Carlig v M H Heath and M P Jones (t/as Allmand Jones and Partners)
[2019] VCC 1175
•2 August 2019
| IN THE COUNTY COURT OF VICTORIA AT MELBOURNE COMMERCIAL DIVISION | Revised Not Restricted Suitable for Publication |
GENERAL CASES LIST
Case No. CI-18-04488
| EDY CARLIG | Plaintiff |
| v | |
| M H HEATH & M P JONES (T/AS ALLMAND JONES & PARTNERS) | Defendants |
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JUDGE: | HIS HONOUR JUDGE COSGRAVE | |
WHERE HELD: | Melbourne | |
DATE OF HEARING: | 9, 10 and 12 July 2019 | |
DATE OF JUDGMENT: | 2 August 2019 | |
CASE MAY BE CITED AS: | Carlig v M H Heath & M P Jones (t/as Allmand Jones & Partners) | |
MEDIUM NEUTRAL CITATION: | [2019] VCC 1175 | |
REASONS FOR JUDGMENT
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Subject:PARTNERSHIP – EVIDENCE
Catchwords: PARTNERSHIP – resignation of partner from accounting firm – no partnership agreement – whether plaintiff’s equity 10% or 15% – valuation of minority interest where no clawback, restraint, or non-compete provisions – whether minority discount applies – entitlement to unpaid partnership profits
EVIDENCE – weighing account of a witness against contemporaneous documents
Legislation Cited: County Court Civil Procedure Rules 2018 (Vic); Partnership Act 1958 (Vic)
Cases Cited:Ebrahimi v Westbourne Galleries Ltd [1973] AC 360; Manley v Sartori (1927) 1 Ch 157; Orrong Strategies Pty Ltd v Village Roadshow Ltd [2007] VSC 1; Re Wondoflex Textiles Pty Ltd [1951] VLR 458
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APPEARANCES: | Counsel | Solicitors |
| For the Plaintiff | C Charnley | Borchard & Moore Solicitors |
| For the Defendant | L Molesworth | Holding Redlich |
HIS HONOUR:
Summary
1 In November 1998, the plaintiff, Edy Carlig (“Carlig”), became a partner in a firm that provided accounting and taxation services. The current partners in the firm are Michael Heath and Mary Jones, the two defendants. Carlig resigned from the partnership on 7 February 2017. As yet, he has not been paid for his interest in the partnership. Accordingly, the main issues in the case are what equity Carlig held in the partnership at the time of resignation and the amount owed to him in respect of that interest.
Background
2 Carlig began working for the partnership around January 1995. He performed general accounting and taxation work under the supervision of the then partners, Ross Allmand, Jones, and Heath.
3 In November 1998, Carlig became a partner in the firm, acquiring a 10% interest in the partnership.
4 Allmand, who was a founding partner of the firm, resigned his partnership in September 2009. When he resigned, he held a 40% interest in the partnership. He agreed to remain a consultant to the firm and to continue working. He agreed with the partnership that he would receive a base monthly consulting fee of $10,000. In addition, as an incentive, the firm would pay him 5% of its profits each year. He received no separate payment for the surrender or gifting of his capital or equity interest in the firm to the other partners. With his departure from the firm, Carlig received a further 5% equity in the firm, and Jones and Heath shared the balance of Allmand’s equity. None of Carlig, Jones, or Heath was required to pay Allmand any consideration for the additional equity.
5 The firm suffered a major blow in April 2013. The firm had an established and lucrative association with a financial planner for whom the firm did a considerable amount of work. The planner’s clients operated self-managed superannuation funds and the firm performed accounting and/or auditing work for these clients. As a result of newly developed software, the planner developed the capability to produce in-house for its clients work that it had previously outsourced to the firm. As a result, the planner no longer required the services of the firm. The immediate effect was that the partnership’s cashflow was badly affected because it did not receive by 30 June 2013, or indeed at all, approximately $400,000 in fees that it was expecting.
6 The parties agree that Carlig and Jones met in May 2013 to discuss the ramifications of this unexpected development. However, they do not agree about the substance of the discussions. During the course of the meeting between Carlig and Jones, they each signed a document dated 13 May 2013. The document comprises various handwritten notes made by Jones on the back of an envelope. The meaning and significance of the document is disputed.
7 Carlig said that, in about June 2016, he told Jones that he had purchased a business and that he wanted to leave the partnership.[1] It appears to be common ground that Jones asked him to stay until June 2017 so that there would be a smooth handover of the clients and files. Carlig attempted to persuade the vendor of the business to grant him an extension of time to complete the purchase. However, the vendor refused and Carlig was unable to acquire the business.
[1]T40.
8 Again, it seems to be common ground that, after 23 January 2017, Carlig did not attend at the partnership’s offices. Heath tried unsuccessfully to persuade Carlig to return to work. On 7 February 2017, Heath visited Carlig at his home in Mordialloc and collected some partnership property, including client documents, client banking tokens, and details of client banking usernames and passwords. When Carlig repeated to Heath that he was not willing to return to work, Heath asked him to sign a letter of resignation that he had brought with him. Carlig signed the letter dated 7 February 2017, which said that Carlig resigned as a partner of Allmand Jones & Partners effective immediately.
9 Carlig registered the business name “Bayside SOS Taxation & Accounting Services” on 28 January 2017. In February, he began operating the business based at his home.
10 Carlig began this proceeding by filing a writ and statement of claim in October 2018. Carlig alleged he had not been paid for his 15% interest in the partnership. Further, he claims not to have been paid his full profit share for the period from 1 July 2013 to 7 February 2017.
11 Jones and Heath contend that Carlig’s equity share in the partnership is only 10% and they are prepared to pay him the fair value of that partnership interest. However, the value they attribute to that share is significantly less than the sum sought by Carlig. They argue that there are no unpaid partnership profits owing to Carlig.
Preliminary points
12 A preliminary matter that arose at trial was a dispute between the parties about the contents of the court book which, together with several other documents, constituted the evidence in the case.
13 The disputed documents were at pages 89 – 131, 240, 243, 250, 261, and 271 of the court book.
14 The first document was an expert report prepared by Terry Natoli of PPB Advisory for the defendants. Natoli was not called to give evidence. I ruled that pages 12 and 13 of the report comprising paragraphs 52 – 63 were admissible because the defendants’ second expert referred to and relied upon that material in preparing his own report.
15 Save for page 250, the defendants’ essential argument for the inclusion of the other pages was that they formed part of the firm’s financial statements for the financial year in question and should be admitted into evidence because other documents comprising part of the financial statements were specifically referred to. From the beginning of the trial, I had made clear to counsel that, subject to objections, I would conduct the hearing on the basis that any document that counsel took me to in opening or questioned a witness about was to be admitted into evidence. Both counsel agreed to this approach. Ultimately, the defendants’ counsel said that pages 240, 243, and 261 could be removed from the court book. This concession saved me from having to rule against the defendants. In my view, it was not enough that a document could be part of the firm’s financial statements for a given year. If no witness were questioned about the particular page in the court book or gave evidence about it, then there was, in my view, no proper basis upon which to regard the document as admissible. Counsel for the plaintiff agreed that page 271 could remain in the court book.
16 As for page 250, again, counsel for the defendants ultimately said that he was not concerned about this document. Because the only reference to it was mistaken in the sense that counsel erroneously asked the witness to go to that page in the court book and then told him to immediately turn to another page without asking any question about it, I would not have allowed that page to remain in evidence.
17 A second issue concerned the relief sought. Although the statement of claim referred to forms of relief including the dissolution of the firm and orders under sections 43, 46, 47, and 48 of the Partnership Act 1958 (Vic), in final address, counsel for the plaintiff indicated that he was primarily seeking a monetary remedy rather than dissolution of the partnership.
Issues
18 The critical issues in this case are:
(a) What interest does Carlig have in the partnership business?
(b) What amount should the partnership pay Carlig for that interest?
(c) Is Carlig entitled to any and what amount for unpaid partnership profits?
What interest does Carlig have in the partnership business?
19 It is clear on the evidence that, when he became a partner in the business, Carlig bought a 10% interest. Similarly, it is clear that, after Allmand surrendered his partnership interest in 2009, Carlig received an additional 5% equity without making any extra payment.
20 The question of Carlig’s equity in the partnership is determined largely by the meeting that took place between Carlig and Jones in May 2013. The meeting was held at the office of the business.
21 Carlig said that the meeting took place in a context in which he was informed that the firm had lost a major client worth about $400,000 in annual fees. Carlig said that he offered to leave the firm and then Heath, whose client it was, could retain his staff member rather than terminating her employment. Jones told Carlig that his departure from the firm did not suit Heath. Then Carlig said that he would work a three-day week for $3,000 per month. For reasons that were not canvassed in the evidence, that option was not accepted. The upshot was, according to Carlig, that he agreed to work a four-day week for $100,000 per annum.
22 In cross-examination, Carlig said that Jones and Heath did not want him to leave the business. He claimed that was why Jones agreed to the proposal of a four-day week for $100,000 per annum rather than a three-day week for $36,000 per annum. He said that the other partners were trying to incentivise him to stay. Carlig said that the agreement was struck so that he had a guaranteed minimum wage in circumstances where the partnership reduced his profit share by 5%. Carlig said that the reduction related only to his profit share and not his equity in the partnership.
23 Carlig alleged that the agreement about the four-day working week was never implemented and, to that extent, Jones and Heath did not keep their side of the bargain. Carlig said that this failure of the agreement was the basis of his compensation claim – he said that, because the partnership did not observe the terms of the agreement and, essentially, he continued to work a five-day week, he wanted the 5% profit share which he had agreed to surrender as his part of the bargain.
24 For her part, Jones said that once the partnership suffered the sudden loss of the major client in April 2013, it had to cut costs in order to try and minimise the harm to the business.
25 Jones said that once the problem emerged, she spoke to Allmand about paying him less. Although he retired from the partnership in 2009, he continued to work full-time in the business as a consultant and was paid $10,000 per month and received a 5% allocation of the firm’s profit. Allmand agreed to work part-time, be paid $1,000 per month, and forgo any profit share.
26 Jones said that she gave Carlig the choice to remain with the partnership or to leave. She says Carlig indicated that he wanted to remain a partner in the firm. She said that they agreed that, in view of the firm’s straitened circumstances, Carlig’s equity in the partnership would be reduced from 15% to 10% and he would be paid either $100,000 per annum or 10% of the profits, whichever was the greater. This was designed to give Carlig a secure base payment. There was some talk of Carlig working only a four-day week, in which case his agreed minimum wage would be $80,000.
27 In cross-examination, counsel for the plaintiff put a number of propositions to Jones. She disagreed that:
· Carlig offered to resign from the firm;
· in response to that offer, she persuaded him to stay; and
· because Carlig agreed to a reduced share of the profits, Jones agreed he would have a four-day working week and be paid $100,000 per annum.
28 Jones seemed to accept that, for a short time, Carlig worked a four-day week but soon resumed a normal five-day working week. She asserted that the minimum wage of $100,000 per annum assumed a five-day week and, if the working week were shorter, the wage was to be correspondingly reduced on a pro rata basis.
29 In contending that Jones and Heath reduced only his share of the profit and not his share of the equity in the business, Carlig relied upon the “agreement” document written by Jones where she noted, “RA 5% out” and “EC 5% out”. Carlig suggested that, in respect of both Allmand and himself, there was a 5% reduction in profit agreed with the partnership.
30 Jones repudiated this proposition, noting that the concept of loss of profit share applied only to Allmand because, at the time, he had no equity in the firm as he left the partnership in 2009. In contrast, she said that the notation about Carlig was intended to convey the 5% reduction in equity. Jones also drew attention to the firm’s financial documents and the distributions subsequently made to Carlig which she said were consistent with the agreement for which she contended.
Analysis
31 In my opinion, the better view of the evidence is that, as a result of the agreement reached between Carlig and Jones in May 2013, Carlig’s equity in the partnership was reduced to 10%. I have reached this view for a number of reasons.
32 First, all parties accepted that Jones prepared the handwritten accounts of the partnership on a quarterly basis. After the May 2013 meeting, Jones wrote on a number of these accounts that Carlig’s profit share was $100,000 per annum or 10% of the firm’s profit, whichever was the greater. She also wrote that Carlig’s share in the equity of the firm was 10% and the equity belonging to her and Heath was 45% each. These notations appeared, for example, in the reconciliations for the periods ending 31 March 2015, 20 June 2015, 30 September 2015, and 30 June 2016, respectively.
33 Carlig agreed in evidence that, after he became a partner in the firm, he was aware how much the partnership earned each year and how much each partner received by way of distribution. That was the situation from the time he joined the firm until he left. He also said that he had seen these statements that Jones produced so he was aware of those documents and their contents.
34 Notwithstanding the clear statements of his equity interest and the formula for paying him, Carlig took no effective measures to assert the interest and payment entitlement that he now claims. If Carlig genuinely believed that:
· he had a 15% equity interest in the partnership;
· he was entitled to that share of the partnership profits; and
· the firm was not paying him in accordance with the May 2013 agreement made with Jones,
then I would have expected him to assert his alleged rights and to complain about the partnership’s failure to act as agreed. As an experienced accountant, accustomed to dealing with clients’ financial and taxation affairs, I would have expected Carlig to be well aware of the significance of accuracy in financial matters. This need for accuracy would extend to his own affairs.
35 In particular, I am not satisfied with Carlig’s explanation for failing to challenge Jones and/or Heath about the discrepancy between the agreement allegedly made in May 2013 and the profit distribution arrangements that followed.
36 My dissatisfaction comprised several elements. Carlig failed to give evidence about the issue in his evidence in chief. It is troubling when a party whose claimed profit share and/or equity entitlement is a major issue in the case gives no evidence in chief about his failure to challenge the defendants. J D Heydon in the most recent edition of Cross on Evidence notes that the omission to ask questions of a friendly witness can be more significant than the failure to call the witness at all.[2]
[2]J D Heydon, 11th ed, 2017 at [1215].
37 Next, the evidence that Carlig gave in cross-examination and re-examination was unclear and uncertain. In cross-examination, Carlig conceded that he never raised the issue of his alleged underpayment.[3] He explained that he did not do so because he feared he “would have got a blatant no.”[4]
[3]T34/16.
[4]T34/11.
38 In re-examination, Carlig intimated that he had a conversation with Jones about the matter. He gave evidence hesitantly and made comments such as “I don’t want to use the word”[5] and “that was some of the words, but I’m being nice about it”.[6] Carlig said that the response from Jones was to the effect of “you know how it is, or you leave with nothing – they are the numbers, take it or leave it”.[7] It appeared as if Carlig was trying to avoid giving direct evidence on the matter or possibly to avoid confronting Jones. This behaviour was puzzling in circumstances where Carlig resigned from the firm more than two years ago and sued his former partners.
[5]T45/22.
[6]T45/28.
[7]T46.
39 In short, given Carlig’s failure to address the issue of the discrepancy between his equity interest and his annual payments in examination in chief, the apparent inconsistencies in his evidence (namely, suggesting both that he did and did not raise the matter with Jones), and the lack of clarity that characterised this aspect of his evidence, I do not accept that Carlig attempted to raise the issue with Jones and/or Heath prior to commencing these proceedings. This view is consistent with Carlig’s evidence in cross-examination where he acknowledged that he did not complain to the defendants about his claim to a 15% equity interest but only raised it as an issue for the first time in the writ.[8] I note also that it was not put to Jones in cross-examination that Carlig complained after May 2013 about the reduction in his equity to 10%.
[8]T33-4.
40 Secondly, in the financial years ending 30 June 2015 and 30 June 2016, Carlig accepted the minimum wage of $100,000 even though he knew, or should have known, that a 10% share of profits amounted to a lesser figure – the profit in the 2015 financial year was $827,679 and in the 2016 financial year was $878,751. There was no evidence of any complaint by Carlig that in those years he did not receive his proper 15% share which would have totalled around $125,000-$130,000. I infer that Carlig was aware that he was being paid consistently with his equity interest and in accordance with the agreement he made with Jones and that he accepted his position.
41 Thirdly, for the financial year ending 30 June 2013, the partnership profits were about $634,717. If Carlig retained 15% equity in the firm, this share of profit was worth $95,207. It followed from the theory underpinning Carlig’s case that he won a pay rise for that financial year by negotiating a minimum payment to himself of $100,000. This occurred notwithstanding the substantial loss of revenue to the firm and its impact on profit, which had declined from $765,645 the year before. I regard this as commercially improbable in a context where Jones was anxious to reduce costs.
42 Fourthly, I found Jones a more credible witness than Carlig. Jones was clear and direct in her answers, and her evidence about Carlig’s reduced equity and guaranteed minimum annual payment found support in contemporaneous documents.
43 Carlig, by comparison, was more stilted in his answers and his demeanour was significantly less impressive. Carlig tended to be vague and unspecific and gave the court no confidence that his testimony could be confidently relied upon. For example, in his evidence in chief, Carlig said that initially in his discussions with Jones, he wanted to work three days a week for $3,000 per month. He then said that the agreement they made was for four days work for $100,000 per annum. Carlig gave no explanation of how the negotiation was conducted or how these figures came to be agreed. Such a progression seems to me highly unlikely and, without better explanation, strikes me as inconsistent with commercial reality. My doubts about Carlig’s evidence were not assisted by Carlig’s failure to raise this matter with Jones in her cross-examination.
44 I find that after May 2013, Carlig had a 10% equity interest in the partnership, not a 15% interest as he claimed. He was to be paid 10% of the partnership profits or $100,000, whichever was greater.
What amount should the partnership pay Carlig for his interest?
45 Both the plaintiffs and defendants filed expert reports in connection with the value of Carlig’s interest in the partnership. Carlig relied upon a report by Thomas Fitzgerald, a chartered accountant operating as a sole practitioner. The defendants obtained a report from Paul Lom, a director of PKF Melbourne Corporate Pty Ltd.
Admissibility or weight of Fitzgerald’s report
46 A preliminary issue arose regarding the Fitzgerald report. The defendants took exception to the report because of the alleged non-compliance with Order 44 of the County Court Civil Procedure Rules 2018 (Vic) (“the Rules”) and the Expert Witness Code of Conduct.
47 It is clear that the Fitzgerald report did not comply with the Rules and/or the Expert Witness Code of Conduct in that:
· the report filed with the Court was unsigned;
· Fitzgerald did not acknowledge in the report that he had read the Code and agreed to be bound by it or that he had prepared the report in accordance with the Code;
· Fitzgerald did not attach to the report the letter of instruction from the plaintiff’s solicitor engaging him to act as the expert; and
· Fitzgerald’s qualifications and experience, as revealed in the report, did not provide compelling evidence of his expertise to provide an opinion about the value of partnership interests. The tertiary qualification was not from a well-recognised academic institution, and Fitzgerald’s work experience did not obviously support the existence of the requisite expertise.
48 Fitzgerald swore an affidavit in February 2019 in an effort to overcome the deficiencies in his report and make it compliant with Order 44 and the Code. The defendants contended that, not only was this attempt to adduce further evidence without leave impermissible, it contrasted poorly with the conduct of the defendants who, having obtained a report that did not properly comply with the Code, retained another expert from a different firm who produced a new report.
49 The Court retains discretion to dispense with strict compliance with the Rules of Court. Although the defendants’ observations about the report’s non-compliance with Order 44 and the Code were largely correct, the objections were directed more to procedural rather than substantive issues of non-compliance. By this, I mean that the defendants, while criticising Fitzgerald’s report, did not identify any specific prejudice which they, or their expert, suffered by reason of Fitzgerald’s failure to comply with the Rules regarding experts and their reports. While I appreciate that a Court should be loathe to condone experts who flout the Rules, in this case, I am prepared to treat Fitzgerald’s report as admissible and for Carlig to rely upon it. The weight to be attached to the report is a separate question.
Gist of the reports
50 The gist of the reports can be summarised as follows. Fitzgerald stated the purpose of his valuation was to determine the value attributable to Carlig’s interest in the firm upon his termination from the partnership in February 2017. He valued Carlig’s interest as at 7 February 2017 on the basis of the firm’s accounts for the three year period from 30 June 2014 to 30 June 2016. He assumed that any change to the value of Carlig’s interest between 30 June 2016 and February 2017 was not material. Fitzgerald saw and relied upon no financial statements of the firm for the period after 30 June 2016. He said that Carlig’s interest in the firm was valued in the range of $210,000-$220,000 and that there were unpaid profit distributions owing to him of $85,236.
51 Lom’s report exhibited a letter of instruction from the defendants’ solicitor which asked him to provide an independent opinion on the value attributable to 100% of the equity interest in the firm as at 7 February 2017. Lom posited different scenarios in his valuation. In the first, he assumed that the three partners as a group were willing sellers prepared to offer a purchaser of the business the benefit of restraints and non-compete provisions. On this basis, the value of the firm was in the range of $750,000 to $1,170,000 with a midpoint of $960,000. The second scenario assumed the three partners were willing to sell, but not prepared to give the purchaser the benefit of clawbacks, restraints, and non-compete clauses. Lom considered that this valuation of the firm effectively excluded the value of client relationships. The value of the firm on this basis was $60,000 to $180,000. In addition, Lom said that the values which he gave assumed the purchaser would control the assets acquired. If a purchaser were offered only a minority interest, he suggested that the proportional value might be discounted or reduced to reflect that minority interest. If a minority interest were applicable, a 10% interest in the firm would be valued in the range of $52,500 to $87,750 if restraints were in place and at $4,200 to $13,500 if there were no restraints.
Fitzgerald Report
52 Fitzgerald discussed a number of possible methods of valuation before concluding that the most applicable was the capitalisation of future maintainable earnings. He said that this approach applied where the future maintainable earnings of a business exceeded the earnings required to cover the expenses of the business, future capital requirements, and the personal exertion of the owner. He said that the difference was represented by an intangible asset, namely goodwill.
53 Fitzgerald noted that when Carlig bought his 10% interest in the firm, he paid $150,000. This was at a time when the firm’s annual revenue was about $1,500,000. He saw no reason to doubt that the basis of Carlig’s admission to the partnership was other than a negotiation between the parties on a knowledgeable, willing, but not anxious basis and at arm’s length. On that basis, he considered that this was representative of the market value of his interest at that time.
54 Fitzgerald said he was instructed that after Allmand left the partnership, he was paid a consulting fee. This represented his exit payment from the partnership.
55 In determining an average operating profit, Fitzgerald examined the reported profit and loss results for the financial years ending 30 June 2011 to 30 June 2016 and the profit distributions for the same period. In order to work out the operating earnings of the business for the purposes of capitalisation, Fitzgerald made several adjustments:
(a) he treated the payments to Allmand as termination payments. Over the financial years 30 June 2014 to 30 June 2016, these amounted to $19,300.
(b) he allowed for private expenses of the partners. The private expenses were primarily computers, motor vehicles, and travel. In each of the three financial years in question, the allowance was between $63,000 - $73,000.
(c) he allowed $450,000 each year as notional partner salaries. Fitzgerald amended his written report when giving evidence to change a figure in paragraph 3(c) on page 6 of his report from $105,000 to $150,000. He said that this was a typographical error.
56 After making these allowances, Fitzgerald said the adjusted operating profit for the three financial years 2014–2016 inclusive was $341,408, $385,129, and $428,340, respectively, with the average over the three year period being $384,959.
57 In deciding upon the appropriate capitalisation rate, Fitzgerald had regard to the valuation and pricing paper issued by CPA Australia in 2017. This paper indicated that there were about 9,000 public practice accounting firms in Australia and of them, over 80% were firms run by sole practitioners or two partners. The majority of firms with a normal risk profile commanded a multiple of 3.4 to 4.2 earnings. Fitzgerald considered the firm in this case to have a risk profile which was normal for the industry. Fitzgerald adopted a multiple of 3.8, which he considered reasonable in the circumstances.
58 After allowing for the value of operating and non-operating assets and liabilities as at June 2016, Fitzgerald opined that the net value of the firm was $1,422,000, and hence, Carlig’s 15% interest was valued in the range of $210,000 to $220,000. In oral evidence, Fitzgerald agreed that a 10% interest in the firm would be valued at about $142,000.
59 In arriving at that view, Fitzgerald did not take into account any liability the firm had to Ian McAlister. He was an accountant who joined the firm in the late 1990’s from a large accounting firm. He brought some clients with him and worked as an independent consultant at the firm. Fitzgerald accepted that if there were a contingent liability to McAlister of $165,000, as suggested in the accounts, then a corresponding adjustment to his figures was necessary.
Lom’s report
60 Lom stated in his report that he was instructed to value 100% of the equity in the partnership as at 7 February 2017. Because he did not have a complete set of financial statements or the partnership tax returns for the financial years ending 30 June 2015, 30 June 2016 and for the period ending 7 February 2017, he relied upon profit and loss statements and balance sheets for those dates. He said that, in relation to partners’ expenses, he had details for the financial year ending 30 June 2017 so he pro-rated the expenses for the seven months to January 2017.
61 Lom identified several instructions he was given as follows:
· partners in the firm did not have and had never had a formalised or written partnership agreement and/or any formal employment agreements with the firm;
· in the event of a partner departing from the firm, partners were not, at all material times, subject to any restraints, non-compete, and/or solicitation restrictions; and
· in the event that the firm were sold as a whole, the partners were, at all material times, not obligated to provide a purchaser with any safety nets (including, but not limited to, clawbacks, restraints, and non-compete clauses).
62 In relation to the valuation methodology to adopt, Lom set out six potential methodologies before identifying the capitalisation of future maintainable earnings as the appropriate one. He said that this methodology involved the determination of a level of earnings that could reasonably be expected from a business in the future. It was not a level that would necessarily be achieved in each and every year but was an anticipated level of earnings. He said that there were several variations of the methodology but, for this business, the best approach was the capitalisation of earnings before interest and tax (EBIT). The key assessments to be made were:
· an arms-length level of future maintainable earnings;
· the selection of an appropriate capitalisation rate or multiple which reflected the risks facing the business and the achievement of the expected EBIT;
· identification of any surplus assets which did not contribute to EBIT; and
· determination of the level of interest-bearing debt.
63 Lom examined the firm’s profit and loss statements to arrive at EBIT figures for the financial years ending 30 June 2014 to 30 June 2016 and the period from 1 July 2016 to 7 February 2017.
64 Lom made various adjustments to determine the normalised EBIT for the firm. The adjustments included notional salary packages for the three partners, and partners’ vehicle and computer expenses. Lom contended the maintainable EBIT was in the range of $310,000-330,000. He noted that his figure was lower than Fitzgerald’s for several reasons: Fitzgerald only allowed $105,000, not $150,000, for Carlig as a notional salary; Fitzgerald allowed 11.5% for superannuation and payroll tax, whereas Lom allowed 15%; Fitzgerald added back payments to Allmand, whereas Lom treated them as a normal operating expense.
65 I note that, at paragraph 7.2.2 of his report, Lom said:
“I have been instructed to prepare an evaluation of 100% of the equity in AJP [the firm] with Mr Carlig being a partner at the valuation date. I was instructed to value the firm at fair market value on a going concern basis. The following comments are provided to aid in an understanding of the impact of these instructions on the value of AJP.” (my emphasis)
Although the matter was not pursued in cross-examination or final address, I am not sure how comfortably this methodology sits with the capitalisation of future maintainable earnings. Fitzgerald, in his report, treats “market value” and “fair value” as different methods for determining the value of an enterprise. In his discussion of valuation methodologies, Lom makes no reference to fair market value.
66 In section 7.2 of his report, Lom explained why he prepared two alternative valuations depending upon whether or not the vendors were offering clawback, restraint, and non-competition clauses to the purchaser of the business. I have detailed these two scenarios at paragraph 45 above.
67 Lom arrived at his earnings multiple after considering both a company listed on the Australian Stock Exchange whose business was comparable with the firm’s and a newsletter from a broker of financial planning and accounting practices. The latter showed that EBIT multiples in recent sales were between 3 and 4.5. Lom considered this consistent with the range 3.4 to 4.2 in the document apparently written by Greg Hayes for CPA Australia (being the valuation and pricing paper which Fitzgerald relied upon). Lom said that he chose a slightly lower range of 3 to 4 as his multiple because, in his view, it better reflected the fact the transactions for the sale of accounting practices invariably included a deferral of part of the consideration for one or two years.
68 On the above basis, Lom said that the enterprise value of the firm before adjustments was between $930,000 and $1.320 million. The value had to be increased by the value of surplus assets and decreased by interest-bearing debt.
69 An important item concerned the firm’s contract with McAlister. Lom was instructed the agreement with McAlister remained in force. The agreement provided for a staged termination payout equivalent to 25% of the average annual billing for the two years before retirement. Lom assessed the net present value of the liability of McAlister as $140,000–150,000. He reduced the liability by the value of the tax deduction available upon payment. He did this using a low value, being the 30% corporation tax rate, and a high value of 45%, being the personal tax rate. In working out the equity value of the firm, Lom allowed for an estimated net present value (after tax) of the liability in the range of $77,000 – $105,000.
70 Table 8.3.7 of Lom’s report sets out the calculations he undertook to arrive at a range of values for the firm of $750,000 to $1,170,000 after adjustments. Lom said Appendix E to his report showed the net tangible assets were $70,000 so the value of the intangible business assets was around $900,000.
71 Lom believed that the most valuable intangible asset was the client relationships. The clawback, restraints, and non-complete clauses were designed to protect the value of that asset.
72 In Lom’s view, if a vendor was not prepared to offer these clauses or safeguards to a purchaser, then the EBIT multiple would drop to a range of 0.75–1. Again, with the maintainable EBIT range of $310,000 – $330,000, the enterprise value would drop to $232,500 – $330,000. The same adjustments would apply to this valuation. Thus, the equity value of the firm, after adjustments, would fall into the range of $60,000 – $180,000.[9]
[9]Table 9.3.2 of Lom’s Report dated 22 February 2019.
73 Lom said in his report that, if a minority discount were to be applied because the purchaser was obtaining a minority interest in the partnership and had limited control over the direction of the business, then using his commercial judgment, it should be in the range of 25-30%.
74 One aspect of both valuations which troubled me was the apparent failure to address specifically the particular context of the valuation exercise in this case. Here, the issue is the value attributable to Carlig’s equity share in the firm at the time of his departure. It seems clear from the evidence that:
· Although Heath had direct dealings with Carlig at his home on 7 February 2017, he did not discuss with him at that time the question of compensation for leaving the partnership. Heath, at the time, was more focused on obtaining a written resignation to satisfy the firm’s obligations to the Tax Practitioner’s Board and Institute of Chartered Accountants. Heath said he thought they would sort out the rest later.
· Carlig agreed that, after he left the firm, he had some discussions with Heath and/or Jones about agreeing upon a value to resolve his payout.
· Around September 2017, when his former partners sent him the annual accounts for the financial year 30 June 2017, Carlig also got a note inviting him to agree upon a value for his equity stake in the firm.
· Heath did a valuation at some point around September-November 2017 which was sent to Carlig.
75 From these matters, I infer that Jones and Heath were willing to buy Carlig’s equity in the partnership. One could easily imagine that to be the case because they were the two remaining partners. They might have agreed, for example, to each hold 50% of the equity in the partnership. There was no suggestion that any third party had been approached to buy Carlig’s equity or that any third party had expressed any interest in buying Carlig’s equity. This is not surprising because the context concerns a partnership where Jones and Heath would need to agree upon and accept any new partner into the business and to choose someone with whom there was an appropriate level of cooperation and trust.
76 This partnership scenario is quite different from one in which any potential purchaser could buy Carlig’s interest – for example, purchasing shares in a company listed on the Australian Stock Exchange.
Comparison of the expert reports
77 In looking at the two reports, the experts agreed on the valuation methodology and the basic mathematical principles for arriving at an enterprise value.
78 Fitzgerald said in evidence that there were four differences in the two valuations.
79 First, Lom reduced EBIT by $24,000 per annum for payroll tax on the partners’ notional salaries. Because the partners obtained their payments as distribution of the profit of the business rather than as salaries, Fitzgerald considered no payroll tax was payable.
80 Second, they differed on the multiple. Fitzgerald considered that Lom adopted too low a figure, especially when he reduced the multiple to 0.875.[10] Fitzgerald considered the risk factors were exaggerated and there was no obvious reason why this accounting practice had a significantly different risk profile from other firms of similar size.
[10]T55/26.
81 Thirdly, Fitzgerald assumed for the purposes of his report that any sale of an interest in the partnership would be accompanied by clawbacks, restraints and non-compete clauses. He said that those provisions were a normal feature in the sale of any business.
82 Finally, while Lom favoured a minority discount, Fitzgerald did not. Fitzgerald believed that it was applicable only to corporate entities and not partnerships.
83 I consider each of these matters in turn.
Payroll tax
84 While it is true that the partners in the firm take their share of profits as a partnership distribution and not salaries, it is also correct that, as part of the process in arriving at a valuation of the business, certain adjustments must be made. One such adjustment reflects the cost of employing someone to carry out the tasks needed to generate profit in the business. This is part of what an investor does in realistically assessing EBIT. To merely differentiate between profit share and salary is too simplistic an approach to this issue.
85 Fitzgerald’s evidence on the point was also affected by a change he made to his expert report when giving oral evidence in court. He altered paragraph 3(c) on page 6 of his report to replace the final figure of $105,000 with $150,000. Immediately after the altered figure, the text of his report said:
“The latter amount being the average of the amounts paid to Mr. Carlig from 2014 to 2016. I have allowed for on-costs at 11.5%”
In my view, that first statement cannot be correct when one takes account of the changed evidence in court. It is inconsistent with the figures appearing in section 3.2 of the report which show that in the financial years ending 30 June 2014 – 2016 inclusive, Carlig received $105,000, $100,000, and $110,000 respectively – the average amount received over that time was not $150,000. Although he was not cross-examined about the change to his report, the context suggested that the change Fitzgerald made was not purely a typographical error as he claimed. Further, the report, and in particular table 3.3, did not readily disclose where the 11.5% on-costs were allowed for.
86 On balance, I consider that the question of payroll tax was sufficiently related to the notional earnings of the three partners as to justify its inclusion in the list of appropriate allowances.
Multiple
87 The choice of multiple in this case is critical. The two experts were quite close in nominating 3.5 and 3.8 respectively on the assumption that the vendor would grant the purchaser the benefit of clawback, restraint, and non-compete provisions in the sale of his equity. However, while Lom provided a valuation on the alternative assumption that the vendor would not provide the benefit of such provisions to the purchaser, Fitzgerald did not. In court, Fitzgerald acknowledged that the failure to provide clawbacks and restraints would diminish the value of the vendor’s interest, but he proffered no evidence on what the applicable multiple should be.
88 Lom’s view was that, in this case where the vendor was not offering any form of clawback, restraint, or non-compete provisions, the multiple should be reduced to a range of .75 - 1.0. The rationale was that the connection between the vendor and the clients of the partnership was the most important asset of the firm and under the terms of the sale, the vendor was not prevented from continuing his connection with the clients.
89 While not necessarily bound to accept the view of an expert, courts should not lightly ignore expert opinions, especially when the opinion concerns a highly technical field. That is the position in this case.
90 I do not possess the skills to undertake a valuation of a person’s interest in a partnership. The experts agree that the absence of restraints reduces the applicable multiple. I accept the rationale for that view. Given Lom’s extensive experience, unquestioned expertise, and the detailed nature of his report, I am content to find that 1.0 is an appropriate multiple to apply in valuing Carlig’s interest in the firm. The fact that Fitzgerald did not even consider this scenario is a matter of some concern. However, in fairness to him, it may be that he was not instructed about this unusual, but central, characteristic of the partnership.
Clawbacks and restraints
91 I have already set out the positions of the valuers on this issue. Fitzgerald mistakenly assumed the vendor would provide clawback, restraint, and non-compete provisions for the benefit of the purchaser. As already indicated, I accept that the absence of any restraints on a vendor will, or most likely will, adversely affect the value of the interest which is sold.
92 I note two matters in passing. First, although the defendants asserted implicitly, if not explicitly, that Carlig’s ability to immediately compete against the firm had an adverse effect on the firm which, in turn, reduced its value and the value of his equity, there was no evidence to show that:
(a) clients left the firm because of anything which Carlig initiated, and
(b) the clients would not have left the firm if Carlig had remained there.
93 Secondly, although the defendants must have been able to produce the evidence had they so chosen, they provided the court with no material about any adverse impact on the firm as a result of Carlig leaving and, later, some clients also leaving the firm. The court has no idea whether the clients who moved their business from the firm to Carlig after February 2017 represented, for example, 30% of the firm’s revenue or .3%. Nor does the court know if any new clients engaged the firm as their accountants after Carlig left because he left the firm.
Minority Discount
94 There was a clash of views between the parties about whether a minority discount should apply to Carlig’s interest in the partnership. The defendants argued that a minority discount should apply because the interest being valued was a minority interest of 10% in the firm. It was not a percentage greater than 50% which enabled the purchaser to have control of the firm. Lom said that the minority discount was the reciprocal of a control premium whereby, for example, a purchaser buying shares in an ASX listed company and thereby obtaining control of the company would pay a premium of 25-30%. Lom also said that if he were to buy a 10% interest such as that offered for sale by Carlig, he would not pay the proportional value for the interest, but a price which reflected the minority discount because he would be in a minority position and have limited influence over the policies of the business.
95 I note that Lom did not explicitly say that the minority discount should apply. Rather, his evidence was that it was a matter for the court to decide. But, if the court considered that it should apply, then he provided his opinion that the extent of the discount should be 25-30%.
96 Carlig argued that the minority discount did not apply to a minority interest in a partnership. He referred to the decision of Romer J in Manley v Sartori,[11] to contend that where each party has an interest in all the assets of the partnership, one could not identify a lack of control which might result in a minority interest holder to suffer a discount.
[11](1927) 1 Ch 157, 163-4.
97 Carlig further submitted that where the valuation of a minority interest arises in the context of oppression proceedings, the acquisition of the minority interest represents not a market transaction but a judicial remedy. For that reason, it is generally accepted that, where the court orders the purchase of a minority shareholding as relief against oppression, it is not appropriate to apply a minority discount. However, contrary to Carlig’s submissions, where there are no acts of oppression and a party freely chooses to sell a shareholding, that rationale militating against a minority discount does not apply.
98 Although Carlig made no allegations of oppression or like conduct in the present action, the defendants’ position was that they were willing to pay Carlig fair compensation for his interest in the partnership.[12] The value of Carlig’s 10% interest to a third party is different in my view from the value of his interest to the defendants. A third party purchasing Carlig’s interest would acquire a minority holding. However, the defendants’ purchase of Carlig’s share would serve only to increase their shareholding.
[12]Defendants’ Outline of Closing Submissions, paragraph 84.
99 Regarding the applicability of a minority discount, Lom said it depends on the circumstances:[13]
“So if you asked me to join a partnership as, say, minority partner or a 10 per cent partner and somebody else is controlling it, then, I certainly believe that it does apply because I don't have control over key decisions. It – it really depends on the – on the facts and circumstances. If you have 10 partners each with 10 per cent, well, then, you know, you're going to have the discussion about who actually controls it and you probably wouldn't have that – you may not have the minority discount or it might be much less in practice.”
[13]T105/18-28.
100 The defendants would not only maintain control through the acquisition of Carlig’s shareholding but, as a partnership, they have an interest in ensuring that Carlig’s holding is not acquired by a third party who does not share a mutual level of cooperation and trust with the partnership. This interest comes at a price. It is a fair assumption that the partnership would be prepared to pay more for the minority holding than an unknown third party.
101 I consider the application of a minority discount in the amount of 25-30% in the present case rather unrealistic. The defendants each hold a 45% share in the partnership and have a special interest in acquiring Carlig’s share. Neither Jones nor Heath would be acquiring a minority interest. Assuming they each acquire half of Carlig’s 10% interest, their shareholding would simply increase by 5% and their rights would remain equal. If either Jones or Heath acquired a greater share of Carlig’s interest, then that would only increase the value of Carlig’s interest because it would confer upon the purchaser a majority interest in the partnership.
102 Neither counsel was able to identify any cases involving partnerships where questions similar to those in issue here had arisen. That was possibly because most partnerships have a written agreement setting out the essential terms of the relationship between the partners. It is unusual to have no documentation embodying the agreement between the partners.
103 In circumstances where:
· Carlig had 10% equity in the firm;
· Jones and Heath each had 45% equity in the firm;
· Jones and Heath were and remain willing to compensate Carlig for the sale of his equity;
· either Jones and Heath will retain equal interests in the partnership after the sale or one will probably hold a 55% interest and the other will have a 45% interest;
· there is no written documentation setting out the terms of the partnership entered into by Jones, Heath, and Carlig. Fitzgerald stated that the minority discount did not apply to partnerships; and
· Lom said the minority discount, if applicable, should be 25-30%,
I consider that the defendants should pay Carlig the proportional value of his interest without any minority discount.
104 Partnerships involve close personal relations between people who agree to carry on a business in common with a view to profit. Partners owe one another fiduciary duties. They usually decide together what business to carry on and are normally entitled to be involved in the daily work of the business. They are personally liable for the debts and other obligations of the partnership.
105 By comparison, companies have an independent legal existence. They obtain their funds from shareholders who are normally passive investors and who have no personal liability for the actions of the company. A board of directors conducts the operations and policies of the company. Shareholders usually have no particular managerial rights in the company and do not owe each other or the company any fiduciary duty.
106 While I understand why in cases like Re Wondoflex Textiles Pty Ltd[14] and Ebrahimi v Westbourne Galleries Ltd[15] courts spoke of the application of equitable considerations of a personal nature which might arise in a partnership context to the rights of shareholders in small companies, I do not accept that concepts such as minority discount, which are found in corporate law, necessarily apply to persons in a partnership. The defendants’ inability to direct me to case law or authoritative texts supporting the application of a minority discount to an interest in a partnership confirmed my view.
[14][1951] VLR 458.
[15][1973] AC 360.
107 I also note the judgment of Habersberger J in Orrong Strategies Pty Ltd v Village Roadshow Ltd.[16] This case concerned the detailed consideration of a number of contractual entitlements claimed by the plaintiff in relation to certain consultancy services which it provided to the defendant. Part of the case related to a valuation dispute. The plaintiff relied upon Lom as its expert forensic accountant. His Honour noted in his judgment that Lom provided alternative valuations of a business depending upon the type of gearing which the company used. Lom calculated the plaintiff’s interest in the business and gave two figures – the value depended upon whether or not the plaintiff’s shareholding was subject to a discount for being a minority interest or one which was difficult to market. The defendants criticised Lom’s report and independence, inter alia, on the ground that, although he was instructed to value the plaintiff’s interest on the basis that no minority discount applied and on the basis that a discount of whatever magnitude he saw fit did apply, nowhere did he state his opinion as to which basis was correct. His Honour regarded this criticism of Lom’s independence as “devastating”.[17] His Honour said he considered Lom derelict in not stating in his report, as opposed to cross-examination, that he was of the opinion that the discount for a minority interest applied.
Valuation
[16][2007] VSC 1.
[17]Ibid at [986].
108 Having considered the expert reports, I need to value the firm’s business and Carlig’s interest in it.
109 Fitzgerald’s report said that he had no regard to financial data after 30 June 2016. He assumed that any change would not be material. The defendants criticised his report for this reason and commented that because net profit before tax in the year to 30 June 2017 was 29% lower than the prior year, this reduced future maintainable earnings by about $34,000.
110 Fitzgerald’s report took an average of the financial position over the three years, 30 June 2014 to 30 June 2016 inclusive. It is apparent from table 3.1 in his report that profit before tax in the period between 2011 and 2016 varied between $619,000 and $808,000. Even if the profit in the 2017 financial year dropped back to a range of $600,000 - $650,000, that would not necessarily mean that the future maintainable earnings figure would be gravely affected and reduced. Had the trend continued downward, there would be greater cause for concern, but there was no evidence of the position in the financial years ending 30 June 2018 and 30 June 2019.
111 While it would have been preferable for Fitzgerald to use financial data which was current at the time of Carlig’s departure from the partnership, Lom acknowledged in evidence that the data he used for the period between 30 June 2016 and 7 February 2017 did not have any significant impact on his valuation.
Other matters
112 In my view, the assessment of future maintainable earnings is affected by the level of rent payable by the firm, the fees payable to Allmand, and the firm’s liability to McAlister.
113 The rent expense in the 2016 financial year was artificially and temporarily reduced by virtue of the rent free period of four months granted by the lessor to the firm at the beginning of the lease. Plainly, in future years the rent would have increased by about one third. The defendants argued that including the partnership’s rent commitments would have reduced future maintainable earnings by about $12,743.
114 Lom’s report shows that revenue in the financial year 30 June 2017 was $1,815,553 and expenses were $1,244,071. The expense figure was about $55,000 - $75,000 greater than the previous two years. Most of the expenses were similar over the three year period. However, in the 2017 financial year:
(a) rent was $173,000 compared to $149,000 and $122,000 respectively in the two previous years; and
(b) staff employment expenses were $74,000 compared with $600 and nil in the earlier two years.
If these greater expenses were to continue and not to be affected by increased revenue or off-setting savings, they would, in all probability, affect the valuation.
115 I consider that the fees paid to Allmand were a normal business expense incurred by the firm and not appropriate for adjustment. The defendants argued that this point reduced the future maintainable earnings by $6,433.
116 In relation to McAlister, I note that Fitzgerald said that if there were a contingent liability to McAlister, then a corresponding adjustment would be required. I find that with McAlister still working at the firm, the liability to him does exist and needs to be reflected in the valuation. To the extent that Carlig complained about the defendants’ failure to call McAlister, I consider there is no substance in the complaint. Jones was well able to give the evidence about the work relationship between him and the firm.
117 For the purposes of arriving at a valuation of Carlig’s equity in the partnership, I will rely upon the firm’s financial results over the three year period 30 June 2014 to 30 June 2016 inclusive. I shall also have regard, where appropriate, to financial data as at 7 February 2017.
118 The operating profit or net profit before tax for the firm in those years was not identical in the two expert reports, although the figures were close. The figures which I adopt are:
2015 2015 2016 7 February 2017 $715,872 $763,558 $808,651 $458,419
To the extent the figures used by Fitzgerald and Lom differ, I have preferred those in Lom’s report because, overall, I found his report to be more thorough and comprehensive.
119 The next matter is that of the adjustments to be made to the net profit. After adjustments, Fitzgerald adopted an average adjusted operating figure for the three years of approximately $385,000. Using his multiple of 3.8, Fitzgerald arrived at an enterprise value of about $1,463,000. Lom concluded the maintainable EBIT was in the range of $310,000 - $330,000 which, with his multiple, gave an enterprise value range of $930,000 - $1,320,000. Both experts agree that the private expenses of the partners are to be taken into account and allowance made for notional salary packages and superannuation. In addition to these items, I find that this allowance should include applicable payroll tax. Unlike Fitzgerald, it is not my view that an allowance should be made for the money paid to Allmand.
120 Fitzgerald’s figures require further adjustment in my opinion because, while he says that he allowed for on-costs of 11.5%, no such provision clearly appears in table 3.3 of his report. Lom has allowed an extra sum of about $65,000 each year to cover superannuation and payroll expenses. In the circumstances, and after making due allowance, I consider the maintainable EBIT figure should be in the range of $310,000 - $330,000.
121 As set out previously, I regard 1.0 as an appropriate multiple for this exercise. Applying this to the EBIT figure gives a future maintainable earnings value of the enterprise of $310,000 - $330,000.
122 Both experts seemed to agree that the enterprise value in turn was to be adjusted for other operating and non-operating assets and liabilities.
123 In his report, Fitzgerald made adjustments to the enterprise value to arrive at the “net value” of the partnership business. These included the following “Operating Assets”:
Trade Debtors 78,287
Creditors and Provisions (65,047)
Net operating assets 13,240
124 Lom did not include the above operating asset in his adjustments.
125 Fitzgerald also included the following “Non-Operating Assets and Liabilities”:
Term Deposit 20,000
Other assets 1,749
Bank Overdraft (75,677)
Sub-Total (40,688)
126 The balance of the operating and non-operating assets came to $40,688. Fitzgerald then subtracted this sub-total from the enterprise value of $1,462,844 to reach a net value of $1,422,156.
127 The above non-operating assets in Fitzgerald’s report, although described slightly differently, correspond exactly to the amounts set out in Lom’s report under the heading “Add: Surplus assets”.
128 Lom, by contrast, included the following amounts under the heading “Less: Net debt”:
Ian McAlister liability (105,000)
Partner accounts (16,597)
(121,597)
129 As indicated, in my view it is necessary to make allowance for the McAlister liability. I agree with Lom that the same applies to the partner accounts. With respect to what Fitzgerald identified as net operating assets of $13,240, again, I agree with Lom’s evidence that the enterprise value is the value of the business which generates the earnings. The adjustments are to exclude assets and liabilities which do not generate earnings. I agree that the assets of $13,240 should not be specifically taken into account in addition to the enterprise value.
130 Fitzgerald reduced his enterprise value by about $40,000 and Lom reduced his too. Fitzgerald attributed a net value of $1,422,000 to the firm and Lom had a range from $750,000 to $1,170,000, and a midpoint of $960,000. The major point of difference was the McAlister liability. As stated, I find Lom’s approach on this issue to be preferable.
131 When the relevant adjustments are made to the enterprise value of $310,000-$330,000, the equity value of the firm at the higher end is approximately $180,000.[18] Hence, I find that Carlig’s 10% equity in the firm is worth $18,000.
[18]Table 9.3.2 of Lom’s report dated 22 February 2019.
132 Due to the facts of this case and the matters referred to at paragraphs 68-69 and 97, I think it appropriate to use the higher end of Lom’s valuation for the purpose of assessing Carlig’s equity.
133 I appreciate there is a substantial difference between the acquisition cost of Carlig’s 10% interest in 1998 and the current value of that interest. Initially, I was concerned that the value of the equity had dropped so significantly. However, I am satisfied that there is no necessary connection between the two valuations given that they are about 20 years apart and the evidence does not establish that the circumstances were relevantly the same at both times.
134 There was no evidence before me of:
· what induced Carlig to buy equity in the partnership;
· what information Carlig had at his disposal in assessing the offer to become a partner;
· what if anything the existing partners told him about the partnership and the valuation of his interest at the time of acquisition;
· the basis upon which Carlig became a partner and the criteria he used in assessing the suitability of the purchase price of his 10% equity.
Carlig did not in his statement of claim allege that he had been duped or misled in acquiring his equity in the partnership. His trial was conducted on the basis that it was concerned only with the extent and value of his equity and any outstanding profits owing.
Is Carlig entitled to any and what amount for unpaid partnership profits?
135 Carlig claims unpaid profit distributions at paragraph 11(b) of his statement of claim. That claim is particularised as follows:
11.Since the end of the partnership period and to date, the defendant:
…
(b)has not paid to the plaintiff profit distributions.
PARTICULARS
The plaintiff’s equity share has been calculated in a valuation report prepared by Tom Fitzgerald, chartered accountant, dated 17 May 2018 (the Fitzgerald report).
The plaintiff’s profit share is the sum of:
A.$82,536 (as stated in the Fitzgerald report), being the shortfall between:
i.the total profit distributions credited to the plaintiff during the period 1 July 2013 to 30 June 2016; and
ii.the profit distributions to which the plaintiff was entitled pursuant to his 15 percent equity in the defendant business, and
B.$2,656, being the shortfall between:
i.the total profit distributions credited to the plaintiff during the period 1 July 2016 to 7 February 2017; and
ii.the profit distributions to which the plaintiff was entitled pursuant to his 15 percent equity in the defendant business.
136 The Fitzgerald report quantified the value of unpaid profit distributions owed to Carlig at $82,536, comprising:
(a) $71,325, being the shortfall between the total profit distributions paid to him during the period 1 July 2013 to 30 June 2016 and the entitlement to 15% equity which he claims; and
(b) $11,211, being the shortfall between the profit distributions paid to him during the period 1 July 2016 to 7 February 2017 and the entitlement to 15% equity which he claims.
137 It is unclear to me why the particulars of paragraph 11 include an additional $2,656 for the period 1 July 2016 to 7 February 2017 in circumstances where the unpaid profit claim for that period is already incorporated into the total $82,536 set out in the Fitzgerald report. These matters were not canvassed in the final submissions or address. There appears to be a case of double-counting and I would not allow the claim for $2,656.
138 For the reasons set out above, I have found that Carlig was entitled to 10% equity in the partnership business from the time of his agreement with Jones in May 2013 to his resignation in February 2017. The terms of that agreement were that Carlig would receive as payment for his work either 10% of the partnership profit or $100,000 per annum, whichever was greater.
139 On the basis of that agreement, I find that the profit distributions owing to Carlig should total $14,982, comprising:
(a) $12,755 for the financial year ending 30 June 2013; and
(b) $2,227 for the period 1 July 2016 to 7 February 2017.
My reasons are as follows.
Financial year 30 June 2013
140 In relation to the year ended 30 June 2013, I consider that the agreement between Carlig and Jones took effect immediately from 13 May 2013. I base this finding on factors including:
· the reconciliation for accounting purposes for the period ended 30 June 2013 provides that “Equity % + profit” for the three partners MJ (Jones), MH (Heath) and EC (Carlig) was 45, 45 and 10 respectively. This suggests the agreement took effect in May 2013;
· no witness suggested that the agreement reached between Carlig and Jones took effect other than immediately;
· the perceived urgency of the need to take cost saving measures; and
· evidence of Michael Heath that later the same day or the following day after the agreement was made, Jones said words to the effect, “Edy has agreed to … stay and to go forward on the basis we discussed”,[19] and that it was his understanding that those changes were then implemented.[20]
[19]T125/8-18.
[20]T125/22-29.
141 Table 3.2 of Fitzgerald’s report shows that Carlig was paid $87,245 in the year ended 30 June 2013.[21] Assuming the May 2013 agreement took effect for the 2013 financial year, and given my finding that Carlig was owed the greater of 10% of profits or $100,000, Carlig should have been paid $100,000 in that year.
[21]Fitzgerald’s report dated 17 May 2018, page 5.
142 Accordingly, Carlig is owed the difference between $100,000 and $87,245, being $12,755.
Period ended 7 February 2017
143 In relation to the period 1 July 2016 to 7 February 2017, Fitzgerald’s report asserts that Carlig was paid $58,321 (representing 12.6% of total distributable profit of $463,547) but that he was entitled to $69,532 (representing 15% of total profit) pursuant to the alleged agreement.[22] Accordingly, Fitzgerald concludes that Carlig is owed the difference between $69,532 and $58,321, being $11,211.
[22]Fitzgerald’s report dated 17 May 2018, pages 5-6.
144 Again, because I have found that Carlig was only entitled to the greater of 10% of profits or $100,000 per annum, Fitzgerald’s calculation as to Carlig’s entitlement for the period ending 7 February 2017 should not be accepted.
145 Carlig did not adduce any evidence of the firm’s financial results for the year ended 30 June 2017. However, in his report, Lom noted that he received copies of the firm profit and loss statements and balance sheets for the financial years ending 30 June 2015, 30 June 2016, and the period ending 7 February 2017. His report (table 7.1.3) said that, as at that date, the firm’s fee income was $1,152,129, its EBIT was $458,365, and its net profit before tax was $458,419. The firm’s normalised EBIT after adjustments, as set out in table 7.1.4, was $194,202. The comparison with prior years was as follows:
Financial Year 2014 Financial Year 2015 Financial Year 2016 1 July 2016 – 7 February 2017 EBIT 717,021 763,709 808,240 458,365 Adjustments 455,899 451,876 443,537 264,163 Profit before tax 714,723 763,558 808,657 458,419 Normalised EBIT 261,122 311,833 364,703 194,202
On the basis of these figures, I consider it highly likely that, for the year ending 30 June 2017, EBIT and the amount available for distribution to partners in the firm would have been less than $1,000,000. Assuming that to be correct, Carlig, had he remained a partner for the full financial year, would have received a salary of $100,000.
146 The number of days from 1 July 2016 to 7 February 2017 is 221. As a proportion of the 365 days in a calendar year, this represents about 60.55%. On a pro rata basis, Carlig would therefore be entitled to $60,548.
147 Fitzgerald’s report notes that Carlig was paid $58,321 for the period 1 July 2016 to 7 February 2017. On the basis that he was entitled to $60,548 for that period, he is owed the difference of $2,227.
Financial years 2013 to 2016
148 Fitzgerald’s report provides that Carlig was paid the following in the years ending 30 June 2013 to 30 June 2016 inclusive:[23]
[23]Fitzgerald’s report dated 17 May 2018, page 5.
· $87,245 in 2013 (representing 13.0% of total profits);
· $105,000 in 2014 (representing 13.5% of total profits);
· $110,000 in 2015 (representing 13.3% of total profits); and
· $100,000 in 2016 (representing 11.4% of total profits).
Because Carlig was entitled to the greater of 10% of the firm’s profits or $100,000 per annum, and in the financial years 2014, 2015 and 2016, 10% of the profits represented less than $100,000,[24] Carlig received the agreed payment because the firm paid him a base salary of at least $100,000 in each of those years.
[24]Total profit distributions in the years 2013 to 2016 inclusive were $672,447, $778,259, $827,679 and $878,751 respectively.
149 Accordingly, Carlig has no claim to any shortfall for the financial years 2014 to 2016 inclusive.
150 In short, the total profit distributions owing to Carlig is $14,982, comprising:
(a) $12,755 being the shortfall between the profit distributions of $87,245 paid to him in the financial year ending 30 June 2013 and his entitlement to a minimum salary of $100,000 for that year; and
(b) $2,227, being the shortfall between the total profit distributions of $58,321 paid to him during the period 1 July 2016 and 7 February 2017, and his entitlement to $60,548 pro-rated on the basis of his $100,000 minimum salary.
Conclusion
151 In summary, my findings in this case are:
(a) at the time of trial, Carlig had 10% of the equity in the partnership;
(b) the remaining partners, the defendants, should pay Carlig $18,000 for his interest; and
(c) Carlig is entitled to $14,982 for unpaid profit distributions.
I will hear the parties on the form of final order and costs.
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