Cba v Jovanovic (No 3)
[2005] SADC 170
•22 December 2005
DISTRICT COURT OF SOUTH AUSTRALIA
(Civil)
CBA v JOVANOVIC & ORS (NO 3)
Judgment of His Honour Judge Lee
22 December 2005
MORTGAGES - MORTGAGES AND CHARGES GENERALLY - REMEDIES OF THE MORTGAGEE - SALE UNDER POWER - MODE OF EXERCISE OF POWER
MORTGAGES - MORTGAGES AND CHARGES GENERALLY - REMEDIES OF THE MORTGAGOR
EVIDENCE - ADMISSIBILITY AND RELEVANCY - OPINION EVIDENCE - EXPERT OPINION
Sale of hotel property by plaintiff under power of sale in mortgage – claim by plaintiff against guarantors to recover shortfall – counterclaim by guarantors and mortgagor – after plaintiff's claim allowed, Full Court held on appeal that plaintiff in breach of obligation under s 420A of Corporations Act 2001 (Cth) to take all reasonable care to sell property for not less than market value – action remitted to trial judge to determine price which would have been obtained had plaintiff taken all reasonable care in terms of section – action assigned to another judge after trial judge disqualified himself – application by defendants to call further valuation evidence – meaning of requirement to "take all reasonable care to sell the property for not less than market value" discussed - whether previous witnesses addressed correct test – application allowed subject to condition that only previous witnesses be called – witnesses directed to confer – terms imposed including term that conference be under supervision of Master.
Corporations Act 2001 (Cth) s 420A, referred to.
Jovanovic & Ors v Commonwealth Bank of Australia [2004] SASC 61; Murray v Figge (1974) 4 ALR 612; Hines Exports Pty Ltd v Mediterranean Shipping Co (SA) (2001) 80 SASR 268; Florgale Uniforms Pty Ltd v Orders (2004) 187 FLR 142, considered.
CBA v JOVANOVIC & ORS (NO 3)
[2005] SADC 170
On 3 March 2004, in Jovanovic & Ors v Commonwealth Bank of Australia [2004] SASC 61, the Full Court of the Supreme Court ordered that orders of a judge of this Court be set aside and that the action be remitted to the judge for the hearing and determination of the issue identified by the Full Court in its reasons. Later the judge disqualified himself, and the action was assigned to me.
Although I have already read and heard lengthy written and oral submissions on that issue, I am not yet in a position to finally deal with it. I must first determine an application by the defendants and a plaintiff by counterclaim to call further evidence.
The relevant background is as follows:
1. In November 1995, the defendants (Mr and Mrs Jovanovic) arranged to purchase a property known as the Plaza Hotel in Hindley Street, Adelaide. The property is located approximately 250 metres west of the intersection of Hindley and King William Streets. The property included three ground level shops. The price was $750,000. The property was owned at that time by Roclin Pty Ltd (Roclin). Roclin was controlled by two male persons each named Govedarica. A hotel business was conducted on the property. The contract excluded from the sale “All Tenant’s goods, chattels, plant and equipment and stock in trade”.
2. The transfer of the property was taken in the name of Fortson Pty Ltd (Fortson). Fortson was acquired as a shelf company by Mr and Mrs Jovanovic for that purpose.
3. The plaintiff in the action (the Bank) advanced the sum of $750,000 to Fortson to fund the purchase. The loan was secured by a mortgage over the property, a charge over the business, and a guarantee by Mr and Mrs Jovanovic.
4. At the time of the sale, Mr and Mrs Jovanovic entered into an agreement with the Govedaricas to hold two thirds of the property and the business on trust for the Govedaricas. This agreement was not disclosed to the Bank at that time.
5. By early 1997, Fortson was in serious default with repayments of the loan to the Bank, and the Bank had begun to consider the exercise of its power of sale under the mortgage.
6. In February 1997, the Bank decided to sell the property by way of a private tender process.
7. On 14 July 1997, the Bank accepted an offer from the Govedaricas to purchase the property through Roclin for $800,000. The Bank financed the purchase with a loan to Roclin of $620,000. The loan was guaranteed by the Govedaricas. The contract excluded from the sale “all goods, chattels, plant equipment and machinery and moveable items not in the nature of permanent improvements in or about the Land”. Two of the shops were occupied.
8. On 11 February 1998, the Bank commenced the action in this Court against Mr and Mrs Jovanovic under their guarantee. The amount sought was $39,615.90. Fortson entered the proceedings as plaintiff to a counterclaim against the Bank.
9. On 13 June 2003, after a protracted interlocutory history and a hearing between 3 and 19 March 2003, the primary judge entered judgment for the Bank against Mr and Mrs Jovanovic for $77,643.93. Fortson’s counterclaim was dismissed.
10. On 3 March 2004, the Full Court set aside the primary judge’s orders as having been based upon the wrong test. The Full Court decided that the Bank’s sale of the property by a private tender process was in breach of s 420A of the Corporations Act. The Full Court remitted the action to the primary judge for the hearing and determination of the issue identified in its reasons.
11. On 6 September 2004, after a hearing over three days, the primary judge disqualified himself on the ground of perceived bias, and the action was assigned to me.
There are other events in the background which I need not detail. They are relevant, however, to the issue of credit. Besanko J dealt with those events at paragraph 101 of his reasons. Part way through that paragraph, his Honour said:
The Judge found that from 1995 onwards the Jovanovics and the Govedaricas engaged in a devious web that perhaps could also be viewed as fraudulent conduct to defeat their creditors and for the purpose of retaining the ownership of The Plaza Hotel. That finding was amply justified on the evidence.
Before leaving the background, I should say more about the hotel business at the property. The business was that of an unlicensed budget style hotel of 67 rooms. The Govedaricas continued to conduct the business after the sale to Fortson in November 1995. It was common ground that the Bank purported to exclude the business from the sale to Roclin in July 1997 of the freehold title of the property. The primary judge was not satisfied that Fortson owned the business at that time, and the Full Court did not think that he was in error in that regard. It seems that the issue of the ownership and entitlement to the profits of the business is the subject of separate proceedings between the Jovanovics and the Govedaricas. In the end, the Full Court found that the Bank did not act in breach of duty in relation to the hotel business at the time of the sale in July 1997.
Section 420A(1) of the Corporations Act 2001 provides:
In exercising a power of sale in respect of property of a corporation, a controller must take all reasonable care to sell the property for:
(a) if, when it is sold, it has a market value—not less than that market value; or
(b) otherwise—the best price that is reasonably obtainable, having regard to the circumstances existing when the property is sold.
There is no suggestion that the property did not have a market value. So subsection (1)(a) applies. The duty is not to take reasonable care in a general sense. It is a duty to take all reasonable care to sell for not less than market value. It must follow that the duty is not discharged merely by the obtaining of market value. If there is an opportunity to sell for more, the mortgagee’s failure to take that opportunity may amount to a breach of the section.
When it comes to the measure of any loss, there is a difference between asking “What is the market value of the property?”, and asking “What price would be achieved by taking all reasonable care to sell the property for not less than market value?”. The second question, unlike the first, does not focus exclusively upon market value. Assets are often sold under or over their market value. Sometimes a buyer with a special interest in acquiring an asset will pay a premium on market value. So the second question would permit consideration of information that a buyer was prepared at the relevant time to pay more than market value.
The issue which I am required to determine emerges from the following paragraphs of the reasons (with which Mullighan J agreed) of Besanko J:
117 The question remains as to the price which would have been obtained for the freehold title of the property had the Bank taken all reasonable care in terms of the section. In the circumstances of this case that involved appointing an agent, conducting a proper marketing campaign and putting the freehold title of the property to the market. The difference between the price which would have been obtained had that been done and the price the Bank in fact obtained, together with appropriate adjustments in relation to the expenses of the sale, is the measure of the loss for the breach of the duty in s 420A. Unfortunately, this Court is not in a position to determine that figure. It involves an assessment of the valuation evidence including an assessment of the extent to which that precise issue has been addressed by the valuers, and a determination as to the valuation evidence which should be preferred. It may be noted that the market value as defined by one or more of the valuers who gave evidence is not necessarily the same as the sale price that would have been achieved had the Bank appointed an agent, conducted a proper marketing campaign and put the freehold title of the property to the market.
118 The question which I have identified must be determined by the Judge and it will be a matter for him whether, if the parties wish to call further evidence, he allows that to be done. If the conclusion is reached that there is a difference, then Fortson is entitled to have the difference brought to account in the taking of accounts between it and the Bank. Depending on the figure, it may or may not have a counterclaim. The Jovanovics are entitled to bring to account by way of an equitable set off to the claim on the guarantee the difference, if there be a difference. As guarantors they are not entitled to bring a counterclaim, and although they were directors and shareholders of Fortson, they are not entitled to claim for loss sustained by the company (Gould v Vaggelas (1985) 157 CLR 215). For these reasons, I disagree with the conclusion of Gray J that the Jovanovics are entitled to pursue their counterclaim against the Bank.
Two points emerge. The issue for determination is “the price which would have been obtained for the freehold title of the property had the Bank taken all reasonable care in terms of the section”. In the particular circumstances of this case, the requirement to take “all reasonable care in terms of the section” would have been met by the Bank “appointing an agent, conducting a proper marketing campaign and putting the freehold title of the property to the market”.
It is apparent that the witnesses who gave oral evidence about the value of the property did not pose the correct question for themselves, that is, the question which arises from s 420A. Each purported to advise on market value. Each adopted the definition of the International Asset Valuation Standards Committee and the Australian Property Institute, namely
Market Value is the estimated amount for which an asset should be exchanged on the date of valuation between a willing buyer and a willing seller in an arms-length transaction after proper marketing, wherein the parties had each acted knowledgably, prudently and without compulsion.
Doubtless Besanko J had that definition in mind when he said (at para 117):
It may be noted that the market value as defined by one or more of the valuers who gave evidence is not necessarily the same as the sale price that would have been achieved had the Bank appointed an agent, conducted a proper marketing campaign and put the freehold title of the property to the market.
and (at para 118):
…. it will be a matter for (the judge) whether, if the parties wish to call further evidence, he allows that to be done.
Although, as it turns out, the point is not of any significance, I do not agree with counsel for Fortson that the Full Court has made new law. Besanko J’s observation that the Bank would have taken all reasonable care in terms of the section if it had appointed an agent, conducted a proper marketing campaign and put the freehold title of the property to the market is not new law. It is applying the law of s 420A to the particular circumstances of this case.
I turn to the valuation evidence that was put before the primary judge. I need to decide whether the issue remitted by the Full Court can be determined satisfactorily upon the basis of that evidence, notwithstanding that the correct question was not asked.
The witnesses were Mr PJ Burton of Knight Frank, called by counsel for the Bank, and Mr R Williamson of FPD Savills and Mr R Taylor of Richardson & Wrench, called by counsel for Fortson and the Jovanovics.
I have said that all three witnesses adopted the same definition of market value.
The other approach that was common to the witnesses was to capitalise a projected net rental return for the purpose of arriving at market value. However, as will appear, each adopted a different capitalisation rate.
In The Valuation of Businesses, Shares and Other Equity (4th Edition) by Wayne Lonergan, under the heading “Capitalisation of Income” at page 371, the author said this:
Income producing properties are generally valued by capitalising the (pre tax) net rental income the property produces at a capitalisation rate (often referred to as a running yield) based on the yield reflected in contemporaneous sales of comparable income producing properties.
For example, if an office building generated net rental income (before tax) of $8m per annum and the prevailing capitalisation rate was 8 per cent, then the building would have a value of $100m ($8m net rent divided by 8 per cent equals $100m capital value). This valuation method assumes a continuation of current rental income, and that the potential for rental and capital growth risks associated with investing in the property and any tax deductions available to an owner of the building are all reflected in the yield.
This method is relatively easy and inexpensive to apply. It is also favoured by many property valuers.
I will use a table at this point to compare the figures which the witnesses adopted to arrive at their valuations.
Burton
Williamson
Taylor
hotel rental
70,000
75,000
70,000
shop rental
38,750
45,000
45,164
108,750
120,000
115,164
deduction for land tax
5,825
-
-
102,925
120,000
115,164
capitalisation rate
13.5%
11%
11.5%
762,407
1,100,000
1,000,000
Burton
Williamson
Taylor
deductions for · repairs 50,000 - - · letting up allowance
55,000
-
-
add back rental surplus
866
-
-
capital value $660,000 $1,100,000 $1,000,000
It will be apparent that the witnesses are not all that far apart on their projections of rentals for the hotel and the shops. Yet there is a substantial divergence between Mr Burton’s ultimate figure of $660,000 on the one hand, and Messrs Williamson and Taylor’s ultimate figures of M$1.1 and M$1 on the other. The divergence boils down to differences between them with respect to the capitalisation rate, and with respect to the deductions that Mr Burton made for land tax, repairs and letting up allowance.
Small differences in capitalisation rate will lead to large differences in capital value. For example, had Mr Burton applied to his projected rental of $108,750 Mr Williamson’s capitalisation rate of 11%, he would have arrived at a capital value of, in round figures, $989,000.
The witnesses looked at or were asked about sales of other properties, but I do not propose to detail their evidence on that topic at this stage. I mention, however, the sale of the old Miller Anderson store at 12-16 Hindley Street as a possible explanation, or one of the possible explanations, for the difference between the witnesses with respect to the capitalisation rate for the Plaza Hotel. It appears from Mr Burton’s report that the Miller Anderson store was sold for $1,475,000 in March 1996, and that the “holding income” at that time was $108,360. On those figures, the capitalisation rate was 7.3%. Mr Williamson said that, of all the sales mentioned by Mr Burton in his report, the Miller Anderson sale was “the most comparable”, because the property was bought by an owner/operator. Mr Burton was not cross-examined for his view about that. In his written report, however, Mr Burton said that the location of the Miller Anderson store was superior to the Plaza Hotel. It should be emphasised that resales of the store after July 1997, as with subsequent sales of other properties, are not relevant to the enquiry.
I go back to the projections that the witnesses made with respect to hotel rental. Messrs Burton and Williamson assumed that the occupancy rate of the hotel at the time was in the order of 50%. Mr Taylor assumed that the rate was between 35% and 40%. It appears, however, that none of the witnesses was asked to take into account the evidence of a Mr Stefanovic. He was the night manager of the hotel between March 1992 and May or June 1998. He was the only first hand source of information about the actual occupancy rate of the hotel. He said that, of the 67 rooms that were available for letting, 40 to 45 rooms were occupied by permanent residents, and about 15 rooms on average were occupied by casual guests. He said that an average of one or two rooms would have been in an unfit state to let at any one time. 53 rooms as a percentage of 67 rooms is 79%. As for room rates, the following is a summary of Mr Stefanovic’s evidence on that topic:
permanent residents
standard room $91 per week
room with ensuite $130 to $140 per week
casual guests
one person
standard room $25 per nightroom with ensuite $35 per night
two persons
standard room $35 to $40 per night per roomroom with ensuite $45 to $50 per night per room
three persons
standard room $50 per night per roomroom with ensuite $75 per night per room
In relation to the occupancy rate, a point should be made about how potential residents and guests might have viewed the condition of the hotel in 1997. Each of Messrs Burton, Williamson and Taylor inspected the hotel at that time, but Messrs Williamson and Taylor said that their inspection was only brief. Mr Williamson said that the condition of the property was very poor. Mr Taylor said the building was dated in terms of facilities, and he could not say with any certainty whether or not all of the rooms would have been habitable. Mr Burton’s evidence was as follows:
Q…. Can you just tell us in your own words how you assessed the presentation of the hotel at the time you inspected it.
APoor to very poor.
QYou talk about capital expenditure, we will deal with that a bit later, I think you put a figure on that of at least $60,000. Was that the minimal amount of capital expenditure required, would you expect more or was that what you considered a prudent purchaser would have to expend.
AWould have to be an absolute minimum. From memory, when we inspected the premises, the upper floors, particularly in some of the hotel rooms, had significant water damage, so to say that they could be effectively leased would be wrong, given that there was a significant amount of water damage, so our allowance for capital expenditure was to get that rectified but not do any more. So it was to bring it to a minimum standard such that you would be able to rent the rooms. But quite a bit more would potentially be able to be spent on the property.
In the final analysis, I have decided to allow the parties to call further evidence, subject to conditions which I will mention in a moment. My decision to do so is based upon the following grounds:
1. At the trial before the primary judge, the witnesses posed for themselves the incorrect test, and I am not satisfied that the evidence that they did give would enable me to make a determination in accordance with the correct test.
2. Notwithstanding extensive submissions and references to transcript by counsel, I am unable to discern any clear and satisfactory basis for preferring or rejecting the evidence of any of the three witnesses, especially with respect to the capitalisation rate. I expect that this difficulty arises from my not having had the advantage of hearing and seeing the witnesses first hand, and of being able to intervene to seek clarification as and when necessary.
3. As the table discloses, the witnesses were within tolerable limits in their projections of rental income. But, as I have said, each assumed an occupancy rate for the hotel of not more than 50%. From Mr Stefanovic’s evidence, it would appear that the occupancy rate may have been in excess of 50%, and that the net rental income of the hotel may have been in excess of $75,000 per year.
Counsel for the plaintiff contended that the application does not meet the test for the calling of further evidence, as propounded in Murray v Figge (1974) 4 ALR 612. However that may be, the overriding principle is the obligation to do justice, and in each case there will be different considerations which must be brought to bear on its application: Hines Exports Pty Ltd v Mediterranean Shipping Co (SA) (2001) 80 SASR 268 at 276. I assume that Besanko J had that principle in mind when he said that it will be a matter for the trial judge whether, if the parties wish to call further evidence, he allows that to be done.
As for the conditions upon which further evidence is to be called, I rule that the parties should not call other than the witnesses who gave oral evidence before the primary judge, namely Messrs Burton, Williamson and Taylor. The ultimate question for the witnesses to consider is: “What price would have been obtained for the freehold title of the property in July 1997 had the Bank appointed an agent, conducted a proper marketing campaign and put the freehold title of the property to the market?”
As I have already said, this question would permit consideration of information that a buyer was prepared at the relevant time to pay more than market value. It would be necessary, however, that there be reliable information upon which a positive finding could be based. Mere conjecture would not be enough. Moreover, any such buyer would had to have been genuine and at arms length. I would not attach any weight to any offers said to have passed between the Govedaricas and the Jovanovics.
I direct that, before the witnesses give further oral evidence, they should confer. Although I am prepared to hear submissions on the terms upon which the witnesses should confer, I have in mind the following:
1. The witnesses should be provided with Practice Direction 46A, and their attention should be directed in particular to paragraph 4, namely
4.1An expert witness has an overriding duty to assist the Court on matters relevant to the expert’s area of expertise.
4.2An expert witness is not an advocate for a party.
4.3An expert witness’s paramount duty is to the Court and not to the person retaining the expert.
2. The conference should be held at the Sir Samuel Way Building in Victoria Square under the supervision of Master Norman at a time to be arranged.
3. The conference should be informal, but it should also follow such procedures or guidelines as are determined by Master Norman after consultation with the witnesses.
4. The parties should not be present or represented at the conference.
5. The witnesses should not accept or act upon any instructions of the parties or their representatives.
6. The witnesses should refer as and when necessary to reports and evidence already before the Court, and should alter or modify any view or opinion expressed therein if, upon further consideration and having regard to matters discussed at the conference, it becomes appropriate to do so.
7. The conference is not for the purpose of negotiating a compromise. Rather, its purpose is to enable the witnesses, after discussion, to identify matters of agreement and matters about which there remains a difference of opinion.
8. After matters of agreement and matters about which there remains a difference of opinion have been identified, the witnesses should prepare a brief joint statement in writing of those matters, with Master Norman providing such assistance as may be required.
9. With respect to each matter about which there remains a difference of opinion, the statement should contain a brief outline of the reasons for the difference, and any suggestions for resolution of the difference.
10. The statement should be signed by the witnesses, and then delivered to Master Norman for submission to me and to the parties.
In devising these terms, I have borrowed from an order made by Goldberg J on 20 September 2004 in the Australian Competition Tribunal in a matter concerning the Sydney Airport. The order is mentioned in a paper which Murray McInnis, Federal Magistrate, presented to a conference conducted by the International Institute of Forensic Studies in Broome, Western Australia, in October 2005.
Without intending to limit the discussion at the conference, I invite the attention of the witnesses to my summary of the evidence of Mr Stefanovic about the occupancy rate and rental income of the hotel at the relevant time. That summary will have to be considered in light of the condition of the hotel. I also invite attention to the table in these reasons, and to the differences between the witnesses including differences with respect to the capitalisation rate.
Counsel for Fortson contended that Mr Burton’s capitalisation rate of 13.5% was based upon an expectation that the market for the Plaza Hotel would be confined to the traditional investor. My reading of Mr Burton’s report and evidence does not support that contention. Mr Williamson did not dispute the reasonableness of 13.5% for a market that was confined to the traditional investor, but said that the hotel would have appealed to a developer or owner/occupier for whom the risk would be less. Less risk means a smaller capitalisation rate and a higher capital value. Doubtless these matters, and the significance of other sales, will be topics of discussion at the conference.
Before concluding, I should mention that, notwithstanding extensive references to authority by counsel, dealing mainly with a mortgagee’s equitable duty, I need not explore the precise meaning of the expression “market value” where it second appears in subsection (1)(a) of s 420A. The expression is not used in isolation. Its context includes the words “all reasonable care” and “not less than”. My task in any event is to answer the question which has been remitted by the Full Court. I content myself with a reference to a useful discussion of the history of the section, and the role in that history of the Discussion Paper of the Australian Law Reform Commission General Insolvency Inquiry (the Harmer Report), by Dodds-Streeton J in Florgale Uniforms Pty Ltd v Orders (2004) 187 FLR 142 at 187 to 204.
I now need confirmation from counsel that all three witnesses will be recalled. I will then discuss with them the dates that should be set aside for the conference, and for the oral evidence of the witnesses if it emerges from their joint report that further evidence is required. If further evidence is required, I have in mind to order that the witnesses give their evidence concurrently. Again I would be prepared to hear submissions on that aspect of the matter.
0
6
1