Hosking v Ipex Software Services Pty Ltd
[2004] VSC 299
•25 August 2004
IN THE SUPREME COURT OF VICTORIA Not Restricted AT MELBOURNE
COMMERCIAL AND EQUITY DIVISION
COMMERCIAL LISTNo. 2024 of 1997
MARK HOSKING Plaintiff v IPEX SOFTWARE SERVICES PTY LTD
(ACN 056 165 309) AND OTHERSDefendants
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JUDGE:
HABERSBERGER J.
WHERE HELD:
MELBOURNE
DATE OF HEARING:
25-27 February; 3-6, 12, 13, 19, 20, 24 March 2003;
9 February and 28 May 2004DATE OF JUDGMENT:
25 August 2004
CASE MAY BE CITED AS:
Hosking v Ipex Software Services Pty Ltd
MEDIUM NEUTRAL CITATION:
[2004] VSC 299
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CONTRACT – Assessment of damages for breach of agreement to give plaintiff 5% of the equity in a group of companies and unit trusts – Meaning of entitlement – Proof of plaintiff's claim – Admissibility of expert's report – Capitalisation of future maintainable earnings – Relevant factors.
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APPEARANCES:
Counsel Solicitors For the Plaintiff Mrs S.M. Crennan QC with
Mr J.A. Riordan and
Mr C.J. Horan
9 February and 28 May 2004:
Mr C.M. Scerri QC with
Mr C.J. HoranVadarlis & Associates For the Defendants Mr J.W.K. Burnside QC with
Mr J.P. Carney
28 May 2004:
Mr J.W.K. Burnside QC with
Mr J.D.S. BarberArnold Bloch Leibler TABLE OF CONTENTS
The History of the Proceeding......................................................................................................... 1
The Hearing......................................................................................................................................... 6
The Meaning of the Plaintiff's Entitlement to Five Per Cent of the Equity in the Ipex Group 7
Did The Plaintiff Make Out His Claim For Damages?............................................................. 19
Five Per Cent of the Profits............................................................................................................. 21
Five Per Cent of the Capital Reserve Distribution.................................................................... 24
Calculation of the Plaintiff's Claim for Damages...................................................................... 25
The Date of Assessment of the Damages..................................................................................... 26
The Ipex Group................................................................................................................................ 29
The Evidence of Mr Joel Schwalb................................................................................................. 31
The Evidence of Mr Jonathan Sheiman....................................................................................... 38
The Valuations.................................................................................................................................. 39
Mr Michael Shulman....................................................................................................................... 39
Mr Michael Churchill...................................................................................................................... 49
Mr Marcus Rose................................................................................................................................ 51
Mr Craig Edwards............................................................................................................................ 54
Ms June Wilson................................................................................................................................ 58
Valuation of Mr Hosking's 5% Interest........................................................................................ 62
Number of Past Years Taken into Account................................................................................. 63
Service Contract Revenue............................................................................................................... 67
Other Adjustments to Earnings..................................................................................................... 71
(i) Amortisation of Intellectual Property................................................................................. 73
(ii) Provision for Long Service Leave....................................................................................... 73
(iii) Salary at Commercial Rate................................................................................................. 73
(iv) Legal Costs............................................................................................................................ 74The Use of Results from the 2003 Financial Year....................................................................... 74
The Multiple to be Applied........................................................................................................... 79
Discount for Minority Interest....................................................................................................... 84
Calculation of the Plaintiff's 5% Equity in the Ipex Group..................................................... 87
Orders................................................................................................................................................. 88
HIS HONOUR:
The History of the Proceeding
1 The plaintiff's claim in this proceeding was for damages for breach of an agreement made with the first to sixth defendants ("the Ipex Group", "Ipex" or "the Group"). After a trial on liability only in August 1998, Hansen J found in favour of the plaintiff, Mr Mark Hosking, on 24 February 1999.[1] The factual background, which I do not propose to repeat, is set out in his Honour's detailed reasons for judgment. However, it is necessary to refer to the agreement and, although it is quite lengthy, I will set out its terms virtually in full.
[1][1999] VSC 28
2 The agreement was dated 29 April 1994 but was found to have been signed on 29 and 30 August 1994. It read as follows:
"The parties agree that the following is an accurate outline of agreement reached between J Schwalb, 'Ipex Group', D Cohen (or nominated entity) 'DC', J Sheiman (or nominated entity), 'JS' and M Hosking (or nominated entity) 'MH'.
1.The Ipex Group, 'the group' is defined as all current and future Australian trading entities consisting of:
a)Takapana Investments Pty Ltd ATF The Schwalb Family Trust No. 1.
b) Ipex Information Technology Group Pty Ltd.
c) Ipex Research and Development Pty Ltd.
d) Toren Pty Ltd ATF Toren Unit Trust.
e)Ipex Software Services Pty Ltd ATF Ipex Software Services Unit Trust.
f) Melton Gully Pty Ltd ATF The Schwalb Family Trust No 2.
2.The parties hereby agree that the following agreement is to be effective from 1 July 1994 ('The effective date').
3.The fundamental basis of the agreement is that David Cohen and J Sheiman and M Hosking are to become entitled to the following % of the equity in the group:
DC 14 %
JS 5 %MH 5 %
4.The above entitlements are unconditional and effective immediately except that in the case of JS the following vesting arrangement is to apply:
a) Immediate unconditional entitlement to 1.5%.
b)Balance of entitlement to be 'vested' over 2 years commencing 1 July 1994 in equal proportions for each completed year.
c)In the event of a formal group restructure or listing prior to the expiry of the 2 year period the balance of the entitlement % will automatically vest in JS.
d)…
e)…
5.Due to commercial constraints the parties agree that a formal restructure of the group is not currently feasible but that the agreement is intended to be as legally and commercially binding as if a restructure had been completed.
6.The group referred to in 1 above consists of companies and trusts and thus have different taxation treatments applying to profits generated in the respective entities.
7.Notwithstanding the above, it is agreed that all future profit generated in trust structures will be distributed to companies in the defined group, such that the value of the group will be increased each year by the increase in the groups net profit after tax (i.e. not assets).
8.Furthermore, if dividends are paid from companies in the group then a proportionate distribution of profits will be made from trust structures to entities associated with DC or JS or MH. (It is noted however that dividends and distributions are in any case restricted by conditions imposed by the group bankers, Hong Kong Bank).
9.The entitlement referred to in 3 above is to be formally restructured and given effect to in the following circumstances:
a)A proposed sale of the group or part thereof prior to or in the course of a formal restructure or listing of the group, or
b) In any event by 1 July 1996.
10.In the event of the death, or total & Permanent Disability of DC, JS or MH prior to a formal restructure, the Ipex Proprietors (Schwalb family) will be required to make a termination payment to DC, JS or MH in a manner mutually agreed between the parties.
11.The termination payment shall, in the absence of an agreed amount to be [sic] determined by reference to the following formula:
A = X% (G+NA) – 1A
Where
A = Termination payment
X = % entitlement of DC or JS or MH
G= Goodwill of the group calculated as being the average group net profit after tax for the prior 3 completed financial years multiplied by a price/earnings multiple of 10.
NA= Consolidated net tangible assets as at 30 June of the last completed financial year.
LA= Insurance amount payable referred to in 14 and 15 below (if any).
12.By way of indication based on the group consolidated results for the 3 years ended 30 June 1993, the goodwill valuation would be approximately $10M and net tangible assets were approximately $1.8M at that date.
13.Any loan account balances owing at the time of death, will also need to be paid out or deducted as the case may be.
14. …
15.Any amount due under 11 above shall be paid to DC, JS or MH or their beneficiaries as soon as possible but at least at the rate of equal monthly instalments over 3 years with interest accruing at bank overdraft rates from time to time on the outstanding balances.
16.…
17.In the event of resignation or termination the following procedures are to apply:
a)The departing party is to remain entitled to the equity percentage referred to in 3 above and will be entitled to a formal shareholding consequent on the events specified in 9 above.
b)The departing party will be free to dispose of his entitlement or shareholding in any manner and to any party, subject to a first right of refusal being held by the remaining parties.
c)The value of the entitlement or shareholding and terms of sale is not hereby fixed but will be subject to negotiations between the parties at that time.
d)…
18.Consolidated group financial accounts at 30 June 1994 are to be prepared and presented to the parties by 31 December 1994, setting out the net assets of the group at 30 June 1994."
3 The judgment given by Hansen J on 25 March 1999 read as follows:
"THE COURT DECLARES THAT:
1.On 30 August 1994 the Plaintiff and each of the First to Sixthnamed Defendants (collectively 'the Ipex Group') entered into a binding agreement ('the agreement') which was effective from 1 July 1994 and pursuant to which:
(a)the Plaintiff acquired the right to 5% of the equity in the Ipex Group;
(b)the Ipex Group agreed to give effect to that entitlement on or before 1 July 1999.
2.The First to Sixthnamed Defendants breached the agreement in that they each refused and failed and continue to refuse and fail, to give effect to the Plaintiff's entitlement to 5% equity in the Ipex Group.
3.The First to Sixthnamed Defendant are liable to the Plaintiff for breach of the agreement, with damages to be assessed by a Master under order 51 of the Supreme Court Rules.
THE COURT ORDERS THAT:
4.The proceeding against the Seventhnamed Defendant is dismissed.
5.The costs of the proceeding, including the costs of today are reserved."
4 The first to sixth defendants appealed that decision. On 15 December 2000, the Court of Appeal by a majority (Batt JA and Eames AJA (as his Honour then was), Callaway JA dissenting) dismissed the appeal,[2] although it did by consent allow the appeal for the purpose of varying the first three paragraphs of the judgment of Hansen J. The order made by the Court of Appeal read as follows:
[2][2000] VSCA 239
"THE COURT OF APPEAL ORDERS THAT:
1.The Appeal is allowed by consent for the purpose of varying the first three paragraphs of the judgment given by the Honourable Justice Hansen on 25 March 1999 to read:
'1.On 30 August 1994 the Plaintiff and each of the First to Sixthnamed Defendants entered into a binding agreement ('the agreement') which was effective from 1 July 1994 and pursuant to which:
(a)the Plaintiff acquired the right to 5% of the equity in 'the Ipex Group' (as defined in the agreement); and
(b)the First to Sixthnamed Defendants agreed to give effect to that entitlement in respect of profits from 1 July 1994 and otherwise on or before 1 July 1996 as pleaded in paragraph 10 of the Fourth Further Amended Statement of Claim dated 19 December 1997.
2.The First to Sixthnamed Defendants breached the agreement in that they each refused and failed, and continue to refuse and fail, to give effect to the Plaintiff's entitlement to 5% of the equity in the Ipex Group.
3.The First to Sixthnamed Defendant are liable to the Plaintiff for breach of the agreement, with damages to be assessed by a Judge but otherwise in accordance with Order 51.'
2.The Appeal is otherwise dismissed with costs."
The defendants unsuccessfully sought leave to appeal to the High Court of Australia.
5 Paragraph 10 of the Fourth Further Amended Statement of Claim which was referred to in the order of the Court of Appeal, read as follows:
"There were terms of the Agreement, inter alia:
(a)that the Plaintiff was entitled to 5% of the equity in and profits of the Ipex Group from 1 July 1994;
(b)that all future net profits of the Ipex Group generated in trust structures would be distributed to companies within the Ipex Group so that the value of the Ipex Group would be increased each year by the increase n the Group's net profit after tax;
(c)that if dividends were paid by companies within the Ipex Group then a 5% distribution of profits would be made from trust structures to entities associated with the Plaintiff;
(d)that the Plaintiff's entitlement to 5% equity in the Ipex Group was to be given effect by the formal restructuring of the Ipex Group, the sale of part of the Ipex Group or in any event by the 1st July 1996."
6 The question of the assessment of the plaintiff's damages came before me rather than a Master because the Court of Appeal accepted the parties' view that, if the appeal were unsuccessful, damages should be assessed by a judge.[3] Callaway JA, who dissented on the substantive point, said:
"It is likely that questions will have to be decided of at least the same difficulty as those which had to be decided at the trial. In my view, it is not impossible that the assessment of damages will prove more difficult than the determination of liability."[4]
[3][2000] VSCA 239 at [10]
[4][2000] VSCA 239 at [11]
Eames AJA, who delivered the main majority judgment, which was substantially agreed with by Batt JA[5], stated that "the likely complexity of the issues" that would arise made it "appropriate" that the assessment be conducted by a judge.[6]
[5][2000] VSCA 239 at [32]
[6][2000] VSCA 239 at [79]
The Hearing
7 At the hearing, the plaintiff called evidence from three valuers, Mr Michael Shulman, Mr Michael Churchill and Mr Marcus Rose, and one other witness, Mr Jonathan Sheiman, who had also been a party to the agreement made in August 1994 with the Ipex Group. Mr Hosking did not give evidence on this occasion. The defendants called evidence from two valuers, Mr Craig Edwards and Ms June Wilson, and from Mr Joel Schwalb, the founder and managing director of the Ipex Group, and a solicitor, Mr Jack Stuk, a partner in the firm Jerrard & Stuk. At the conclusion of the hearing, a solicitor employed by the Ipex Group, Mr James Cook, was also called to give evidence about the results of searches for certain documents, which are referred to below.
The Meaning of the Plaintiff's Entitlement to Five Per Cent of the Equity in the Ipex Group
8 The defendants submitted that the assessment of the plaintiff's damages involved an assessment of common law damages for breach of an "indefinitely expressed contractual obligation", that is, an obligation which gave the promisor some latitude in the way the obligation was to be performed. This meant, so the defendants submitted, that the assessment involved a two step process. The Court must first define the mode of performance upon which damages were to be assessed and then assess the damages flowing from the failure to perform that obligation.
9 The plaintiff did not agree that the assessment involved a two step process. Furthermore, there was considerable disagreement between the parties concerning the mode of performance upon which damages were to be assessed. The disagreement extended to the issues of what was meant by the plaintiff's entitlement to 5% of the equity in the Ipex Group, how that entitlement could have been satisfied by the defendants and what evidence was required to make out the plaintiff's claim. All of these issues need to be resolved before I can embark on the task of actually assessing the damages.
10 I turn, first, to events following the judgment of the Court of Appeal. Pursuant to an order made by Mandie J on 2 February 2001, "pleadings" defining the issues were exchanged by the parties. On 6 March 2001, the defendants delivered a document entitled "Defendants' Statement of the Range of Modes of Performance upon which Damages are to be assessed." However, the relevant version of the "pleadings" is to be found in a document entitled "Defendants' Amended Statement of the Range of Modes of Performance upon which Damages are to be assessed" dated 11 April 2001 ("the defendants' statement") and a document entitled "Plaintiff's Response to Defendants' Amended Statement of the Range of Modes of Performance upon which Damages are to be assessed" dated 2 May 2001 ("the plaintiff's response").
11 In paragraph 6 of the defendants' statement it was asserted that it was open under the agreement for the defendants to tender to the plaintiff his entitlement to 5% equity in the Ipex Group as defined in the agreement by:
(a) restructuring the Ipex Group by:
(i)establishing a new entity or entities (the "restructure vehicle"), which could be either a corporation or a unit trust, in whatever form the defendants decided;
(ii)effecting the transfer of the assets of the defendants as they stood at 1 July 1996 to the restructure vehicle;
(iii)effecting the assumption of the liabilities of the defendants as they stood at 1 July 1996 by the restructure vehicle; and
(iv)granting securities to the financiers of the defendants in substitution for the securities granted by the defendants to their financiers as at 1 July 1996; and
(b)tendering to the plaintiff 5% of:
(i)the issued shares in a corporation or corporations regulated by a constitution containing provisions determined by the defendants (if the restructure vehicle were to be a corporation or corporations); or
(ii)the issued units in a unit trust to be held pursuant to a Trust Deed, the terms of which would be determined by the defendants (if the restructure vehicle were to be a unit trust or trusts).
It was then stated that because the modes of performance available to the defendants were so diverse the plaintiff was only entitled to nominal damages.
12 Alternatively, it was said in paragraph 10 of the defendants' statement that if the defendants had tendered to the plaintiff equity in the form of shares in a corporation, or units in a unit trust, those shares or units could have been issued with various restrictions, which were then set out.
13 Further, the defendants claimed in their statement that, as no dividends were paid by companies within the Ipex Group between the date of the agreement, 30 August 1994, and 1 July 1996, no entitlement to profits arose.
14 In paragraph 6 of his response, the plaintiff admitted that it was open under the agreement for the defendants to tender to the plaintiff his entitlement to 5% equity in the Ipex Group as defined in the agreement by:
(a)restructuring the Ipex Group by establishing a "restructure vehicle" (which could be either a corporation or a unit trust);
(b)effecting the transfer of all of the assets of the defendants as at 1 July 1996 to the restructure vehicle;
(c)effecting the assumption by the restructure vehicle of all of the liabilities of the defendants as at 1 July 1996;
(d)effecting the transfer to the restructure vehicle of the whole of the business or businesses which were being carried on by the defendants as at 1 July 1996;
(e)tendering to the plaintiff shares in the restructure vehicle if that vehicle was a corporation, or units if the restructure vehicle was a unit trust, equal in value to 5% of the value of the Ipex Group.
However, in paragraph 10 of his response, the plaintiff said that in any such restructure, each of the shares or units tendered to the plaintiff was required to have the same rights and liabilities as any other share or unit in the restructure vehicle and that the defendants were not entitled in the mode of performance to discriminate against the plaintiff by transferring to him a share or unit which had lesser rights or greater liabilities than any other share or unit in the restructure vehicle.
15 Further, the plaintiff contended that the entitlement to profits was not conditional upon the payment of dividends.
16 In his response, the plaintiff claimed an amount consisting of the sums of:
"(i)5% of the profits of the Ipex Group from 1 July 1994 to the date of payment; and
(ii)5% of the value of the Ipex Group as at the date of assessment by this Honourable Court."
17 As set out in his final version of Particulars of Loss, this translated into a claim for $7,623,000 calculated as at 30 June 2002 as follows:
Adjusted fair value of equity $2,935,000
Share of after tax profits from 1 July 1994 $2,190,000
to 30 June 2002
Share of capital reserve distribution $1,291,000
Share of franking credits from 1 July 1994 $1,151,000
to 30 June 2002
Profit normalisation $ 56,000
$7,623,000.
18 Mrs Crennan QC, who appeared with Mr Riordan and Mr Horan of counsel on behalf of the plaintiff, submitted that the plaintiff's entitlement to 5% of the equity in the Ipex Group meant 5% of the value of the Group and that this value could have been transferred in a number of ways – by shares or units or a combination of both, so long as it was equivalent to 5% of the value of the Group. Counsel for the plaintiff pointed out in their final submissions that the fact that, at the time of the agreement, the Ipex Group was constituted by both companies and trusts meant that neither 5% of the shares in the companies nor 5% of the units in the trusts could amount to 5% of the equity of the Group. Whether the defendants' obligation was to be satisfied by a grant of shares or a grant of units, it was submitted that an assessment was necessary as to whether what was granted matched 5% of the value of the Group.
19 On behalf of the defendants, Mr Burnside QC, who appeared with Mr Carney of counsel on behalf of the defendants, submitted that the plaintiff's entitlement under the agreement was to:
(a)5% of "the equity in the group" (clause 3 of the agreement) on "a proposed sale of the group or part thereof prior to or in the course of a formal restructure or listing of the group" or "in any event" by no later than 1 July 1996 (clause 9 of the agreement), and
(b)5% of the profits of the group between 1 July 1994 and the granting of the 5% interest on 1 July 1996, (clause 2 of the agreement), if dividends were declared by the companies in the group (clause 8 of the agreement).
Mr Burnside submitted that the appropriate mode of performance was for this entitlement to be translated into 5% of the share capital of the restructure vehicle ("Newco") which Mr Schwalb said that he would have set up, probably after seeking the advice of Mr Stuk. Mr Burnside further submitted that because the defendants were entitled to perform the contract in the way most favourable to them, this share capital would have been subject to a number of restrictive aspects, which would considerably reduce the value of the plaintiff's interest.
20 Mr Burnside submitted that the plaintiff's approach was not only incorrect as a matter of construction of the agreement, it was also contrary to the position previously taken by the plaintiff. Therefore, Mr Burnside submitted, the plaintiff was in effect estopped. He referred to two statements by the plaintiff's then senior counsel in directions hearings before Mandie J in February and April 2001 to the effect that the mode of performance against which loss was to be measured was that there would have been a new company which would have issued 5% of its shares to the plaintiff and that was what he should have had. Mr Burnside also referred me to paragraphs 6 and 10 of the plaintiff's response, which he submitted, proceeded on the same basis.
21 Mrs Crennan disputed that the plaintiff's response should be read in this way. She emphasised that paragraph 6 of the response admitted that it was "open" to the defendants to tender to the plaintiff his entitlement to "5% equity" by tendering to the plaintiff:
"shares in the restructure vehicle if that vehicle was a corporation … equal in value to 5% of the value of the Ipex Group."
Further, Mrs Crennan referred to the paragraph of the plaintiff's response which set out in general terms the plaintiff's claim (quoted in paragraph 16 above) including a claim to "5% of the value of the Ipex Group as at the date of assessment by this Honourable Court."
22 I accept the plaintiff's submissions on this point. There was, in my opinion, no change of position by the plaintiff nor any estoppel. The plaintiff has consistently claimed that he was entitled to 5% of the value of the Ipex Group. As the plaintiff's counsel stated in their final submissions, the plaintiff did not say (and had never said) that the defendants could not perform the agreement by issuing or transferring to the plaintiff shares in a restructure company vehicle for the Ipex Group. It was open to the defendants to have tendered the plaintiff's entitlement in the form of shares in a restructure vehicle, provided that the value of such shares was equal to 5% of the value of the Ipex Group.
23 In his judgment at first instance, Hansen J dealt with the argument by the defendants that no binding agreement had been made. In the course of rejecting the submission, his Honour said:
"Then it was argued that the word 'equity' was uncertain. Counsel for the plaintiff submitted that it was plain, in the context, that 'equity in the group' meant shares or units in an entity mentioned in cl.1 of the agreement. In my view that is correct. It accords with references to holding shares in cl.17. It also accords with a common and well understood meaning of the word equity as referring to the holding of shares in a company. See Ford's Principles of Corporations Law, paras.17.020 and 17.070."[7]
[7][1999] VSC 28 at [116]
24 It seems to me that Eames AJA also considered "equity" as referring to shares or units. There are references to that view in paragraphs 66, 67 and 69 of his Honour's reasons. In paragraph 72, Eames AJA said:
"Hansen J, with whose reasons as to the issue of uncertainty I am in substantial agreement, held that the phrase 'equity in the group' meant shares or units in the entities which at present or in future would comprise the Group."
Further, his Honour also said that given that it was a 5% equity in the Group as a whole which was to be provided:
"it did not follow that a 5% equity must necessarily have been provided in each company or trust, so long as overall such an interest was achieved."
By "such an interest", I consider his Honour was referring to shares or units representing 5% of the value of the Group, as the plaintiff contended.
25 The next question is whether the damages are to be assessed by deciding what 5% of the equity in the Ipex Group was worth or by valuing 5% of the shares in Newco, which shareholding would be subject to the differential rights and the numerous restrictions which Mr Schwalb said he would have required if that entity were to have been set up.
26 Counsel for the defendants submitted that the defendants' ability to choose a mode of performance which was least disadvantageous to them was in accordance with well established principles. They referred to Paula Lee Ltd v Robert Zehil & Co Ltd[8] ("Paula Lee") where Mustill J held that where damages were required to be calculated for breach of contract in a situation where the defendant could fulfil its part of the contract by performing its obligation by alternative methods and had a freedom of choice which method to use, damages were to be assessed by reference to that method of performance which was least unfavourable to the defendant. Mustill J also referred to the distinction:
"which exists between (a) an obligation expressed in terms of a range of alternatives from which the promisor may choose and (b) a single obligation expressed in an indefinite way"
and expressed the view that damages would be assessed on the basis of what would have been a reasonable method of performance with the interests of both parties in mind.[9]
[8][1983] 2 All ER 390
[9][1993] 2 All ER 390 at 394
27 Defendants' counsel also referred to the restatement of this principle by McHugh JA (as his Honour then was) in Biotechnology Australia Pty Ltd v Pace[10] in the following terms:
"Where the contingency is dependent upon the way in which the party in breach of the contract would perform the contract, the settled rule is that damages are assessed on the basis that the wrongdoer would have performed the contract in the way most favourable to himself."
[10](1988) 15 NSWLR 130 at 156
28 The following passages from the judgments of the Court of Appeal were also relied on by the defendants. In his judgment, Eames AJA said that:
"Hansen J was entitled to find, as he did, that 'the agreement itself contained no suggestion of differential rights among the holders of the equity in the Group'. Hansen J held, appropriately in my view, that one interpretation which was open was that the meaning to be given to the phrase, insofar as shares were involved, was that ordinary shares would be involved, not preference shares. He was not called upon to resolve that issue, because specific performance was not required. There were alternative interpretations which were open, but that did not mean that the term was uncertain.
…
The plaintiff agreed to terms which place him at something of a disadvantage in determining how his loss may be assessed. The damages will be assessed on the basis, so far as applicable, that the appellants would have performed the contract in the way most favourable to themselves."[11]
The above quotation from the judgment of McHugh JA was cited by Eames AJA in a footnote to this passage.
[11][2000] VSCA 239 at [72] and [74]
29 Callaway JA noted that:
"Mr Scerri [senior counsel for Mr Hosking] was driven to concede that the bargain entailed that the respondent would accept his 5% of the equity in the group in whatever form the appellants decided."[12]
His Honour went on to record that Mr Scerri pointed out that there would be some limits on the appellants' freedom of choice, such as acting honestly, acting reasonably or at least not purporting to perform the contract in a way that no reasonable person would adopt, and not discriminating between the minority shareholders.
[12][2000] VSCA 239 at [26]
30 Mr Burnside therefore submitted that, following the Court of Appeal's decision, it was open to the defendants to choose the way in which the agreement could have been implemented. That meant that the defendants could choose the mode of performance which was least disadvantageous to it, including the creation of Newco along the lines advised by Mr Stuk, which Mr Schwalb said he would have accepted.
31 Mrs Crennan disputed this approach. She submitted that Mr Scerri's concession was only about the fact that 5% of the equity could be given in various ways (such as by shares or units or cash) and not that the defendants could, if they chose, perform the contract in a way that did not correlate with giving 5% of the value of the company.
32 Mrs Crennan emphasised that under the agreement Mr Hosking was to receive 5% of the equity in the Group (clause 3 of the agreement) by no later than 1 July 1996 whether or not there had been a sale or a formal restructure or listing of the Group (clause 9 of the agreement). Therefore, she submitted, it was 5% of the value of the Group, whether or not shares had been issued or the Group restructured or sold or profits distributed. Clauses 7 and 8, particularly with the reference in clause 7 to increasing "the value of the group" fitted in with this approach.
33 Mrs Crennan picked up the distinction drawn by Mustill J in Paula Lee[13] between the situation where there was a single promise, but it was somewhat vague, and the situation where the promise itself expressly provided for various ways of performing the promise. Mrs Crennan submitted that it was in that second situation that the principle of the defendant being entitled to choose the mode of performance which best suited it became applicable. In the present case, which fell within the first category, it was submitted that there was only a single promise, namely, to give Mr Hosking 5% of the equity in the Ipex Group. Further, Mrs Crennan submitted that the defendants would not have given Mr Hosking 5% equity in the Group if the form in which it would have been given did not truly represent 5% of the equity or value in the Group.
[13][1983] 2 All ER 390 at 394
34 In support of that submission, Mrs Crennan referred to the decision of the English Court of Appeal in Abrahams v Herbert Reiach Limited[14]. This case involved the assessment of damages for breach of an agreement to publish in book form a collection of articles by the plaintiff on training for athletics. The form and price of the book, the number of copies to be printed, and the date of publication were left to the discretion of the publishers, although the fee to be paid to the authors for every copy of the book sold was agreed. Bankes LJ rejected the contention by the publishers that this was one of those contracts which might be performed in one of several ways, with the plaintiff having to be content with having the damages assessed by the standard which was the least onerous to the defendant. His Lordship continued:
"In the cases to which we have been referred the contracts provide on the face of them for alternative methods of performance. This contract only imposes one obligation upon the appellants – namely, to publish. The question is what will satisfy that obligation?"[15]
[14][1922] 1 KB 477
[15][1922] 1 KB 477 at 480
35 Atkin LJ concurred in the result. He held that:
"… in the present case there are no alternatives, and to adjust the rights of the parties the only method is to form a reasonable estimate of the amount the respondents would be in pocket if the appellant had kept his promise."[16]
[16][1922] 1 KB 477 at 483
36 I agree that the defendants' promise was a single promise. The breach of contract in this case was, as the plaintiff contended, that the defendants did not give him his 5% equity in the Ipex Group. The general rule concerning the awarding of damages is that:
"Where a party sustains a loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation, with respect to damages, as if the contract had been performed."[17]
Thus, the damages to be awarded to the plaintiff have to be such that he is placed in the same situation as if the contract had not been breached.
[17]Robinson v Harman (1848) 1 Ex 850 at 855 per Parke B. This statement has been approved and applied in Australia: see Wenham v Ella (1972) 127 CLR 454 at 471 per Gibbs J (as his Honour then was) and The Commonwealth of Australia v Amann Aviation Pty Ltd (1991) 174 CLR 64 at 80 per Mason CJ and Dawson J.
37 If there had been no breach, then on 1 July 1996, at the latest, Mr Hosking would have been given his 5% equity in the Group, which interest could have been represented by shares or units or a combination of both. In my opinion, whatever the form of the performance by the defendants of their contractual obligation, whether or not there had been satisfactory compliance would be tested by deciding whether or not the alleged performance in fact represented the promised 5% of the equity in the Ipex Group. This in turn would involve assessing whether what had been given to the plaintiff had a value equivalent to 5% of the equity in the Ipex Group. In the case of shares in a new company or units in a new trust, it would be a relatively simple exercise to check whether all of the assets of the relevant business of the defendants as at 1 July 1996 had been transferred to the new entity and whether all of the liabilities had been assumed by the new entity and whether the number of shares or units represented a 5% holding. In my opinion, if all of the rights and liabilities attaching to the shares or units were the same, then such an exercise would represent 5% of the equity in the Ipex Group. Hansen J held that "the agreement itself contained no suggestion of differential rights among the holders of the equity in the Group."[18] That statement was quoted with approval by Eames AJA in his judgment in the Court of Appeal.[19] On the other hand, if the rights and liabilities attaching to the shares or units were not the same then, in my opinion, the plaintiff would not have received his 5% of the equity in the Ipex Group.
[18][1999] VSC 28 at [119]
[19][2000] VSCA 239 at [72]
38 Furthermore, if the defendants had decided that they no longer wanted Mr Hosking to have an interest in the Group but nevertheless had been prepared to honour their promise to him, presumably they could have met Mr Hosking's entitlement by paying him cash. In order to check whether Mr Hosking had received his contractual entitlement, it would be necessary to calculate the value of 5% of the equity in the Ipex Group.
39 In the circumstances, whichever way one looks at it, the plaintiff was entitled to be awarded damages which placed him, so far as money could do it, in the same situation as if the contract had not been breached. This means that he is entitled to receive damages equivalent to 5% of the equity in the Ipex Group, which can only mean, in my opinion, 5% of the value of the Ipex Group.
40 The conclusion that the agreement required that any shares in a new company or units in a new trust granted to the plaintiff have the same rights and liabilities attaching to them as applied to the other 95% shareholdings or unitholdings does not mean that in assessing the value of a 5% interest in the Ipex Group, account can not be taken of the fact that this was a minority interest, with a proportionately lesser value than that of any greater interest, for example 51%, which carried with it a premium for control. All that I have decided so far is that the agreement did not provide for differential rights, with the shares or units to be given to Mr Hosking to be burdened by a raft of onerous restrictions applicable only to his holding. Whether there should be any and what discounting for the nature of a minority interest will be examined later in this judgment.
41 This finding means that much of Mr Stuk's evidence was, as the plaintiff maintained, irrelevant to the issue before me. Mr Stuk said that in October 2002 he was asked by the defendants' solicitors to prepare a blueprint of how the transaction would have proceeded if it had been implemented. Mr Stuk said that his proposal was sensible, tax neutral and commercially efficient. He agreed that his instructions were to draw it in the least advantageous way to Mr Hosking. Nevertheless, he said that it still had to be commercial to the minority shareholder and that it could not be onerous or oppressive. Mr Stuk said that his proposal satisfied these requirements. I find that statement rather hard to accept given that Mr Stuk gave evidence that if he had been acting for Mr Hosking in negotiating the terms on which the shares in Newco were to be granted to Mr Hosking, he would have opposed virtually all of the restrictions he had advised Mr Schwalb to impose. However, as I have said, much of this evidence was irrelevant in the light of my finding that all of the shares in Newco would have had to have the same rights and liabilities attaching to them.
Did The Plaintiff Make Out His Claim For Damages?
42 My acceptance of the plaintiff's approach to the question of the method of assessment of his damages, as discussed above, also means that an important preliminary submission by the defendants must be rejected.
43 This issue arose out of the fact that, as I have stated, Mr Hosking did not give evidence in this hearing. The defendants submitted that, in the circumstances, the plaintiff had failed to make out his claim for damages for expectation loss. It was pointed out that the plaintiff had stated in his response that the amount claimed by him as the value of the Ipex Group constituted:
"the price which a willing, but not anxious, buyer, acting at arms-length and having all necessary information would be prepared to pay a willing, but not anxious seller, of the Ipex Group as a going concern."
44 Mr Burnside submitted that this approach anticipated evidence from the plaintiff proving that on the balance of probabilities had the agreement been performed:
(a)the plaintiff would have sought to have sold his shares as a willing but not anxious seller; and
(b)a market would have existed for those shares consisting of a willing but not anxious purchaser.
He submitted that, because the plaintiff did not give evidence at this hearing, there was no material concerning his intention with respect to, or how he would have dealt with, the shares or units he was supposed to have received. It was submitted that very different scenarios could arise, depending on Mr Hosking's evidence, each with quite different consequences for the assessment of damages. These different scenarios could include holding the shares in the long term, hoping that the company would be wound up or the assets distributed, or that the company would be listed on the stock exchange so that the shares would become readily tradeable, or alternatively looking for a buyer in the short term in order to sell at whatever price could be obtained. Mr Burnside therefore argued that the value of what Mr Hosking lost depended on what plans he had and there was no evidence at all on this point. Moreover, Mr Burnside submitted that there was a gap in the evidence regarding the existence of a buyer and that it was not reasonable to assume that anyone would be willing to pay money to buy the 5% shareholding. Therefore, it had not been shown that Mr Hosking had lost anything of value. All that Mr Hosking had lost, Mr Burnside submitted, was the possibility of getting an indeterminate amount of money at an indeterminate time in the future, which was not capable of quantification. Therefore, all that he could be awarded was nominal damages for expectation loss.
45 Although the defendants submitted that the plaintiff should fail in his claim for damages for expectation loss, they did concede that he would be entitled to recover damages suffered by way of reliance loss. They accepted that on the evidence this could amount to the sum of $160,000 but no more. The plaintiff rejected the concession that he had established reliance damages in the sum of $160,000.
46 I do not consider that the defendants' submission that the plaintiff failed to make out his claim for damages for expectation loss is correct. As I have previously held, Mr Hosking's loss is to be measured by the value of his 5% equity in the Group. It was simply not relevant to investigate what Mr Hosking would have done with his 5% shareholding or unitholding if in fact the defendants had given it to him.
47 If, contrary to my view, the Court is required to engage in the extraordinarily hypothetical exercise of deciding in what way the defendants would have chosen to perform the agreement if they had not decided to breach it, then I consider that there is no evidence before the Court allowing me to reach any definite conclusion. The evidence from Mr Schwalb only was that if he had had to perform the agreement, he probably would have engaged Mr Stuk and would have instructed him to consider a whole range of restrictions on Mr Hosking's shareholding and would have accepted his advice on these matters. As I have previously said, I do not consider that giving the plaintiff such a downgraded and unequal shareholding would have constituted performance of the requirement to give him 5% of the equity of the Group. That evidence from Mr Schwalb is therefore irrelevant and once it is excluded, I am not able to say what mode of performance the defendants would have chosen. Mr Schwalb may nevertheless have gone ahead with a more equitably structured Newco or he may have decided that in these circumstances he did not want Mr Hosking to have any part to play in Newco and simply paid him out. These possibilities were not canvassed because the defendants' position throughout was that all of the restrictions were reasonable and in accordance with their contractual obligation. As I have said, I do not agree.
48 It therefore seems to me that the plaintiff is correct in submitting that his claim for damages was made out upon proof of the value of his 5% equity in the Ipex Group.
Five Per Cent of the Profits
49 A further aspect of the plaintiff's entitlement under the agreement, about which the parties remained in dispute, was whether the plaintiff had any entitlement to profits. Mr Burnside submitted that the entitlement was only pending the receipt of the 5% equity, that is, until the sale, restructure or listing or in any event by no later than 1 July 1996, if dividends were declared in this period. He submitted that as none were declared before 1 July 1996, the entitlement to profits added nothing to the plaintiff's claim. Alternatively, he submitted that the plaintiff had no entitlement to profits either before or after 1 July 1996, because any such entitlement only arose if dividends were declared, and none had ever been declared.
50 On the other hand, Mrs Crennan submitted that Mr Hosking was entitled to a share of the profits of the Group until such time as he was given his 5% equity interest and that this was clearly recognised by both Hansen J and the Court of Appeal. She further submitted that the plaintiff was entitled to his share of the profits, whether or not they had been distributed, Accordingly, his entitlement did not depend on dividends having been declared by the Group. However, counsel for the plaintiff accepted that he did not have an "independent" right to 5% of the profits in addition to his right to 5% of the equity in the Group and agreed that the 5% equity interest carried with it an entitlement to a share of the retained profits of the Group. Therefore, in order to prevent double counting, it was submitted that it was appropriate to adjust the value of the 5% equity interest by removing the plaintiff's share of retained profits and that that amount form a separate head of the claim for damages. It was submitted that, although the total amount awarded would be equivalent to 5% of the value of the Group, it was useful for the Court to calculate Mr Hosking's share of profits because such an approach was consistent with the judgments of Hansen J and the Court of Appeal, the separate amount would represent the minimum figure to which the plaintiff should be entitled and it made clear that the plaintiff was also entitled to an amount for the loss of the franking credits which he would otherwise have received upon the distribution of the after-tax profits by way of dividends.
51 Hansen J held that Mr Hosking was entitled to "5% of the profit from 1 July 1994 and to receive his interest in the Group no later than 1 July 1996."
52 Eames AJA said:
"It is apparent that Hansen J considered that an immediate entitlement to 5% equity, which was to be effective as from 1 July 1994 (as provided by clauses 2, 3, 4), translated, at least, to an entitlement to profits, in the period between 1 July 1994 and 1 July 1996 (the date stipulated in clause 9(b) as the last date by which the entitlement to be provided by equity in the restructured company had to be delivered). Thus 5% of the equity carried an entitlement to 5% of the profits. Given that the breach occurred at 1 July 1996 that is the date at which the 5% equity in the Group must then be determined for the purpose of calculating damages. The entitlement of the respondent to 5% of the profits from 1 July 1994 was not challenged before us. Subject to hearing counsel, I consider that it would be appropriate that the order of the court should reflect the fact that Hansen J held that there was such an entitlement."[20]
[20][2000] VSCA 239 at [77]
53 This suggests to me that Eames AJA was saying that the plaintiff was entitled to 5% of the profits, at least for the period between 1 July 1994 and 30 June 1996, regardless of the fact that no dividends were declared in this period. I note that in the next paragraph of his reasons Eames AJA also said that:
"once the agreement is deemed not incomplete or uncertain … the entitlement to profits must also be taken into account when calculating damages."
It must be remembered that Eames AJA was clearly assuming that damages would be assessed as at the date of breach, being 1 July 1996. However, as will be seen, in the end the damages were assessed as at 30 June 2002.
54 Despite what was said in the above passages from the earlier judgments, Mr Burnside referred me, without objection,to the draft minutes of orders proposed by the plaintiff for the Court of Appeal's order. Paragraphs 1 and 2 of that draft read as follows:
"1.On 30 August 1994 the Plaintiff and each of the First to Sixthnamed Defendants entered into a binding agreement ('the agreement') which was effective from 1 July 1994 and pursuant to which:
(a)the Plaintiff acquired the right to 5% of the equity in 'the Ipex Group' (as defined in the agreement);
(b)the First to Sixthnamed Defendants agreed to give effect to that entitlement on or before 1 July 1996; and
(c)the Plaintiff was entitled to 5% of the profits of the Ipex Group from 1 July 1994.
2.The First to Sixthnamed Defendants breached the agreement in that they each refused and failed, and continue to refuse and fail, to give effect to the Plaintiff's entitlement to 5% of the equity in the Ipex Group, or to his entitlement to 5% of the profits of the Ipex Group from 1 July 1994."
A comparison of this draft with the final form of the order shows that sub-paragraph 1(c) was deleted and instead words were added in sub-paragraph (b), and the last part of paragraph 2 was deleted. The second omission is particularly significant because this would suggest that, after hearing counsel, the Court of Appeal was not prepared to declare that the defendants had breached the agreement by failing to give effect to the plaintiff's entitlement to 5% of the profits of the Group from 1 July 1994. This could only be, in my opinion, because no dividends had been declared.
55 The plaintiff's entitlement to profits was, in my opinion, only until he received his 5% equity in the group, in whatever form that took, and until 1 July 1996 at the latest. Thereafter he became entitled to damages for breach of the agreement. Further, in my opinion, the plaintiff's entitlement to profits in what turned out to be a two year period only arose if dividends were declared. The plaintiff was not to be in any better position than the other parties owning equity in the Group. Moreover, if profits were retained in this period then the plaintiff's 5% equity in the group as at 1 July 1996 would be correspondingly greater. Equally, it seems to me from what the valuers said, and counsel for the plaintiff accepted, that the retention of profits would have been reflected in a greater valuation figure of the group as at 30 June 2002. In those circumstances, it would be, as the plaintiff's counsel conceded, double counting to award damages calculated by reference to 5% of the profits from 1 July 1994 to 30 June 2002 as claimed by the plaintiff, as well as damages calculated by reference to the plaintiff's 5% equity in the Group.
56 In my opinion, there is no entitlement to an award of damages representing 5% of the profits between 1 July 1994 and 30 June 2002. But even if there were, I do not consider that it would be appropriate to treat this claim as a separate item rather than assessing the value of 5% of the equity in the Ipex Group, including in such calculation all of the retained profits. I therefore reject the claim by the plaintiff of $2.19 million for 5% of the profits and the consequential claims of $1.151 million for a 5% share of franking credits and $56,000 for his share of profit normalisation adjustments.
Five Per Cent of the Capital Reserve Distribution
57 The plaintiff also claimed an entitlement to 5% of the capital reserve distribution carried out on 13 August 1998 when the trustees of the Schwalb Family Trust No. 1 resolved to distribute $25.85 million equally to Mr Schwalb and his three sons. The plaintiff submitted that this was a very large amount which had been removed from the Group, in respect of which the plaintiff had not received his 5% entitlement. It was irrelevant that it was only a paper transaction in that the sums had been immediately lent back to the Group. Nevertheless, the plaintiff argued, insofar as these beneficiary loans were treated as liabilities of the Group in calculating Mr Hosking's 5% equity in the Group, the plaintiff was denied his entitlement to 5% of that sum. Therefore, the plaintiff submitted that the amount of the capital reserve distribution either should be seen as an extra item of entitlement for the plaintiff or the beneficiary loans should be treated as forming part of the equity in the Group and not as liabilities.
58 The defendants initially argued that as this step was taken by them after the date of breach on 1 July 1996, and thus after the plaintiff's cause of action for damages had arisen, the plaintiff could not recover anything in respect of the transaction. This submission rather overlooked, in my view, the fact that the defendants had agreed to the assessment of the damages as at 30 June 2002, which was after the distribution. In those circumstances, one could not ignore the effect the transaction had had on the Group's financial position as at 30 June 2002. Perhaps in recognition of this point, evidence was led from the defendants' own valuer, Mr Edwards, concerning a further valuation he had prepared, on the instructions of the defendants' solicitors, based on the assumption that this transaction had not occurred. I refer to this valuation in more detail below.
59 In my opinion, the capital reserve distribution has to be taken into account in some way in calculating the plaintiff's damages and the most appropriate way is once again not to treat the relevant beneficiary loans as a separate item but to take them into account when calculating the value of the equity in the Group.
Calculation of the Plaintiff's Claim for Damages
60 My rejection of these additional items in the plaintiff's calculation of his damages means that the dispute comes down to only one issue, namely, the amount of damages which is equivalent to the plaintiff's entitlement to 5% of the equity in the Ipex Group.
The Date of Assessment of the Damages
61 The final paragraph of the defendants' statement read:
"Further, damages are to be assessed as at 1 July 1996."
This accorded with normal contractual principles that damages should be assessed as at the date of breach. However, a court may depart from the general rule where necessary to do so in the interests of justice, or to provide a remedy which will most fairly compensate the plaintiff for the wrong that he has suffered. In such circumstances, the court may assess the damages at a later date than the date of breach.[21]
[21]Johnson v Perez (1988) 166 CLR 351 at 355-356 per Mason CJ
62 Paragraph 13 of the plaintiff's response stated:
"The Plaintiff contends that the damages are to be assessed as at the date of the assessment by this Honourable Court."
During the trial, Mrs Crennan contended that this meant assessment by reference to the last complete financial year because assessment as at the date of the hearing or judgment was not feasible. Mrs Crennan also explained that the principal consideration which made it inappropriate to assess damages as at the date of breach was that, if the defendants had performed their obligations under the agreement by giving effect to the plaintiff's 5% interest in the Group, the plaintiff would not have been required immediately to sell or dispose of that interest. Thus, she submitted that the plaintiff was entitled to hold on to his 5% interest and to take the benefit of any subsequent increase in the value of that interest.
63 The matter of the assessment of damages first came before me on 5 April 2002, when the defendants sought further directions. The trial date was fixed for 21 October 2002.
64 On 20 August 2002, the defendants' solicitors, Arnold Bloch Leibler, wrote to the plaintiff's solicitor, Mr Eric Vadarlis, raising the question of possible agreement between the parties on the date at which damages were to be assessed. The defendants' solicitors suggested that the parties agree on 30 June 2002. Subsequently, on 4 October 2002, as no agreement had been reached, Arnold Bloch Leibler wrote to Mr Vadarlis stating that:
"Our clients will accept that the damages are to be assessed as at the date of the assessment by the Court."
That is, the defendants accepted the position put forward in the plaintiff's response that the damages should be assessed as at the date of the hearing and not the date of breach.
65 The matter then came before me in mid October when the plaintiff sought an order that the trial date be vacated because of the allegedly late delivery by the defendants of a substantial amount of recent financial information. Regrettably, I felt compelled to vacate the trial date until early in the new year. In the course of the hearing of that application, the question was raised whether the parties could agree that the experts should address the last balance date prior to the date of hearing, namely 30 June 2002. Otherwise, it was said, the problem of assessing recent financial information would constantly re-occur. However, senior counsel then appearing for the defendants raised the problem of post balance date events. He said that he expected that the valuers would want to consider whether any post balance date events affected their valuation.
66 This proved prophetic because in their expert witness statements, the defendants' valuers took into account, in differing degrees, the pessimistic outlook and potential losses in the financial year ending 30 June 2003 referred to in Mr Joel Schwalb's witness statements. The importance of this point was apparently not appreciated by the plaintiff's advisers until shortly before the hearing date which had been refixed for 25 February 2003. They became concerned at their inability to get to grips with this new financial information and sought to limit the defendants to events occurring in the period ending 30 June 2002.
67 By letter dated 19 February 2003 Arnold Bloch Leibler wrote to Mr Vadarlis pointing out that:
"There has been no agreement between us (or order of the Court) that 30 June 2002 is to be the date of the assessment of damages."
68 The plaintiff then applied just before the hearing for an order that I fix the date of assessment at 30 June 2002 and refuse to allow the defendants to file any supplementary material. I declined to make any such order at that stage.
69 Subsequently, during the course of the hearing, I ruled that the parties' agreement that damages were to be assessed as at the date of assessment by the Court, by which they meant an assessment of the plaintiff's loss based on the position of the Ipex Group as at the last completed balance date, namely 30 June 2002, and insofar as that position was affected by any post balance date events, be implemented. This came about in the following circumstances. The defendants foreshadowed evidence to the effect that the Ipex Group had suffered a loss in the six months ending 31 December 2002 and that it was anticipated that greater losses would be incurred in the full financial year. The plaintiff indicated that it would object to this evidence because of the late and non-existent discovery about those post 30 June 2002 events. It was even tentatively suggested that perhaps I should reject the parties' agreement and do my own calculations based on the date of breach. Mr Burnside objected to this course because assessment of damages as at 1 July 1996 was not how the case had been prepared. Mr Burnside also argued that evidence of the situation of the Ipex Group post 30 June 2002 was admissible. A ruling was therefore required so that the parties knew how the matter was to proceed.
70 As it transpired, it would certainly have been a lot simpler if I had insisted that the damages be assessed as at the date of breach, namely 1 July 1996, and not given effect to the parties' agreement that they be assessed as at the date of the assessment by the Court, which both parties understood to mean an assessment based on the figures for the year ended 30 June 2002. However, the parties had prepared their evidence accordingly and insistence on assessment as at the date of breach would have probably caused another adjournment of the hearing to allow the parties to recast their evidence. In the circumstances, I did not consider that it would be unfair to either party to continue on more or less the same basis as they had been expecting.
The Ipex Group
71 Counsel for the plaintiff submitted that the Ipex Group was a large, successful and profitable enterprise. It had reported a profit in every year since its inception in 1983. Over the last decade, it had diversified its business from a manufacturer and supplier of personal computers to cover a broad range of IT products and services, including systems integration, project management, outsourcing and software development. The Ipex Group had a "blue-chip" government and corporate customer base, and had been ranked as one of the top 20 Australian IT businesses. Accordingly, it was submitted that the Group was a "major player" in the Australian IT industry.
72 It was further submitted that Ipex presented itself as a well-established and successful company, and was recognised as such in the industry. For example its website (as at 28 June 2001) stated:
"Ipex ITG is recognized internationally, as a desktop integration company of excellence, with the capacity to handle the most technical and logistically complex multi-million dollar projects.
Since 1982, Ipex ITG has built its success on providing total, fully integrated IT solutions enabling business to make quick, informed decisions, automate, monitor and control business and organizational processes and streamline internal and external communications."
The marketing brochures of the Ipex Group described it as "the largest and most successful Australian-owned IT Company", noting that it is ranked as a "Top 20 IT Systems Integrator" and a "Top 5 Desktop/Server Manufacturer". In describing its financial capacity, these brochures stated that:
"Ipex's long term success is evident in the consistently high ratings given by independent financial analysts. Ipex ITG is regarded as one of the most financially stable and secure IT companies in the industry, and stands ahead of almost all of its multi-national competitors."
73 It was also pointed out that the Ipex Group had a letter of credit facility of approximately $50 million with HSBC Bank Australia Ltd, secured by (among other things) fixed and floating charges over the assets and undertakings of companies within the Ipex Group. Under the terms of this facility:
(a)Ipex was required to provide to the Bank audited consolidated annual accounts, budget forecasts and cash flow projections, and quarterly management accounts;
(b)Ipex gave continuing warranties that its most recent accounts provided to the Bank were a true, fair and accurate statement of its financial position, that there had been no material adverse change in the financial position since those accounts were prepared, and that Ipex had disclosed in writing all facts which were material to the assessment of the nature and amount of the risk undertaken by the Bank; and
(c) the Bank must be notified of any change to Ipex's core business.
Counsel for the plaintiff submitted that in its dealings with the Bank, Ipex had consistently represented itself as a highly profitable company. Moreover, it had distributed retained profits which represented goodwill of $25.85 million in 1998.
74 On behalf of the plaintiff, it was submitted that the Ipex Group had demonstrated over a lengthy period its ability to remain profitable, anticipating and adapting to changes in the IT industry. It was argued that some statements by the valuers supported this conclusion. For example, according to Mr Rose, the management of Ipex had shown themselves to be adroit in dealing with such changing circumstances. One of the defendants' valuers, Ms Wilson, had stated in her report that the financial information "demonstrates that Ipex has a long track record of positive earnings", and "there is no evidence to suggest that the business will not continue to trade at least for the medium term." Finally, Mr Churchill said in re-examination that his reading of the financial information about the Ipex Group was that "on balance there is a very positive trend in most of the numbers, suggesting a profitable company that will in all likelihood continue to be profitable." There were no signs of a company that was about "to encounter any significant difficulties."
The Evidence of Mr Joel Schwalb
75 Mr Joel Schwalb was the founder and managing director of the Ipex Group. He said in his witness statement that he was an electrical engineer by training. He had a B.Sc. (Electronics) from the Israel Institute of Technology and a M.Sc. (Computers) from the University of Wisconsin. Mr Schwalb said that he had "responsibility for accounts, finance and the procurement of products for sale or assembly."
76 In his witness statement prepared in October 2002, Mr Schwalb gave an overview of the current activities of the Ipex Group. He said that the Ipex Group sold computer hardware and information technology ("IT") services. About 65% of its sales were to government and 35% to corporate entities. About 78% of its sales revenue was made up of sales of computer hardware and the balance of 22% was made up of services. The Ipex Group had approximately 600 employees in twelve offices around Australia. Mr Schwalb said that the Ipex Group began in 1983 as a computer hardware manufacturer and supplier. It branched out into systems integration and networking in 1989. This led to it becoming a provider of IT related services. From 1989 it had also provided software services. In 1998 it commenced an outsourcing business. In 1999 it started a software development business.
77 Mr Schwalb said that as a computer hardware supplier the Ipex Group designed computer equipment, imported the necessary computer components and manufactured the equipment from these components, including desktop workstations, notebooks, servers and monitors. As a service company, the Ipex Group provided technical support and warranty services for the equipment it sold and a range of services which included every aspect of an organisation's IT needs. Amongst other things, these included providing consultancy services on all IT issues, installing and designing computer networks and training.
78 Mr Schwalb said that outsourcing was, in effect, a combination of both the computer sales and service businesses. Outsourcing involved the Ipex Group contracting to perform some or all of the task of the IT department of a business or government entity, including the provision of hardware. Ipex was paid a monthly fee over the life of the contract.
79 The Ipex Group was also a software developer, which involved the customisation or development of business related software. Between 1989 and 1999, the Group's software activities were primarily related to the customisation of the software or other software manufacturers (some unsuccessful attempts at software development were made prior to 1996). Since 1999 the focus had shifted to writing the Group's own software for business applications.
80 According to Mr Schwalb the Group's major competitors included Acer Computer Australia Pty Ltd, Compaq Computer Australia Pty Ltd, Dell Computer Pty Ltd, Hewlett-Packard Australia Ltd, IBM Limited and Optima ICM Limited. He said that of these companies, the one most like the Ipex Group was Optima ICM Limited ("Optima ICM"), a publicly listed Australian company based in Sydney. Optima ICM was a computer manufacturer, IT services provider and outsourcer like the Ipex Group. The two companies often competed for the same work. In 2003, for example, Optima ICM beat the Ipex Group in obtaining a Department of Defence contract to supply 25,000 computers.
81 Mr Schwalb said that since its commencement he had run the Ipex Group with the aim of maximising its potential for growth. His policy was to seek to achieve and then maintain cash holdings of 30% of sales revenue. This meant that profits were "ploughed" back into the business and not distributed to equity holders.
82 Mr Schwalb explained that the Ipex Group had credit facilities provided by the Hong Kong Bank of Australia Limited. They were secured by a debenture charge and personal guarantees. The various forms of the credit facilities totalled nearly $50 million.
83 The prospects of the Ipex Group were painted as very gloomy by Mr Schwalb. He said that "the market for service contracts has now collapsed." In his view the decline was permanent. Previously, this had been a very lucrative part of the Group's business.
84 In Mr Schwalb's opinion, the IT industry was "in recession." It was suffering from the aftermath of the temporary surge in sales running up to the year 2000, due to Y2K and the GST, and "a pessimistic business outlook post 11 September 2001." Competition had increased. There had been a fierce price war since about April/May 2001. Mr Schwalb said that he did not see a future for the Ipex Group as a hardware supplier because it would not be able to compete with the large manufacturers, all of whom were likely to be based in China.
85 In addition, Mr Schwalb said that the market for outsourcing had "substantially disappeared." For different reasons both the government market and the business market had collapsed. Just before government departments lost interest in outsourcing, the Ipex Group had won the Group 8 contract and commenced providing services to eight Commonwealth Government agencies or entities in June 2000 for a contract price of $143 million over five years. Mr Schwalb said that the Group made a big investment in outsourcing only to find "that the market that we anticipated no longer exists."
86 Mr Schwalb said that he did not consider it likely in the foreseeable future that any part of the assets of the Group would be distributed to equity holders "whether through the payment of dividends or otherwise."
87 Mr Schwalb also gave evidence about how he would have performed the agreement with Mr Hosking if he had had to do so. He probably would have instructed Mr Jack Stuk of the firm Jerrard and Stuk. He would have given instructions that he wanted maximum possible control, with no shareholders' agreement unless necessary, no payment of dividends until the 30% of the company's turnover could be maintained, no board representation for Mr Hosking and a casting vote for himself in the case of deadlock, restrictions on selling shares and a requirement that shareholders proportionally bear the burden of providing collateral security to support any external creditors' facilities.
88 Further examples of the Ipex Group's struggle to survive given by Mr Schwalb were the 8% reduction in staff, the reduction from $100,000 to $20,000 in the minimum target size of prospective engineering projects and the reduction in cash reserves from $60 million as at 30 June 2000 to approximately $24 million in October 2002. This last example appeared in Mr Schwalb's witness statement after the sentence: "Our financial strength has been depleted badly." Counsel for the plaintiff submitted that this was an example of Mr Schwalb attempting to twist the facts in order to support misleading assertions. As was pointed out, the diminution of $36 million in the Group's cash reserves was brought about by the purchase of approximately $38 million of computer equipment for the Group 8 contract, which commenced in mid-2000. It was therefore submitted that the diminution of cash reserves did not indicate any depletion of financial strength. Rather, the plaintiff argued, the Ipex Group had applied its significant cash reserves so as to derive higher returns by acting as a financier under the Group 8 contract.
89 In a supplementary witness statement prepared in March 2003, Mr Schwalb produced responses given to further questions from the defendants' valuers about a variety of matters. One response referred to two deals or "wins" since the end of the 2002 financial year. One was a contract with Telstra which he said was likely to be a loss given that the cost price of the 27,000 computers was $1,399 and they were being sold to Telstra at about $1,201 (ex GST). This was done in order to retain Ipex's position on Telstra's panel, with the "hope that we will be able to increase our price over the duration of the agreement." The second deal or win was a contract to supply the Australian Tax Office with about 20,000 computers at an expected gross margin of $110 per computer. The response setting out management's expectations for the financial year ending 30 June 2003 was as follows:
"Management's original expectation was that Ipex would incur a loss of between $5-7 million in FYE 2003.
This was based on results for the first four months of the year, being an operating loss of $1.24 million (extrapolated to a full year operating loss of $3.72 million) combined with the net effect of the two new deals.
This methodology, in Management's opinion, remains valid. However, the net effect of the two new deals needs to be revised to recognise that only half the Telstra PCs will be purchased in FYE 2003. On this basis, we have forecast a loss of $2.67 million arising from the sale of PCs to Telstra in the remainder of this financial year. Offset against this is the $2.2 million gross profit we will make through the sale of 20,000 PCs to EDS for the Australian Tax Office, leaving us with a net loss of $0.47 million on these two deals.
As a result, Management has forecast an operating loss of $4.19 million for FYE 2003."
90 Subsequently, Mr Schwalb produced in evidence a sheet of handwritten calculations said to show the cost of the computers at the time of the Telstra tender. At an exchange rate of $0.56 to the US dollar, the cost was said to be $1,357 compared with a sale price of $1,141. However, he later said in cross-examination that he initially offered the computer at $1,278. The $1,141 figure happened only in December and supply to Telstra did not begin until January. Moreover, Mr Schwalb agreed that prices were fixed only for the first 90 days of the contract, and that in any event Ipex was doing better than it had quoted because the exchange rate was above $0.56. Mr Schwalb agreed that the costings for a computer changed daily in that the exchange rate changed and the cost of components changed. In trying to work out the cost price of a computer to Ipex, Mr Schwalb made the point that it was not necessarily the most current price of a part. Ipex might use a part from its stock on hand which had been purchased at another price. On top of the cost of the parts making up the computer sold to Telstra, there had to be added, according to Mr Schwalb, another 18-20% in overheads. Nevertheless, the alleged loss of nearly $200 per computer sold to Telstra had been considerably reduced by the end of Mr Schwalb's evidence on this topic.
91 In respect of the Australian Tax Office contract, Mr Schwalb first said that he "committed" to purchasing the parts for all 20,000 computers at the same time, when he got the letter of intent. He said that at least 7,000 computers were pre-built in December 2002, with a further 2,000 to 3,000 in early January, and that the components for those computers were already in stock. This evidence was given apparently in rejection of the suggestion that the Group had benefited from the recent improvements in the exchange rate in supplying computers under the Australian Tax Office contract. However, later when seeking to justify the low figure in the profit and loss statement for closing stock as at 31 December 2002, Mr Schwalb appeared to agree that his earlier evidence was inaccurate and that many of the components had not been delivered before 7 January 2003. The favourable changes in the exchange rate had increased the Group's margin on each computer sold to the Australia Tax Office.
202 Given the lack of examination of these items during the hearing, I have decided to ignore all of those items where a majority of the valuers did not consider the item worthy of adjustment, even where the explanation given by the one valuer for the inclusion of the item appears superficially reasonable. I turn then to an examination of the four items dealt with by the three valuers.
(i) Amortisation of Intellectual Property
203 According to Ms Wilson's report, in the financial year ended 30 June 2000 Ipex capitalised certain intellectual property costs of around $635,000 and wrote them off over a three year period. The amount written off in the financial year ended 30 June 2002 was $324,000. As the amortisation charge will not recur in future financial years, all of the valuers agreed that there should be an adjustment in arriving at a future maintainable earnings figure.
204 Both Mr Shulman and Ms Wilson allowed a figure of $324,000 for this item. The difference between their figure and Mr Edwards' figure of $0.3 million appears to be due simply to rounding. I would therefore increase the earnings figure in the 2002 year by $324,000 for this item.
(ii) Provision for Long Service Leave
205 Due to a change in accounting policy, Ipex incurred a charge for long service leave of $883,000 in the 2002 year, compared with the charge of $84,000 in the previous year. The valuers agreed that the "catch up" amount should not be included, but could not agree on the amount, in the absence of an estimate from Ipex management. Ms Wilson explained in her report that she had assumed that the ongoing charge would be around 50% of the 2002 year charge. That assumption can only be a guess, in my opinion. Mr Shulman did not explain his calculation. I prefer Mr Edwards' approach which was to add back the approximate additional one-off charge resulting from the change in accounting policy and apportion it over 2002 and prior years. This results in an increase in the earnings figure in the 2002 year of $0.7 million.
(iii) Salary at Commercial Rate
206 The three valuers agreed that there needed to be an adjustment to take account of the fact that at $150,000 Mr Schwalb was not paid a salary at the appropriate commercial rate for a person in his position. Mr Shulman would have allowed a $336,000 increase for Mr Schwalb's salary, Mr Edwards a $279,000 increase and Ms Wilson a $100,000 increase. Mr Shulman would also have increased the salaries of Mr Yaron Schwalb by $43,000 and Mr David Cohen by $33,000 and would delete entirely the $106,000 salary of Mr Yoav Schwalb, allegedly because he did not work in Australia for the Ipex Group. This would lead to a $30,000 drop in the adjustment for Mr Joel Schwalb's salary. Mr Edwards would make no such adjustments relying on Mr Schwalb's admission in his witness statement (paragraph 66) that the total remuneration paid to these three was "within the range of what they could have received elsewhere in the market." I consider Ms Wilson's salary for Mr Joel Schwalb of $250,000 to be too low.
207 In all the circumstances, I consider that I should use Mr Shulman's figure of a decrease in earnings of $306,000. This amount is very close to the average of Mr Shulman's and Mr Edwards' adjustment for Mr Schwalb's salary alone.
(iv) Legal Costs
208 Both Mr Edwards and Ms Wilson base their figure on the evidence of Mr Schwalb by way of an answer to a question from the valuers set out in his witness statement. It is limited to costs incurred in respect of this litigation. Mr Schwalb was not challenged on this answer. Mr Shulman referred to other litigation which he regarded as not part of the ongoing expenditure of the group necessary to maintain its operations. It is not clear to me whether this explains the discrepancy in the 2002 figures, or whether he found records which cast doubt on Mr Schwalb's evidence. In the circumstances, I must accept the $79,000 figure based on Mr Schwalb's statement.
209 The result of the above consideration of the four items is that I have concluded that, apart from the question of service contract revenue, the appropriate adjustment to the 2002 year earnings is to increase them by $797,0000. This means that the figure for future maintainable earnings is increased to $3.013 million.
The Use of Results from the 2003 Financial Year
210 After all of the time spent during the hearing on the question of what were the Ipex Group's results for the incomplete 2003 financial year and what they showed about the future prospects of the Group, it was rather frustrating to find how little reliance was placed on those results in the final submissions of both the plaintiff and the defendants.
211 In his March 2003 supplementary report Mr Edwards had criticised Mr Shulman for not taking into account the forecast operating loss of $4.19 million for the year ending 30 June 2003. Mr Edwards said that whilst he had treated the forecast loss as "an aberration", in his opinion allowance had to be made for it in the valuation because a future loss represented a future liability of the business which had to be funded. This was one reason for the significant difference between Mr Shulman's and Mr Edwards' original valuations. However, in cross-examination Mr Edwards conceded that because the examination of the results of the Ipex Group to January 2003 had indicated not a loss but a break even result or a small profit to that date, he no longer thought it appropriate to deduct the $2.933 million loss after tax.
212 Therefore, in final submissions, the defendants' position with respect to the question of what use, if any, could be made of the 2003 figures was that they should not be used at all. Mr Burnside submitted that the figures were not enough of a basis to form any confident view about what was happening in 2003. However, he still submitted that it looked likely that the trading result for 2003 was not going to be as healthy as 2002.
213 The anticipated profit figure for the 2003 year of about $24 million which Mr Shulman had calculated would obviously have been a great improvement on the 2002 results. Nevertheless, Mr Shulman said, in giving evidence at the main hearing, that he would not make any change to his previous report based on what he now knew about post-balance date events.
214 The plaintiff's position in final submissions was that although the experts' reports may not have changed, the 2003 figures confirmed that Mr Shulman's methodology was accurate and showed just how unreliable Mr Edwards' and Ms Wilson's methodologies were because of what was said to be the huge disparity between the future maintainable earnings assessed by them compared to what they had actually turned out to be. That submission was obviously based on the claim that the records of the Ipex Group showed unequivocally a profit to the end of February 2003 of about $16 million.
215 However, as I previously stated, on 19 December 2003 I granted the plaintiff's application to re-open his case in order to call further evidence concerning the sixth defendant's financial statements and report for the year ended 30 June 2003. Part of the evidence in support of that application was an affidavit by the plaintiff's solicitor sworn 15 December 2003 in which he deposed that he had been informed by Mr Shulman and believed that the new information would "have a significant effect upon the valuation of the Ipex Group as at 30 June 2002."
216 The sixth defendant's financial statements showed that it had made an operating profit before tax of $3.3 million, an increase of $1.2 million from the previous year. In order to obtain the full picture of the results for 2003, I also ordered that the defendants make discovery of the consolidated amounts of the Ipex Group for the year ended 30 June 2003 and the accounts of each entity comprising the Ipex Group upon which those consolidated accounts were based.
217 The consolidated accounts of the Ipex Group for the year ended 30 June 2003 showed that it had generated sales revenue of $185.9 million, which was a $20.6 million or 12.5% increase on the 2002 figure of $165.3 million. However, the Group's gross margin fell from $60.6 million in 2002 to $59.0 million in 2003, and its net operating costs excluding income tax had increased marginally to $51.99 million compared with $51.76 million in 2002. The unadjusted EBIT figure for 2003 was $5.82 million compared with $7.81 million in 2002.
218 Mr Shulman prepared a further report dated 4 February 2004 in which he reviewed the 2003 accounts. He pointed out in this report that whilst the 2003 financial year results prima facie had deteriorated, there was no loss as predicted by Mr Schwalb and that the unadjusted EBIT figure was more than double the future maintainable earnings figures projected by Mr Edwards ($2.4 million) and Ms Wilson ($2.0 million to $2.5 million).
219 In his report Mr Shulman explained that, on the basis of the information he had, he could not accurately normalise the earnings for 2003. However, he then went on to estimate a minimum figure for normalised EBIT for 2003 of $8.68 million by adding $1.44 million in legal fees, which he believed to be of an abnormal nature, and $1.42 million, which he said was the average in the years to 2003 of other non-recurring or abnormal expenditure. (The accuracy of the latter figure is doubtful when one looks at the normalisation adjustments over the years in the table in paragraph 106 above.)
220 Mr Shulman concluded that the new 2003 financial information did not require him to make any revision to his previous report. He stated that his tentative normalised 2003 EBIT figure of at least $8.68 million was "not materially different" to his earlier estimate of future maintainable earnings of $11.64 million. I consider this statement to be quite extraordinary. Clearly, even Mr Shulman's unsubstantiated tentative normalised 2003 EBIT figure of at least $8.68 million was materially different to his future maintainable earnings figure of $11.64 million. As the defendants' counsel pointed out in their further submissions, the latter figure is 34% higher than the former. On any view, in my opinion, this was a material difference. In cross‑examination, Mr Shulman said that his normalisation adjustments were "estimates" not "guesses", although he agreed that he could not say on his oath that they were correct. He rejected criticism of his statement that his figure of $8.68 million was "not materially different" to his $11.64 million figure, although he agreed that it was "significantly different".
221 Mr Edwards' further report was dated 30 January 2004. In his report he said that Ipex's actual result for the year ended 30 June 2003 was "irrelevant" to his valuation "unless it was reasonably foreseeable as at the valuation date (i.e. 30 June 2002)". Mr Edwards pointed out that in his report dated 19 December 2002 he had assumed that maintainable earnings were equal to the adjusted level of earnings achieved in the year ended 30 June 2002 and that he had treated management's projected loss as an "aberration". He emphasised that his final position at the hearing had been to ignore any suggestion of a loss in the 2003 year. Treating the profit actually obtained in that year as irrelevant was therefore consistent with his previous approach.
222 Ms Wilson also prepared a further report which was dated 30 January 2004. She said in cross-examination that she would not change her evidence as a result of seeing the results disclosed in the 2003 accounts because she did not consider that the accounts represented in any way what would be defined as a post-balance date event. She said that the 2003 accounts made no difference to her evidence as to the value as at 30 June 2002 because the accounts would not have been known at the time.
223 Counsel for the plaintiff submitted that Mr Edwards and Ms Wilson were both shown to be quite inconsistent in this approach to post balance date information. Whilst they took management's projected loss in 2003 into account to a greater or lesser degree, they refused to take into account the actual results for that year. I accept that their approaches on this issue did seem to be inconsistent.
224 The more important question is what flows from the proof of the actual results of the Ipex Group for the year ended 30 June 2003. It was submitted on behalf of the plaintiff that the actual 2003 results had a significant bearing on the question of what expectations would have been reasonable as at the valuation date. Assuming, without accepting, that this is correct, it seems to me that the issue is still left up in the air because it is impossible to say what expectations were reasonable as at the valuation date. One only has to compare the various estimates of the end of year results, based on the partly completed year's figures, with the actual results to see how difficult it was to predict the final outcome.
225 Counsel for the plaintiff strenuously argued that the 2003 results showed that the future maintainable earnings figures projected by Mr Edwards and Ms Wilson were unrealistically low. But the 2003 EBIT figure of $5.82 million was unadjusted. If an adjustment were made for the deferred service contract revenue in 2003, then as I understand the figures, this could possibly be about $2.7 million, in which case the discrepancy is not nearly so large. Obviously, there would have to be other adjustments which could increase or decrease the final normalised earnings figure for 2003. However, that information was simply not available, and I am not prepared to treat Mr Shulman's estimates as necessarily correct. In the absence of such information I cannot conclude that the 2003 results show that Mr Edwards' and Ms Wilson's future maintainable earnings figures were unrealistically low or that Mr Shulman's was unrealistically high.
226 Whilst the parties sought to make use of this new evidence as supporting their previously adopted positions, it seems to me that very little can be gained from it. It is true that Mr Schwalb's prediction of a significant loss was shown to be incorrect, but equally Mr Shulman's estimate of an approximate $24 million profit was also not borne out. In any event, none of that evidence has influenced me in my above discussion of the appropriate figure for future maintainable earnings.
227 I have therefore concluded that despite all of the time spent on issues relating to the results of the Group during, and for, the year ended 30 June 2003, no change needs to be made to the previously calculated figure for future maintainable earnings of $3.013 million.
The Multiple to be Applied
228 The defendants submitted that, as Ms Wilson stated, selecting a multiple was an art not a science. It was submitted that the Court was not well placed to determine for itself the appropriate multiple, but that it could decide which of the experts commanded the greatest confidence. There is much to be said for this view.
229 The defendants submitted that Mr Edwards and Ms Wilson acted entirely independently of the client and of each other, that they used appropriate companies as points of comparison, and that they derived multiples which were sufficiently similar (5.7 to 6.5 in the case of Mr Edwards and 5.0 to 5.5 in the case of Ms Wilson) to give confidence that their choice of multiple was reliable and should be preferred.
230 They contrasted this situation with that of Mr Shulman who agreed in cross-examination that he discussed his choice of multiple and choice of comparable companies with Mr Hosking, who derived his multiple from significantly larger United States companies and whose multiple of 9.0 to 9.5 stood alone, well above that of Mr Edwards and Ms Wilson.
231 The first point to consider about Mr Shulman's choice of multiple is whether his selection of the three United States companies (IBM, Compaq and Dell) as comparable companies was valid. I find it extremely difficult to accept that the US companies, which Mr Shulman agreed had market capitalisations hundreds or even thousands of times greater than Ipex, could be regarded as comparable. In his supplementary report, Mr Edwards said that collectively IBM, Dell and Compaq were the largest IT hardware and service companies in the world. He concluded that the high multiples these companies traded on were justified by "branding, brute size, economies of scale, distribution networks, potential and future growth, market position and size, global reach and intellectual property." This description does not seem to fit Ipex.
232 Further, the defendants submitted that Mr Shulman's basis for using IBM, Compaq and Dell as comparable companies and as the starting point for deriving a multiple applicable to Ipex was not made clear in his report of 17 December 2002. It was submitted that Mr Shulman did not identify in his report what characteristics of the businesses of the three United States companies he thought justified their description as "comparable companies" which could be used to give "an indication of the price levels at which portfolio investors are prepared to invest in these businesses." In evidence, Mr Shulman justified his use of IBM, Compaq and Dell partly at least on the ground that they were comparable to Ipex "in terms of service delivery." The defendants submitted that no evidence was given in support of this conclusion. It was also submitted that the conclusion must be open to doubt because the uncontested evidence of Mr Schwalb was that about 78% of Ipex's sales consisted of sales of computer hardware and that, although no figures were given about the businesses of IMB, Compaq and Dell, it was doubtful whether they were as heavily based on hardware sales. Further, it was submitted that the three United States companies were themselves very different companies. Mr Shulman's reported EBIT multiples of 11.15 for IBM, 16.23 for Compaq and 29.95 for Dell and PE multiples of 16.16, 21.20 and 42.70 respectively meant that a multiple derived from an average of these figures was meaningless.
233 The defendants also submitted that Mr Shulman's report did not provide any details as to the amount of the specific adjustments made to the United States derived multiples in deriving an EBIT figure. It was submitted that he did not expose the reasoning behind his discount of between 51% and 53% other than referring to private company status, potential illiquidity (as opposed to actual liquidity) and "other factors." In this context, the criticism referred to above, that in an earlier draft report Mr Shulman had discounted the average EBIT multiple of the three United States companies by 37% to 40% for the same factors, needs to be taken into account. No explanation was given by Mr Shulman of his use of different discounts for the same factors. It was therefore submitted that the Court could not be confident of the integrity of Mr Shulman's approach to the choice of multiple.
234 Mr Churchill said in his report that he would normally consider Australian companies as comparables in preference to offshore companies. He noted that the Australian capital market often provided few directly or validly comparable companies from which to determine appropriate multiples. In such a case, he said that he would prefer to construct a multiple from Australian companies despite the fact that they might not be solely or predominantly involved in the activities of the subject company. Mr Churchill said that in his view:
"The use of foreign comparables is complicated by 'conversion' difficulties due to the significant differences in capital markets, relative strength of economies in which such businesses operate, scale of operations, business models and risk profiles."
I accept the validity of this point of view.
235 In his report, Mr Churchill expanded on some of these conversion difficulties. Because Mr Shulman had used the simple average of the last four years earnings his future maintainable earnings figure did not precisely correspond with a multiple appropriate for the year ended 30 June 2002. The time frame was different. Also the multiples obtained from the three overseas companies were possibly based on the year ended 31 December 2001, not 30 June 2002. Mr Churchill said in evidence that this failure to match the appropriate multiple to the earnings in the same period was a "minor error" which was likely to result "in an understatement of value." Nevertheless, despite all of these concerns, Mr Churchill said that he was not "unhappy" with Mr Shulman's range of 9 to 9.5.
236 It is interesting to note that in considering the question of comparable sales and values, Mr Rose said in his report that he had:
"reviewed a number of trade sales of both public and private companies in Australia and overseas as well as reviewing values and earning multiples of relevant listed companies. Importantly, there were no sales or listed entities that [he] felt were directly comparable to Ipex in terms of size, activities and geographical location. Accordingly, [he had] found the need to extrapolate and make some allowances as well as assumptions, in order to make the data relevant to this valuation."
237 Mr Rose said in his report that the multiple used in the capitalisation of future maintainable earnings approach reflected "a composite mix of growth factors and risk factors." In evidence he explained that in working out this figure initially one would take an overview of the general market, then look at the risk and growth prospects of the particular sector, IT, and finally make an assessment of how well the particular company had performed in the past and how it was "travelling" at the present.
238 The defendants further submitted that the fact that Mr Shulman looked only at the three United States companies in his report, yet later sought in the course of his evidence to justify his multiple by reference to Australian companies, meant that he was giving different reasons to support his original conclusion which was based on other grounds.
239 The defendants also submitted that Mr Shulman nowhere explained why, apart from Optima ICM, he had not considered other Australian companies in his report, even though in evidence in chief he referred to the Australian companies KAZ, Volante and Altium and found, on a number of measures, that Ipex sat "somewhere between these three entities."
240 When it comes to looking at how the various valuers relied on differing Australian companies to guide them in their choice of multiples, it is very difficult to carry out any appropriate analysis. As I have previously said, it is not easy to logically track each step in a valuer's decision making process. Many competing factors are legitimately sythesised into the final choice of multiple.
241 The one Australian example which received some attention was the acquisition by Iocom (now Optima ICM) of Optima. Although Mr Shulman said in his report dated 18 December 2002 that Optima ICM was "also understood to be a competitor to the Group", he did not use it as a comparable company for the purpose of calculating his multiple. In cross-examination Mr Shulman agreed that at the time he prepared his report he knew that Mr Schwalb had suggested in his witness statement that Optima ICM was a closely comparable company to Ipex and that Optima ICM had beaten Ipex in a tender for a substantial contract with the Defence Department. Mr Shulman said that Optima had some similarities with Ipex but not the breadth of service that Ipex had. Mr Shulman also agreed that at the time of the merger with Iocom, namely November 2001, Optima was accurately described as "the largest PC vendor in Australia providing IT services as well as manufacturing sales and systems integration." Iocom was described as an "IT services provider offering outsourcing and systems integration solutions primarily to SME [small to medium enterprises] markets." Mr Shulman eventually agreed that Ipex and Optima ICM were more similar in terms of size (such as capitalisation or number of employees), than Ipex and the three United States companies. He maintained that Ipex and Optima ICM were different in terms of previous performance and market places in which they operated and service delivery. They were different in terms of previous performance because Iocom had never made profits and Optima had made small (less than $1.75 million) pre-tax profits in 1999 and 2000. Optima ICM was still a loss making company.
242 Rather surprisingly, Mr Shulman said that having decided that Optima was not a comparable company, he nevertheless calculated a multiple based on the acquisition transaction. Again this suggests a results driven approach.
243 For all of the above reasons, I have little confidence in the reliability of Mr Shulman's choice of multiple. This leaves me with the multiples selected by Mr Edwards and Ms Wilson, which seem to me to be more appropriate. Mr Edwards used the acquisition of Optima as part of his process of deciding that the appropriate PE ratio was a range of 7.0 to 7.5, which when converted to an EBITA and recalculated as at 30 June 2002 became a range of 5.7 to 6.5. Ms Wilson's EBIT multiple was a range of 5.0 to 5.5.
244 In deciding what multiple should be applied in capitalising the Group's future maintainable earnings, one figure must be chosen. Ms Wilson's range was probably too low because, as she herself said, she had taken Mr Schwalb's suggestion that the Group was going to lose between $5 million and $7 million in the 2003 financial year into account in selecting her multiple. I have therefore decided that the appropriate multiple is 6.5, being the higher end of Mr Edwards' range.
Discount for Minority Interest
245 I have previously stated that it might be appropriate to apply a discount for the minority interest nature of the plaintiff's 5% interest, notwithstanding that I had held that new shares or new units issued to Mr Hosking would have the same rights and liabilities as the other holdings. I turn then to consider whether there should be any discounting.
246 Mr Edwards explained in his report why he believed that there was a need to discount for non-negotiability. He said that investors preferred equity investments that had access to a liquid secondary market and which could be readily converted into cash. Equity interests without such marketability characteristics normally sold at a discount in order to provide an investor with compensation for this lack of liquidity. Mr Edwards said that the discount for non-negotiability associated with an interest in a privately held entity reflected the difficulty or inability of the owners to sell their interests owing to the fact that there was no established market for interests in privately held entities, and in particular, a lack of buyers for minority interests in private companies.
247 According to Mr Edwards, minority shareholders could generally only sell their shares in a private company if either:
(a) the company listed its shares on a stock exchange; or
(b)the company (or the underlying business) was sold or merged with another company; or
(c)they sold their shares to either the company (for example, in a share buyback) or to another shareholder.
All of the above options required the approval or co-operation of the majority shareholder(s).
248 Mr Edwards said that, in essence, the discount for non-negotiability reflected the fundamental problem that there were normally significant delays and search costs in locating a purchaser for a minority shareholding in a private company even if, as a practical matter, a purchaser could be found at all.
249 Mr Edwards said that unlisted shares were generally an unattractive investment in comparison to listed shares for a variety of reasons, including:
(a)the articles of private companies frequently contained restrictions on their transfer;
(b)there might also be pre-emptive clauses that gave the existing shareholders the right not only to acquire the shares but to have the price fixed by the auditors if the existing shareholders considered the asking price was too high;
(c)shareholders in a private company were effectively at the mercy of the controlling shareholders in respect of not only their annual dividend income but, because of the flow on effect of dividend policy to share value, the capital value of the shares;
(d)private companies usually had less depth of management than their listed counterparts;
(e)private companies generally were of a smaller absolute size than their listed counterparts; and
(f)the potential sources of additional equity capital available to private companies in the case of need were less numerous.
He said that all of these factors could be regarded as adding risk to the investment in shares of unlisted companies (and thereby reducing their value) when compared with listed counterparts.
250 Mr Edwards concluded that in the absence of any restrictions in the Articles of the Company relating to the ability of a minority shareholder to sell their shares in Ipex it was still appropriate to apply a discount for non-negotiability. This was primarily because it was still very difficult for a minority shareholder in a private company to locate a buyer. Such a discount typically ranged from 25% to 45% and he considered the appropriate discount to be around 30%.
251 Ms Wilson said in cross-examination that the 5% share holding was "very non-negotiable". She said that because it was a 5% holding in a private company that was controlled by one family it was not "particularly attractive to a hypothetical purchaser." The suggested restrictions made a holding of that type "very unattractive" according to Ms Wilson. Even if Mr Hosking were to be appointed a director, it would make little difference, in her opinion, because "once you have less than a 75% shareholding, you have very little ability to control anything." Ms Wilson said that there was "no easy exit strategy for a 5% holder in Ipex." In her opinion, the appropriate minority discount was 25%.
252 As has been seen, Mr Shulman included "the private companies status of the Group", "the potential illiquidity of a 5% ownership interest in the Group" and "the other factors noted pertaining to the Group's operations" in his 51% to 53% discount of his average US derived multiple. Just what percentage discount was allowed for each factor was not made clear.
253 Mr Churchill said in cross-examination that he had not specifically addressed the question of whether a further minority discount should apply to Mr Hosking's shareholding. He agreed that in order to do that he would need to know whether there was any significant market for such a 5% minority parcel in a private company, and whether there was a shareholder agreement covering matters such as dividend policy. He agreed that the cumulative effects of these matters could be very substantial.
254 Mr Churchill agreed that a 30% discount for lack of negotiability or tradeability of the 5% shareholding and that a further discount of 15% for lack of voting rights and existence of governing director were reasonable.
255 In the circumstances, I consider that there should be a discount for the minority interest nature of the plaintiff's 5% interest and for non-negotiability or illiquidity. The appropriate discount, in my opinion, is the 30% figure suggested by Mr Edwards and Mr Churchill.
256 However, I do not consider that there should be any further discounts. The suggestions that there would be a governing director or that the shares would not carry voting rights cannot sit, in my opinion, with the decision that Mr Hosking's shares or units would have to have been issued on the same basis as the other holdings.
Calculation of the Plaintiff's 5% Equity in the Ipex Group
257 In making the final calculation of the plaintiff's 5% equity in the Ipex Group, there remains the issue of the capital reserve distribution and the beneficiary loans. In my opinion, the most appropriate way to take this into account is to follow the calculations used by Mr Edwards in his valuation set out in paragraph 151 above.
258 As a result of the above, it seems to me that the plaintiff's 5% equity in the Ipex Group should be calculated as follows:
2002 reported earnings $ 8,842,000
Less interest on surplus cash $ 1,026,000$ 7,816,000
Less deferred service contract revenue in 2002 $ 5,600,000
$ 2,216,000
Plus other adjustments to 2002 earnings $ 797,000
$ 3,013,000
Multiplied by EBITA multiple 6.5
$19,584,500
Plus cash balance $25,922,000
$45,506,500
Less other beneficiary loan accounts $ 1,637,000
$43,869,500
Plus tax benefit on beneficiary loan interest $ 252,000
$44,121,500
Plus investment in Nexus Energy $ 40,000
$44,161,500
Divided by 20 for 5% interest $ 2,208,075
Less 30% minority interest discount $ 662,422.50$ 1,545,652.50
Given the approximate nature of this calculation I propose to award the plaintiff damages of the rounded amount of $1,545,650.
Orders
259 Once the parties have had the opportunity to consider those reasons, I will hear submissions on the questions of interest and costs.
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