Dshe Holdings (Receivers and Managers Appointed)(In Liquidation) v Nicholas Abboud (No 3); National Australia Bank Limited v Nicholas Abboud (No 4)

[2021] NSWSC 673

Supreme Court

New South Wales

• Summary available

Medium Neutral Citation:

DSHE Holdings (Receivers & Managers Appointed)(In Liquidation) v Nicholas Abboud (No 3); National Australia Bank Limited v Nicholas Abboud (No 4) [2021] NSWSC 673

Hearing dates:

16 - 20, 30 March 2020; 21 - 25, 28 - 30 September 2020; 1, 6, 8, 9, 12 - 16, 19 - 23, 26 October 2020; 2 - 6, 18, 19, 23 - 25 November 2020; 1, 3, 4, 7, 8, 10 - 11; 15 - 18 December 2020; 4, 5, 8 - 12 and 15 February 2021

Decision date:

11 June 2021

Jurisdiction:

Equity - Commercial List

Before:

Ball J

Decision:

See paragraphs [612] and [613]

Catchwords:

CORPORATIONS – Directors and officers – Directors’ duties – Duty of care and diligence – Where executive directors alleged to have adopted a “rebate maximisation policy” – Whether policy led to buy stock irrespective of consumer demand – Whether non-executive directors failed to put in place internal controls to monitor procurement activities

CORPORATIONS – Shares – Dividends – Where dividend allegedly declared in breach of section 254T Corporations Act 2001 (Cth) – Where dividend allegedly declared in breach of directors’ duties – Whether directors can act in breach of duty when declaring a dividend even without contravening section 254T – Whether reference to “creditor” in section 254T includes future creditors –– Meaning of “materially prejudice” expression in s 254T – Whether business judgment rule applies to decision to declare dividends

CONSUMER LAW – Misleading and deceptive conduct – Whether executive directors made misleading and deceptive statements when negotiating credit facilities – Where executive director made statements concerning matters within his area of responsibility and about which he had personal knowledge – Where statements misleading or incomplete – Executive director found to have personally engaged in misleading and deceptive conduct on the facts

DAMAGES – Damages caused by misleading and deceptive conduct – Proof – Where misled party acquired something of value as result of misleading conduct by way of security over loan – Held misled party’s onus of proof is discharged by showing value of security lower than value of loan

DAMAGES – Damages caused by misleading and deceptive conduct – Quantification – Held damages to be assessed as the difference between the amount lent and the amount actually received in the receivership – Whether payment by receivers of creditors’ legal costs amounts of a distribution in the creditors’ favour

Legislation Cited:

Australian Consumer Law

Australian Securities and Investments Commission Act 2001 (Cth)

Corporations Act 2001 (Cth)

Corporations Amendment (Corporate Reporting Reform) Act 2010 (Cth)

Cases Cited:

Attard v James Legal Pty Ltd [2010] NSWCA 311; [2010] NSWCA 311

Australian Competition and Consumer Commission v LG Electronics Australia Pty Ltd [2017] FCA 1047

Australian Competition and Consumer Commission v TPG Internet Pty Ltd (2013) 250 CLR 640, [2013] HCA 54

Australian Securities and Investments Commission v Maxwell [2006] NSWSC 1052; (2006) 59 ACSR 373

Australian Securities and Investments Commission v Narain (2008) 169 FCR 211, [2008] FCAFC 120

Australian Securities and Investments Commission v Rich (2009) 236 FLR 1

Australian Securities and Investments Commission v Warrenmang Ltd (2007) 63 ACSR 623; [2007] FCA 973

Bennett v Elysium Noosa Pty Ltd (in liq) (2012) 202 FCR 72

Boyd v Leftwich (1982) 43 ALR 280

Campbell v Backoffice Investments (2009) 238 CLR 304, [2009] HCA 25

Cassimatis v Australian Securities and Investments Commission (2020) 275 FCR 533; [2020] FCAFC 52

Cleary v Australian Co-Operative Foods Ltd (Nos 2 & 3) (1999) 32 ACSR 701, [1999] NSWSC 991, [1999] NSW 1062

Connective Services Pty Ltd v Slea Pty Ltd (2019) 767 CLR 461, [2019] HCA 33

Demagogue Pty Ltd v Ramensky (1992) 39 FCR 31

DCT Projects Pty Limited v Champion Homes Sales Pty Limited [2016] NSWCA 117

EK Nominees Pty Ltd v Woolworths Ltd [2006] NSWSC 1172

Fabcot Pty Ltd v Port Macquarie-Hastings Council [2011] NSWCA 167

Genocanna Nominees Pty Ltd v Thirsty Point Pty Ltd [2006] FCA 1268

Global Sportsman Pty Ltd v Mirror Newspapers Ltd (1984) 2 FCR 82, [1984] FCA 180

Henville v Walker (2001) 206 CLR 459, [2001] HCA 52

Houghton v Arms (2006) 225 CLR 553, [2006] HCA 59

Ikon Communications Pty Ltd v Advangen International Pty Ltd [2018] NSWSC 1650

Industrial Equity Limited v Blackburn (1977) 137 CLR 567, [1977] HCA 59

Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets (No 6) (2007) 63 ACSR 1, [2007] NSWSC 124

KGDInvestments Pty Ltd v Placard Holdings Pty Ltd [2015] VSC 712

Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722

Kuhl v Zurich Financial Services Australia Ltd (2011) 243 CLR 361; [2011] HCA 11

Lam v Ausintel Investments Australia Pty Ltd (1989) 97 FLR 458

Moloney v Bells Securities Pty Ltd [2005] QSC 13

Miller & Associates Insurance Broking Pty Ltd v BMW Australia Finance Limited (2010) 241 CLR 357, [2010] HCA 31

Pages Property Investments Pty Ltd v Boros [2020] NSWSC 1270

Pico Holdings Inc v Voss [2004] VSC 263

Placer (Granny Smith) Pty Ltd v Thiess Contractors Pty Ltd (2003) 196 ALR 257 at [37]f [2003] HCA 10

QBE Insurance Group Ltd v Australian Securities Commission (1992) 38 FCR 270

Re Centro Property Trust [2011] NSWSC 1171

Re CSR Ltd (2010) 183 FCR 358; [2010] FCAFC 34

Swiss Re International SE v Simpson (2018) 354 ALR 607; [2018] NSWSC 233

Ted Brown Quarries Pty Ltd v General Quarries (Gilston) Pty Ltd (1977) 16 ALR 23

Wardley Australia Limited v State of Western Australia (1992) 175 CLR 514

Williams v Pisano (2015) 90 NSWLR 342, [2015] NSWCA 177

Texts Cited:

Australian Government, Department of Industry, Innovation, Climate Change, Science, Research and Tertiary Education

Category:

Principal judgment

Parties:

DSHE Holdings Limited ACN 166 237 841 (Receivers & Managers Appointed) (Administrators Appointed) (Plaintiff | Cross Defendant on Sixth Cross Claim )
Nicholas Abboud (First Defendant | Cross Claimant on Second Cross Claim | First Cross Defendant on Sixth Cross Claim)
Michael Potts (Second Defendant | Cross Claimant on Third Cross Claim | Sixth Cross Defendant on Sixth Cross Claim)
Phillip John Cave (Third Defendant | Cross Claimant on Fifth Cross Claim | Second Cross Defendant on Sixth Cross Claim)
Robert Murray (Fourth Defendant | First Cross Claimant on First Cross Claim | Fifth Cross Defendant on Sixth Cross Claim)
William Wavish (Fifth Defendant | Cross Claimant on Fourth Cross Claim | Ninth Cross Defendant on Sixth Cross Claim)
Lorna Raine (Sixth Defendant | Second Cross Claimant on First Cross Claim | Seventh Cross Defendant on Sixth Cross Claim)
Robert Ishak (Seventh Defendant | Third Cross Claimant on First Cross Claim | Fourth Cross Defendant on Sixth Cross Claim)
Jamie Tomlinson (Eighth Defendant | Fourth Cross Claimant on First Cross Claim | Eighth Cross Defendant on Sixth Cross Claim)
David Robert White and others listed in Schedule 1 t/as Deloitte Touche Tohmatsu (Cross Claimants on Sixth Cross Claim | Cross Defendants to First, Second, Third, Fourth and Fifth Cross Claims)

2017/81938:

National Australia Bank (First Plaintiff)
HSBC Bank Australia Limited (Second Plaintiff)
Nicholas Abboud (First Defendant | Cross Claimant on First Cross Claim | Second Cross Defendant on Third Cross Claim)
Michael Potts (Second Defendant | Cross Claimant on Second Cross Claim | Third Cross Defendant on Third Cross Claim)
David White and others listed in Annexure A t/as David Robert White and others listed in Schedule 1 t/as Deloitte Touche Tohmatsu (Cross Defendants to First Cross Claim and Second Cross Claim | Cross Claimants on Third Cross Claim)
DSHE Holdings Limited trading as DSHE Holdings Ltd ACN 166 237 841 (Receivers and Managers Appointed) (In Liquidation) (First Cross Defendant on Third Cross Claim)

Representation:

Counsel:

2017/81927:

JC Giles SC with JA Arnott, JA Granger & PR Gaffney (Plaintiffs)
RM Smith SC with N Simpson (First Defendant | Cross Claimant on Second Cross Claim | First Cross Defendant on Sixth Cross Claim)
S Nixon SC with A Jordan and A Zheng (Second Defendant | Cross Claimant on Third Cross Claim | Sixth Cross Defendant on Sixth Cross Claim)
SJ Finch SC with F Assaf SC and S Hartford-Davis (Third Defendant | Cross Claimant on Fifth Cross Claim | Second Cross Defendant on Sixth Cross Claim)
IM Jackman SC with J Williams SC and L Rich (Fourth and Sixth to Eighth Defendants | First to Fourth Cross Claimants on First Cross Claim | Fourth, Fifth, Seventh and Eighth Cross Defendants on Sixth Cross Claim)
R Foreman SC with KE Boyd and J Entwisle (Fifth Defendant | Cross Claimant on Fourth Cross Claim | Ninth Cross Defendant on Sixth Cross Claim)
P Braham SC with A Shearer, R Mansted & S Tame (Cross Claimants on Sixth Cross Claim | Cross Defendants to First, Second, Third, Fourth and Fifth Cross Claims)

2017/81938:

JC Giles SC with JA Arnott, JA Granger & PR Gaffney (Plaintiffs | First Cross Defendant on Third Cross Claim)
RM Smith SC with N Simpson (First Defendant | Cross Claimant on First Cross Claim | Second Cross Defendant on Third Cross Claim)
S Nixon SC with A Jordan and A Zheng (Second Defendant | Cross Claimant on Second Cross Claim | Third Cross Defendant on Third Cross Claim)
P Braham SC with A Shearer, R Mansted & S Tame (Cross Defendants to First Cross Claim and Second Cross Claim | Cross Claimants on Third Cross Claim)

Solicitors:

2017/81927:

Norton Rose Fulbright (Plaintiffs)
Clayton Utz (First and Second Defendants | Cross Claimants on Second and Third Cross Claims | First and Sixth Cross Defendants on Sixth Cross Claim)
Allens Linklaters (Third Defendant | Cross Claimant on Fifth Cross Claim | Second Cross Defendant on Sixth Cross Claim)
Arnold Bloch Liebler (Fourth and Sixth to Eighth Defendants | Cross Claimants on First Cross Claim | Fourth, Fifth, Seventh & Eighth Cross Defendants on Sixth Cross Claim)
Webb Henderson (Fifth Defendant | Cross Claimant on Fourth Cross Claim | Ninth Cross Defendant on Sixth Cross Claim)
Clifford Chance (Cross Claimants on Sixth Cross Claim | Cross Defendants to First, Second, Third, Fourth and Fifth Cross Claims)

2017/81938:

Norton Rose Fulbright (Plaintiffs | First Cross Defendant on Third Cross Claim)
Hall & Wilcox (First and Second Defendants | Cross Claimants on First and Second Cross Claims | Second and Third Cross Defendants on Third Cross Claim)
Clifford Chance (Cross Claimants on Third Cross Claim | Cross Defendants to First Cross Claim and Second Cross Claim)

File Number(s):

2017/81927 and 2017/81938

Publication restriction:

None

Judgment

Introduction

Preliminary matters

Factual background

Anchorage acquires Dick Smith

The decision to increase supplier support

The “turnaround strategy”

Mr Wavish’s method for provisioning for obsolete stock

Other changes to the business

The FY13 accounts

The prospectus

Events immediately following the float

Deloitte retained for FY14 audit

Increase in targeted stock on hand

Greater emphasis placed on O&A rebates

Collection of O&A rebates as part of “fighting fund”

FY14 accounts and FY15 budget

Increase in weeks covered

FAC meeting on 12 August 2014

Recording of O&A rebates

Emphasis on O&A rebates continued in FY15

Private label suppliers required to pay O&A rebates

Further evidence concerning O&A rebates

DSH acquires too much stock

DSH delays paying some suppliers

DSH exceeds its banking facilities on some occasions

Instructions in relation to O&A rebates in preparation for half yearly review

Events in January 2015

Bank facilities

Meeting with HSBC on 3 February 2015

Deloitte’s report in relation to the HY15 review

FAC meeting on 12 February 2015

Board meeting on 16 February 2015

Reduction in O&A collection following reduction in OTB

HSBC’s credit approval process

Board meeting on 17 March 2015

Mr Tomlinson appointed to the board

Meetings on 20 April 2015

Meeting with representatives of NAB on 28 April 2015

NAB’s credit application

Payment of the interim dividend

Meeting with Mr Potts on 6 May 2015

Events following the meeting with Mr Potts

Board meeting on 19 May 2015

Board meeting on 16 June 2015

Syndicated Facility entered into

Events leading up to end of FY15

Board meeting on 20 July 2015 and subsequent events

FAC meeting on 11 August 2015

Board meeting on 17 August 2015

Mr Holtzer engaged in relation to DSH’s inventory

The Extension Agreement

Presentation by Messrs Holtzer and Powell

Events in September and October 2015

Mr Orrock resigns

Dick Smith announces profit downgrade

HSBC enters into Extension Agreement

Analysis of Mr Holtzer and Mr Powell

Board resolves to take a $60 million impairment on stock

Events following announcement of impairment

The receivership

The “bad stock” case

Introduction

Some preliminary points

Did DSH engage in the conduct complained of?

Did the directors breach their duties in relation to the Rebate Maximisation Policy?

The position of the NEDs

The position of Mr Abboud and Mr Potts

Damages

The dividend cases

The plaintiffs’ case

DSH’s constitution

Issues with the plaintiffs’ case

A pleading point

The interim dividend

The final dividend

Damages

Other defences

The Bank Proceedings

Introduction

Relevant legal principles

HSBC’s primary claim

The pleaded case

Consideration

NAB’s claim

The pleaded case

Consideration

The Extension Agreement

The pleaded case

Consideration

Damages and the apportionment defence

NAB’s claim for damages

HSBC’s claim for damages in relation to the Extension Agreement

Orders

Judgment

Introduction

1. Prior to its collapse in January 2016, Dick Smith was a well-known retailer of consumer electronics in Australia and New Zealand. It was acquired from its eponymous founder by Woolworths Limited between 1981 and 1983.

2. In September 2012, Woolworths sold the shares in DSE Holdings Pty Limited (DSE), the holding company of various subsidiaries through which the Dick Smith business was carried on, to Dick Smith Sub-Holdings Pty Limited (DSSH) which had been established to acquire the shares in DSE and which was owned as to 98 percent by Anchorage Capital Partners Limited (Anchorage), a private equity firm, and as to two percent by LMA Investments Pty Limited (LMA), a company controlled by Mr Nicholas Abboud, who became Dick Smith’s managing director and chief executive officer (CEO). The sale price for the shares was $20 million plus an amount contingent on the subsequent sale of the shares above an agreed threshold. In September 2013, Mr Michael Potts joined Dick Smith as its chief financial officer (CFO) and company secretary.

3. At the end of 2013, the Dick Smith business was floated on the Australian Securities Exchange (ASX). For the purposes of the float, a new company, Dick Smith Holdings Limited (now known as DSHE Holdings Limited (in liq)) (DSH), was incorporated on 25 October 2013 to acquire the shares in DSSH from Anchorage and LMA and to invite subscriptions for its shares in accordance with a prospectus which was initially lodged on 14 November 2013 and which was replaced on 21 November 2013. The offer price was $2.20 per share, which reflected a market capitalisation of $520.3 million.

4. At the time DSH was established, Mr Abboud became its managing director and CEO and Mr Potts its company secretary and CFO. Mr Potts was appointed a director of DSH on 12 August 2014. The other (non-executive) directors of DSH were Mr Phillip Cave, a managing director of Anchorage who became chairman of DSH, Mr William Wavish, Ms Lorna Raine and Mr Robert Ishak. In addition, Mr Robert Murray was appointed a director of DSH on 12 August 2014 and he became the non-executive chairman of DSH on 1 March 2015, following Mr Cave’s resignation. Mr Jamie Tomlinson was appointed a non-executive director of DSH on 10 April 2015, following the resignation of Mr Wavish. In this judgment, the persons who served as non-executive directors of DSH will be referred to as the non-executive directors or NEDs.

5. Trading of the shares in DSH on the ASX commenced on 4 December 2013. Anchorage retained 20 percent of the shares and committed to retain that interest until the announcement of DSH’s financial results for the financial year ending 30 June 2014 (FY14). It sold those shares on 15 September 2014.

6. In June 2014, DSH and Dick Smith Electronics Pty Limited (DS Electronics), a subsidiary of DSH, entered into a vendor financing arrangement with Macquarie Bank Limited (Macquarie) with a $15 million limit. On 27 June 2014, various companies in the Dick Smith Group, including DSH, entered into a facility agreement with Westpac Banking Corporation (Westpac) and its New Zealand subsidiary with a limit of $82 million to replace a then existing $65 million facility with GE Commercial Corporation (Aust) Pty Ltd and GE Commercial Finance (NZ). The facility with Westpac was amended over time, largely by Westpac granting formally and informally temporary increases in the facility limit. On 22 June 2015, the Westpac facility was replaced by a syndicated facility agreement and associated agreements (together, the Syndicated Facility) with National Australia Bank (NAB) and HSBC Bank Australia Limited (HSBC) (together, the Banks) by which NAB agreed to provide working capital facilities to DSH up to a total commitment of $75 million and HSBC agreed to provide an overdraft financing facility to DSH up to a total commitment of $60 million. On 16 November 2015, HSBC agreed to increase its total commitment from $60 million to $80 million until January 2016 (the Extension Agreement).

7. On 29 November 2015, the board of DSH resolved to take a $60 million non‑cash impairment in relation to the carrying value of its inventory. On 4 January 2016, DSH went into voluntary administration. On the same day, NAB and HSBC appointed receivers. DSH went into liquidation on 25 July 2016.

8. Originally, these events gave rise to five proceedings. Three of those were representative proceedings brought by shareholders of DSH. Those proceedings settled during the course of the hearing and nothing further needs to be said about them. The remaining two proceedings are brought by the Banks (the Bank Proceeding) and by the receivers in the name of DSH (the Company Proceeding).

9. The Banks sue Mr Abboud and Mr Potts in respect of misleading and deceptive conduct they are alleged to have engaged in connection with the Syndicated Facility and the Extension Agreement which is said to have induced the Banks to enter into those agreements. The Banks claim the total amount owing to them at the time DSH went into voluntary administration ($124,889,342.27) less amounts recovered during the receivership. Depending on how the amounts held by the receivers are treated and the treatment of legal costs paid by the receivers, that amount is between $50,090,510.93 and $92,245,967.77, together with interest and costs.

10. The conduct said to be misleading and deceptive involves misstatements about DSH’s financial position and a failure to disclose DSH’s dependence on “over and above” (O&A) rebates (described in more detail below) and the effect that those rebates had on the quality and level of DSH’s stock. Originally, the conduct was said to have extended to misstatements in DSH’s audited accounts. In connection with that aspect of the case, Mr Abboud and Mr Potts filed cross-claims against Deloitte alleging that if they were liable to the Banks then Deloitte was liable to them for misleading and deceptive conduct in connection with the statutory audit of the FY15 accounts and the half-yearly review of the HY15 accounts. However, during the course of the hearing, the allegation that the HY15 and FY15 accounts were materially misstated were struck out or abandoned, with the result that the case against Deloitte was dismissed.

11. DSH sues Mr Abboud and Mr Potts and the NEDs for breaches of the duty of care they owed under s 180(1) of the Corporations Act2001 (Cth) (the Corporations Act) and the general law by:

1. Deciding to declare an interim dividend of $16.555 million on 16 February 2015;

2. Deciding to declare a final dividend of $11.826 million on 17 August 2015; and

1. Failing to cause DSH to implement any adequate procedures, practices or systems to manage the obvious risks created by the alleged adoption of a scheme to maximise rebates, particularly O&A rebates.

Again, Mr Abboud, Mr Potts and the NEDs filed cross-claims against Deloitte alleging that if they are liable to DSH, then Deloitte was liable to them for misleading and deceptive conduct in connection with the statutory audits for FY14 and FY15 and the half-yearly review for HY15. Again, those claims were dismissed during the hearing following the striking out and abandonment of any allegation that any of DSH’s statutory accounts materially misstated its financial position.

12. Two other points should be made by way of introduction. First, a number of the defendants prepared detailed affidavits but did not give evidence. They included Mr Potts, Mr Cave, Ms Raine and Mr Ishak. What inferences if any should be drawn from the absence of evidence from those witnesses will, to the extent necessary, be dealt with later in this judgment where the issue arises.

13. Second, one of the witnesses who provided affidavit evidence for the plaintiffs was Ms Rachel Howard, who was the Transaction Processing Manager of Dick Smith from February 2011 until the appointment of receivers to DSH. In that role, Ms Howard was involved in reconciling general ledger balance sheets, preparing payment forecasts, generating payments to vendors and interacting with vendors in relation to payment expectations and enquiries. Ms Howard died before the hearing. However, her affidavit was admitted into evidence. What weight should be given to that affidavit is dealt with later in this judgment where the issue arises.

Preliminary matters

14. Before setting out the relevant factual background in more detail, it is helpful to say something more about the Dick Smith business and some of the terminology and accounting concepts relevant to it.

15. At the time of the float, Dick Smith operated approximately 359 Dick Smith branded retail stores in Australia and New Zealand together with 30 outlets in stores operated by David Jones Limited known as “Electronics Powered by Dick Smith” and one specialist store under the brand name “Move”. It also sold product online and commercially to institutions, such as businesses and schools, through dedicated sales staff. The different methods of sale (in store, online and commercial) were known as “lines” or “channels”.

16. Dick Smith sourced products from a variety of manufacturers and suppliers. As is common in retail, each product of exactly the same type available for sale as an individual item was referred to as a “stock keeping unit” or “SKU”. The SKUs bought and sold by Dick Smith were classified into groups for management purposes. The classification of SKUs changed somewhat over time. For much of the time DSH operated, there were four groups known as “Office”, “Mobility”, “Entertainment” and “Accessories”, which in turn were broken down into categories of product. Stock was bought centrally and stored in a centralised warehouse in Chullora, New South Wales, where Dick Smith’s headquarters were located and from where it was distributed to individual stores.

17. The precise structure of Dick Smith’s buying department is not easy to identify from the evidence and appears to have changed somewhat over time. Within the buying department, particular staff members were given responsibility for buying particular categories of product. The buying staff were divided into two groups known as merchandise planners and buyers. The merchandise planners were responsible for the internal management of stock including forecasting sales, developing budget plans, the replenishment of distribution centres and individual stores, managing aged inventory and maximising sales. The buyers were responsible for dealing with third party suppliers including negotiating the terms on which Dick Smith acquired stock from those suppliers and the terms on which suppliers provided rebates and other support in connection with the sale of their products. One such buyer was Mr Darren Freeman, who gave evidence for the plaintiffs in the proceedings. At various stages he was responsible for buying products in the Power (PO) category (comprising items used to power electronic devices including batteries, surge protectors and chargers), the Seasonal (SE) category (comprising Christmas lights and trees, children’s toys, fitness products, appliances and other products that did not neatly fit into another category), the Protect (PR) category (comprising items to protect electronic devices such as bags, covers and cases) and the Imaging/Photographics (XG) category (comprising camera and photographic accessories).

18. The merchandise planners were supervised by Mr Christopher Borg, who joined Dick Smith in March 2013 as the Merchandise Planning Manager but whose title later changed to “General Manager – Planning”. In that capacity, he was responsible for managing, budgeting and forecasting all key financial metrics, including stock and stock provisions. He was also responsible for monitoring and controlling buyers’ compliance with targets set for the buyers, although Mr Borg says and I accept that the decisions he made in relation to the authority buyers had to buy stock were frequently modified by those who were more senior than him, including Mr Abboud. Mr Borg was also responsible, along with other general managers, for approving the movement of certain items within provisioning classifications.

19. Mr Borg left Dick Smith in November 2015. At the time he started at Dick Smith, he reported to Mr Neil Merola, the Director of Strategy, and Mr George Papacosta, who became the Director of Dick Smith’s online and private label channels. Both Mr Merola and Mr Papacosta had started with Dick Smith on 26 November 2012 as part of the team engaged by Anchorage to run Dick Smith following its acquisition from Woolworths. Subsequently, Mr Merola became the Director of Buying and in that capacity had overall responsibility for the buying function at Dick Smith.

20. For a time in 2014, Mr Borg reported to Mr John Skellern, who was the Director of Commercial, Property, Procurement and Supply Chain. Mr Skellern had joined Dick Smith as part of the original management team on 21 December 2012. In the later part of 2014, Mr Borg commenced reporting to Mr Rodney Orrock, who replaced Mr Merola as Director of Buying on or about 28 July 2014. Mr Orrock held that position until October 2015, when he was succeeded by Mr Mark Scott. Each of Mr Skellern and the director of buying reported directly to Mr Abboud. Mr Borg also gave evidence for the plaintiffs.

21. The buyers reported to merchandise managers, who in turn reported to the Director of Buying. In June 2014, there were two Merchandise Managers, one of whom was Mr Carl Bonham. Mr Bonham was responsible for the Accessories group of products. One of the buyers reporting to him was Mr Freeman. Mr Bonham also gave evidence on behalf of the plaintiffs.

22. Dick Smith set budgets for each buyer which identified the value of stock that the buyer was authorised to buy. The available budget was referred to “open to buy” or “OTB”. Although OTB was set as part of the budgeting process in each financial year, it was reviewed and adjusted during the year. The overall OTB was set by Mr Potts and the finance team. However, Mr Borg, with the assistance from merchandise managers, was responsible for splitting the overall figure down by month and category of stock.

23. The procedure for purchasing inventory involved the buyer completing a stock order form, which would be signed by the buyer, the relevant senior merchandise planner and then approved by Mr Borg. If a purchase exceeded OTB, approval was required from one of Mr Orrock, Mr Potts or Mr Abboud. Mr Borg prepared regular reports comparing the OTB targets of buyers with their actual purchases.

24. Dick Smith also sold private label (PL) stock branded “Dick Smith” or “Move”, which it sourced from China. It had dedicated staff who were responsible for sourcing that product and it reported separately on the sales performance of stock falling within that category. PL stock accounted for approximately 15 percent of sales and approximately 33 percent of gross profit.

25. Dick Smith’s primary source of revenue was obviously from the sale of merchandise. However, it also earned other forms of revenue including from the payment or allowance of rebates on goods sold by Dick Smith or for services provided by Dick Smith. Dick Smith negotiated for rebates and other support in two ways. First, it negotiated rebates as part of the general terms of trade it negotiated with suppliers, which were normally set out in written contracts. Those rebates took various forms. The most common types of rebate were volume rebates, scan rebates, warehouse rebates and advertising rebates or subsidies (known as Ad Sub). Volume rebates were paid by reference to the total volume of product of that supplier sold by Dick Smith during a particular period, which were generally calculated as a percentage of the value of goods sold. Scan rebates were rebates payable by reference to actual sales of products at the register. Warehouse rebates were payable in respect of the cost of storing and distributing stock. Ad Sub was payable to support the cost of marketing a supplier’s products and in some cases could exceed those costs.

26. In addition, Dick Smith, like other retailers, negotiated rebates outside the normal trading terms. Although it appears that the terminology was not universally accepted, rebates of that type were generally referred to within Dick Smith as “over and above” or “O&A” rebates. O&A rebates are generally negotiated in connection with the promotion of a particular product or range of products or as a contribution by the supplier to a discount offered on a product as a means of clearing superseded or slow-moving stock. Again, the rebate could take various forms, such as a scan rebate payable as a contribution to the discounted price of the stock or as a rebate that was paid as a contribution to marketing. At Dick Smith, O&A rebates were often agreed informally. In some cases, they were agreed orally and in others were evidenced only by an email between the relevant buyer at Dick Smith and a representative of the supplier. Normally, they were negotiated at the time a purchase order was placed with a supplier and, as will become apparent, they were usually treated as a contribution to marketing.

27. As might be expected, Dick Smith had a stock management system, which was known as the AS400 system. It was a computerised database which contained information about each SKU, including the cost price of the SKU, any rebates payable in respect of the SKU, the price for which SKUs were sold, which stores carried the SKU and the quantity of the SKU held in each store and other information relevant to stock management. According to unchallenged evidence given by Mr Wavish, the AS400 system allowed merchandise planners and senior management to manage the amount of money allocated at a group, category or SKU basis and to allocate maximum reorder quantities by buyer, category and SKU. Separate databases existed for the Australian and New Zealand businesses. The AS400 system was a legacy system inherited from Woolworths and was somewhat antiquated. One feature of the system was that it only measured the aging of stock from the last date on which a particular SKU was purchased.

28. Until late 2014, Dick Smith did not have any centralised system for recording O&A rebates that had been negotiated by the Dick Smith buyers. Instead, Mr Skellern, who met weekly with the buyers, kept a record of them on a whiteboard in his office. In late 2014, Mr Tomer Bar-Ami, General Manager of Merchandise Planning & Business Intelligence, began copying Mr Skellern’s whiteboard into an excel spreadsheet, but that information never formed part of the AS400 system and it is not possible using that system to link particular purchases or the supply of other services with particular O&A rebates. As is already apparent from what has been said, O&A rebates and the emphasis placed on them by Dick Smith is an important issue in these proceedings.

29. The gross profit earned by Dick Smith on the sale of a particular SKU – sometimes also referred to as “second margin” and often expressed as a percentage of sales – was the amount derived from the sale of that SKU during a particular period less the Cost of Goods Sold (COGS) (sometimes also referred to as Cost of Sales (COS)) and after allowing for certain rebates payable under the trading terms between Dick Smith and the relevant supplier. At Dick Smith, COGS was (in accordance with the relevant Accounting Standard) calculated as the weighted cost price of the SKU determined across the entire inventory of that SKU held at a particular time. The difference between the sale price and COGS (excluding rebates) of a SKU was known as the “first margin”.

30. A number of rebates offered by suppliers, such as volume rebates and warehouse rebates, had the effect of reducing the purchase price of the SKU and therefore COGS. When rebates of those types were agreed as part of the trading terms on which Dick Smith bought stock from a particular supplier, the value of the rebate would be spread across the entire inventory and would only be brought to account in terms of an increase in gross profit as a result of a reduction in COGS as stock was sold. Some types of rebate, such as Ad Sub rebates, did not fall into that category. Rebates of that type were payable for the provision of advertising services and could be recognised as income when the services were provided.

31. In addition to COGS, Dick Smith, like all retailers, incurred general business expenses such as salary and wages, marketing and promotional expenses and rent. These costs are referred to as costs of doing business (CODB). Net profit is derived by deducting both COGS and CODB from the revenue generated through sales. Gross profit is often referred to as profit “above the line” and net profit as profit “below the line”. Net profits after tax (NPAT) is a common measure of below the line performance as is earnings before interest and tax (EBIT) and earnings before interest tax, depreciation and amortisation (EBITDA).

32. Accounting Standard AASB 102 requires that “Inventories shall be measured at the lower of cost and net realisable value”. There is a risk that not all stock purchased by a retailer will be sold for more than the cost of acquisition (that is COGS). That risk is of particular significance for electronics retailers because of rapid developments and changes in technology, which may make current products unattractive or obsolete. Accordingly, it is usual for a retailer, consistently with the requirements of AASB 102, to make some general provision in its accounts in respect of that risk.

33. There are two other metrics that are important measures of the performance of a retail business which took on considerable significance in this case. One metric is known as “weeks covered” – that is, the number of weeks that it is expected to take to sell the existing inventory of a particular SKU. If weeks covered is too low, there is a risk that the retailer will run out of stock before it can be replaced, with the result that the retailer will lose sales. If weeks covered is too high, the capital of the company will be tied up unnecessarily in inventory and there is an increased risk that that stock will become obsolete and will have to be sold below cost or written off.

34. Weeks covered calculations are often forward looking. That is, the calculation is performed by dividing the total number held of a particular SKU by the projected weekly sales of that SKU. However, weeks covered calculations can also be backwards looking. That is, the calculation can be performed by dividing the total number held of a particular SKU by the average number of sales per week of the SKU in some past period – such as the past three or six or twelve months. The risk of a backwards looking calculation is that past results are not necessarily a good guide to the future, particularly if there have been significant changes in the business in the meantime or the particular SKU in question is approaching the end of its useful life because, for example, it is about to be replaced by a later model. As part of his reporting function, Mr Borg prepared reports setting out closing targets for each category of stock and the number of weeks covered for each category of stock, some of which are referred to later in this judgment.

35. The other metric is the aging of inventory – that is, the length of time (usually measured in days or weeks or months) since the inventory was received by the business. Obviously, the greater the age of stock, the greater the risk of obsolescence. At Dick Smith, the aging of stock was a somewhat unreliable metric because, as I have said, the age of stock was calculated from the date of last purchase.

36. DSH’s board met monthly except in December, January and September. As might be expected, board papers, which contained monthly financial information, were distributed to board members in advance of the meetings. Like many retailers, Dick Smith reported by reference to “financial months”, which ended on the last Sunday of a calendar month, unless the Sunday was the last day of the month, in which case the financial month ended on the previous Sunday. Consequently, some trading months covered five weeks and others, four. Similarly, Dick Smith’s financial year ended at the end of the June financial month, which would not necessarily be the 30^th of June of that year. One consequence of this method of accounting, which again took on some significance in these proceedings, is that the monthly cash flow statements and forecasts that were provided to the board would not generally show the peak debt incurred by Dick Smith during a month, since the statements and forecasts showed the position at the end of the relevant financial month whereas a number of expenses, such as some supplier invoices, were payable at the end of the calendar month or the beginning of the following month.

37. DSH’s Board had two committees: a Remuneration Committee and a Finance and Audit Committee (FAC). The FAC met quarterly, usually in February, May, August and November of each year. Following the float, Mr Wavish became the chairman of the FAC. Its other members were Ms Raine and Mr Ishak. Ms Raine was an accountant and held senior finance roles at Fairfax Media and senior management roles at Yum! Restaurants (the master franchisor in Australia of Pizza Hut and KFC). Mr Ishak was a lawyer specialising in corporate and commercial law.

Factual background

Anchorage acquires Dick Smith

38. On 26 September 2012, DSSH, the Anchorage controlled entity, entered into a contract with Woolworths to acquire all of the issued shares in DSE, the then holding company of the Dick Smith group.

39. As part of its planning for the acquisition of the Dick Smith business, Anchorage put together a management team with the assistance of Mr Wavish, who had discussed the possible acquisition with Mr Cave and who had been engaged by Anchorage as a consultant to assist with the acquisition. Before joining Dick Smith, Mr Wavish had had extensive retail experience. Between 1969 and 1985, he had worked for The Dairy Farm, Ice & Cold Storage Company Ltd, a publicly listed Asian food conglomerate based in Hong Kong, where he rose to the position of group chief financial officer and then chief operating officer for Hong Kong, China and North Asia. In 1985, Mr Wavish moved to Sydney. He worked in various positions, including the CFO of Arnott’s Biscuits Ltd, until 1999, when he was appointed Finance Director of Woolworths Ltd. He held that position until 2002, when he became Head of Supermarkets. He left Woolworths in 2004. Between 2006 and 2009 he was the Executive Chairman at Myer. Whilst at Myer, Mr Wavish had met Mr Abboud and a number of other senior executives who were offered positions at Dick Smith following its acquisition by Anchorage. Those executives included Mr Skellern, Mr Merola, Mr Papacosta, and Mr Mark Scott.

38. At the time of his appointment as CEO of Dick Smith, Mr Abboud had had about 25 years’ experience in retail, 19 years of which were with Myer. Whilst at Myer, Mr Abboud had managed a number of stores, including Myer Sydney. He had also worked in various regional management roles and as the National Operations Manager of the Megamart business. In that position, Mr Abboud had obtained some buying experience. He became the Director of Retail Stores in March 2008. He had not previously held the position of CEO.

The decision to increase supplier support

41. At the time that Anchorage was considering acquiring Dick Smith, Mr Wavish was conscious that its financial performance had been poor. In 2010, its EBIT to sales was 1.77 percent and in 2011 the figure was 1.44 percent. It was Mr Wavish’s view that it should be possible to increase that figure to five and maybe up to seven percent by reducing costs and improving supplier terms. It was his view, affirmed in his mind by information obtained during the due diligence process, that Woolworths’ management had “fallen asleep at the wheel” in terms of its dealings with its suppliers and had not obtained favourable terms from its suppliers and had not extracted enough supplier support (including rebates). It was his experience that rebates formed an important source of revenue for retailers. On that subject, he gave the following evidence:

In my view, based on my retail experience, getting the best possible deal out of your suppliers is one of the most important aspects of retailing, particularly in industries which involve low margins, fierce competition and/or low levels of customer loyalty (such as groceries, supermarkets, fashion and consumer electronics). Supplier support (including rebates) is of critical importance to retailers around the world, not just in Australia.

By obtaining the maximum supplier support (including rebates), retailers are able to significantly increase their profitability and competitively price their products. In my experience, suppliers have budgets to provide support (including rebates) and if you are not getting support from that budget, your competitor will be.

42. Mr Wavish also gave the following information about the importance of rebates to Woolworths’ group profit during the time that he was there:

FY	Rebates ($m)	EBIT ($m)	Rebates to EBIT (%)
1999	$300.40	$539.40	55.69%
2000	$372.40	$621.60	59.91%
2001	$473.60	$706.60	67.03%
2002	$511.80	$832.70	61.46%
2003	$493.20	$945.70	52.15%
2004	$547.30	$1,065.10	51.38%

43. Mr Wavish’s evidence was corroborated by evidence given by Mr Robert Murray. Mr Murray had been the CEO of Lion Nathan Limited until December 2012. After that time, he had held a number of directorships, including with Super Retail Group Limited, an ASX listed retailer, and Metcash Limited, an Australian wholesale, distribution and marketing company listed on the ASX, the businesses of which include IGA, Cellarbrations and Mitre 10, where he became non-executive Chairman in August 2015. Mr Murray was appointed to the board of DSH on or about 12 August 2014. He gave the following unchallenged evidence in cross-examination:

Q. And you learned that Dick Smith was concerned to try to maximise rebates?

A. Certainly think, as I said, that the business wanted to get the best share of rebates they possibly could. I mean, this is just what retailers do. They all do it. It is what all - it is the game that all suppliers play with them. This is the dance, you know. You look at the scale of the numbers and, frankly, when you've got O&A included, $70 million of rebates of one form or another, going into a business like Dick Smith, and you make $45 million a year profit, then this is pretty important. I think without exception, if all those discretionary moneys were taken away from the retailers that I've been involved with, they would all be in some form of significant trouble. So this is a fact of retailing life. I really believe that.

44. According to Mr Wavish, prior to the acquisition, he and Messrs Cave and Abboud decided that if they were successful in their bid for Dick Smith, increasing supplier support (including maximising rebates) should form a key part of their overall strategy to improve Dick Smith’s profitability.

The “turnaround strategy”

45. Following the acquisition, Anchorage commenced work on what was described as a “turnaround strategy”. That strategy had a number of components or “work streams” under the supervision of senior executives. One work stream was “category mix and buying”, which included a number of initiatives. One initiative was “inventory right sizing”, which involved the identification of aged and problem stock and the development of initiatives and a timeframe to clear that stock and the establishment of benchmarks for the amount of stock that should be held. Another initiative involved a review of Dick Smith’s product range to identify SKUs that should no longer be carried and new products that ought to be carried.

46. While under the control of Anchorage, Dick Smith classified stock into Active (A), Discontinued (D), Not for Reorder or No Reorder (NR or N) and Quit (Q). Active stock was stock that continued to be ordered and sold. No Reorder stock was stock which continued to be sold but was the last of the product of that type to be ordered. Discontinued stock was stock that was no longer to be reordered and was to be actively moved through the Dick Smith stores. Quit stock was stock that was to be disposed at highly discounted prices and in a short timeframe. Although the position is not certain, it appears that the different categories had been developed by Dick Smith while it was under the control of Woolworths and that the division of stock into those categories continued after the acquisition by Anchorage.

47. The Dick Smith buyers manual which was current as at June 2013 set out how active stock was to be reclassified as NR, D or Q and the consequences of reclassification, although, as will become apparent, the procedures for classifying stock changed over time; and it is unclear whether classification ever occurred strictly in accordance with the manual. According to the manual, it was generally the responsibility of a buyer to “derange” stock by changing its status to NR. The manual stated (at 4.8.1.2):

This process can occur at any time but will generally occur as a result of several key events:

➢   Range Reviews

➢   Item Performance Reviews

➢   Vendor discontinuing item / Item reaching end of life

➢   New Line Introduction (as a result of DS’s One in One Out Policy)

➢   Business Planning (e.g. exiting a class/category)

48. Following reclassification of stock as NR, the buyer was expected to develop an exit plan for the stock which the buyer was then required to manage. The manual states:

The key to this are negotiations with Vendors in which Buyers are able to discuss the problem lines to get support for clearance options and leverage this against purchases of new/strong-performing lines

49. The manual explains that Dick Smith’s stock management system automatically changes the status of an item from NR to D when:

• No stock remained in the DC [Distribution Centre];

• No stock was on order;

• No stock was in QC reserve.

50. According to the manual, stock was automatically reclassified as Quit when:

• There was less than one unit in stock on average for each ranged store;

• There was more than two months cover.

51. The plan for dealing with aged and problem stock involved setting targets for the sale of stock falling within the D, NR and Q categories and using some of the provision in the accounts to enable some stock to be sold at a loss. The plan that was put in place proved to be successful. The evidence is that from the start of January to the end of April 2013, Dick Smith was able to sell $74.62 million worth of NR, D and Q stock utilising a provision of approximately $8.5 million. By the end of FY13, the value of inventory in DSSH’s accounts had reduced from $370.55 million to $192.7 million, of which $26.3 million was classified as NR, $15.2 million as D and $1.1 million as Q.

Mr Wavish’s method for provisioning for obsolete stock

52. It is not clear what method was used by Dick Smith for calculating the provision for obsolete stock at the time of its acquisition from Woolworths. There is a spreadsheet in evidence which suggests that the provision was calculated by reference to the classification of the stock and its age. So, for example, the provision for stock classified as discontinued was 25 percent if it was over 12 months old, 35 percent if it was over 16 months old and 50 percent if it was over 20 months old. According to a calculation done in April 2013 using that methodology, an appropriate provision at that time was $4,893,845, which was said to be $268,231 less than the current provision in Dick Smith’s accounts. However, other evidence suggests that as at the end of April 2013, the provision was $8.6 million.

53. In any event, on 29 April 2013, Mr Tim Gunn, the General Manager, Merchandise, wrote to Mr Abboud attaching the most recent “inventory right sizing” update and saying that Dick Smith had used up its obsolescence provision and continued to hold $23.3 million worth of pre-acquisition stock falling into the NR, D and Q categories as well as post-acquisition “non-productive stock” of $46.62 million. Mr Abboud forwarded that email to Mr Wavish, who replied that he would follow up on ““inventory provision” issue when I get back”, but referred to some adjustments that needed to be made in respect of rebates and suggested the following approach to provisioning:

Then there is a provision to exit the quit stock all to be achieved well before 30 June 2013. Today this may need to be 50%.

There [sic] there is a provision to clear discontinued lines - maybe 20%

Then there is a provision to clear not for reorder - maybe 20%

Then there is a general provision against the balance being good stock which inevitably will today contain within it some stock that next year will become quit, discontinued or not reorder stock which will need to be discounted to move - maybe 2% general provision.

54. Mr Wavish accepted in cross-examination that the percentage discounts he proposed involved a “broad brush exercise in judgment” on his part which was informed by his general experience and his involvement with Dick Smith’s inventory right sizing initiative. However, some support for the application of a 20 percent provision for stock classified as No Reorder and Discontinue can be found in an analysis undertaken by Mr Borg, which he sent to Mr Merola and Mr Papacosta on 4 May 2013. That analysis involved identifying each category of stock falling within the Discontinue and No Reorder categories, the gross profit that would be earned on products falling within that category if they sold for their then current price (expressed as a percentage), the amount by which the price of the products would need to be discounted in order to clear them and the profit or loss that would be suffered on the sale of those products at that discount expressed as a percentage. The average of those percentages came to -20.42 percent, which represented the total provision required in respect of the whole of the stock. There is an error in this approach, since the percentage reduction was calculated by reference to the then current price rather than cost, which is the price at which the goods were to be carried in the accounts in accordance with AASB 102. But adopting that as the base, the percentage reduction would be less.

55. At one time, the method of provisioning adopted by Dick Smith was an important issue in the case because it was said to be faulty and to have been one of the matters that led to DSH’s accounts being misstated. However, its significance has been greatly reduced following the abandonment of any allegation that DSH’s published accounts were materially misstated.

Other changes to the business

56. Mr Wavish and others also engaged in a process of identifying the ideal quantity of stock that should be held going forward, although it appears that no formal benchmarks were adopted. So, for example, according to an email Mr Wavish wrote on 11 September 2015, shortly after Anchorage took over Dick Smith, he, Mr Abboud and Mr Skellern undertook a category by category analysis of inventory and concluded that it was appropriate for Dick Smith to hold sufficient stock to provide approximately 60 to 70 days covered, although in cross-examination Mr Wavish suggested that they had actually agreed on about 80 to 90 days cover. Similarly, on 27 June 2013, Mr Wavish sent Mr Skellern, Mr Merola, Mr Papacosta and Mr Abboud an email referring to inventory right sizing as “a big prize”, which “will take time and effort” and which stated:

Whilst I suspect that we will ultimately get store inventory down to 6 to 8 weeks and warehouse inventory down to 1 to 2 weeks (say total 8 to 9 weeks) @$17 mil = $136 to $153 mil) I have no predetermined answer and we will finish where the data leads us.

57. According to Mr Wavish, Dick Smith also commenced implementation of the strategy to increase supplier support, including by maximising rebates, although precisely what steps were taken in that regard prior to the float is not clear from the evidence.

58. Following the acquisition of Dick Smith from Woolworths, Mr Wavish became aware that, while under the control of Woolworths, Dick Smith had not been required to prepare cash flow forecasts. He gave evidence that he thought weekly and even daily cash flow forecasts “were a desirable tool to predict and assess cash flow needs, risks and opportunities” and, in particular, that they would assist the finance team to monitor creditor payments and ensure that Dick Smith complied with it banking facility limits. He worked with a number of employees, predominantly Ms Reiko Sun, Senior Commercial Analyst, on the preparation of cash flows and by the end of the process was confident in the ability of the finance team to prepare cash flows. From that time, DSH prepared weekly and daily cash flow forecasts, as well as the monthly cash flows that were provided to the board.

The FY13 accounts

59. With one modification, the proposal in Mr Wavish’s email was adopted for calculating the provision to be included in the accounts for the 10 months ending 30 June 2013. The modification involved applying a reduction of 100 percent to stock classified as Quit rather than the 50 percent originally proposed by Mr Wavish. The FY13 accounts contained a total provision of $12.4 million in respect of obsolete stock.

60. There is some evidence to suggest that at the time the FY13 accounts were prepared some steps were taken to reduce the number of SKUs classified as No Reorder, Discontinue or Quit, presumably with the intention of reducing the provision to be included in the FY13 accounts. In light of the way the case developed, the correct classification of stock ceased to be important and nothing more needs to be said about it.

61. Deloitte issued its audit report on the accounts for the 10 months ending 30 June 2013 to the DSSH Board on 17 October 2013. Two days earlier, Mr Damien Cork, an Account Director, Assurance & Advisory, with Deloitte prepared a detailed file note setting out a summary of approach and key issues in relation to the audit.

62. In relation to inventory, the note set out how management had calculated the provision for obsolete inventory. The note explained that Deloitte had independently assessed the provision. The evidence on that issue was once important because it was relevant to the question whether later sets of accounts were materially misstated and, if so, whether Deloitte bore some responsibility for that. However, following the abandonment of any allegation that DSH’s accounts were materially misstated, the details of the work that Deloitte did on the provisioning methodology is no longer relevant and nothing more needs to be said about it, except to observe that, applying its own methodology, Deloitte concluded that the provision should be $379,419 greater than that proposed by DSSH, which was immaterial.

63. On 17 October 2013, Deloitte issued its audit report to the board for the period ended 30 June 2013. In relation to stock obsolescence, the report said:

A significant amount of management judgement was required to determine an appropriate fair value adjustment to inventory at the date of acquisition. It is management’s intention to review the method of inventory provisioning for the next reporting period to ensure that the provision methodology adopted continues to be appropriate for the profile and ageing of its inventory based on the new business structure and experience.

To assessing the adequacy of the inventory provision at 30 June 2013 we have performed various alternative analyses, including reviewing the various categories of inventory, the split of inventory between that acquired pre and post acquisition by Dick Smith Holdings Pty Limited, subsequent sales in the 3 month period to 30 September 2013, and the type of inventory held by the trading department.

Of the $19.1 million acquired inventory at 26 November 2012 unsold at 30 June 2013, $4.2 million was sold and $3.5 million was written off in the 3 month period to 30 September 2013.

The provision for inventory obsolescence as at 30 June 2013 is considered to be reasonable based on the profile of inventory and subsequent sales made to 30 September 2013.

We note that the current system does not allow for an accurate ageing of inventory as the ageing is based on the last activity date for a SKU rather than the individual SKU date of purchase. We have therefore recommended to management that a means of generating a more accurate ageing report is developed to assist their review of aged inventory and in determining an appropriate inventory provision.

We recommend that management undertake a review of inventory provision methodologies as the legacy inventory is sold or disposed, utilising past history, expectations of future obsolescence rates and stock ageing.

The recommendation relating to a more accurate ageing report was never adopted by Dick Smith. However, as will be seen, the recommendation to undertake a review of inventory provision methodologies was.

64. At about the time the accounts were finalised, Mr Wavish prepared a paper dealing with an adjustment for rebates that could only be brought to account when the relevant goods were sold and with the provision for obsolescence. In relation to the provision for obsolescence, the paper records the following:

Not for Reorder is generally quite good current stock and is not a significant problem

The provision is arguably overstated

We also provide 20% on this stock but Nick [Abboud] argues for a much lower %

As we provided 20% at June 2013 this provision is arguably overstated by 15% or $3 mil.

Active stock is not provided against in many retailers (eg Woolworths)

We provide 2% - although Nick would state that it overstated by at least 1% or $2 mil

Applying his provisioning methodology, Mr Wavish concludes that the provision (said to be $12.3 million) was overstated by $1.940 million, which is said to have arisen from accounting errors resulting in inventory being overvalued by $1.9 million.

The prospectus

65. On 13 November 2013, the directors of DSH met to approve the prospectus for the IPO. At the same time, a copy of DSH’s constitution was tabled. The final version of the prospectus was lodged on 21 November 2013. It is not relevantly different from the version approved on 13 November 2013 and lodged on 14 November 2013. The financial information included in the prospectus included the results for 1Q14. By then, the inventory had increased to $211.8 million, reflecting an increase in purchasing activity in September as the business started to build inventory levels ahead of the Christmas trading period. Of the total inventory, $177.4 million was classified as Active, $13.3 million as No Reorder and $21.1 million as Discontinued. None was classified as Quit. Applying the percentages suggested by Mr Wavish, the total provision for obsolete stock (leaving aside a one-off item of $0.1 million) was $10.4 million.

65. Under the heading “Investment Overview” the prospectus included the following table setting out a summary of the pro forma historical results for FY2011 to 1Q2014 and a pro forma and statutory forecast for FY2014:

Pro forma historical				Pro forma forecast	Statutory forecast
($m)	FY2011	FY2012	FY2013	1Q2014	FY2014	FY2014
Sales	1,281.1	1,369.5	1,280.4	273.3	1,226.0	1,226.0
Gross Profit	335.2	340.0	303.6	68.4	307.8	307.8
EBITDA	36.5	32.6	23.4	11.6	71.8	46.6
EBIT	23.9	20.1	10.9	9.0	58.7	33.5
NPAT	15.9	13.2	6.7	6.1	40.0	11.5

67. On 28 November 2013, the board adopted charters for the board and for the FAC. The board charter stated that the board’s role included monitoring the performance of Mr Abboud and Mr Potts as CEO and CFO, approving management’s corporate strategy and performance objectives, determining and financing dividend payments, approving and monitoring financial and other reporting, and reviewing and ratifying systems of risk management, internal compliance and control, and legal compliance, to ensure appropriate compliance frameworks and controls were in place.

68. The FAC charter stated that the purpose of the FAC was to assist the board to achieve its governance objectives in relation to financial reporting, the application of accounting policies, business policies and practices, legal and regulatory compliance, and internal control and risk management systems. One of the objectives of the FAC is stated to be to “ensure effective internal and external audit functions and communication between the board and the internal and external auditor”. Paragraph 5 of the FAC charter relevantly states:

5. Risk management and internal control

The responsibilities of the Finance and Audit Committee are:

Risk management and internal compliance and control systems

(a)   overseeing the establishment and implementation of risk management and internal compliance and control systems and ensuring that there is a mechanism for assessing the ongoing efficiency and effectiveness of those systems;

(b)   reviewing and approving policies and procedures on risk oversight and management to establish an effective and efficient system for:

(i)   identifying, assessing, monitoring and managing risk; and

(ii)   disclosing any material change to the Group's risk profile;

(c)   receiving reports from management concerning the Group's material risks in order to assess the internal processes for determining, monitoring and managing these risks and to monitor the risk profile of the Group.

Events immediately following the float

69. Following the float, Mr Potts, who had joined Dick Smith on 18 September 2013, replaced Mr Tim Fawaz as the CFO. Mr Potts had previously worked as the CFO and Company Secretary of Nicki Scali Limited, a listed furniture retailer and had had over 20 years’ experience in senior finance roles with major retail companies, including Sussan Group, Bunnings and Myer. Mr Wavish assumed the role of a non-executive director and was no longer involved in the day to day operations of the business. A series of weekly management meetings was introduced. The meetings included a buyer/planning meeting that was attended by buyers, merchandise planners, Mr Borg and the Director of Merchandise, which occurred on most Mondays. At those meetings the results of the previous week were discussed, including which products worked, who achieved sales and second margin targets as well as planning for the current week.

70. As I have said, the board of DSH met monthly, except in the months of December, January and September. The directors were provided with board papers in advance of the meetings, which were primarily prepared by Mr Potts and Mr Abboud, with the assistance of management. The format of the board papers changed somewhat over time. They included a CEO update, which included a table showing how profit and loss and CODB were tracking to budget for the month and year to date and a summary (in bullet point form) of the principal points of note. They also included a CFO update, which included a series of tables showing for the current financial year on a monthly basis actual and forecast balance sheets, working capital statements and monthly cash flow statements. The working capital statement included a calculation of net inventory days covered and a breakdown of the value of stock by reference to the four categories of Active, Discontinued, No Reorder and Quit and a calculation of the provision. The CFO update also generally included a summary of DSH’s debt facilities, and, in most cases, confirmation that the company complied with its debt covenants. The monthly cash flow forecasts provided to the board differed from the daily cash flows prepared by management in one significant respect in that they, like the weekly cash flow forecasts, included cash in transit, which consisted of actual cash collected from stores by Armaguard and credit card sales which had not been processed, and cash held in a number of subsidiary bank accounts, including an account in the name of MAC 1 Pty Ltd, a company acquired by DSH during FY15. Given the size and nature of Dick Smith’s business, on any given day those amounts could be millions of dollars and on some days up to about $13.5 million.

71. In 2014, a new category for the provisioning of stock was introduced called “End of Life” to which a provision of two percent was applied.

Deloitte retained for FY14 audit

72. On 13 December 2013, DSH retained Deloitte to audit the FY14 Financial Statements and conduct a review of the HY14 Financial Statements. According to Mr Wavish, shortly after Deloitte was engaged, he had a conversation with Mr David White, of Deloitte, in which Mr Wavish said that he wanted the accounting for and collection of rebates to be a key focus of the audit. Mr White responded that it already was.

73. In January 2014, Deloitte provided to Mr Potts a document setting out its audit strategy for the FY14 accounts. Mr Potts provided that document to other members of the board on 16 January 2014. According to that document, “key risk areas” included (1) rebates and vendor allowances, (2) the stock obsolescence provision, and (3) AASB 102 costing.

74. On 4 February 2014, Deloitte issued a “Report to the Finance and Audit Committee for the half-year ended 29 December 2013”, which was considered at a meeting of the FAC on 18 February 2014. At that meeting the FAC resolved to recommend to the board that the HY14 Financial Statements be approved. They were released to the market on 19 February 2014.

Increase in targeted stock on hand

75. The Project Turnaround Steering Committee continued to meet during this time. One of the issues it continued to address was “Ranging right sizing & Trading Terms”. According to the material accompanying the agenda for the committee meeting to be held on 5 February 2014, one of the issues to be addressed was described in the following terms:

Dick Smith’s extensive range of products includes many duplications of type, generating different margins. Right sizing the range should improve gross margin and free up shelf space for better selling, higher margin product.

The material stated that the “deliverables” in respect of that item included:

•   Minimise obsolescence/stock overhang

•   Reduced inventory holding (weeks cover reduce from 13 to 10 weeks by June 2014)

76. According to Mr Wavish, at the time DSH was floated, it had adopted a benchmark of $200 million as the value of stock on hand. Mr Wavish gives evidence that in early 2014 Mr Abboud sought to obtain his agreement to increasing that benchmark to $250 million in order to provide sufficient stock for new stores and to stock more fully existing stores. Initially, Mr Wavish resisted that proposal. However, by mid-2014 he says that he was convinced that it was appropriate.

77. The plaintiffs take issue with this evidence. In particular, they point to a cash flow forecast for FY15 that was provided to Mr Wavish on or around 21 July 2014 which showed that stock at the end of September would be $224 million and stock at the end of the financial year would be $220 million, which does not appear to be consistent with an agreed target of $250 million. In addition, on 6 August 2014, Mr Wavish had previously requested and obtained from Mr Potts the July 2014 financial statements. Those financial statements projected that inventory would be $205 million by the end of September 2014, would peak at $265 million at the end of November 2014 in preparation for Christmas trading and then close at $208 million at the end of January 2015 and $197 million at the end of the 2015 financial year. In response, Mr Wavish said in an email dated 6 August 2014:

Inventory reduction is disappointing (along with lower payables) so I hope that by Aug 18 you will be able to say inventory is back to normal as previously discussed with Nick.

78. The plaintiffs suggest that Mr Wavish was expressing his disappointment at the fact that the cash flow showed that stock would peak at $265 million, well above what they say was Mr Wavish’s original target of $200 million. However, that appears to be a misreading of the email. As will be explained, it is apparent that by the time Mr Wavish wrote his email the board had accepted (at least tacitly) that $250 million was an appropriate level of stock; and it appears that Mr Wavish’s concern was that the cash flow suggested that stock would be substantially below the amount he had agreed with Mr Abboud.

Greater emphasis placed on O&A rebates

79. In the first half of (calendar) 2014, DSH began to place greater emphasis on obtaining O&A rebates. It appears that that was prompted at least to some extent by the fact that the accounts presented at the board meeting on 18 March 2014 indicated that DSH was $0.9 million behind budgeted EBITDA for the year to date (which reflected the figures set out in the prospectus) and by a further deterioration in gross profit later in the financial year. Mr Abboud, delegated responsibility for collecting O&A rebates to Mr Skellern. At some stage, Mr Skellern began setting budgets for each buyer setting out the amount of O&A rebates that each was expected to obtain. Although Mr Borg and Mr Freeman have different recollections on the matter, it appears that from about April 2014 Mr Skellern introduced what Mr Borg describes as “O&A meetings” which were initially held each Friday in Mr Skellern’s office and which became more frequent later in the year. Those meetings were attended by buyers, merchandising managers, the head of buying and Mr Skellern. At those meetings, targets were set for O&A rebates and Mr Skellern encouraged buyers to meet those targets. He was critical of buyers who had failed to do so and offered a prize each week to the buyer who had reported collection of the most O&A rebates. There was also an O&A achievement incentive offered in each quarter for the buyer who achieved the highest percentage collection of O&A rebates above their target for the quarter. From April 2014, buyers were required to complete tracking sheets showing O&A and other support received against all orders. Mr Skellern’s approval was required before an order could be placed with a supplier and often his approval was conditional on obtaining O&A rebates from that supplier.

80. It was Mr Freeman’s evidence that Mr Abboud would often say in Monday morning buyers meetings words to the effect of “What’s your plan to close the gap?”, referring to the gap between targeted and actual O&A rebates. Mr Borg gave evidence to similar effect. From time to time, Mr Skellern circulated emails setting out the amount of O&A rebates collected by each buyer in the current quarter measured against the targets for those buyers. The following email sent by Mr Skellern on 13 April 2014 is illustrative:

Hi All

Pls attached as of Friday the current O&A collect for the qtr

67.4% (3.2mil) for April so far 1.5mil to go needs to be in play before we go to Easter as per Nick's email

6.1mil so far collected for the qtr

I have also added a ranking column purely on % of April collected

Greg leads the MM's with 70.2%(2.0mil), Carl some work to do at 57.3%(534k)

Anthony at 106% is the star closely followed by Marisol 100% and Matt at 82%

Frank, Karolina and Adam all below 50% collected for April some work to do

Lets all go hard this week do [sic] you can all have an Easter break lots more to do for the qtr but a great start
Cheers

81. Similarly, on occasions Mr Abboud encouraged the collection of O&A rebates. An early example is an email dated 27 April 2014 he sent to Mr Skellern and others saying:

Guys,

The gp [gross profit] dollars fell short for the week.

We will need 5.5 in O/A for April.

I suggest we meet at 745am in the board room.

…

82. In order to meet budgeted EBITDA for the year, Mr Abboud, Mr Potts and Mr Skellern developed a plan in April 2014 which involved reducing the marketing expenses for the remainder of FY14 from $9.7 million to $7.6 million and increasing the target for O&A rebates from $10.2 million to $17.2 million. In order to achieve that increase, Mr Abboud approved an increase in OTB by $20 million and subsequently $23 million. It also appears that, in line with projections provided by Mr Paul Backo, General Manager of Finance, to Mr Abboud, DSH proposed to recognise in FY14 fees totalling $1 million that it expected to recover from participants in a conference organised by it to be held in late July 2014. Those projections were prepared at Mr Wavish’s request to show how DSH planned to achieve the $71.8 million target for EBITDA set out in the prospectus. A final version of the projections together with a final draft of the ASX announcement stating that DSH was on track to meet the prospectus forecast was provided to Mr Wavish by Mr David Cooke, Company Secretary, on 10 April 2014. Later in the financial year, the budget for O&A rebates for May and June 2014 was increased to $17.9 million, which included an additional $2 million in conference fees.

83. Mr Abboud says in his affidavit evidence that his reason for releasing the additional $23 million in OTB “was to enable the purchase of sufficient stock to achieve the forecast sales for June 2014” and that he “released the additional OTB to drive sales and profit during June when sales are higher than an average month”. However, after giving a somewhat evasive answer, he conceded in cross-examination that “the increase in the over and above rebate collect would be achieved, at least in part, by $20 million extra OTB”, although he said that the release of a further $3 million in OTB was because “ a lot of our regional stores didn’t have enough stock to get the sales, and we were about to go into the June tax time period”.

84. In some cases, DSH refused to buy product from suppliers who declined to provide O&A rebates. So, for example, Mr Abboud said in an email dated 9 May 2014 to Mr Bonham in relation to issues concerning stock in the Neutral Bay store:

The no ‘O&A’ no ‘order’ is a factor also.

Force charges for example, they refused O&A so we have sourced an alternate brand, Not ideal, and I get your point about customer experience when you see that bay at Neutral Bay.

85. From about May 2014 (Mr Borg’s recollection was that it was not until September 2014), buyers were given a budget for the O&A rebates they were to obtain from vendors and those budgets formed part of a buyer’s KPIs, along with sales, first margin, second margin and stock on hand. As I have said, Mr Skellern had a whiteboard in his office and from early 2014 to late 2014 or early 2015, he recorded on the whiteboard weekly O&A targets and the amount buyers reported had been promised by suppliers. At the end of each month, the amounts recorded on the whiteboard were entered into DSH’s accounts.

Collection of O&A rebates as part of “fighting fund”

86. In order to increase the level of O&A rebates, some buyers suggested on occasions that suppliers increase the price of their products and provide the difference in the form of O&A rebates. An early example of that practice is contained in a series of emails sent in early May 2014 between Mr Brett Leyshon, a buyer with Dick Smith, and others in which Mr Leyshon proposed that Take 2 (a supplier of games) increase the price of a particular game by ten percent so that Take 2 “can show the 10% O&A to your business”. A number of other suppliers including Belkin Limited, Jackson Industries Pty Limited, Maxwell International Australia Pty Limited, Targus Australia Pty Limited and Cellnet Group Limited, agreed to that practice. Mr Freeman gave evidence that the amounts raised by that practice was sometimes referred to within Dick Smith as a “fighting fund”.

87. How widespread that practice was, however, is unclear. Both Mr Freeman and Mr Bonham give evidence of it. Indeed, the evidence suggests that Mr Bonham was the architect of the practice. Mr Freeman gives evidence that the expression “fighting fund” was used openly in the business, including during Mr Abboud’s Monday meetings. However, it appears that the expression “fighting fund” was used ambiguously to refer both to that practice and more broadly to “a bucket of fund [sic] that a vendor might hold to be drawn down for certain agreed events” (to quote from the evidence of Mr Borg).

88. There is no evidence that the board, including Mr Abboud and Mr Potts, were aware of the practice. There is evidence that on one occasion in December 2014 Mr Bonham became aware of an opportunity to make a purchase from the supplier Kaiser Baas, involving a purchase order of $2 million which would attract an O&A rebate of $400,000, which he raised with Mr Abboud. Mr Bonham suggested that “we could uplift price to make it $500 collect”. Mr Abboud replied “No uplift of product please, I don’t want to play in that space”. The plaintiffs suggest that this is evidence that Mr Abboud was aware of the practice and was prepared to authorise it on some occasions. No such conclusion can be drawn from the email. There is no evidence that the practice was raised again with Mr Abboud. The only reasonable inference is that it was raised with him once, he rejected it and it was not raised with him again.

FY14 accounts and FY15 budget

89. On 26 May 2014, there was a board meeting to approve the FY15 budget. The meeting was attended by Mr Abboud, Mr Potts, Mr Cave, Mr Wavish, Ms Raine and Mr Ishak. The proposed budget, which was approved at the meeting, forecast that DSH would earn $32.8 million in O&A rebates and $29.2 million in Ad Sub rebates, with a gross marketing spend of $45 million. It also forecast net profit of $47.3 million and projected that inventory would be $226 million at 28 June 2015 and that net end of financial month debt would peak in March 2015 at $55 million.

90. In connection with the preparation of the FY14 accounts, it appears that Mr Potts asked Deloitte for advice on whether, consistently with the accounting standards, it would be possible to recognise O&A rebates as a reduction in COGS so as to increase gross profit. In response to that request, on 26 May 2014, Mr Cork sent Mr Potts an email in which he said:

Further to the discussion on Friday around the O&A rebates, we would like some further information around the transactions and their treatment for the company before we can provide our view on the arrangements. …

…

The proposed change is to continue to recognise the rebates immediately, however shift the rebate received from CODB to within Cost of Sales, having the impact of increasing the Gross Margin but also increasing CODB. Our view is that, generally, where a rebate is negotiated as part of a purchase of inventory, and the purchase is conditional on the rebate being provided, then the rebate should be taken up into the cost of inventory and recognised in the P&L only when the inventory is sold (through COS). If there is no condition and the two negotiations are separate, then the rebate may be recognised immediately but should be entered through CODB rather than Cost of Sales.

555. It follows that, in my opinion, Mr Potts’s conduct at the meeting on 6 May 2015 or in his subsequent conversation with Mr Menzies was misleading and deceptive because it gave a misleading impression concerning the reasons for the build-up in stock in January 2015 and the appropriateness of the steps that DSH had taken to address the problem.

556. In my opinion, NAB relied on Mr Potts’s conduct. Ms Peter and Mr Taylor give evidence of reliance which is couched in terms of NAB’s pleaded case concerning the Rebate Maximisation Policy and its alleged consequences. That evidence is of no assistance. However, as I have explained, NAB was concerned to understand what had caused the build-up in stock and wanted to be satisfied that DSH had taken appropriate steps to prevent it from happening again. Careful stock management was obviously important to the profitability and success of a business such as DSH’s. NAB understood that and that explains why it paid considerable attention to the stock position in January 2015. It would not have given the issue the attention that it did if the way in which DSH managed its stock was not important to its decision. In my opinion, the likelihood is that if it had been told that one of the reasons for the build-up in stock was the emphasis on O&A rebates and that DSH had not taken steps to change its policies and procedures to deal with that problem, it would not have agreed to participate in the syndicate with HSBC.

The Extension Agreement

The pleaded case

575. The claim in respect of the Extension Agreement is only made against Mr Potts. The pleaded representations are to the following effect:

1. On 2 September 2015 Mr Potts stated that DSH may need a $20 million temporary increase in its finance facility with HSBC for the first two weeks of each of November and December 2015 and January and February 2016;

2. On 13 October 2015, Mr Potts requested that HSBC increase by $20 million its finance facility with DSH for the period 15 November to 31 December 2015;

3. On or before 14 October 2015, Mr Potts represented to HSBC that the purpose of the increase was to fund increased inventory required for anticipated Boxing Day sales;

4. On or before 19 October 2015, Mr Potts represented to HSBC that the increase in funding was a normal seasonal requirement and the requirement was in line with the previous year when similar financing of $20 million was provided by Westpac;

5. By engaging in that conduct, Mr Potts represented that the financing facility was a seasonal requirement and that Westpac had provided a similar extension for the same reason in the previous year.

576. In addition, HSBC alleges that Mr Potts engaged in misleading and deceptive conduct by failing to disclose essentially the same matters that are the subject of the non-disclosure case in relation to the Syndicated Facility, including the Rebate Maximisation Policy and its alleged consequences, the Rebate Accounting Approach, the absence of internal controls, the absence of a proper basis for concluding that the HY15 and FY15 accounts provided a true and fair view of DSH’s financial position and prepared on a proper and adequate basis, the absence of a proper basis to pay the interim dividend and the final dividend and the fact that DSH had delayed paying certain invoices.

Consideration

577. The first two paragraphs of the claim do not set out representations or other conduct that itself is said to be misleading. It is difficult to see what the last paragraph adds to the fourth. Moreover, the broad-ranging non-disclosure case of the type pleaded must fail for the same reasons as it must fail in relation to the Syndicated Facility. It cannot possibly be the case that by asking for a temporary increase in the facility limit for specific reasons Mr Potts effectively became obliged to disclose a range of matters relevant to DSH’s financial position that were not the subject of any enquiry by HSBC.

578. In substance, HSBC’s case is that Mr Potts engaged in misleading conduct by stating that the temporary increase in the facility was (1) needed to fund an increase in inventory for the Boxing Day sales; and (2) a normal seasonal requirement which had been provided by Westpac in previous years, whereas the true position was that DSH was facing serious liquidity problems resulting from the fact that it was overstocked, substantially as a consequence of its strategy to obtain O&A rebates.

579. I have already found that the likelihood is that Mr Potts was the source of the information that the increase in the facility was required to fund an increase in inventory for the Boxing Day sales. It is less clear whether he was the source of the information concerning Westpac and whether the extension was a normal seasonal requirement. That information was given by Mr Kowik in response to questions contained in emails from Mr Byrne. But there is no evidence that Mr Kowik spoke to Mr Potts before responding to Mr Byrne’s emails. He kept call reports of the earlier conversations he had had with Mr Potts concerning the Extension Agreement and it is to be expected that he would have done so if he had spoken to Mr Potts again. It is plausible that Mr Kowik already thought that he knew enough about DSH’s business to respond to Mr Byrne’s questions without seeking further information from Mr Potts. In the absence of evidence from Mr Kowik, I am not satisfied that he spoke to Mr Potts again about the extension.

580. In my opinion, Mr Potts did engage in misleading conduct when he said that the increase in the overdraft was to fund the acquisition of additional stock for the Boxing Day sales. Even if that was literally true, that state of affairs had come about because DSH was facing serious problems with its liquidity, which are described earlier in this judgment: see para [292]ff. DSH was overstocked and sales had declined substantially. If it required additional stock that was because it was overstocked with product that was selling poorly. To say that DSH needed a temporary increase in its facility to buy additional stock for the Boxing Day sales suggested that the business was otherwise performing satisfactorily and DSH wanted additional funds to capitalise on an opportunity. The true position was that it needed additional funds because it was in financial difficulties.

581. The real question is whether Mr Byrne relied on Mr Potts’s conduct. Mr Potts submits that he did not. He submits that no weight can be placed on Mr Byrne’s evidence of reliance. Evidence of that type carries little weight and, in any event, it is directed at quite a different case than the one that is made out. Before the Extension Agreement was signed, DSH announced its profit downgrade. Despite that, HSBC signed the Extension Agreement. There is no other objective evidence of reliance.

582. I accept that no weight can be placed on Mr Byrne’s evidence of reliance. Little can be inferred from the fact that HSBC entered into the agreement following the profit downgrade. Mr Byrne says that he was concerned about the profit downgrade but thought that HSBC was committed to entering into the Extension Agreement. It is unlikely that Mr Byrne would have thought that HSBC was committed to entering into the agreement if he had thought that he had been misled. It is more likely that the profit downgrade itself was not something that was sufficiently important to HSBC to cause it to act differently.

583. The profit downgrade was not the only issue confronting DSH. As I have explained, at the time it requested an increase in the facility limit it was facing serious liquidity problems. In my opinion, if Mr Potts had disclosed that the reason DSH wanted an increase in its facility was because it was facing serious liquidity problems, HSBC would not have entered into the Extension Agreement on the terms that it did. But it may well still have granted an extension on some terms. Support for that conclusion can be found in the reaction of the Banks when DSH announced that it was taking a provision of $60 million and Mr Potts asked for an extension of the temporary increase in the facility limit. The Banks did not refuse that extension. Instead, they placed tight restrictions on DSH and monitored DSH’s financial position closely. It is true that by that stage the money had been advanced. It is one thing for a lender to agree to an extension of a loan already made. It is quite another for it to agree to lend additional money. Moreover, it is apparent from what happened when the Banks discovered that the Macquarie facility had been repaid on 31 December 2015 that they were willing to take a hard line. But by that stage, HSBC may well have thought that it had been seriously misled in relation to DSH’s financial position, which helps to explain why it acted in the way that it did. And the fact that it was prepared to act somewhat precipitously at the end of December 2015 does not establish that it would have done so if DSH had disclosed the true reason it required the increase in the facility limit at the time the increase was requested. It is hard to believe that if HSBC was satisfied that DSH needed an additional $20 million to trade out of its difficulties it would not have advanced that sum on any terms when the Banks agreed to an extension of the facility once they knew the true position. Certainly, there is no evidence from HSBC which would explain why it would not have agreed to advance the money on some terms if it had known the true position. Indeed, an unsatisfactory aspect of Mr Byrne’s evidence is that he says in a somewhat formulaic way that he would not have approved the increase if he had known certain things without saying what steps he would have taken and how those steps were consistent with HSBC’s policies and procedures. Given the existing relationship between DSH and the Banks it is not plausible that Mr Byrne would simply have refused the increase and that that would have been the end of the matter.

584. HSBC’s case on reliance is that it would not have entered into the Extension Agreement at all. It does not advance an alternative case that it would have been prepared to enter into some other agreement that would have been more beneficial to it. It bears the onus of proof on reliance. I am not satisfied that it has discharged that onus.

Damages and the apportionment defence

585. I have concluded that NAB’s case in respect of misleading and deceptive conduct succeeds but HSBC’s case fails. The question therefore arises what damages NAB is entitled to recover. It is unnecessary to say anything about the damages to which HSBC might have been entitled if it had succeeded in its claim in respect of the Syndicated Facility, since the issues are the same as those that arise in relation to NAB’s claim. It will, however, be necessary to say something about HSBC’s claim for damages in respect of the Extension Agreement.

586. I have also concluded that NAB’s claim only succeeds against Mr Potts. Consequently, the question of apportionment does not arise. Nor is it possible to say something useful about the position if, contrary to my findings, NAB was entitled to succeed against Mr Abboud. That would depend on precisely how the claim succeeded, which raises a hypothetical question with more variables than it is practical to consider.

NAB’s claim for damages

587. It is common ground that NAB’s loss should be assessed by comparing the position it is in now with the position that it would have been in if it had not advanced the funds and that NAB bears the onus of proof in relation to that matter. It is also common ground that in determining the amount to which NAB is entitled it must give credit for any benefit it received from the transaction. Applying those principles, NAB seeks to calculate its loss by proving the amount that it lent and deducting from that the amount that it has recovered in respect of its loan. According to uncontested evidence given by Mr Taylor, the amount the Bank lent was $74,500,000. Mr Taylor also gives evidence that NAB has received $18,321,488.18 from the receivership. NAB is also prepared to accept that it should give credit for the interest and fees it received under the Syndicated Facility on the basis that it would not have received those amounts if it had not entered into the Syndicated Facility. It is agreed that the total of those amounts is $973,192.15. Accordingly, NAB submits that it is entitled to recover $55,205,319.67 plus interest.

588. Mr Potts submits that that analysis is not adequate to prove that NAB has suffered a loss. The Banks obtained security at the time they entered into the Syndicated Facility. NAB must give credit for the value of its security and it bears the onus of proof on that issue, since it bears the onus of establishing that it has suffered a loss. NAB has failed to discharge that onus, since it has failed to lead any evidence on the value of the security that it obtained – and, in particular, that the value is less than the amount it is owed. In making that submission, Mr Potts relies on a number of cases including Moloney v Bells Securities Pty Ltd [2005] QSC 13. In that case, Chesterman J stated the relevant principles in these terms:

[105]   … In ‘no transaction’ cases, of which this is one, the assessment depends upon the extent to which the plaintiff is worse off as a result of entering the contract which, on the relevant hypothesis, he did because of the negligence or statutory contravention.

[106]   The plaintiffs are therefore entitled to recover the difference between the amount of $1,040,000 advanced by the contributors and the amount recovered from the sale of the mortgaged property. This amount will reflect appropriate expenses incurred in the realisation. As well the plaintiffs are entitled to interest from the date of the advance to judgment. The capital amount on which interest accrues will be the amount of the initial advance until the date of receipt of the proceeds of sale and thereafter on the amount reduced by those proceeds.

589. Mr Potts also relies on the principle that, in proving its loss, NAB must do so with a degree of precision which reflects the proof that is reasonably available to it. The Court will do the best it can to assess damages where evidence of the precise loss is unavailable. However, that principle will not be applied to relieve a party of proving damages precisely where it can: Placer (Granny Smith) Pty Ltd v Thiess Contractors Pty Ltd (2003) 77 ALJR 768 at [38] per Hayne J (with whom Gleeson CJ, McHugh and Kirby JJ agreed); Pages Property Investments Pty Ltd v Boros [2020] NSWSC 1270 at [196] per Black J (where the relevant authorities are collected).

590. Applying those principles, Mr Potts submits that NAB has not proved that it has suffered any loss, since it has not proved that it has realised all that it can from its security. According to Mr Potts, an obvious way NAB could have proved its loss was through evidence of one of the receivers setting out all the secured assets that had been identified during the course of the receivership, the amount realised from those assets, the costs of realisation and, if some assets had not yet been realised, proper evidence of the value of those assets. That evidence was available to be given by NAB. In failing to give that evidence, NAB has failed to prove that it has suffered any loss.

591. NAB, on the other hand, contends that Mr Potts bears the onus of proving “the benefit has been gained and the extent to which the prima facie loss or damage arising because of the misleading or deceptive conduct has been avoided by the benefit obtained from such expenditure”. In support of that proposition, NAB refers to EK Nominees Pty Ltd v Woolworths Ltd [2006] NSWSC 1172; Ikon Communications Pty Ltd v Advangen International Pty Ltd [2018] NSWSC 1650 and Bennett v Elysium Noosa Pty Ltd (in liq) (2012) 202 FCR 72, among other cases. In EK Nominees, for example, the plaintiff was a developer who was misled into believing that the defendant would lease and build a supermarket on the plaintiff’s land and who incurred expenditure as a consequence of the misleading conduct. The plaintiff claimed as damages the amount of the wasted expenditure. The defendant resisted that claim on the basis that the plaintiff had to prove that the expenditure had no value to it. In rejecting that argument White J, after referring to the decision of the High Court in Ted Brown Quarries Pty Ltd v General Quarries (Gilston) Pty Ltd (1977) 16 ALR 23, said this (at [195]):

The present case is not of that kind. It is one thing to say that where the measure of damages is the difference between the purchase price and the value of the property purchased, the plaintiff bears the onus of showing both the purchase price and the value of the property purchased. However, that is not the relevant principle in this case. E K Nominees was induced to incur expenditure by reason of Woolworths’ misleading and deceptive conduct. Prima facie, its damages are the money it spent which it would not otherwise have spent. To the extent to which that expenditure resulted in a benefit to E K Nominees, the benefit must be allowed for in the calculation of damages because it is a direct consequence of the breach of s 52 of the Trade Practices Act (British Westinghouse Electric & Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673 at 690, 691). That is what is meant by E K Nominees being entitled to damages for wasted expenditure. However, the defendant bears the burden of proving the extent to which the loss arising from the expenditure of money has been avoided by the benefit obtained from such expenditure (Monroe Schneider Associates (Inc) v No. 1 Raberem Pty Ltd (1991) 33 FCR 1 at 17; Tyco Australia Pty Ltd v Optus Networks Pty Ltd [2004] NSWCA 333 at [255], [264]; Ruthol Pty Ltd v Tricon (Australia) Pty Ltd [2005] NSWCA 443 at [44], [53]). [Footnotes omitted]

592. I accept that this case is analogous to cases in which the misled party has acquired something of value as a result of misleading conduct – namely, security over DSH’s assets – and that, as a consequence, it had to prove that the value of its security was less than the amount it advanced. However, the analogy is not perfect. In the cases to which Mr Potts refers, the claimant acquired an asset as a consequence of misleading and deceptive conduct and, in order to prove a loss, it had to prove that the value of the asset was less than the amount paid. In the present case, on the findings I have made, NAB advanced money as a result of misleading and deceptive conduct in exchange for a promise to repay that money and security. The security took the form of a charge over DSH’s assets which was enforceable by the appointment of receivers. The receivers had broad powers to operate the business, pursue rights and sell assets of the company that were the subject of the security. The benefit NAB obtained was the right to be paid dividends out of the receivership.

593. It appears to be Mr Potts’s contention that, before NAB can prove that it has suffered a loss, it must prove the total amount of the dividends to which it is entitled and that that amount is less than the amount advanced. Although it is not entirely clear, it also appears that, according to Mr Potts, NAB must prove that the receivers conducted the receivership in accordance with their obligations and, in particular, conducted the receivership with reasonable skill and care and complied with their obligations under s 420A of the Corporations Act, which requires the receivers in exercising a power of sale to exercise all reasonable care to sell the secured property for its market value, if it has one, or for the best price that is reasonably obtainable, if it does not.

594. I do not accept either of those propositions.

595. I accept that NAB must prove that it has suffered a loss and that in order to do so it must prove that the value of its security is less than the value of its loan. However, it can do that by proving that the dividends it has received and is likely to receive are less than the amount of its loan. In my opinion, it has done that. It has certainly proved the amount of the dividends it has received. But I am also satisfied that any future dividend will fall well short of the amount still owing to NAB. It will be necessary to address a number of specific issues raised by Mr Potts. But looking at the position generally, the evidence is that the receivers have sold DSH’s principal assets, including its stock and that they expect there to be a substantial shortfall. It is true that in their report dated 1 November 2018, they say that their estimates do not take account of “any allowance for recoveries which may result from further investigations or litigation, including future preference recoveries made by the liquidators”, although no such qualification was included in their most recent report dated 7 November 2018. It is understandable that the receivers included that qualification, since one of the potential recoveries was their claim in these proceedings, which I have concluded fails. There is no evidence to suggest that the receivers or liquidators are pursuing other substantial claims. In the absence of any evidence to the contrary, it is reasonable to infer that the receivers have complied with their duties and have acted reasonably promptly, and that any substantial claim of which they were aware would have been pursued by now. Although it may have been better for NAB to lead evidence from the receivers concerning the precise stage the receivership has reached, in my opinion, it is apparent from the reports of the receivers in evidence that the receivership is largely complete. It is also apparent from those reports that any future dividends will fall well short of the amount owing.

592. That leaves the question of quantification. NAB has not sought to prove the precise amount of its loss. Instead, it has given credit for the dividends it has received. It accepts that it must also give credit for any future dividends. It submits that it can do that by applying the principle that a claimant cannot recover twice. Accordingly, it submits that if it receives dividends in the future it must set off the amount it receives against the judgment it obtains or, if the judgment has already been satisfied, repay to Mr Potts that amount.

593. In my opinion, the approach adopted by NAB is appropriate and any other approach is likely to lead to unsatisfactory results. NAB’s actual loss is only reduced by the amount of the dividends that it receives. The amount of any future dividend is uncertain. For example, the evidence is that the receivers currently have $21,728,725.62 cash on hand. On the other hand, it is plain that they may have future liabilities in the form of costs orders against them and DSH arising from these proceedings. Until those orders are made, any costs assessed, and the outcome of any possible appeal known, it is uncertain how much of the cash currently held by the receivers will be available for distribution to the Banks, or whether more might become available.

594. It cannot be the case that NAB was unable to bring the proceedings it has until the receivership was complete. Its cause of action arose when it became reasonably ascertainable that it was worse off as a consequence of entering into the Syndicated Facility: Wardley Australia Limited v State of Western Australia (1992) 175 CLR 514 at 527 (Mason CJ, Dawson, Gaudron and McHugh JJ), 536-7 (Brennan J). That became apparent no later than when it became apparent that it would not be possible to sell the business as a going concern and the receivers estimated that there would be a very substantial shortfall in recoveries. There is no principle of law which required NAB to wait to bring proceedings until its loss could be ascertained precisely.

595. Accepting that, there are two possibilities. One is to calculate damages by reference to the amount NAB has actually received, on the basis that if it recovers any more it must account to Mr Potts for the amount of the recovery. The other is to put a value on the prospect of receiving future dividends now. That could never be the subject of accurate proof. It would presumably require the Court to speculate on matters such as the prospect of an appeal being brought by the receivers in the claim that is the subject of this judgment and, if one is brought, its prospects of success and the amount of costs that might have to be paid by the receivers. Plainly, the first of these alternatives is preferable. As I have said, it recognises the fact that NAB’s actual loss is only reduced by the amount of the dividends it receives. It avoids the necessity of the Court engaging in speculation which almost inevitably will result in NAB being over-compensated or under-compensated for its actual loss.

596. As I have said, it is not entirely clear whether Mr Potts also submits that NAB must prove that the receivership was conducted by the receivers in accordance with their legal obligations. I accept that it would be open to Mr Potts to prove, for example, that the receivers did not comply with their duty under s 420A of the Corporations Act and that he should be given credit for the difference between the amount actually realised and the amount that would have been realised if the receivers had complied with their duties. As between Mr Potts and NAB, NAB should bear the consequences of some breach of duty by the receivers. However, in my opinion, it is not for NAB to prove that the receivers did not breach their duties. Rather, it is for Mr Potts to allege and prove the breach he relies on and the financial consequences of that breach. Even if that is not correct, absent evidence to the contrary, it is reasonable to infer that the receivers complied with their duties. That at least casts an evidential onus on Mr Potts, which he has not discharged.

597. Mr Potts points to a number of matters which it is said demonstrate that the distributions to NAB (and HSBC) do not account for the total value of the secured assets. Those matters are:

1. There is evidence that the receivers continue to hold substantial amounts of cash;

2. There is evidence that the receivers paid for the costs of the Company Proceeding and the Bank Proceeding, which was a benefit to the Banks for which NAB has not given credit;

3. There is no evidence concerning the stock held by the receivers or its value;

4. NAB has not given credit for other potential recoveries.

602. I have already dealt with the first of these issues. In my opinion NAB does not have to give credit for amounts recovered by the receivers until those amounts are distributed to it, since it is only then that the amounts distributed reduce NAB’s loss.

603. In relation to the second point, the evidence is that the receivers have paid their own and the Banks’ costs of both proceedings. They have not sought to separate those costs between the two proceedings. The Banks have sought to prove those costs by tendering the relevant invoices, which total $20,426,731.22. They have apportioned those costs between themselves in the ratio represented by the distribution of dividends to date, which itself reflects the proportion of the total debt owed to each of them at the date of the receivership. On that basis, $12,164,023.70 is attributed to NAB.

604. In my opinion, the payment of NAB’s legal costs in a case brought by NAB for its own benefit is equivalent to a distribution of that amount by the receivers to NAB. Consequently, as the evidence stands, the receivers paid NAB’s legal costs of bringing the current proceedings. That was a benefit received by NAB. NAB has sought to prove that benefit by tendering the relevant invoices. It led no evidence from which it would be possible to apportion those costs between the Bank Proceeding and the Company Proceeding. In my opinion, it bore the onus of proving that some of the costs did not relate to the Bank proceeding. It has not discharged that onus. On the other hand, I accept that it is reasonable to apportion the costs as between NAB and HSBC by reference to the dividends that have been paid, since if the costs had not been paid presumably the same amount would have been available for distribution as a dividend. It follows that NAB’s claim must be reduced by $12,164,023.70.

605. The third point made by Mr Potts is not correct. The evidence from the report of the receivers is that all the stock has been disposed of.

606. As to Mr Potts’s fourth point, the point is in the nature of a positive defence. In substance, it is Mr Potts’s contention that there is some claim available to NAB or the receivers which would reduce the loss. In my opinion, Mr Potts bears the onus of proof on that issue: see Boyd v Leftwich (1982) 43 ALR 280 at 282 per Gibbs CJ (Murphy, Wilson and Brennan JJ agreeing). Mr Potts has not discharged that onus.

607. Accordingly, NAB is entitled to judgment against Mr Potts in the sum of $43,041,295.97.

HSBC’s claim for damages in relation to the Extension Agreement

608. The Extension Agreement was executed on 12 November 2015. On that date, the balance of DSH’s overdraft facility with HSBC was approximately $58,149,000. The overdraft then increased to a maximum of approximately $77,844,000 on 20 November 2015. From there, it decreased so that at the time the receivers were appointed on 4 January 2016, it was approximately $50 million (following the late processing of a number of deposits with a “value date” of 4 January 2016).

609. Based on those facts, Mr Potts contends that HSBC suffered no loss as a consequence of executing the Extension Agreement because the amount the subject of the extension had been repaid at the time the receivers were appointed. HSBC, on the other hand, contends that it has still suffered a loss because the cash that DSH generated that was used to reduce the overdraft would have been used to reduce the overdraft as it existed before the extension was granted.

610. I do not accept HSBC’s submission. It assumes that if the extension had not been granted DSH would have been able to continue to trade and would have earned the same income and have continued to pay the same creditors as it did in the actual world. None of those assumptions is made out, and one or more of them is unlikely, since the logical consequence of those assumptions is that DSH did not need the extension to the overdraft at all. As Mr Potts submits, it is also difficult to see how the loss HSBC claims could be said to have been caused by Mr Potts’s misleading conduct. It is HSBC’s case that it was misled into entering into the Extension Agreement and advancing additional money under that agreement. Its loss was the payment of the additional money. That loss was extinguished when the money was repaid. The fact that in the counterfactual world DSH may have had an additional $20 million and that amount may have been used, or may have been available, to repay the amount due to HSBC under the Syndicated Facility does not mean that HSBC suffered a loss that resulted from entry into the Extension Agreement.

611. It follows that even if HSBC had succeeded on the issue of reliance, its case in relation to the Extension Agreement must fail because it has not proved that it suffered any loss as a result of Mr Potts’s misleading conduct.

Orders

612. It follows from what I have said that the Company case must be dismissed. NAB is entitled to judgment against Mr Potts in the sum of $43,041,295.97 together with interest. The Bank case must otherwise be dismissed. I will hear the parties in relation to costs if costs cannot be agreed.

613. The orders of the Court therefore are:

1. Within 21 days of the date of this judgment the parties bring in short minutes of order which give effect to these reasons for judgment and, if costs can be agreed, deal with the question of costs;

2. If the parties cannot agree on the form of orders or the question of costs, the matter be relisted by contacting my Associate to deal with any outstanding questions.

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Annexure 1 (202213, pdf)

Annexure 2 (100544, pdf)  |   Annexure 2 - text version (417228, rtf)

Annexure 3 (119900, pdf)  |   Annexure 3 - text version (122474, rtf)

Decision last updated: 15 June 2021