DNFS Pty Ltd v De Neefe Signs Pty Ltd
[2013] VSC 88
•20 March 2013
| IN THE SUPREME COURT OF VICTORIA | Not Restricted |
AT MELBOURNE
COMMERCIAL AND EQUITY DIVISION
No. 10519 of 2006
| DNFS PTY LTD AND OTHERS (ACN 005 587 593) | Plaintiffs |
| v | |
| DE NEEFE SIGNS PTY LTD AND OTHERS (ACN 115 924 939) | Defendants |
---
JUDGE: | JUDD J | |
WHERE HELD: | Melbourne | |
DATE OF HEARING: | 29–31 October, 1, 7, 8 and 13 November 2012 | |
DATE OF JUDGMENT: | 20 March 2013 | |
CASE MAY BE CITED AS: | DNFS Pty Ltd v De Neefe Signs Pty Ltd | |
MEDIUM NEUTRAL CITATION: | [2013] VSC 88 | |
---
CONTRACT – Sale of business – Construction – Valuation of stock.
---
APPEARANCES: | Counsel | Solicitors |
| For the Plaintiffs | M D Dean | Rennick & Gaynor Solicitors |
| For the Defendants | M W Wise | K&L Gates |
HIS HONOUR:
The trial of this proceeding concerned a ‘stock take’ that was carried out on and following 31 August 2005, purportedly pursuant to a sale of business agreement dated 3 October 2005. The parties to the agreement are the plaintiffs, DNFS Pty Ltd (previously known as De Neefe Signs Pty Ltd, and sometimes referred to as old De Neefe); High SD Pty Ltd (previously known as Highway Safety Developments Pty Ltd); and NNTSIGN Pty Ltd (previously known as Norsign (NT) Pty Ltd); and the defendants, De Neefe Signs Pty Ltd (previously known as Mykios Pty Ltd, and sometimes referred to as new De Neefe); Traffic Technologies Ltd; and Constantine Andrew Scrinis.
The plaintiffs had carried on business as the manufacturers of road safety and other signs used for traffic management, public transport, travel information and other purposes.
The agreement required a valuation of the plaintiffs’ stock to be undertaken immediately prior to 1 September 2005, the ‘Effective Date’ under the agreement. That was the date on which title and risk in a category of stock and other assets passed to the purchaser. That stock, to a value of $2.25 million, was to be purchased by new De Neefe. It was defined in the agreement as ‘Sale Stock’. The remaining stock was to be left with the purchaser, new De Neefe, on consignment. It was defined in the agreement as ‘Balance Stock’. New De Neefe was only required to pay for items of Balance Stock sold or used by it. The plaintiffs’ claim is that on or before 1 December 2005 new De Neefe sold or used items of Balance Stock for which it is liable under cl 7.4 of the agreement, in the sum of $1,703,912.38. There is an alternative claim for damages for conversion of items of Balance Stock to the same value.
The issues were not always so confined. The proceeding underwent a substantial evolution following its commencement on 21 December 2006. In order to assist the parties to reach a negotiated compromise, or perhaps confine the issues for trial, six preliminary questions for determination were formulated and eventually answered by a judge in the trial division on 16 October 2008.[1] Unfortunately, that decision resulted in appeals by both sides against four out of the six answers to the preliminary questions. The appeal was successful in respect of only one answer,[2] but had the effect of delaying this trial for almost two years. Although the delay was unsatisfactory, the outcome also had the effect of narrowing the issues. I note that the Court of Appeal made no criticism of the fact that preliminary questions had been set down for trial.
[1][2008] VSC 424.
[2][2008] VSCA 125.
Prior to trial, some further issues in dispute between the parties, unrelated to the stock take and the claim for payment under cl 7.4 of the agreement, were compromised. The remaining issue at trial was the plaintiffs’ claim for $1,703,912.38, brought under cl 7.4 of the agreement. Clause 7.4 required new De Neefe to pay for items of Balance Stock within 60 days from the end of the month in which that stock was used or sold. Thus, the plaintiffs were required to establish that particular items of consignment stock, to the value claimed, were properly characterised as Balance Stock, and that such items had been used or sold by new De Neefe on or before 1 December 2005. The plaintiffs made no claim based on a constructive or resulting trust of the proceeds from the sale or use of consignment stock.
In their preparation for trial, the parties developed case strategies and adopted paradigms that made it difficult to identify common questions for determination. So disparate were their perspectives, that the appointment of a special referee to decide questions relating to the stock count, classification and valuation would only have exacerbated the already unacceptable delay. Ultimately the plaintiffs required the court to undertake a detailed analysis of a stock count, classification and valuation, undertaken on and after 31 August 2005, at different sites throughout Australia, involving around 4000 categories and approximately 300,000 items of stock.
The plaintiffs set out to establish their case by proving, on an item-by-item basis, the accuracy of the stock count and the correct classification and value of each item. They contended that from incomplete records of the actual count, classification and valuation, there could be extrapolated a value for the consignment or Balance Stock that had been used or sold.
The defendants contended that the plaintiffs’ count, classification and valuation, was so unreliable that it could not be a proper foundation to calculate their liability for any items of Balance Stock sold or used by new De Neefe. They also contended that the stock take was not conducted as required by the agreement. The defendants conceded, however, that if the court was satisfied that, notwithstanding the plaintiffs’ failure to prove the accuracy of the count, classification and valuation, new De Neefe had in fact used or sold some items of Balance Stock, the court would be entitled, doing the best it could, to place a value on any damages suffered by the plaintiffs by reason of the defendants’ non-payment of any amount due under cl 7.4. The defendants contended that any such sum should not exceed $223,443.90.
In my view, the plaintiffs’ case was conceptually misconceived. Furthermore, their attempt to establish the accuracy of their stock take and valuation undertaken on and after 31 August 2005 failed.
The plaintiffs’ primary case depends on their ability to establish a value for items of Balance Stock used or sold by the defendants. In my view, the terms of the agreement coupled with the circumstances in which the stock take was undertaken, made that task impossible. Simply stated, the terms of the agreement prescribed a regime for the definition and identification of Sale Stock and Balance Stock. Balance Stock was consignment stock remaining after Sale Stock had been identified. As the Sale Stock was never identified, it was impossible to identify what, if any, items of Balance Stock had been sold or used.
The court was not assisted by the plaintiffs when opening their case. Counsel did not explain the nature of the business carried on by the plaintiffs at the time of the sale, or the significance of its various operating sites and other factors that would have assisted the court to comprehend the nature and scope of the count, classification and valuation process that was central to their case. The plaintiffs’ counsel seemed to assume, wrongly and unhelpfully that, by some osmotic process, the court would become acquainted with important background information, such as the kind of things that comprised raw materials, what might comprise work in progress and what finished goods might look like.
A reading of the witness statements was of no real assistance. This was a case about counting and classifying things in different stages of manufacture, and yet any description and depiction of the things was absent. What was a ‘16# Blank’ and what did it look like? What was ‘3M’ material and what did it look like? How did the plaintiffs’ finished goods differ from raw materials? What was involved in the ‘manufacture’ of finished goods? These questions were material to the resolution of issues in the case. As the trial advanced, some clarity was introduced but much was left to the imagination. That was not a proper basis upon which to conduct a trial. One consequence was that the significance and relevance of some of the plaintiffs’ evidence was not immediately apparent.
Another serious shortcoming in the case presentation was the court book. Witness statements were prepared which, in some cases, had attached to them very lengthy exhibits to which no reference was made during the trial. Some attachments were apparently included in error, while others received only passing attention during the trial. The stock take cards were one such example. That such cards had been completed was not in dispute. There was no dispute about their authenticity, and yet the plaintiffs’ director, Gregory William Newman, exhibited over 500 pages of copy cards. The court book contained around 900 pages of debtors ledgers. Reference was made to only a few pages at trial. Exhibits GWN 39 and 40 to the statement of Mr Newman are described as Debtors Ledger 30 June 2005 and 31 August 2005 respectively. These documents comprise approximately 400 pages, but any reference to the exhibits in the witness statement had been deleted. No mention was made of the contents during the trial.
Such was the volume of material attached to the statements, to which no reference was made during the trial, or which seemed to be of questionable relevance to issues in dispute, that at the conclusion of the trial the parties were directed to prepare a schedule recording the documents in the court book to which some reference had been made at trial. That schedule is marked Exhibit G.
The agreement
It was common ground that the stock take was to be undertaken as prescribed in the agreement. The relevant parts of the agreement concern the delineation and counting of stock, its valuation and payment. Well before trial the parties had agreed upon rectification of the agreement so that a reference to the words ‘Provisional Completion’ in cl 6.1, should be read as ‘Effective Date’. Provisional Completion took place on 6 October 2005, when new De Neefe assumed control of the business assets, including stock.
Set out below are the relevant provisions of the agreement relating to stock, adjusted to incorporate the change brought about by rectification. The reference to ‘De Neefe Group’ is to the plaintiffs. The ‘purchaser’ is new De Neefe. ‘Traffic’ is a reference to the second defendant.
1. Definitions and Interpretation
1.1 Definitions
…
Balance Stock means the Stock on Hand which will be held by Traffic on consignment for the De Neefe Group being all the Stock on Hand excluding the Sale Stock;
Balance Stock Price means the price the De Neefe Group charges for each item of Balance Stock and being such Stock over and above the Sale Stock;
…
Sale Stock means Stock on Hand to the value of $2,250,000 and includes raw materials, work in progress, finished goods including pipe and PTB metal hardware;
Stock on Hand means all stock on hand in the Business at Provisional Completion including the Sale Stock and the Balance Stock;
…
6. Stock on Hand
6.1Stock at Provision Completion
From Provisional Completion, the Stock on Hand will be dealt with as follows:
(a) The Purchaser will be entitled to the Sale Stock; and
(b)the Balance Stock will be held by the Purchaser on consignment for De Neefe Group in accordance with clause 7.
6.2Valuation
Immediately prior to the Effective Date, the Purchaser and the De Neefe Group will cause its representatives to conduct a stock take to determine the value of each of the items comprising the Sale Stock. The parties otherwise agree to observe the following valuation process:
(a)completed stock items will be valued as per the stock take procedure in the De Neefe stock valuation model which will be post stock take reported in a stock activity report;
(b)Work in progress will be valued as per the stock take procedure in the De Neefe stock valuation model; and
(c)raw materials will be valued as per the stock take procedure in the De Neefe stock valuation model.
6.3Determination of Stock on Hand
After completing the stock take contemplated by clause 6.2, the parties acknowledge that the first $2.25 million of Stock on Hand will comprise the following:
(a) firstly for such raw materials as the parties agree;
(b) secondly for work in progress; and
(c)thirdly for Norsign (NT) Pty Ltd stock, pipe, aluminium stock blanks, temporary stock blanks and PTB frames and pipes;
(d) finally, completed finished good stock.
7. Balance Stock to be held on consignment
7.1 Delivery of Balance Stock
Upon Provisional Completion, the De Neefe Group will deliver to the Purchaser the Balance Stock which is to be held on consignment in accordance with this clause 7. The title to the Balance Stock will pass directly from the De Neefe Group to the ultimate purchaser upon sale.
7.2 Title to the Balance Stock
All consignment stock consigned to the Purchaser by the De Neefe Group under this clause 7 will be and remain at all times under the subject to the ownership, direction and control of the De Neefe Group until sold by the Purchaser to its customers as authorised by this clause 7. On the Effective Date the De Neefe Group will physically identify each item of Balance Stock.
7.3 Records of Sales
The details of the type and quantities of Balance Stock sold by the Purchaser must be recorded and advised to the De Neefe Group on the 30th Business Day of the month after the month in which the Balance Stock is sold by the Purchaser.
7.4 Payment
Payment for sales of Balance Stock, will be made to the De Neefe Group within 60 days from the end of the month the Stock was used of its use or sale unless otherwise agreed in writing by the De Neefe Group. The Purchaser will make and submit to the De Neefe Group a complete inventory of Balance Stock remaining in the Purchaser’s possession at any time when requested by the De Neefe Group. Such inventory will be taken by or under the personal direction of a representative of the De Neefe Group whenever it so requests.
10. Provisional Completion
…
10.5 Risk in the Title to the Assets
(a)Subject to payment of Purchase Price on the Provisional Completion Date title to the Assets (including the Sale Stock) and risk in the Assets will pass to the Purchaser on the Effective Date but risk and title in the Balance Stock will not pass to the Purchaser on the Effective Date.
…
Under cl 6.2 of the agreement a stock count was to be undertaken immediately prior to 1 September 2005. The object of the count was to determine the composition of the Sale Stock. A valuation of the various items to comprise Sale Stock was to be undertaken using the De Neefe stock valuation model. Subject to payment of the ‘Purchase Price’ (as defined in the agreement) on 6 October 2005, title and risk in the Sale Stock passed to new De Neefe on 1 September 2005. The composition of the Sale Stock was prescribed by cl 6.3, to a value of $2.25 million.
Clause 6.2 required the plaintiffs and new De Neefe to ‘cause its representatives’ to conduct the stock take. There was no representative of any of the defendants in attendance at any site for the stock take. The plaintiffs did not rely upon the defendants’ failure to participate in the stock take as the basis for an alleged breach of the agreement.
Under cl 6.2, the parties were ‘to determine the value of each of the items comprising the Sale Stock’, although the regime to be implemented under cl 6.3 made it necessary to count, classify and value all ‘Stock on Hand’. That is because of a value cap placed on defined categories of stock, in a prescribed order, to comprise the Sale Stock.
Under cl 6.3(a) the first category to comprise Sale Stock was ‘such raw materials as the parties agree’. It was common ground that there was no such agreement. The requirement was ignored or overlooked by the parties. I note that in their statement of claim, the plaintiffs alleged that the parties did not agree on raw materials, but in their prayer for relief the plaintiffs sought a declaration as to whether any such agreement had been made. Unfortunately, the absence of agreement on raw materials eroded the utility of the stock take for its intended purpose, because the first category of goods to comprise Sale Stock was never defined.
The plaintiffs did not contend that the failure to agree on raw materials was a breach by the defendants. Instead, they sought to retrospectively redefine the composition of the Sale Stock, by deleting cl 6.3(a) as the first category and relegating it to last place, following finished goods in cl 6.3(d). One consequence of that construction, so the plaintiffs submitted, was that the Sale Stock would include a much higher proportion of finished goods than might otherwise have been the case. It would have been possible that Sale Stock might reach a value of $2.25 million without the inclusion of any raw materials.
I reject the plaintiffs’ contention that, in the absence of agreement on raw materials, a material change should be made to the composition of Sale Stock by the arbitrary postponement of raw materials. The plaintiffs did not seek the implication of any term to bring about such a fundamental change to the composition of the Sale Stock. Even if they had, no such term would have been implied. There was a compelling order and logic to the composition of the Sale Stock.
The purpose of cl 7 was to ensure that new De Neefe accounted to the plaintiffs on the sale of consignment stock, which was intended by the parties to be substantially, if not wholly, comprised of finished goods. The parties intended that raw materials and work in progress were to be absorbed into Sale Stock before finished goods were considered. The evidence was that finished goods would ordinarily be sold within 14 days of completion. Thus, the plaintiffs’ entitlement to payment from the sale of consignment stock would be expected to accrue quite rapidly. There was no occasion to postpone the raw materials component, and every reason to postpone finished goods until last in the composition of Sale Stock. The requirement for agreement on raw materials was quite obviously to ensure that the purchaser did not acquire materials that could not readily be converted into finished goods.
Although the parties proceeded on the footing that new De Neefe would be liable for consignment stock that was sold or used, the terms of cll 7.1, 7.2 and 7.3 would indicate an intention to capture only sales. That was consistent with an evident assumption by the parties to the agreement that the consignment stock would be comprised substantially, if not wholly, of finished goods. The reference to ‘used’ in cl 7.4 is clumsy and probably an error. But, as the parties have adopted a consistent position, I will proceed on the basis that the obligation in cl 7.4 arises ‘on sale or use’.
This was no ordinary stock take. Its purpose was to define a category of stock that would be purchased immediately by new De Neefe, and to differentiate that stock from consignment stock. To that end, the parties agreed that each item of consignment stock would be physically identified by the plaintiffs. The agreement did not specify how that was to be done, although it is plain beyond argument that something was necessary to differentiate the consignment stock from the Sale Stock in a physical sense. That could have been achieved by some form of mark, sticker or physical segregation.
The purpose of the plaintiffs’ obligation to physically identify each item of Balance Stock was plain enough — to define that which would remain in the ‘ownership, direction and control’ of the plaintiffs until sold; and to enable the parties, and in particular new De Neefe, to perform its obligation to record and account for items of consignment stock used or sold by it. Unless each item of consignment stock was physically identified, it would be impossible for new De Neefe to properly account to the plaintiffs under cl 7.4. The intended purpose of the regime for the definition of Sale Stock and Balance Stock, with the delayed assumption of control by the defendants about a month after the stock take (on 5 October 2005), made it imperative that each step required by cll 6 and 7 be carefully undertaken. For example, it was inevitable that new raw materials and items of finished goods would be purchased after 1 September 2005, and that raw materials and work in progress would be converted into finished goods. Thus, a failure to physically identify the remaining consignment stock eroded the effective implementation of cl 7.
Under cl 6.2, there is a reference to the De Neefe ‘stock valuation model’. The parties agree that the relevant model is found in a document entitled ‘Inventory Valuation — Year Ended 2005’. Set out below is the full text of that ‘model’.
INVENTORY VALUATION –
YEAR ENDED 2005
FINISHED GOODS
IMPORTED AND LOCAL
LANDED
WARNING, REGULATORY,
TEMPORARY AND TRUCK SIGNSAS PER WORKSHEET SPECIAL SIGNS, EMBLEMS
GENERAL SCREEN PRINTING ETCLOWEST NUMBERS, NUMERALS,
DELINEATORS AND BRACKETSLOWEST SELLING PRICE LESS 33% PARKING SIGNS
AS PER WORKSHEET
CUSTOM BUILT STOCK
IE. COKE, TARGET, MOBILE ETCLIST PRICE LESS 33% SLOW MOVING STOCK
LIST PRICE LESS 50%
WORK IN PROGRESS
SIGNS – CONVERTING AND
METAL SHOPAS PER WORKSHEET EMBLEMS, GENERAL SCREEN
PRINTING ETC.MATERIAL PLUS $23.35/COLOUR SET UP
PLUS 75c PER COLOUR APPLIED UNDER 6 SQ. FEET.
$1.46 PER COLOUR APPLIED 6–10 SQ. FEET
$2.19 PER COLOUR APPLIED 10 + SQ. FEETRAW MATERIALS
COST PRICE
PACKAGING SUPPLIES
COST PRICE
Mr Newman gave evidence on behalf of the plaintiffs. He was managing director of old De Neefe for a number of years before the sale of the business. He negotiated the agreement with Mr Scrinis on behalf of the defendants.
Mr Newman said that in July or August 2005, when he and Mr Scrinis were negotiating the terms of the agreement, they discussed the desirability of a stock take conducted on an agreed day before the defendants assumed effective control of the business. There was a meeting on 26 August 2005 at which Mr Newman proposed, and Mr Scrinis agreed, that the stock take be conducted on 31 August. Mr Scrinis said he would attend the count, but did not.
The plaintiffs’ principal office was at Eltham, Victoria. They also carried on business at Granville and Queanbeyan in New South Wales, at Maddington in Western Australia, at Winnellie in the Northern Territory, at Glenorchy in Tasmania and at Walkley Heights in South Australia. The business carried on in the Northern Territory was conducted through a separate company, Norsign (NT) Pty Ltd. Accordingly, a count of the plaintiffs’ stock necessarily involved staff at each business site. It is unfortunate that Mr Scrinis and other representatives of the defendants, did not attend the stock take. His attendance at every site could not have been anticipated, but it was possible for a representative of new De Neefe to attend.
Plaintiffs’ case
It was in the absence of any identifiable category of Sale Stock pursuant to cl 6.3, or any physical identification of Balance Stock, that the plaintiffs advanced their case at trial. They relied on their global valuation of stock on hand as at 31 August 2005, deducted $2.25 million and the value of some other items, and claimed that the balance must represent the dollar value of the Balance Stock, which the defendants must have used or sold by 1 December 2005. Their case as presented did not depend upon identifying items of stock that were in fact used or sold by the defendants. Thus, the starting point for the plaintiffs was to establish the accuracy of the count, classification and valuation of their stock on 31 August 2005.
As might be expected with a number of sites, counting the plaintiffs’ Stock on Hand, required organisation and planning. The special purpose of the stock take, and the requirement of the agreement, ought to have been central to Mr Newman’s planning. The purpose of the stock take was singular — to physically differentiate Balance Stock from the defined categories of stock to comprise Sale Stock valued at $2.25 million. Unfortunately, in the planning phase, that purpose was overlooked.
Mr Newman assumed responsibility for the planning and implementation of the stock take. He was the only witness of fact called by the plaintiffs. In the course of planning, Mr Newman issued an instruction to managers which was lengthy, detailed and emphatic. While not mentioning the purpose and the critical need for differentiation, the instructions included the following:
I don’t want any reflection of sloppy stock taking coming back on a branch. So let us all be very vigilant as to what is happening around us.
… Strict adherence to the company’s stock take procedures needs to happen.
…
Mr Newman noted that Traffic Technologies (the second defendant) would ‘most likely be auditing your branch on Stock Take day’. He did not suggest that the defendants would otherwise participate.
The instructions prepared and sent by Mr Newman to site managers mentioned that ‘the recent due diligence uncovered quite a few errors in the processing of the lists of the last Stock Take’. That was a reference to errors mentioned in a report prepared by Paul Lom, an accountant engaged by the second defendant to undertake a ‘due diligence’ investigation of the plaintiffs’ business prior to purchase. Mr Newman introduced a new stock counting approach through the use of ‘In Process’ cards, as a mechanism to record work in progress, to enable the plaintiffs to ‘get a better handle on the checking and therefore the accuracy of the stock take’.
The plaintiffs maintained a computer program to manage their accounting needs, including stock, known as the Arrow System. The system had its limitations, and was rejected by the plaintiffs as an accurate basis to value the stock and arrive at a value for Balance Stock.
Mr Newman said that he observed the persons who were undertaking the stock take of raw materials. He only attended the count at the Eltham site. Mr Newman said that stock take cards had been specially prepared for the task. The cards referred to each category of raw material, with a space to record the number of items counted, and provision to identify the persons undertaking the count. Mr Newman said that he conducted random checks to test the accuracy of the counting. He said that if he identified an error, the card would be amended.
Mr Newman said that there were two types of work in progress to be counted. First, ‘manufactured blanks’, which presumably were shaped metal sheets awaiting printing or other signage. Secondly, there was a general category of other manufactured products, although it was not entirely clear what this category comprised. He said that the count of work in progress utilised two different card systems. There were ‘Blank Cards’ to calculate the ‘manufactured blanks’ and ‘WIP Cards’ for all other products. Mr Newman said that he observed those undertaking the count of work in progress, and carried out random checks.
Mr Newman said that the counting of finished goods differed from the counting of raw materials and work in progress. He said that there were cards produced specifically for each category of finished goods. The cards had three sections separated by perforations, designed to enable those counting the stock to produce three records of their count. There were two counts made as a matter of course, and if there was a discrepancy, a third count was undertaken.
Mr Newman said that the count at Eltham occurred over approximately two days. He said that following the count, he and others, including Kevin Fleurie and Robin Douglas collated the information from the stock cards prepared at each of the plaintiffs’ sites around Australia, including Eltham; but not for Norsign in the Northern Territory. Norsign stock cards were not sent to Eltham. The valuation of Norsign stock was undertaken by Norsign personnel. Mr Newman said that between September and November 2005, Norsign sent spreadsheets to the Eltham office which listed items of stock, quantities and values. While employees were sent from Eltham to assist with the stock take in Western Australia, South Australia and New South Wales, the other sites depended upon their own staff to undertake the process.
Once counted, it was necessary to value each item of stock. Mr Newman said that the valuation of the stock was undertaken in accordance with the stock valuation model. He said that raw materials were to be valued at the last purchased price, except for 3M materials which were valued at an average of the last three months’ price. Mr Newman said that he prepared a pricing schedule, described as the ‘August raw materials pricing schedule’. It would appear that there were two broad categories of raw materials: pressure sensitive materials that were applied to a metal substrate in the manufacturing process; and metals that were purchased by length, weight or area. Mr Newman said that he prepared the raw materials pricing schedule after examining the plaintiffs’ purchase invoices for the particular items of stock. He said that from the relevant stock card a quantity of a particular material could be identified, to which was applied the appropriate price from his pricing schedule. Mr Newman said that he carried out at least half of the calculations. Some stock cards are no longer available.
As for the valuation of work in progress, Mr Newman said that he applied a department overhead and labour rate to raw materials that were in the process of being manufactured into finished goods. To value finished goods, he said that the number of items were multiplied by a value according to the stock valuation model. Mr Newman said that if an item of finished goods had been purchased, its cost was determined by the supplier’s invoice and shipping charges. Finished goods in the nature of warning signs were valued by reference to worksheets that Mr Newman had prepared for ‘16# Blanks’. Mr Newman said that special signs, emblems, general screen printing, numbers, numerals, delineators and brackets had various selling prices, depending on the identity of the intended purchaser. The value attributed to these items was determined by applying a discount of 33 per cent to the lowest selling price. He said that the same approach was taken to custom made stock, but that industrial and safety signage was valued for the purposes of the stock take at a discount of 50 per cent on list price. Mr Newman said that slow moving stock was not valued in the stock take and was provided to the defendants without charge. Slow moving and obsolete stock became a contentious issue. The defendants contended that those categories of stock had been counted and over-valued.
The process of valuation, according to Mr Newman, took some time. He said that between 1 September 2005 and his termination in early November 2005, Mr Scrinis enquired about the progress and likely completion date of the valuation. Mr Newman said that there were frequent discussions, at least twice a week, in September and the first week of October.
Mr Newman said that his checking and reconciliation of the stock take valuation was about three‑quarters completed when, in early November 2005, he was dismissed ‘without reason’ from his employment with the first defendant. It is not entirely clear why the stock take was never satisfactorily completed before Mr Newman’s termination. Mr Newman said that when terminated, he took with him copies of spreadsheets that had been used to complete the valuation of the items of stock, including Norsign’s spreadsheets. He did not, however, obtain a copy of the work in progress spreadsheet. The circumstances surrounding Mr Newman’s termination were not explored at trial.
Mr Newman said that from his experience in the business over the preceding five years, the plaintiffs turned over their stock at least four to five times per year. He said that raw materials, principally aluminium, pipe and reflective goods, were used up every 30 days on average. The adhesive product, known as 3M, was delivered daily and aluminium and pipe was delivered monthly. He said that ‘Stock Blanks’ were turned over every four to six weeks, and were manufactured every 30 days from sheet aluminium. Work in progress would take no more than six weeks to complete, and finished goods were usually sold within 14 days of purchase or manufacture. The purpose of this evidence was to demonstrate that such of the Balance Stock as existed on 31 August 2005 would have been used or sold by the defendants within a few months of their having taken over the business. Thus, the plaintiffs alleged in their statement of claim that the consignment or Balance Stock had been used or sold by 1 December 2005.
In addition to the evidence of the stock take, and its valuation, the plaintiffs relied on some written communications in late 2005 and early 2006 between Andrew Harris, chief financial officer of the second defendant, and Mark Donagan, on behalf of the plaintiffs. They contended that a reference in an email dated 6 April 2006, to ‘purchases by new De Neefe from old De Neefe’, was a reference to consignment stock. The plaintiffs relied on this email as an admission that there was Balance Stock, and that a liability arose to pay for it under cl 7.4.
There was an earlier letter from Mr Donagan to Mr Harris, dated 16 December 2005, and a response from Mr Harris, dated 21 December 2005, that were also said to contain admissions. Mr Donagan seemed to contend in his letter that new De Neefe had purchased Balance Stock of finished goods valued at $87,791.84. That was after the date by which the plaintiffs now contend that all Balance Stock had been used or sold. In his response, Mr Harris pointed out that the defendants did not accept that any liability for Balance Stock had arisen. He wrote:
it is likely that we only commenced purchasing Balanced Stock in excess of Sale Stock in December. Accordingly no payments will be due and payable until the end of February 2006.’
Mr Harris also made it clear that the defendants did not accept the valuation. In the absence of defined Sale Stock, or any form of delineation between Sale Stock and Balance Stock, the uncertainty expressed by Mr Harris was not surprising.
There was also a category of stock that the parties agreed was returned by the defendants to the plaintiffs, and which the plaintiffs conceded should be deducted from their claim. That deduction is reflected in three alternate calculations advanced by the plaintiffs as the quantum of their claim. A first scenario attributed a value of $1,703,912.38 to the Balance Stock used or sold by the defendants; a second scenario attributed a value of $1,091,735.42; while a third, a value of $644,989.42.
The defendants’ challenge
At times the trial descended into an analysis of stock categories and particular items of stock held at different sites, recorded in different formats such as spreadsheets and computer records, and sometimes with different descriptions for similar items. Some of the adjustments that the defendants contended should be made to the stock quantities and values were small, while others were substantial. But a primary contention of the defendants was that the count and valuation made on and after 31 August 2005 did not provide a reliable foundation for the plaintiffs’ claims. I accept that contention.
When new De Neefe took control of the business, Ms Douglas commenced to record the sale of finished goods from old De Neefe stock, in an attempt to calculate the liability of new De Neefe for the sale of consignment stock. She was responsible for accounting functions at the plaintiffs’ business at the time of the stock take. Ms Douglas prepared a spreadsheet that recorded a notional transfer of stock from old De Neefe to new De Neefe, but stopped making entries after February 2006. The process undertaken by Ms Douglas was based upon the stock records in the Arrow System adjusted to take account of the August stock take. When an item of old De Neefe finished goods was sold, or to be sold, it was notionally transferred to an account described as ‘new De Neefe account’, by raising an invoice from old De Neefe to new De Neefe. These transfers were predicated on the assumption that new De Neefe had paid $2.25 million for stock, so that all invoices raised by old De Neefe were to remain at ‘nil value’ until the value of stock ‘transferred’ reached $2.25 million. Thereafter, new De Neefe would be invoiced for the value of finished goods as if drawn from old De Neefe consignment stock. The process of recording transfers, undertaken by Ms Douglas, ignored the terms of the agreement which prescribed the composition of Sale Stock.
The plaintiffs claimed that finished goods owned by the business at 31 August 2005 were valued at $1,916,480.25, excluding Norsign stock. In contrast, the spreadsheet prepared by Ms Douglas attributed a value of finished goods ‘transferred’ to new De Neefe from old De Neefe over a six‑month period of only $1,198,036, including Norsign stock. The difference is substantial.
The plaintiffs contended that the difference reflects adversely on the credibility of the sales and transfers recorded by Ms Douglas. The defendants contended that the difference, when coupled with the evidence given by Mr Newman about the turnover rate of stock, constituted ‘powerful independent evidence’ that the count made on 31 August 2005 was inaccurate. According to Mr Newman, finished goods in existence on 31 August 2005 should have been exhausted by October. The plaintiffs’ claim presupposes that all consignment stock was sold by 1 December 2005.
The spreadsheet indicated transfers made in September to a value of $706,047; in October to a value of $251,131; in November to a value of $137,047; in December to a value of $45,306; in January 2006 to a value of $35,379; and in February 2006 to a value of $23,126. These figures might indicate a decline in old De Neefe finished goods at a rate that was a little slower than predicted by Mr Newman. Excluding obsolete and slow moving stock which, according to Mr Newman, was to be excluded from the valuation, such finished goods as there were in stock on 31 August 2005 would ordinarily have been sold within 14 days.
The spreadsheet was in electronic form. The plaintiffs printed hard copies for the purposes of the trial. It was divided into the months of September, October, November and December 2005 and January and February 2006. The significance of the spreadsheet to the plaintiffs’ case was unclear, unless to support their fallback position based on alleged admissions in the correspondence mentioned above. The plaintiffs seemed to contend that the transactions recorded by Ms Douglas represented sales of only consignment stock.
Cross-examination of Ms Douglas by the plaintiffs’ counsel failed to reveal a basis for that contention, which was contradicted by the evidence. Ms Douglas said that the spreadsheet was maintained to record the movement of all old De Neefe finished goods. I accept the evidence of Ms Douglas that she set out to record all sales of old De Neefe finished goods, invoicing new De Neefe at ‘nil’ value until the value of the finished goods ‘transferred’ exceeded $2.25m.
The plaintiffs also sought to characterise the items of stock recorded in the spreadsheet as confined to consignment stock by linking them to the email from Mr Harris to Mr Donagan dated 6 April 2006. The email had attached stock schedules. A summary contained in the body of the email included a schedule of values of stock from old De Neefe that closely aligned with the figures in the spreadsheet prepared by Ms Douglas. Thus, the plaintiffs argued, the email constituted an admission that new De Neefe was liable for at least $635,017 worth of Balance Stock.
The email does not, in my view, constitute a meaningful admission. It was described by Mr Harris as ‘a first pass’, in an attempt to reconcile stock transfers. The content of the email and the evidence of Ms Douglas about the entries made in the spreadsheet concerned an analysis of all sales of old De Neefe finished goods.
Another approach taken by the plaintiffs, to support their contention that the spreadsheet was only concerned with consignment stock, was based on their contention that because raw materials had not been agreed, that category of stock should be relegated to the end of the cascading list of stock under cl 6.3 of the agreement, for inclusion in Sale Stock. It was to follow ‘finished stock’. I have rejected any such construction of the agreement. The plaintiffs argued that one consequence of such a construction was that Sale Stock would include a much higher proportion of finished goods than might otherwise have been the case. A corresponding consequence would be that consignment stock might include a higher proportion of raw materials than would otherwise have been the case. The plaintiffs conceded that within a few months of the stock take the raw materials would have been converted into finished goods.
It was difficult to discern what point the plaintiffs wished to make that might advance their case, except to argue that the spreadsheet must include finished goods classified both as Sale Stock and Balance Stock. Putting to one side the difficulty that there was no defined category of Sale Stock or Balance Stock, the submission was illogical and did not advance the plaintiffs’ case.
The defendants contended that the stock take was unreliable because old De Neefe finished goods were intermingled with new stock purchased or manufactured after 1 September 2005. Mr Constantinos Lambros Liosatios, managing director of Traffic Technologies, and a director of new De Neefe, said that when new De Neefe took possession of the business on 6 October 2005, he discovered that stock acquired by new De Neefe after 1 September 2005 had been intermingled with old De Neefe stock. He said that the business records did not enable a reconciliation of stock that had been sold or used in that period with new purchases. His evidence was not challenged. He said,
When I started digging deeper that’s when I started finding out for someone to show me the stock. That’s when I found out they couldn’t tell me, it was all mixed in.
Intermingling may, of course, have had an impact on the accuracy of the work undertaken by Ms Douglas. The defendants contended that the spreadsheet should be accepted as an accurate record of the outer limit of the value of sales of finished goods drawn from old De Neefe stock. They argued that it had not been put to Ms Douglas in cross-examination that the spreadsheets did not capture all finished stock transferred from old De Neefe to new De Neefe. That may be so, but Ms Douglas herself had doubts about its accuracy and continuing utility. Depending on the nature of the error, it had the potential to inflate and deflate the value. Intermingling would tend to inflate the value of sales, while the failure to capture sales would mean that the recorded sales may be less than the true value. Ms Douglas said that she was not confident that she was informed of all movement of old De Neefe stock. Both potential errors were either caused, or at least compounded, by the plaintiffs’ failure to physically identify each item of consignment stock.
The plaintiffs also demonstrated valuation errors in the spreadsheet prepared by Ms Douglas, that once corrected had the effect of increasing the value of the transfers by around $120,000. Nevertheless, the spreadsheet provides some evidence of an order of magnitude of old De Neefe finished goods sales and ‘transfers’ over a six‑month period. The difference between the plaintiffs’ valuation of finished goods and the value of sales in the spreadsheet is of such a magnitude as to cast doubt on the accuracy of the plaintiffs’ count and valuation. With the exception of the valuation error identified by the plaintiffs, the effect of any intermingling and a failure to capture stock movements, were not quantified. It is not even possible to assess the extent to which those errors might have neutralised one another. But there was an authenticity and logic to the process undertaken by Ms Douglas which must be given some evidentiary weight. The significance of the spreadsheet, as evidence that cast real doubt on the plaintiffs’ valuation of finished goods, is enhanced by other evidence that leads to the conclusion that the plaintiffs’ count and valuation was unreliable, and is not a proper basis upon which to impose a liability onto the defendants.
Other challenges to the plaintiffs’ valuation
There was a material difference between the plaintiffs’ valuation of the stock as at 31 August 2005 and the value of stock according to the Arrow System. It is true that the value attributed to stock by the Arrow System depended upon correct entries recording stock movements, correct opening stock values and correct computations to arrive at a value for the cost of goods. Excluding Norsign stock, the plaintiffs’ valuation exceeded the Arrow valuation by $562,476. That is before deducting slow moving and obsolete stock.
Ms Douglas said that such a variation was unusually large. Her evidence was challenged on the basis that the value of finished goods, according to the Arrow System, had been calculated by reference to an estimate only of the cost of goods sold. The plaintiffs also contended that the valuation in the Arrow System included a significant component of labour costs not connected with the manufacture of the goods. Labour charges for the installation of goods was given as one such example.
Ms Douglas said that labour costs had been excluded. Furthermore, the employment of an estimated cost of goods, based on historical data, was generally accepted by the experts as an appropriate method to estimate the cost of raw materials, labour and other purchases utilised in the manufacture of goods for sale. Thus, subject to the accuracy of opening balances and the introduction of correct transaction data, the Arrow System should have been capable of producing a reasonably accurate value of closing stock. I accept the evidence of Ms Douglas that the Arrow System would, subject to correct opening balances, provide a reasonably accurate value of stock as at 31 August 2005. Because the plaintiffs claimed to have excluded obsolete and slow moving stock, an allowance would be required for the value of such stock within the Arrow System, if a true comparison were to be made with the plaintiffs’ valuation of stock following the stock take. While there was some evidence to approximate the value of obsolete stock, there was no way of knowing the value of slow moving stock.
The defendants contended that the opening balance was unreliable. In an earlier stock take, undertaken in April 2005, there were significant errors that required correction in the Arrow System. During the course of Mr Lom’s due diligence, representatives of the plaintiffs had informed him of a number of discrepancies with the stock take. Work in progress had been overstated by $302,761. Mr Lom also noted other errors that required adjustments to the April 2005 management accounts. Importantly, he observed that there were no proper controls in the plaintiffs’ accounting system to prevent and detect errors made during an annual stock take. He also said that there was no audit trail to verify whether correct prices had been used to reach valuations.
The error in the calculation of work in progress was apparently caused when a quantity of stock items had been multiplied by the stock code rather than the properly ascribed value. The consequence of the correcting adjustment was a little less clear. Mr Lom said that the overstatement may not translate perfectly into a like adjustment on 31 August 2005, because of the manner in which the cost of goods was calculated and applied in order to arrive at a stock figure. Nevertheless, an adjustment was made to reflect the overstatement.
The next step in the defendants’ challenge to the accuracy of the 31 August stock take was to compare the valuations of different categories of stock as at 31 August 2005 with valuations as at 30 April 2005. There were material differences in all state branches in the categories of finished goods, work in progress and raw materials. The most significant difference was for work in progress, which had apparently increased by $503,879 between 30 April 2005 and 31 August 2005. This substantial increase in work in progress was never satisfactorily explained.
Mr Newman endeavoured to explain the increase by giving examples of two contracts with a customer referred to as ‘Diadem’. One contract was said to be worth $2.5 million, relating to work for the Commonwealth Games. The other was said to be worth around $400,000, for Smart Bus signage and display upgrades. These explanations did not rise above mere assertion. Mr Newman’s evidence about the contracts was contained in a witness statement prepared well in advance of trial. No supporting material was produced. While such an increase in work in progress might have resulted from a large order under production, Ms Douglas said that she was not aware of any large orders at the relevant time. Andrew Rainone, who was the cost accountant employed by the plaintiffs at the relevant time, also said that he could not recall any large projects that would explain the substantial increase in work in progress over that period.
An analysis of the Diadem account with the plaintiffs for the months of April through to August 2005 indicated regular monthly invoicing to Diadem, with no spike in sales that might have been consistent with the accumulation of a large quantity of finished goods over that period. Mr Newman had said in his evidence that the cycle for work in progress was usually around six weeks, and it was usual that finished goods were sold within 14 days. His evidence, in which he relied on the Diadem contracts as an explanation for increased finished goods, was inconsistent with such a cycle, the regular invoicing to Diadem, and the evidence of Mr Rainone and Ms Douglas. I do not accept Mr Newman’s explanation.
The defendants also challenged Mr Newman’s evidence in relation to the application of the valuation model and the classification of stock for the purpose of the 31 August valuation. They pointed to various errors in the schedule to the statement of claim. Some of the complaints seemed trivial, while others were not. The defendants complained that the plaintiffs could not identify the name of suppliers or a pricelist for the purpose of verifying prices that were to be calculated as a percentage of an acquisition cost or a list price. It may be accepted that Mr Newman relied upon secondary evidence, a worksheet prepared by him, to calculate the value of finished goods. The absence of price lists to verify values did not rise higher than a complaint that his evidence was not supported by primary evidence. The defendants did not establish that the values applied by Mr Newman to particular items of stock were unreasonable. The accuracy of the count, and what was included within it, was a different matter.
The defendants further contended that the valuation of Norsign stock did not reflect the agreed valuation model. There were differences, although I am not persuaded that they were material. Mr Jackman, who was not cross‑examined, said that there was usually a mark‑up of 10 per cent to 15 per cent on goods supplied from Eltham branch. He said that Norsign did not use stock cards for its stock take counts in 2005. The stock take was not carried out according to Mr Newman’s instructions but according to Mr Jackman’s usual practice. Following the stock take at the end of August 2005, Mr Jackman said that he sent only one spreadsheet to the Melbourne office.
While the impact of the Norsign discrepancies on the overall value of inventory may only have been slight, its real significance was to undermine Mr Newman’s insistence that he initiated and managed a tightly controlled and structured count and valuation according to the valuation model.
Next, the defendants contended that there were multiple adjustments made to the August stock take in September, October and November 2005, reflecting adversely on the accuracy of the initial count. There was evidence of multiple entries made in a spreadsheet prepared by Ms Douglas, recording items of stock under particular codes. The plaintiffs contended that the multiple entries were the product of a second or even a third count following shortly after the initial count. The defendants contended, on the other hand, that there was evidence of counting continuing into the months of September, October and November. Thus, they argued, there was a risk of confusion between old De Neefe stock and newly produced or acquired stock. If, as the plaintiffs contend, the variations were made as a result of further counts at or around the same time as the initial stock take, that would indicate errors made during the initial count.
I am not satisfied that counting continued into November, although it is clear that adjustments to the initial counts continued up until the time of Mr Newman’s departure in November. The evidence does not make it clear as to why it took so long to finalise the stock take, including the valuations. The delay, coupled with the continuing revisions, even during the trial, undermined the accuracy of the count, classification and overall valuation.
Under the stock valuation model, slow moving stock was to be valued at ‘list price less 50 per cent’. It was common ground that obsolete stock should not have been valued. Mr Newman said that he did not count slow moving stock, providing it free of charge to new De Neefe. An example of slow moving stock, given by Mr Newman, was rolls of coloured vinyl used for the production of signage for trams, procured in anticipation of a contract with MTram. A contract did not eventuate and old De Neefe was left with the stock and unable to use it. It could not be returned. It was obsolete.
I do not accept Mr Newman’s evidence that slow moving and obsolete stock was not counted and valued. No instruction was given to those engaged in the stock take to exclude such items. Mr Newman said that he arranged for the segregation of slow moving and obsolete stock at the Eltham premises. He said that areas were marked off by tape. He said that he instructed employees not to count such stock. Mr Newman said that the segregated areas had been taped‑off on the day or the night before the count on 31 August 2005. He said that he and a foreman walked around the premises and discussed what was to be counted and what was not to be counted. Mr Newman did not claim to have personally taped‑off the areas to be segregated.
While the segregation of slow and obsolete stock was a live issue well before trial, Mr Newman had said nothing about segregation by taping off stock areas until his fourth witness statement filed in about August 2012. If there was a witness who could have supported Mr Newman’s evidence on this topic, he or she would have been called by the plaintiffs. The foreman, with whom Mr Newman claims to have had such a conversation, or to whom any such instruction was given, or who might have been involved in the segregation of any such stock, was not called to give evidence.
Ms Douglas said that she gave instructions to employees at Eltham on how the stock take was to be conducted. She gave no instructions that they should not count slow moving or obsolete stock. Ms Douglas said that it had never been the practice in the past not to count such stock. She said that she was not aware of anyone giving an instruction of that kind. She said that in practical terms it would have been impossible for anyone in the field to make a decision as to whether an item was slow moving or obsolete.
Mr Newman did not claim that slow moving and obsolete stock was segregated at any site other than at Eltham. When questioned under cross‑examination about the approach to such stock at other sites, Mr Newman explained, for the first time, that prior to the stock take all slow moving and troublesome stock had been sent to Eltham. He made no mention of any such stock movement in any of his witness statements. Ms Douglas said that while new De Neefe recalled stock from interstate, old De Neefe did not. She also said that if stock had been recalled to Eltham, corresponding adjustments would have been required to be made by her in the Arrow System.
I am not satisfied that slow moving and obsolete stock was recalled from interstate to Eltham in anticipation of the stock take in August 2005; nor am I satisfied that such stock was taped‑off or otherwise segregated from the stock count at Eltham. It is most probable that slow moving and obsolete stock was counted at every site. I do not accept Mr Newman’s evidence on this topic. His evidence about segregation and the recall of stock to Eltham, had all the indicia of opportunistic invention. Mr Newman’s lack of candour on this topic undermined the credibility of his evidence concerning the integrity of the count and valuation and ultimately the credibility of the plaintiffs’ case.
The volume of stock that might be described as slow moving or obsolete was uncertain. New De Neefe undertook a search for obsolete stock that was eventually recorded in the Rosenberg List. That process was undertaken by Mr Steinkrug, who was assisting Mr Rosenberg. The process started in late 2005, and continued into 2006. A list was prepared in 2007. That task was assisted by the introduction of barcodes.
Following its acquisition of the business, new De Neefe introduced a barcoding system for stock, enabling a more accurate recording and tracking system. Michael Walter Seelig, now a barrister, was instrumental in introducing the system during the first half of 2006. He said that it was used during the audited stock take undertaken for the financial year ended 30 June 2006.
If the Rosenberg List is any indication, the impact on the overall count by eliminating obsolete stock may not have been substantial. But the potential impact on the valuation of slow moving stock is unknown.
The Public Transport Board of South Australia was a significant customer of the business. The Walkley Heights site seems to have been dedicated to the supply of product to the PTB. It was the practice of the PTB to prepay invoices in order to maintain its budgetary allocations. The process was a contrivance, in that invoices would be raised by old De Neefe for goods that were not delivered and may not exist. While a corresponding credit note would be issued, the invoices would be paid by the PTB, creating a pool of funds in old De Neefe available to be applied in payment for stock when delivered to the PTB.
The true character of the payments and the impact on the stock take was masked by the parties who refused to acknowledge the payments as liabilities of old De Neefe, notwithstanding a substantial liability recorded in its books of account in favour of the PTB. As at 30 June 2005, the accounts of old De Neefe recorded a liability to the PTB of $887,870.
The parties proceeded on the basis that the payments by the PTB translated into specific items of undelivered stock, held by old De Neefe, but owned by the PTB. The trouble was that no one was certain as to what was owned by the PTB and what stock ultimately intended for delivery to the PTB was owned by old De Neefe. A great deal of time was spent at trial by the plaintiffs attempting to demonstrate that it did not count the PTB owned stock, while the defendants sought to demonstrate that the plaintiffs included a significant volume of such stock in their count and valuation.
The commercial and accounting significance of the arrangement was never clarified, even though this part of the case was probably conducted on a false premise. If, as the parties assumed, the PTB owned particular items of stock that had been purchased, but not delivered, and which were retained on site at Walkley Heights, the implications for any stock take are obvious. It would be critical to differentiate between stock that was owned by the PTB and that which was owned by old De Neefe.
Another possibility was that, having paid in advance, the PTB did not acquire title to any particular items of stock until re-invoiced, or the cancellation of the credit note on delivery. Thus, the PTB would have been a creditor of old De Neefe until the debt was extinguished. Under that scenario, no items of stock at the premises should have been treated as having been owned by the PTB.
Mr Seelig, who visited the Walkley Heights premises, said that the staff in South Australia were unable to differentiate between that which was owned by the PTB and that which was not. The written instructions for the stock take, prepared by Mr Newman, made no reference to the need for any distinction between the PTB stock to be counted and that which was not. Instead, the instructions emphasised the need for a complete and accurate count. According to the August stock take, the value of the PTB stock owned by old De Neefe was $539,200.
Mr Newman spoke of segregating the PTB owned stock from old De Neefe owned stock, for the purpose of the stock take, although the evidence did not support any segregation. In fact, having regard to the way in which the count was undertaken, there would have been no point. Mr Newman said that all stock was counted at the Adelaide site and an adjustment made to deduct what was owned by the PTB.
The defendants contended that all but around $30,000 worth of the PTB finished goods was owned by the PTB. Mr Newman was uncertain about the correct allocation. He conceded that there may be a substantial part of the stock that had been valued which belonged to the PTB.
In my view, the jointly assumed premise, that the PTB owned some items of stock, was probably incorrect. But in any event, the arrangements with the PTB had the effect of creating further uncertainty about the accuracy of the count and valuation.
There were other anomalies. Stock counted at the business site in Western Australia was later discovered to have been owned by the Education Department. Some stock supplied by 3M Australia Pty Ltd was held on consignment while the plaintiffs contended that other 3M stock was owned by old De Neefe. The amount of material supplied by 3M was substantial. Old De Neefe paid for stock when it was used. It was common ground that consignment stock should not have been counted in a stock take. It seems clear that some 3M material had been counted and valued in the stock take. I am not clear why any 3M material should be included in the stock take. Once used it would comprise part of work in progress or finished goods. Nevertheless, Ms Douglas gave evidence that it was a problem to differentiate between 3M material to be counted and consignment stock. Mr Steinkrug also said that it was impossible to differentiate between consignment and other 3M stock.
In his fourth witness statement, Mr Newman said that he quarantined the 3M consignment stock from that which was to be counted in the stock take. He did not explain how this was done. His evidence is inconsistent with the evidence given by Mr Steinkrug and Mr Liosatos who said that the 3M consignment stock and old De Neefe owned 3M stock could not be distinguished. There was no other evidence of a quarantine regime for 3M consignment stock. I am not satisfied that Mr Newman quarantined 3M consignment stock.
Another feature of the stock take that reflected adversely on the integrity of the plaintiffs’ case was the flurry of invoicing at the end of August 2005. Over $613,000 was invoiced by old De Neefe on 31 August 2005. That invoicing should take place before a stock take was not unusual, if the objective was to ensure that the Arrow System accurately recorded goods that had been sold and dispatched. Mr Newman mentioned the need to invoice in his instructions to management shortly before the August stock take.
Of the total amount invoiced, $344,968.09 was charged to the PTB. By reference to the PTB sales for the 2005 financial year, sales for the month of August seemed exceptionally high. Average monthly sales were in the order of $80,000 to $90,000, although there would be fluctuations in the ordinary course. Mr Newman said that he had not been involved in the decision to issue the invoices to the PTB. He suggested that it was either Ms Douglas or Mr Bertram.
Ordinarily, an invoice would be raised when goods were dispatched, although the PTB was in a special position. As there were no goods dispatched on 31 August 2005, the raising of the invoices might have had the effect of reducing the indebtedness of old De Neefe to the PTB, while recording items already delivered. Alternatively, the invoices might have recorded items or services not yet sold or provided. Mr Newman conceded that possibility.
There were substantial credit notes issued and later write-offs that corresponded with some of those invoices. The reasons, and the extent to which such activity might have been unusual, was not fully explored. Insofar as the invoices reflected goods that were sold but not delivered, such goods might have been erroneously counted in the stock take. These events added to the uncertainty surrounding the accuracy of the plaintiffs’ count and valuation as at 31 August 2005.
June 2006 audited stock take
New De Neefe undertook an audited stock take on 1 July 2006. By that time Mr Seelig had installed the barcoding system. Pitcher Partners audited the stock take. Sidney Peter Catlin, the partner responsible for the audit, gave evidence of his audit. The stock take was methodical and systematic. Scanners were used on the barcodes to identify stock code and location. Items of stock were then counted. Once counted, a red sticker was placed on the item to indicate that it had been counted. No stock movements occurred during the stock take. Obsolete and damaged stock, which by then had been identified, was not counted. Thus, no value was attributed to such items. Following the count a random selection of stock codes were selected for recounting.
Following the preparation of cost inventory sheets, Pitcher Partners undertook testing. The cost of a randomly selected number of items of raw materials were checked against supplier invoices. The same approach was taken to finished goods with the check made against unit prices. The general ledger and stock lists were then reconciled and Pitcher Partners reported that there were no material errors.
The significance of the audited stock take that took place on 1 July 2006 to this proceeding is that the defendants rely upon it as a basis to ‘roll back’ to 31 August 2005 in an attempt to arrive at a more accurate value and composition of stock as at that date. They contended that a roll back methodology was to be preferred over a ‘roll forward’ from April 2005. The defendants pointed to the uncertain value of the opening stock position, the inherent inaccuracies discovered in the April 2005 stock take, and the systemic failings of the old De Neefe stock taking capabilities.
The most obvious advantage of the 2006 stock take was the deployment of the barcoding system, the isolation of obsolete stock that took place during the implementation of that system, the physical identification of items of stock that had been counted, and of course the audit. Also by that time a reconciliation of ‘paid stock’ had been agreed with the PTB, and the PTB stock was physically segregated at the Adelaide premises.
The plaintiffs challenged the relevance of the valuation of the 2006 stock take, because the valuations did not strictly adhere to the stock valuation model. But that contention has only limited force. An analysis undertaken by Cameron Heath Bodley revealed that for equivalent stock items there were only minor differences between the valuations in August 2005 and June 2006. Those differences were explained by reference to changes in cost and list prices.
The 2006 audited stock take, as a basis for an assessment of stock as at 31 August 2005, is supported by the evidence of Ricky Dale Milburn, sales manager at old De Neefe, who continued in that role with new De Neefe. Mr Milburn had been employed by old De Neefe since 1982. He said that the business conducted by new De Neefe was carried on in the same way as it had been conducted by old De Neefe in relation to stock control, save for the implementation of the barcoding system. According to Ms Douglas, the 2006 audited stock take was undertaken in the same way as previous stock takes. It was not quite clear what she meant, unless to generalise about the process of counting, recording and applying a valuation model. There were some differences identified by Ms Douglas. They included the absence of Mr Newman, the introduction of the barcoding system and the audit. Perhaps the lack of clarity in the evidence given by witnesses concerning the uniformity of the stock taking process is immaterial given that the plaintiffs, through Mr Newman, focussed their complaint about the relevance of the 2006 audited stock take on the failure of new De Neefe to apply the valuation model mentioned in the agreement.
Graham Thomas Lavelle, a chartered accountant, gave evidence on behalf of the plaintiffs in the form of a report dated 10 July 2012. Mr Lavelle summarised his opinion as follows:
Based on my investigations and a detailed review and test checking of the information, documentation and materials provided to me (as identified in this report) I consider that the value of the stock on hand at 31 August 2005 by application of the De Neefe stock valuation model amounts to approximately $4,015,000.
The opinions expressed by Mr Lavelle were misleading and unhelpful because he had not undertaken a ‘detailed review and test checking’ beyond the accuracy of the translation of the records of the stock take, upon which Mr Newman relied to give his evidence, into the compilation of data described as Annexure A to the statement of claim. He did not set out to audit the accuracy of the count, classification or to verify the values applied by Mr Newman.
A roll-back of inventory was undertaken by Geoff Long, a chartered accountant, who gave evidence on behalf of the defendants. Mr Long prepared a report dated July 2012. Mr Long’s objective was to arrive at a stock value on 31 August 2005 by extrapolating backwards from the audited stock take in June 2006. He examined stock movements on a month‑by‑month basis, using an estimated cost of goods, to arrive at a value of stock on 31 August 2005. Closing stock on 30 June 2006 was valued, including Norsign stock, at $3,141,191. Mr Long estimated the average cost of goods at 46.3 per cent. By rolling back from the 30 June 2006 stock value, applying the average cost of goods to sales Mr Long calculated the closing stock on 31 August 2005 at $2,535,672.
After deducting the value of Sale Stock, in the sum of $2.25 million, and the obsolete stock that was returned by the defendants to the plaintiffs (the Rosenberg List items), Mr Long arrived at a notional balance of $223,443.85. It cannot be said, however, that this amount represents Balance Stock, which has a defined meaning and composition under the agreement.
A roll-forward methodology might equally be applied, commencing with the April 2005 stock take. Mr Long undertook that analysis. It was common ground that after adjusting for errors highlighted by Mr Lom during the due diligence investigation conducted by him on behalf of the defendants, prior to their purchase of the business, the closing stock as at 30 April 2005 was $3,393,395. Mr Long imputed that figure as the opening stock on 1 May 2005. After adjusting that figure for actual sales and purchases each month, and applying an average cost of goods sold of 50 per cent, he arrived at a closing stock of $3,569,525 as at 31 August 2005.
Mr Long was of the opinion that the roll-back methodology provided a more accurate valuation of the stock as at 31 August 2005. He based that opinion primarily on the integrity of the audited stock take that took place on 30 June 2006, coupled with concerns about the accuracy of the stock take that took place in April 2005. Quite apart from the errors identified by Mr Lom, there was a substantial increase in work in progress between 30 April 2005 and 31 August 2005 of a little over $500,000. Mr Newman’s explanations for the increase were unsatisfactory.
Conclusion
The plaintiffs have failed to establish that there was any Balance Stock, as that expression is used in the agreement, used or sold by old De Neefe. In the absence of some mechanism to identify the items of Balance Stock that were sold or used by new De Neefe it is not possible to conclude that new De Neefe is liable to the plaintiffs under cl 7.4. The alternative claim for damages for conversion of Balance Stock suffered from the same difficulty. Because there is no way to determine what items comprised Balance Stock, it is not possible to conclude that any such items were converted by new De Neefe.
The plaintiffs’ count, classifications and valuation of the whole of their stock on and after 31 August 2005 did not substitute for the regime prescribed in the agreement to identify the items of Balance Stock. Furthermore, it was not sufficiently reliable as a foundation for the defendants’ liability for the use or sale of items of consignment stock. The imprecision is reflected in the plaintiffs’ final submissions, in which they advanced the three possible scenarios.
While the plaintiffs failed to establish that the stock take undertaken on 31 August 2005 provided a satisfactory basis upon which to determine the value of items of Balance Stock used or sold by new De Neefe, the defendants conceded that consignment stock to the value of $223,443.90 had probably been used or sold by new De Neefe. The defendants’ concession depended, however, upon a finding that some items of Balance Stock were sold or used by new De Neefe. I am not so satisfied.
The plaintiffs did not make a claim under a constructive or resulting trust for the proceeds from the sale or use of old De Neefe consignment stock. The plaintiffs’ case was inextricably tied to the requirement that the items of stock for which the defendants were liable, under cl 7.4 or by way of damages for conversion, were drawn from and could be identified as items of Balance Stock.
If and to the extent that there may hereafter be found to be a basis upon which the plaintiffs are entitled to recover the value of consignment stock that was used or sold by new De Neefe, the best estimate is that made by Mr Long using his ‘roll‑back’ methodology. I would reject the roll-forward methodology, as it depended on an unsatisfactory starting point. The accuracy of the April 2005 stock take is highly questionable and the evidence was not directed to establishing its accuracy.
It must be kept in mind, however, that the estimate made by Mr Long was calculated as if the valuation was made for the purpose of a stock take. In the context of this proceeding, that is understandable. It does not, however, purport to be a valuation of that which was in fact realised by new De Neefe from the sale or use of any such stock. Such an assessment would have been difficult, given the absence of any identification of the items or even categories of stock involved.
Accordingly, the case as pleaded by the plaintiffs must fail. The claim is dismissed. I will hear from the parties on costs.
0
2
0