to August 1992 the Romulds were fully occupied in the warehouse. In early 1993 Mr Romuld became concerned about the performance of the business and in May 1993 sought to identify the causes for losses. By July 1993, Mr Romuld's then accountant reported a loss for the year of $140,000. Subsequently attempts were made to identify the cause of the losses. By December 1993 Mr Romuld came to the conclusion that the ten months operating statements to April 1992 were incorrect.
On 30 March 1994 the solicitors for Mr Romuld issued a letter of demand to Mr Allertz and on 5 August 1994 the applicants commenced these proceedings.
The Issues
The first issue is whether Mr Allertz represented that in addition to the reported profits of the business, the business also generated a further sum of approximately $100,000 which was available to be taken out in cash.
The second issue is what was the gross profit margin in the financial year to 30 April 1992?
The third issue which relates to the assessment has two sub-issues. The first is the impact of any misrepresentations on the value of the business and the second is the extent to which interest should be charged on the damages.
The claims under the Contracts Review Act 1980 (NSW) and under s87 of the Act were not pressed.
The Sale Agreement
The Sale Agreement was dated 1 July 1992, the vendor being Lumocol Australia Pty Limited ("Lumocol") and the purchaser being Brookteck Pty Limited ("Brookteck"). The Agreement recites that Lumocol conducts the business of the retail and wholesale distribution of text books to New South Wales TAFE Colleges, private business colleges and various other educational institutions, together with stationery, compact disc and cassette recordings under the name of Northbridge Book Supplies ("NBS"). The business was conducted from office and warehouse premises situated in Brookvale, and from six permanent retail outlets situated in specified TAFE colleges.
The relevant clauses for present purposes are clauses 1 and 3 which read as follows:
"1. THE AGREEMENT
(a)The Vendor has agreed to sell and the Purchaser has agreed to purchase the Vendors business trading as 'NORTHBRIDGE BOOK SUPPLIES' and all the Vendor's right, title and interest to and in the business of the Vendor, which without limiting the generality of the foregoing shall include the goodwill, plant, fixtures, fittings and chattels and choses in action free from all encumbrances, charges and liens for the sum of $630,000.oo SIX HUNDRED AND THIRTY THOUSAND DOLLARS (hereinafter called "the Purchase Price"); and such sum to be apportioned as follows :-
As to GOODWILL $ 520,000.00
As to FIXTURES, MOVEABLE FITTINGS,
PLANT AND CHATTELS $ 110,000.00
$ 630,000.00
(b)In addition to the abovenamed purchase price the Purchaser shall upon Completion purchase from the Vendor, stock to the value of $150,000.00 One hundred and fifty thousand dollars, on the 1st day of July 1992 and to be paid for by cash or bank cheque directly to the Vendor on or before the 31st August 1992., and the balance to be paid for directly to the Vendor by cash or bank cheque on or before the 31st March 1993. The Valuation of such stock to be agreed to upon a stock take to take place on the agreed date of completion being 1st July 1992., in accordance with the agreed terms contained in Clause 3, hereof.
.....
STOCK
(a)The Vendor agrees to sell and the Purchaser agrees to purchase from the Vendor of the Vendor's good and saleable stock of the business at prices equal to the invoiced cost thereof to the Vendor, such value to be determined as hereinafter set forth and such saleability or otherwise to be determined by agreement between the parties and in default of agreement by the independent stocktaker hereinafter referred to.
..."
First Issue - representation as to $100,000 cash
The applicants' primary submission is that it was represented to them that the business generated sufficient income to enable Mr Allertz to take out cash from the proceeds of the business in an amount of about $100,000 nett during the ten month period from 1 July 1991 through 30 April 1992 in addition to the nett profit shown in the accounting records of Lumocol, for the ten month period.
Mr Allertz contends that when he gave Mr Romuld the financial statements for NBS for the ten month period to 30 April 1992, he told Romuld that the profit figures were too high and that he (Mr Allertz) had reduced stock by $100,000 to give "a more accurate picture of our actual profits so far". Mr Allertz was of the view that the nett profit figure of $516,589, resulted from an overstatement of the opening stock for the year beginning 1 July 1991. His case is that the opening stock was too high by about $100,000, which meant that the true nett profit was in the order of $416,000. It is this amount of $100,000 representing the overstatement in stock, which Mr Allertz says was discussed and he denies that there was ever any suggestion that in addition to the profits of $416,000, there was a further sum of $100,000 generated in cash. Essentially, he says that Mr Romuld misconstrued the discussion in forming his impression as to the substance of the statements made. Mr Allertz denies he asserted to Mr Romuld that the closing stock as at 30 April 1992 was correct and that there was $100,000 in cash taken out and that this could continue.
Mr Allertz does not deny saying that the value of the goodwill was arrived at by looking for $400,000 for the business, which he thought was reasonable and that the assets were worth $100,000. Nor is it denied that he said with Mr Golosky's fee of $30,000, the total would amount to $630,000. The figure of $630,000 is clearly wrong unless account is taken of a further sum of $100,000.
Mr Allertz agreed that when asked how he managed to take out cash out of the business and get away with it, he responded that it was possible to "take as much as you like," and that, "you could take $150,000 per annum if you wanted to" and that "the problem was how to spend it. You can only buy so much furniture and the like, you have to be careful." Mr Allertz does not deny saying that he had bought a number of businesses but had never been paid so much for goodwill as he did when he bought this business and it had been the best value for money that he had ever bought. He also agrees that he said that the business was a retail business like all other retail businesses everyone takes out cash and that documentation was no problem.
Mr Allertz agrees that Mr Romuld commented on 21 June, that when the profit for ten months to 30 April 1992 was first calculated it came out at $500,000 but was then reduced to $416,000. However, he denies that he told Mr Romuld to ignore the $500,000 and that the true figure was $416,000.
It is not disputed that on 24 June 1992, Mr Allertz agreed that the true level of performance of the business was a profit of $477,000 on sales of $3,828,000 or that Mr Romuld, on a note, circled the amounts and drew an arrow connecting them from left to right. Basically, Mr Allertz denies any reference to allowing for $100,000 cash taken out or a claimed profit of $500,000.
Mr Allertz agreed that he was asked by Mr Romuld as to how much he could get out of the business and whether there was a cash component, and he agrees that he said that the business, "generates over a million dollars per year in cash, during peak selling times," that from time to time they would "get flooded with cash" and "have it stacked all over the house", and that they would, "have to count the money until late at night". Mr Allertz claims to have said to Mr Romuld, "I would think that if you took out $100,000 or even $150,000 it would be hardly noticeable."
In relation to the stock adjustment, Mr Allertz agreed that he told Mr Romuld he had the stock figures to 30 April reworked and that the profits worked out for him by Mr Somerville, his accountant, were far too high. He considered that the stock take had quite a few problems and that the June numbers must be low. Accordingly, he said he "knocked $100,000 off the stock in hand to try to equalise the stock position", which reduced the profit by that amount in order to give a more accurate picture of the true profit. He said, "there will be an extra $100,000 to take out of the business when the stock we hold is sold, probably an extra $20,000 on top of that". Mr Allertz mentioned a couple of further low sales months before the end of the year which meant that the profit shown would go down.
When it was suggested to him by Mr Romuld that the gross profit margin, in the accounts, was in the order of 26%, Mr Allertz said that he had not looked at the gross margin but that it could be done and that one would have to look at the figures for the whole of the period during which he had operated in the business. Later Mr Allertz said he had had "a go" at working out the margin and had come up with a "theoretical" maximum about 26%. He emphasised that it would be necessary to look at a longer period to get a reliable percentage. He agreed that the value of the stock was determined at $386,843. Mr Allertz said that for the year ended 30 June 1992 the gross profit of the business from trading was $937,199 or 25.27% of sales. He shows in his calculations the closing stock as $386,843 whereas the 30 April 1992 accounts show $389,692. The Lumocol Unit Trust accounts for the year ended 30 April 1992 also show inventories as $389,692.
The case for the respondents is that whenever the figure of $100,000 was discussed it was in the context of the fact that the value of the closing stock of the business recorded in 30 April 1992 accounts had been reduced by $100,000 from the original $489,692 to $389,692, shown in the second set of accounts to 30 April 1992. By this reduction the cost of sales was increased and thereby the gross profit was decreased. Mr Allertz clearly had a strong concern about having to pay tax on the higher amount because, he said he was of the view that the opening stock on 1 July 1991 was clearly excessive.
Mr Allertz's position was that the removal of $100,000 was not something underhand. It was explained to Mr Romuld. The stock take showed stock as being $489,000, not $389,000. By reducing the closing stock value in April 1992, there would be a lower profit figure recorded in the sum of $100,000 over the period of two and a half years not disclosed. By 23 June 1992 Mr Allertz told Mr Romuld that the real value of the stock $489,692, shown in the original 30 April 1992 accounts, had been reduced in the later accounts to $389,692. Mr Romuld said to Mr Somerville that an extra $100,000 should be added as profit on the figure to 30 April to determine the true profit for the ten month trading period. Therefore, he knew that he was dealing with only one amount of $100,000 and not two and that it was a stock adjustment, not cash. The $100,000 on Mr Allertz's view was not cash being taken out of the business, rather it was a downward revaluation of the stock by that precise figure.
Applicants' Contentions as to the sum of $100,000
The applicants' submissions are as follows:
The 1992 stock-take showed that stock as at 30 April was $489,692
The stock figures shown in the second set of 30 April accounts was $389,692
The stock figure shown in the 30 June 1992 accounts was $205,575.
Mr Romuld was told that there was an adjustment in relation to the amount of stock by $100,000. This was because the opening stock as at 1 July 1991 had been understated.
If the opening stock as at 1 July 1991 were to be adjusted it would mean that the tax figures for the year ended 30 June 1991 would have to be adjusted by increasing the closing stock for that year, which was the opening stock for the year beginning 1 July 1991.
To understate opening stock as at 1 July 1991 is to increase the profit for year ended 30 June 1991.
The applicants suggest that the stock adjustment was revenue neutral because in making such an adjustment it would be necessary to adjust by an equivalent amount, the opening stock. Accordingly, the applicants says that the $100,000 referred to as cash takings was quite distinct from the stock adjustment exercise, which did not result in the ability to take out cash.
The applicants say that there was a representation that in addition to the financial takings of the business as disclosed in the 30 April 1992 statements of account there was a further $100,000 of nett profit, which was undisclosed cash takings.
The respondents claim that the only figure of $100,000 ever mentioned was the $100,000 mentioned in relation to the stock adjustment.
There are however repeated references in Mr Romuld's notes to "cash" takings and both his evidence and the evidence of Mr Allertz show his keen interest in any cash in the business not disclosed in the accounts. Further, this is coupled with the fact that Mr Allertz was seeking to sell his business at the maximum price. The applicants say that if the closing stock figure is changed from $389,000 to $489,000, one must change the opening stock figure from $132,000 to $232,000.
Revised draft accounts for 10 months to 30 April 1992 showed a profit of $416,000 with a closing stock of $389,692. Notwithstanding, that the revised accounts showed a nett profit figure of $416,589, rather than $516,589, the applicants contend that it was the understanding of Mr Allertz that the proper nett profit figure was $516,589. This makes it more likely that he would have told Mr Romuld that there was $100,000 more profit in the business than the books showed. It appears that a nett cash figure of $100,000 would need to be added as it had not been included in the nett profit figure of $416.000. Mr Allertz gave evidence to the effect that the true profit figure in his opinion was the one which included the extra $100,000. That is to say, that the true profit was $516,589 rather than $416,589.
Cash Takings
The applicants submit that there was an express oral representation by Mr Allertz that, in addition to the profits disclosed in the accounts for the period 1 July 1991 to 30 April 1992, the business generated a further sum of over $100,000 in cash, which could be taken from the proceeds of sales. The effect of such a representation was that the true profit of the business for that period was $516,589 and not $416,589 as shown in the accounts. The applicants say that on a number of occasions during June 1992, the "cash" takings were raised in discussions and confirmed by Mr Allertz.
Mr Allertz denies any such representation. He agrees that there was discussion about an amount of $100,000 but this was in the context of a downwards revision of the closing stock as at 30 April 1992 from $489,692 to $389,692. The higher amount had been referred to in an earlier draft of the accounts drawn up in respect of the period to 30 April 1992 by his accountant Mr Somerville. Shortly after they were drawn up, these accounts were discarded.
Mr Allertz's case is that Mr Somerville, who was the accountant for Lumocol, prepared accounts as at 30 April 1992, which included a stock-take as at that date. This determined that the amount of stock was valued at $489,692 and there is no dispute on this. Mr Allertz discussed this figure with Mr Somerville and concluded that the resultant profit figure for the financial year which would end on 30 June 1992 was going to be much too high. After some further discussion, Mr Somerville concluded that the previous stock takes, in respect of the year ended 30 June 1991, must have been inaccurate and it had not included all the stock. Mr Allertz regarded the April 1992 stock-take as having been carried out with better procedures and that it was more reliable than the 30 June 1991 stock take. In the light of his discussions with Mr Somerville, and as a result of the income tax implications, Mr Allertz reviewed the value of the stock as at 30 April 1992 and reduced it to $389,692, which was, in effect, an amount which was calculated to reduce the profits to a figure which Mr Allertz considered reasonable and would more accurately reflect the correct opening stock figure as at 1 July 1991. That figure of course was identical with the closing stock figure for the year ended 30 June 1991.
Mr Allertz made the adjustment known to Mr Romuld on about 3 June 1992, when he said to Mr Romuld in relation to the April stock-take:
"These accounts have been prepared to give us an idea of how we are going so far as tax for the year is concerned. I had the stock figures to 30 April reworked. The amount that Scott (Somerville) had worked out for profit is very high, far too high for me. The amount of stock is way up on the figure for last year. Our stocktake had quite a few problems and our June numbers must be low.
Our stocktake this time was done much better but it creates a problem. I have knocked $100,000 off the stock in hand to try to equalise the stock position, this reduces the profit by the same amount which gives a more accurate picture of our actual profit so far. The amount of stock is really $100,000 more than shown in the accounts, or, should I say, within about $20,000 of that amount. There is always a variance in the stocktake. There will be an extra $100,000 to take out of the business when the stock we hold is sold, probably an extra $20,000 on top of that." (Emphasis added)
The case asserted by Mr Allertz is that there was never any suggestion of taking out an additional $100,000 in cash takings over and above any stock adjustment and that the only $100,000 ever discussed was that relating to the stock adjustment, as a result of the under estimation as at 1 July 1991.
The evidence is that there were in the order of six meetings between Mr Romuld and Mr Allertz in June 1992 at which these matters were considered. There were also some telephone conversations.
The first meeting took place on 1 June 1992. It is common ground that at that meeting Mr Allertz said that there was cash stacked all about the house and that it was possible to take cash out of the business in amounts of between $100,000 to $150,000. A note of the meeting made by Mr Romuld records a question prepared beforehand as to "what financial benefits have been extracted in the last three years?". The recorded answer is "$100,000 in cash..." (emphasis added). This was one of eight written questions drawn up before the meeting by Mr Romuld to elicit information.
In cross-examination, Mr Allertz, speaking of the period "throughout June 1992" and in relation to the 30 April statements of account, gave the following responses:
"QBut it was your view that the inflated figure with the extra $100,000 was the true profit? was not it?
AYes.
Q.And it was true profit because to the profit shown by Mr Somerville's figures there had to be added $100,000 of nett cash taking that you had not included?
AYes."
At a later stage of the cross-examination, Mr Allertz sought to resile from these answers on the basis that he got his "wires crossed" and "got a bit confused". The attempt to retreat from the testimony set out above was unconvincing and I accept that the above evidence correctly reflects his view and therefore makes it more likely that the representation was made as to "cash takings".
This evidence is important because it is basically inconsistent with a denial that there was any cash taking in the order of $100,000 which must be taken into account in order to get the true profit. On his evidence the true profit was $416,000 and there was no further deduction of any cash.
It is important to bear in mind that Mr Allertz had an incentive to magnify the profits of the business in order to secure the highest sale price. The evidence of Mrs Romuld, in addition, although in general terms was that in substance Mr Allertz said that the nett profit was greater than that shown and that the difference was attributable to cash takings. She confirmed that there was mention by Mr Allertz of cash being stacked all his home on occasions.
Mr Allertz agrees that he said to Mr Romuld that there was so much cash that if you took out an amount between $100,000 to $150,000 it "would hardly be noticeable". This context is important.
A second meeting took place on 2 June 1992 at which Mr Allertz alleges he told Mr Romuld that the figures in the first set of accounts up to 30 April 1992 were too high.
On 9 June 1992 a third meeting took place. Mr Romuld recorded that the value of the business was $400,000, cash was $100,000, assets being plant and equipment were worth in the order of $100,000, Golosky's commission on the sale was $30,000; that the total amount was $630,000 with stock to be appraised under the agreement at a further $300,000 plus. The contents of the handwritten note are set out earlier in these reasons.
Mr Somerville stated that the reduction in opening stock did not understate profits because it simply compensated for an understatement of opening stock. Therefore, reference to a "true" profit of $516,000 as stated by Mr Allertz must have been made up from some other income source and cash takings seem the likely source.
The fourth meeting was held on 13 June 1992. The important evidence from this meeting is that of Mr Steele, who was a person of some financial experience and who advised Mr Romuld. His evidence was to the effect that Mr Allertz stated that the gross profit margin was 26%. That evidence reads:
"Steele:Your accounts show a 26% margin but the figures you just quoted give us a gross profit margin of 20%.
Allertz:I don't know why but the accounts up until April 1992 showing a gross profit margin of 26% are the correct accounts."
Mr Steele said that he remembered this because he regarded the gross profit margin as being the key to the business. The evidence indicates that Mr Romuld also considered the gross profit margin to be of great importance.
On 16 June 1992 there was a fifth meeting. Mr Allertz agrees that Mr Romuld expressed an interest in the way in which cash could be taken out of the business without detection. Mr Romuld alleges, and it is not denied by Mr Allertz, that Mr Allertz responded as follows:
"This is a retail business. Like all the other retail businesses around here everyone takes cash out." (Emphasis added)
When Mr Romuld asked about documentation such as sales dockets, Mr Allertz replied:
"That's not a problem"
Mr Allertz suggests that he was only talking in terms of future possibilities and was not asserting that he himself had taken cash out. Again, this seems to me inherently unlikely. The expression "everyone takes cash out" indicates to me that he would not be adverse to taking cash out in accordance with what is represented as, in effect, normal practice. I consider it more likely than not that he did so.
On 24 June 1992 there was a further important meeting. At this meeting Mr Romuld had a sheet of paper. A copy of this is annexed to Mr Romuld's statement (Annexure W). This contained a series of pencil entries prepared by Mr Romuld prior to the meeting. It was given to Mr Allertz who corrected some matters. The relevant entry reads as follows:
"(3.)Realistic results for 1992
Sales -to April 3528 Profit - to April 417
May 110 May (10)
June11060 June (10)
"Cash" 130 "Cash in" 1003878 Stock (20)
3828
477
Mr Allertz changed the figure of 110 for June sales, which is crossed through, to 60 as shown above.
Although Mr Allertz made this specific correction, there was no alteration of the reference to "cash in 100", where it appears under the heading "Profit". Nor was there any correction to the total of the sale or profit columns referred to above which referred to "cash in" amounts of 130 and 100. Moreover, there is a separate reference to "stock (20)" so that cash and stock are effectively treated as separate matters.
At this meeting Mr Allertz agreed that the likely profit of the business to 30 June 1992 would be in the order of $477,000 from sales of $3.828 million and Mr Romuld joined the reference to 477 with an arrow to the figure of 3828 which was the figure amended from 3878 as the result of his alteration of the 110 sum for June to a figure of 60.
There is also in evidence a document, exhibit 8, which set out a series of calculations by Mr Romuld and which contains a number of references to an adjustment for "stock fiddle" of 100 and to "cash in" in the order of 130. This is a six page document and on a number of pages there are references to "cash" and to the words "stock fiddle" on the first page, and there are a number of other references to stock and "cash" on the following pages. On page 6 of this exhibit there is a document bearing date 23 June and headed "Final Analysis of Performance". On the bottom left hand side of this document there is a reference to a stock adjustment of "(100)" and to "cash in" of 40 and "cash out" of 20. On the right hand side of the page there are references to "stock" of 20; "cash in" of 130 and "cash out" of 30 resulting in a residual cash in as distinct from stock of 100. These calculations relate to an attempt to determine "true trading in 92". In my view, these
calculations provide some further support for the conclusion that the sum of $100,000 representing cash takings was mentioned as a separate and distinct issue from any reference to the stock adjustment.
Throughout the exhibits and annexure W to Mr Romuld's statement, there are numerous references to "cash" figures and amounts of $100,000 or more, which are set apart and dealt with differently from items referred to as stock. These provide some indication that the references to "cash" or "cash in", are distinct from the "stock" adjustments.
On the evidence, I am persuaded that there was a misrepresentation made by Mr Allertz that there were additional cash takings in the order of $100,000 which were not disclosed in the published accounts. I conclude that this was not the same figure as that involved in the "stock fiddle" adjustment, which arose as the result of the consideration by Mr Allertz of his tax position as disclosed after the stock-take in April 1992.
Profit Margin
Mr Dolman, chartered accountant, gave evidence that the financial statements to 30 April 1992 showed the cost of sales as 73.7% of the sales and therefore that the gross profit is represented to be 26.3%. The financial accounts to 30 June
1992, adjusted for true closing stock, show a gross profit margin percentage of 28.9%.
Further financial statements for the financial years ended 30 June 1993 and adjusted for unreported cash takings, calculated on a comparable basis show a gross profit margin percentage of 20.1% and for 1994 of 22.2%.
According to Mr Steele, whose evidence I accept on this point, Mr Allertz stated that the gross profit margin which was shown for the April 1992 accounts was correct. Moreover, Mr Allertz does not deny that he confirmed in a discussion with Mr Romuld, on 13 June 1992, that the 26% profit margin was correct.
In fact, as the evidence of Mr Dolman, the accounting expert called by the applicants, shows these figures were incorrect. After carrying out exercises using the 1993 figures, he concluded that the maximum achievable gross profit margin for that year was about 21%. Mr Allertz had control of the conduct of the business, up to and after 30 June 1993. In addition, a Mr Wamsteeker, the former sales manager, remained in employment as a sales manager after the sale.
Mr Dolman's evidence was to the effect that the considerations which could affect gross margins after 30 June 1992 were a reduction in margins and an increase in discounts at TAFE colleges. Other matters referred to in evidence, according to Mr Dolman, affected direct or indirect costs. The evidence was that there was no significant impact on margins as a result of what Mr Allertz alleged were changes in the business. The records as to the extent of discount usage and the amounts of the discounts in the years 1992 through 1994 were not sufficiently adequate to enable an accurate conclusion to be reached but Mr Dolman did not consider that the relevant factors would have produced the reduction in gross profit percentages appearing from the accounts for 30 April and 30 June 1992 and 30 June 1993.
Furthermore, the calculations of Mr Somerville indicate that the gross profit margin of 21.8% for the period from January 1990 to 30 June 1992 affords some corroboration of the conclusions reached by Mr Dolman.
The above calculations do not take into account the representations as to the additional cash takings. When these are included the discrepancy is of course significantly greater. There has been no satisfactory explanation of these discrepancies by any witness called for the respondents.
In the light of this evidence, the discrepancies indicate more probably than not, that the gross profit margin was substantially overstated in the 1992 figures and therefore those accounts were misleading. I am not satisfied that the respondents have proved any reasonable ground to justify the figures represented for gross profit in 1992 or in subsequent years, nor have they established any reasonable grounds to substantiate an assertion that there were additional cash takings generated by the business in the order of $100,000.
Reliance
The inherent likelihood having regard to the nature of the representations is that the applicants relied on them in purchasing the business. By representations, I refer to both the representations as to additional cash takings and to the gross profit margin which the business should be able to achieve.
Mr Romuld analysed the figures furnished to him in a methodical and painstaking way. He made numerous inquires and sought detailed accounting advice during June 1992. He obviously reflected on the figures and approached them in a critical and cautious way. His notes and analyses indicate that the representations as to profit and cash were of great importance to him. Specifically, I am satisfied that he proceeded to purchase the business in reliance on the representation that the financial statements were accurate but that there were additional cash takings referred to above.
I accept Mrs Romuld as a truthful and generally reliable witness and I accept her evidence that she relied on representations which were no doubt conveyed to her, by her husband.
Credit - Mr Romuld
Mr Romuld impressed me as having adopted a cautious and systematic approach to the purchase. This is evidenced by his notes, questions and analyses which were revised as information became available during 1992. He did not "rush" into the purchase.
There were some unsatisfactory aspects of his evidence, such as his initial reluctance to admit that he was told of the stock adjustment of $100,000. He also, of course, has a strong interest in the outcome. Moreover, his answers as to the calculations in Exhibit 8, were to some extent unsatisfactory and it is pointed out that the documents comprising Exhibit 8 were not referred to earlier in his statement.
However, Mr Romuld's evidence when considered as a whole, was supported by that of Mr Steele whom I accept without reservation. Mr Romuld prepared quite detailed documents which on balance support his case, particularly in relation to cash takings. Mrs Romuld also gave evidence which although somewhat general, supported Mr Romuld's evidence. Most importantly, however, Mr Romuld's evidence appears to be more probable in the context of the likely discussions on the sale of this business. It is clear from the evidence that he was interested in any finding out about any cash takings over and above those shown in the accounts and he asked a number of carefully
formulated questions seeking details as to how this would be done.
Mr Allertz
Mr Allertz had a strong incentive to exaggerate the performance of the business so as to achieve a better price. Further, Mr Allertz's own evidence as to large amounts of cash and the ability to take out large sums of cash from the business are strongly supportive of the applicants' version of the conversations between the parties in relation to additional cash takings. Mr Allertz did not keep any comprehensive notes of his meetings or conversations, nor did he confirm the subjects discussed in writing, by letter or otherwise.
Importantly, Mr Allertz's attempts to change his evidence, in relation to the true profit being $516,589 after he apparently realised the ramifications of that answer were unconvincing and raised doubts, as to the general accuracy of his recollection in relation to these matters. Mr Allertz's evidence is largely uncorroborated. In addition, I found his testimony particularly unconvincing when he sought to explain his reference to taking cash out of the business as referring to the possibility of taking cash out, rather than to the fact that additional amounts of cash had been taken out by him, in the past. This must be considered in the light of his admitted
assertion that "everyone takes cash out" in retail businesses. I do not think he was an exception to his general perception.
Accordingly, where the evidence of Mr Romuld and Mr Allertz are in conflict, unless there is corroboration or clear evidence to the contrary, I prefer the recollection of Mr Romuld.
Mr Steele
There was no significant attack on his credit. I found him to be an honest and frank witness with a reasonably accurate recollection of events and discussions.
Exclusion Clause
The respondents rely on the exclusion clause comprised in clause 12 of the Sale Agreement. This reads:
"12 EXCLUSION OF OTHER CONDITIONS
(a)The Purchaser acknowledges that no representations or warranties in connection with this sale or in connection with the business have been made or given by the Vendor or by any person including the Vendor's Agent (if any) on the Vendor's behalf and that the Purchaser has agreed to purchase the business on the terms herein set forth as a result of the Purchaser's own inspection and investigation of the business, the premises from which the business is conducted, and of the fixtures, fittings, plant, equipment and stock hereby agreed to be sold.
(b)The Purchaser warrants having made such investigations and enquiries in relation to the sales takings custom income commitments liabilities and all other financial aspects of and associated with the business as the Purchaser sees fit and that the Vendor has not made any nor has any person including but not limited to the Vendor's Agent made any representation which has induced the Purchaser to enter into this Agreement.
(c)The Purchaser acknowledges and warrants that the Purchaser does not rely on any letter, document, correspondence, representation or arrangement whether oral or in writing as adding to, amending or varying the terms, conditions and warranties herein set forth and that this Agreement embodies all the terms and conditions of the Agreement and arrangements between the Purchaser and the Vendor and that all other terms, conditions and warranties whether statutory or otherwise are hereby expressly excluded except where such exclusion is prohibited by law."
The respondents in submissions acknowledge that there is a line of authority to the effect that similar exclusion clauses are of no effect. See Clark Equipment Australia Ltd v Covcat Pty Ltd (1987) 71 ALR 367 and Petera Pty Ltd v EAJ Pty Ltd (1985) 7 FCR 375.
However, it is said for the respondents that in the present case the above clause severs the relationship between the representations and the agreement, so that there is no reliance or causation in the present case.
Having found there were misrepresentations made in contravention of the Act, I do not consider that the exclusion clause has effect to negative reliance or causation. The misrepresentations were of such a nature as to be likely to induce entry in to the Sale Agreement and the effect of the Act cannot be evaded. This is particularly so in circumstances where the misrepresentations were express and where the misrepresentations in relation to additional cash takings over and above the amounts shown in the records of account were of such a nature that they were not likely to have been referred to in the agreement.
Damages
The accounting witnesses, Mr Dolman and Mr Sanford, adopted different approaches. They both agreed that the usual approach is to ascertain the likely future maintainable earnings and capitalise this sum using an appropriate capitalisation rate and then to deduct any amounts appropriated in respect of tangible assets.
The purpose of the exercise is, of course, to calculate the loss suffered by a representee as a result of the misleading conduct.
Mr Dolman says that this approach is not possible in the present case because the records are not shown to be comprehensive or reliable. Mr Sanford, on the other hand, asserts that the records are adequate.
Mr Dolman calculates the damages as being the impact on goodwill and sets to quantify this in dollar terms. He estimates the differences between the actual gross profit margin percentages represented for the periods 30 June 1993 and 1994 and the adjusted gross profit percentage for the year ended 30 June 1992.
Using this approach he calculates two figures. The first reflects an inclusion in the 1992 figure of $100,000 cash takings, which is not shown in the accounts. The second ignores cash takings. The figures he then arrives at are $595,016 or $390,724 if cash takings are not included. As the former figure exceeded the price agreed for goodwill in the Sales Agreement, he concludes that effectively there was no goodwill. If one ignores the cash takings then the overpayment for goodwill is $390,724.
Mr Sanford's approach is to capitalise future maintainable earnings, after tax, at a rate of 15% which is said to result in a figure which reflects the retail value of the business including the stock, plant and goodwill. Future maintainable earnings are calculated by him as being $231,968 for the period up to 30 June 1992 from which he deducts income tax of $90,468, leaving a nett profit after tax of $141,500. This is then capitalised at 15% to give a figure of $943,333 from which is deducted the plant and stock of $431,550 resulting in a goodwill valuation of $511,782 which closely approximates
the amount assigned to goodwill in the Sale Agreement, which was $520,000.
In the course of cross-examination of Mr Sanford, it became obvious that substantial adjustments needed to be made to the figures he used to estimate future maintainable earnings. These adjustments related to the tenure of the shops, and the sale of the signs and leisure cycles and the value of plant and stock. The effect of these adjustments, as elicited in cross-examination, was to reduce the annual average maintainable earnings after tax to figure in the order of $98,000. Given the uncertainty of the records and the degree of estimation involved I consider that an appropriate earnings figure is $110,000.
The applicants contend that the capitalisation range should be higher than 15% and that it should be in the range of 25%-30%, because of the then current and emerging risk factors. Some of the risks referred to in support of the 25%-30% range, were the fact that there had been a change in the nature of the core business after it was first purchased; that there was increasing competition emerging; discount rates were increasing; and there was a greater tendency to seek out discounts on the part of book buyers.
Notwithstanding these considerations, the business had shown considerable promise as at April 1992 and it operated in a
niche market. It seems to me quite wrong to suggest that there was no goodwill to this business.
There was evidence from Mr Merrell that as at 30 June 1992 the official call rate was 6.5%; the three year Commonwealth Bond rate was 7.04% and the ten year Commonwealth Bond rate was 8.76%. A capitalisation rate of 15% therefore allows for a substantial premium above the current money market rates of return.
In a case such as the present, where the records are far from complete, so that their accuracy cannot be strictly verified, I consider the better approach is to use the method proposed by Mr Sanford in his calculations, but apply the capitalisation figure of 15%.
This is not a matter in which it is possible to be exact, but doing the best I can I consider that a reasonable figure for likely maintainable earnings is an amount of $110,000 capitalised at 15%. This gives a value to the business of $733,000. From this should then be taken the adjusted stock and plant figure of $519,000 which places the goodwill value at $215,000, leaving a shortfall of $304,000 from the amount of $520,000 allocated and paid under the Purchase Agreement for goodwill.
Accordingly, I am of the view the loss to the applicants was $304,000. In addition, there must be an adjustment for an amount $14,531 in respect of a deficiency in stock. This will then reduce the amount of the cross-claim. Furthermore, I am satisfied on the evidence in exhibits B and D that stock in the sum of $39,360 comprising sunglasses, compact discs and other assets was unsaleable and this amount will further reduce the amount payable under the cross-claim. I do not consider that clause 3 of the Sales Agreement operates to preclude the Court from determining the question of saleability of the stock.
Conclusion
The loss suffered by the applicants in the present case is the difference between the value of the business bought and the price paid which results in a figure of $304,000. In addition there should be interest awarded up to judgment on this amount. The respondents are entitled to succeed on the cross-claim, but an adjustment must be made in respect of stock referred to above. The nett amount of the cross-claim should be set off against the damages awarded on the claim and there should be judgment for the balance.
The applicants did not press their application to have the personal loan agreement or statutory demand set aside.
I direct the applicants to bring in Short Minutes to give effect to these reasons and I will hear the parties on costs and the quantum of interest.
I certify that this and the preceding
forty (40) pages are a true copy of
the Reasons for Judgment herein of
his Honour Justice Tamberlin.
Associate:
Date: 23 October 1996
Counsel for Applicants: Mr R C McDougall QC
Solicitor for Applicants: Gordon & Johnstone
Walsh James
Counsel for Respondents: Mr F G Lever
Mr P Toni
Solicitor for Respondents: Marshall Marks Kennedy
Date of Hearing: 5,6,7 & 8 February and
20,21,22 & 23 May 1996
Date Judgment Delivered: 23 October 1996
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