RILEY & RILEY - [2016] FamCA 535

FAMILY COURT OF AUSTRALIA

RILEY & RILEY

[2016] FamCA 535

FAMILY LAW – PROPERTY SETTLEMENT – Valuation of a business as a going concern – hearing on a discrete issue by agreement – where there were two competing expert valuations leading to significantly different valuations after an unsuccessful attempted sale of the business – net tangible assets valuation preferred.

Evidence Act 1995 (Cth), s 140
Family Law Act 1975 (Cth), ss 79, 79(2), 79(4)

Bevan & Bevan (2013) FLC 93-545; [2013] FamCAFC 116
Georgeson & Georgeson (1995) FLC 92-618; 19 Fam LR 302
Harrison & Harrison (1996) FLC 92-682; 20 Fam LR 322
Hull & Hull (1983) FLC 91-360
Lenehan & Lenehan (1987) FLC 91-814; 11 Fam LR 615
Mallet v Mallet (1984) 156 CLR 605
Nettler & Nettler [2007] FamCA 1374
Nettler & Nettler [2009] FamCAFC 185
Reynolds & Reynolds (1985) FLC 91-632; 10 Fam LR 388
Sapir & Sapir (No 2) (1989) FLC 92-047
Scott & Scott [2006] FamCA 1379
Spencer v Commonwealth (1907) 5 CLR 418
Stanford v Stanford (2012) 247 CLR 108
Turnbull & Turnbull & Ors (1991) FLC 92-258; 15 Fam LR 81
Wilde & Wilde [2007] FamCA 1044

APPLICANT:

Mr Riley

RESPONDENT:

Ms Riley

FILE NUMBER:

MLC

9926

2011

DATE DELIVERED:

1 July 2016

PLACE DELIVERED:

Melbourne

PLACE HEARD:

Melbourne

JUDGMENT OF:

Thornton J

HEARING DATE:

3, 4, 7, 8, 9, 10, 15 and 16 March 2016

REPRESENTATION

COUNSEL FOR THE APPLICANT:

Mr Jeremy W St John QC
Mr Thomas A Hutchings

SOLICITOR FOR THE APPLICANT:

M A Legal

COUNSEL FOR THE RESPONDENT:

Mr Andrew G E Robinson

SOLICITOR FOR THE RESPONDENT:

Mills Oakley Lawyers

Orders

The value of the business of the company Riley Pty Ltd is $909,356.

IT IS NOTED that publication of this judgment by this Court under the pseudonym Riley & Riley has been approved by the Chief Justice pursuant to s 121(9)(g) of the Family Law Act 1975 (Cth).

FAMILY COURT OF AUSTRALIA AT MELBOURNE

FILE NUMBER: MLC 9926/2011

Mr Riley

Applicant

And

Ms Riley

Respondent

REASONS FOR JUDGMENT

The applicant husband and the respondent wife are in dispute about the alteration and valuation of their interests in the property acquired during their 15 year marriage. The key issue is the valuation of the business of Riley Pty Ltd (“the Company”) in which they are equal shareholders.
Because of the large amount of money already expended by the parties on legal costs in litigation leading up to the trial, the parties jointly proposed that the Court determine the discrete issue of the valuation of the business of the Company. This was with a view to the parties ultimately negotiating and attempting to settle the other issues relating to the alteration of property. Therefore the only current issue for determination is the value of the business of the Company.
As a result of previous litigation and Court orders, the parties jointly formally engaged accountant Mr S to attempt to sell the business of the Company from 18 December 2013. Despite a number of parties expressing interest during the sale attempt, there were ultimately no offers received for the purchase of the business. Mr S’s services as selling agent concluded on 21 April 2014 and the husband has continued to work as the managing director of the Company.
The husband is the sole director of various companies within a group of entities known as the Riley Group which includes the business of the Company. The Company is a business engaged in acquisition and importation. The Company sources products overseas and in Australia. The Company is a wholesaler and sells to the servicing industry, including manufacturers and re-packagers. The husband has been operating the Company on a full-time basis for the last 13 years.
It is common ground that the wife has taken no part in the management of the business since its inception, either during the marriage or following final separation in November 2010.
There are a number of real properties registered to trusts which are part of the Riley Group and there is agreement between the parties as to the valuation of those properties.
The former matrimonial home, where the wife resides, is R Street, Suburb W (“the Suburb W property”) and is registered in her name. The farm where the husband resides, is comprised of two properties at South Gippsland (“the South Gippsland properties”) registered to Riley Pastoral Pty Ltd, a trust company of the Riley Group.
Each party engaged a chartered accountant to value the business of the Company and the accountants conferred and produced a Report, referred to in the proceedings as the Second Joint Report of Experts (Exhibit C1). The difference in valuation between these experts is approximately $1.7m.
The husband engaged chartered accountant Mr A. The wife engaged chartered accountant Mr K. There is no challenge to the expertise of either accountant.

Background

The parties were married in 1995 and finally separated in November 2010; the husband vacated the former matrimonial home in December 2010. The husband is aged 50 years.
The wife is aged 55 years and is engaged in home duties. She resides with the three children of the marriage in the former matrimonial home. This property is registered in her name and encumbered with a mortgage funded through the parties’ loan accounts from the Company.
Although the wife deposed that she did work for the Company at various times, she has primarily been working at home caring for the children. For about 18 years, since the birth of the eldest child, she has been employed in minimal paid work. She deposed that since late 2013 she has been seeking paid work and is currently employed as a casual sales assistant. The wife has no control over the Company.
The substantive matter commenced by way of an Initiating Application filed by the husband on 8 November 2011, seeking final orders for a property division between the parties.
Mr S was engaged to sell the business when the husband changed his position on the first day of a previously listed trial and proposed that the business be sold rather than retained by him.
There has been considerable further delay resulting from the fact that the parties were unaware of tax implications and accounting issues which arose and which required expert accounting advice.

The Riley Group

Riley Pty Ltd (“the Company”) was registered on 14 November 2001 and the parties were and are equal shareholders. The husband is the sole director.
The following companies and trusts were created on accounting advice:
·       Riley Property Trust, a discretionary family trust, was created by Deed of Trust dated 31 July 2003. The trustee is the Company.[1] The expert witnesses agree that the value of the Riley Property Trust is $1,078,159.
·       Riley Investments Pty Ltd was incorporated on 12 May 2004. It is the trustee company for Riley Investments Trust (the “Investments Trust”).
·       N Pty Ltd (“N”). The expert witnesses agree that the value of N is a loss of $66,980.
·       Riley Trading Trust, a discretionary family trust, was created by Deed of Settlement dated 1 June 2004. The trustee is the Company. The husband and the wife are appointors of the Riley Trading Trust.
·       Riley Pastoral Pty Ltd was incorporated on 19 May 2005. The parties are the only directors and equal shareholders. This company became the trustee of a further discretionary trust, the Riley Pastoral Trust, subsequently created by Deed of Trust.[2] The small cattle farm where the husband resides is on the South Gippsland properties, which are registered in the name of Riley Pastoral Pty Ltd (as trustee of the Riley Pastoral Trust). The expert witnesses agree that the value of the Riley Pastoral Trust is $551,542.
[1] Husband’s trial affidavit filed 19 August 2015 at paragraph 38.
[2] Ibid at 40.

Evidence

The documents relied upon by the parties are listed in Annexure A to this judgment and were admitted into evidence after rulings were made on objections. However, the documents relied upon by the parties in their Case Outlines were not reviewed when the proposal to proceed only with the litigation of the discrete issue was adopted.

The valuation dispute

The valuation of the business of the Company is at the heart of the dispute. Both accountants approached the valuation of the business on the basis of capitalisation of future maintainable earnings at the outset.
The husband relies upon the valuation of chartered accountant, Mr A. Mr A ultimately adopted a net asset methodology based on a going concern and rejected an Earnings Before Interest, Tax and Amortisation (“EBITA”) methodology. [Amortisation was not a relevant factor in issue between the expert accountants, and there were references to “EBITA” and “EBIT” methodologies as if they were essentially interchangeable for the purpose of the trial]. Mr A was of the opinion that the earnings based approach produces an insufficient rate of return on Net Operating Assets and therefore the appropriate methodology for valuation of the business is not the EBIT methodology but the value of the Net Operating Assets of the business. After conferring with Mr K, his opinion was unchanged and he valued the business of the Company at $909,356.
The wife relies upon the valuation of Mr K. Mr K maintained the capitalisation of future maintainable earnings approach, adopting an EBITA methodology. Ultimately after conferring with Mr A he valued the business of the Company at $2,686,467, being the midpoint in a range.
A significant difference in the approach of the accountants was the treatment of the Company’s trade creditors and finance arrangements.

The procedure adopted as jointly proposed by the parties

The parties agreed on the procedure to be adopted for the trial. To ensure an efficient hearing of the dispute I acceded to their joint proposal. The evidence was confined to the issue of the valuation of the Company.
It was agreed that the husband would be cross-examined by counsel for the wife about the conduct of the business and attempted sale of the business. It was agreed that the accountant who was previously engaged to sell the business of the Company, Mr S, would be cross-examined by counsel for the husband about the husband’s role in the sale process. It was agreed that the accountant expert witness for each of the parties would be cross-examined about the valuations they had produced. Each of those witnesses were cross-examined. The expert witness for the wife was chartered accountant Mr K and the expert witness for the husband was chartered accountant Mr A. The expertise of Mr K and Mr A to give evidence as expert witnesses was unchallenged.
During the course of preparation for previous trials, Mr A had compiled a number of reports. Mr A’s valuation reports referred to in this trial were:
·the First Report dated 13 August 2013;
·the Second Report dated 18 September 2013;
·the Third Report dated 23 April 2014; and
·the Fourth Report dated 6 August 2015.
During the course of preparation for previous trials, Mr K had prepared a number of reports. Mr K’s valuation reports referred to in this trial were:
·the First Report dated 21 August 2013; and
·the Second Report dated 26 August 2015.
Mr K’s Third Report dated 30 September 2015 was a report regarding the loan accounts of the business.
Both experts conferred and compiled a Second Joint Report of Experts dated 21 September 2015 (Exhibit C1) (the First Joint Report was not relied upon for this trial).

Standard of proof

In determining the facts, I have applied s 140 of the Evidence Act 1995 (Cth), which is the civil standard of proof. Where I have made findings, I am satisfied that the facts have been proven on the balance of probabilities.

The husband’s case regarding the valuation of the company

Concerning the unsuccessful attempted sale of the business, it is the husband’s case that he discussed all significant operation decisions with representatives of the selling agent and did not otherwise act in his management of the business in any way contrary to the opinion of the selling agent in order to ensure its optimal marketing and sale price.[3] The husband claims that “there is no value ascribed to goodwill in the marketplace and the only value that should be ascribed to the business” is the value of “its net tangible assets.”
[3] Husband’s case outline filed 23 February 2016 at paragraph 19.
The husband relies upon the report of Mr A where he “deposes that the future maintainable earnings methodology is not appropriate to value the business as it produces an insufficient return on the required net operating assets to identify and measure goodwill”.[4] He further relies on Mr A’s most recent report where he concludes that the value of the Company is $909,356 on a net tangible assets basis as at 30 June 2015. He relies on Mr A’s expert opinion that it is inappropriate to use a future maintainable earnings methodology because the working capital required to run the business is disproportionate to the profitability, or return received on investment.[5] (The husband emphasised that the net tangible assets of the Company vary significantly from time to time due to the variations in the stock held by the Company at any given time and the variations in the prevailing exchange rate.)
[4] Ibid at 13.
[5] Mr A’s view summarised by the husband in the husband’s case outline filed 23 February 2016 at paragraph 17.

The wife’s case regarding the valuation of the company

The wife’s case regarding the valuation of the business of the Company is contained in her Case Outline as follows:
1.      [Mr K] has applied both in his current report and in all previous reports, the orthodox valuation method of capitalisation of future maintainable earnings (FME).
2.      In his most recent report [Mr K] uses an FME of $900,000 (revised to $820,000 in the joint report) and a range of capitalisation rates between 3.0 and 3.5. On that basis, [Mr K] concludes that the value of the business is between $2,460,000 and $2,870,000 and the value of the [Riley Trading Trust] at between $2,481,467 and $2,891,467.
3.      Mr A has applied both in his current report and in all previous reports, the same orthodox valuation method as [Mr K] (capitalisation of future maintainable earnings).
4.      In his most recent report, [Mr A] uses an FME is [sic] $722,869 and a range of capitalisation rates between 3.0 and 3.5. On that basis, [Mr A] calculates that the value of the business would be $2,350,000.
5.      However, in his most recent report [Mr A] determines that the orthodox valuation method is not appropriate because he says it provides insufficient return given the Net Operating Assets of the business. [Mr A] therefore departs from the orthodox valuation method and applies the Net Assets approach.
6.      Mr A does so by determining the Net Operating Assets of the business at $6,990,386 and he says that the normalised EBIT does not provide sufficient return on those assets. However, in determining the Net Operating Assets at $6,990,386, [Mr A] has excluded Trade Creditors of $5,813,269. This creates an artificially inflated value of the Net Operating Assets.
7.      If the Trade Creditors were treated by [Mr A] as part of the Net Operating Assets of the business, the normalised EBIT would provide sufficient return on the Net Operating Assets of $1,172,883.
8.      The approach adopted by [Mr K] was to include Trade Creditors as part of the Net Operating Assets of the business, resulting in his valuation of the [Riley Trading Trust] being determined by application of the capitalisation of future maintainable earnings method.
9.      It is inappropriate to exclude the amounts recorded in the balance sheet as Trade Creditors from the assessment of Net Operating Assets, the consequence of which is an artificially low valuation of $909,356.
10.    The Court should conclude that the appropriate methodology is capitalisation of future maintainable earnings.
11.    The Court should prefer or accept [Mr K's] opinion as to the value of the [Riley Trading Trust].
It is also the wife’s case that the failure of the business to attract an offer for purchase is not indicative of a lack of any value. Implicit in her case was a suggestion that the husband had not fully cooperated in the process of sale because he had indicated to the selling agent that he would only stay for a period of six months once the business was sold, thereby indicating that he was not prepared to continue to work in the business for the duration of what might be considered a reasonable or ideal transition period.

Legal principles

Section 79 of the Family Law Act 1975 (Cth) (“the Act”) provides for the discretionary alteration of property interests between the parties to a marriage. Under s 79(2) of the Act, an order cannot be made unless it is just and equitable in all the circumstances.
In Bevan & Bevan (2013) FLC 93-545 at 87,232, the Full Court of this Court considered s 79 of the Act and set out the three fundamental propositions in relation to this section which the High Court of Australia laid down in Stanford v Stanford (2012) 247 CLR 108. These are as follows:
1.      Determination of a just and equitable outcome of an application for property settlement begins with the identification of existing property interests (as determined by common law and equity);
2.      The discretion conferred by the statute must be exercised in accordance with legal principles and must not proceed on an assumption that the parties’ interests in the property are or should be different from those determined by common law and equity;
3.      A determination that a party has a right to a division of property fixed by reference only to the matters in s 79(4), and without separate consideration of s 79(2), would erroneously conflate what are distinct statutory requirements. (original emphasis)
In applying those principles, the parties’ legal and equitable interests in property must first be identified. In this case, by agreement between the parties, I am determining only the value of the business of the Company as part of the first step in the process of identifying the existing property interests.

Evidence of the husband

The evidence of the husband is as follows.
The Company primarily engages in acquisition and importation from overseas and local producers to wholesalers, processors and re-packers. It does not engage in retail sale. Virtually all of the products are imported from outside Australia.
The husband engages in sales negotiation with the most important Australian clients but his primary role within the business is the acquisition and importation of overseas products.
In order to avoid the need for substantial long-term cash deposits as security for the increased line of bank credit necessary to meet the financial requirements of the Company, the husband decided to acquire additional real property which he reasoned would have the advantage of higher investment return.[6]
[6] Husband’s trial affidavit filed 19 August 2015 at paragraph 36.
Since approximately 2013, the Company has operated an AUD$5 million credit facility, Westpac Trade Finance (‘WTF’), with the Westpac bank. In cross-examination the husband said that this is secured by a fixed and floating charge on the Company as well as being secured on the real properties at South Gippsland, 4 Z Street, Suburb U and the stock in trade. The credit facility is a ‘market to market’ facility – that is, a facility expressed in Australian dollars (“AUD”) based on the prevailing daily US dollar (“USD”) exchange rate against the Australian dollar. Nearly all the imported food products are purchased in USD, and if the USD value appreciates against the AUD, more Australian currency is required to meet USD contracts. Thus, the value of the AUD in relation to the USD is of some significance to the business.

In order to minimise risk against the USD, the husband arranges protection in the form of “forward exchange contracts, smart forward and ratio forward contracts.” This comes at a financial cost. The business also now bases its sales on the daily exchange and must constantly amend prices to reflect replacement cost of the product.
The husband claims that declines in profits have been attributable to factors including:
·       currency variation;
·       reduced margins caused by increasing product stock of certain products (despite increases in gross sales in the 2014-15 period);
·       client reluctance to buy or commit to long forward sales contracts and preferring product acquisition on short notice at set prices for set quantities for six to twelve months “locked in”, with the ability to draw down on stock;
·       clients beginning to unilaterally extend terms of payment – the industry standard was settlement within 30 days end of month in previous years, whereas now periods of 60 days end of month are routinely imposed, causing additional costs;
·       increased warehousing costs as a result of the Company’s warehousing facilities supplier going through a financial crisis that resulted in a need for price increases;
·       the uncertainty of reliable forward sales, the fixed costs and the risks (including currency variation) associated with forward contracts to purchase overseas stock resulting in the husband pursuing fewer such contracts despite their merits and greater potential to generate profit.
The husband claims that to keep the Company financially viable, he has reduced fixed costs and focussed on core product lines. He did not actively replenish the stock that had been underperforming for some time. The funds from this reduction were applied to reduce the WTF, as required by the bank. The husband has also taken other measures to maintain profitability including buying imported product at the time of harvest, working with a more affordable warehousing distribution facility, reducing his own salary and reducing staff. In his latest affidavit, the husband deposes to having to retrench his sales manager and deposes that sales personnel will reduce from four to two within 12 months.
Because of the high capital cost of importing and stocking product, a substantial line of credit is essential to the Company’s ability to trade. This is because a substantial proportion of the Company’s suppliers require pre-payment or security for payment when exporting containers to Australia and the cost per container load can be quite high, averaging around USD$125,000.
In addition to the Company’s AUD$5 million credit facility with Westpac, the Company has a credit facility of USD$1.5 million with Toyota. The husband in cross-examination explained that the Toyota credit facility was secured by way of an unlimited director guarantee with the husband as guarantor.
Despite holding forward exchange contracts at higher levels than the prevailing rate, and despite having previous established USD loans, the fall in the AUD in the 12 months preceding July 2015 resulted in the Company breaching its WTF AUD$5 million limit on a number of occasions. No additional funds were available for trading until the outstanding liabilities were within WTF limits.
The husband anticipates a further decline in the value of the AUD, and says that the Company will shortly take additional cover for the next six months to minimise its exposure.
The husband remains concerned that any payment required for the property settlement sought by the wife will result in the reduction of assets to secure the credit for the business which will impact on the capacity of the Company to trade.
The husband claims further that the unsuccessful attempt to sell the Company has resulted in the initial loss of two large clients. He claims that these clients mentioned the attempted sale during discussions about renegotiating ongoing product sales and they were concerned about security of supply. One of those clients is still transacting business with the Company albeit on a substantially smaller scale, and no contracts have arisen with the other client.
In his latest affidavit,[7] the husband deposes to an ongoing decline in gross profit of the Company. He attributes this to the following factors in no particular order of priority:
·       the vacillations and overall decline in value of the Australian dollar;
·       ongoing reductions in available credit (both to the Company and its customers);
·       substantial price fluctuations, or large increases, in the cost of core products;
·       general market uncertainty and depressed trading;
·       further competition in the marketplace; and
·       the erosion of market confidence in the Company arising from its attempted sale.
[7] Husband’s updating affidavit filed 4 February 2016.

Letters of Credit

Mr K essentially comments in the Second Joint Report of Experts that he assumed that the Company utilised letters of credit but understood, after conferring with Mr A and compiling the Second Joint Report of Experts that the Company instead, used finance provided by a financial institution.
Mr K, in his comments in the Second Joint Report of Experts dated 26 August 2015, expressed the opinion that the utilisation of letters of credit in the business of the Company would be a cheaper financing solution than the use of a finance facility. It was his opinion that this financing option might be used by a prospective purchaser.
The husband deposes that he has not utilised letters of credit as a financing option for the purposes of the business of the Company for about 10 years.[8] He is of the view that the utilisation of letters of credit is a more expensive financing option with disadvantages that do not apply to the existing trade finance facilities operated by the Company. The husband filed a detailed affidavit on 20 October 2015 about the disadvantages he perceived in utilising letters of credit. It is unnecessary to outline the finer details of the reasons why he does not use letters of credit as it was not ultimately disputed that the Company uses the institutional financing facility outlined by the husband.
[8] Husband’s affidavit filed 20 October 2015 at paragraph 20.
In cross-examination the husband confirmed that in his opinion, the utilisation of letters of credit as a facility for the purpose of the business would be a more expensive proposition than his current finance facility. This is because of the transaction fees on each transaction, the costs associated with establishment and negotiation, the timing of interest being charged by the bank, and an additional factor concerning the timing of the payment, which amounts to the funds being quarantined by the bank for a total of 60 days.
In cross-examination the husband confirmed the credit arrangements for the Company being an AUD$5 million credit facility with Westpac bank, and a USD$1.1 million credit facility with Toyota. He also referred to a $10 million Westpac facility in relation to foreign exchange cover which was “hand in hand with the import and trade facility”. He stated that he could not book forward transactions unless he had a foreign exchange facility in place. He agreed that he could effectively book up to $10 million of contracts to purchase money being foreign exchange contracts.[9] The evidence regarding the use of this facility was not clear but the focus of the trial centred on the Company’s financing arrangements by way of the AUD$5 million Westpac bank credit facility and the USD$1.1 million credit facility with Toyota.
[9] Transcript of proceedings of 8 March 2016 at pages 4-5.
The husband denied in cross-examination that he had any detailed discussions with the Westpac bank about his capacity to borrow for the purposes of the property settlement. He acknowledged that he had discussions about the fact that the parties were significantly apart regarding the value of the net pool of property and that should the wife retain the Suburb W property he would need $550,000 to pay the mortgage to provide her with clear title. He acknowledged that the Suburb W property was not part of the security for the $5 million trade facility.
In cross-examination the husband also conceded that he had not investigated whether he could obtain any further credit from Toyota. He conceded that it was a unique trading facility from Toyota which relied upon only a personal guarantee. However, he pointed to the interest rate being charged by Toyota as between 8.2 and 8.5 per cent. He noted that the interest charged by Westpac varies but is between 3.5 and 3.8 per cent.
The husband agreed in cross-examination that he had paid legal costs of $920,000 through the loan accounts of the Company and conceded that if he had not paid that money, it would have remained in the business. When asked whether the payment of legal fees has had a significant impact on the business, he conceded that it did “to a degree” and that the money used to pay legal costs would otherwise have been used to purchase stock.
The husband deposed to borrowing money from his brother in late November 2014 to assist the Company in paying down the Westpac trade finance facility. He deposed that this was because the value of the Australian dollar decreased significantly resulting in the business exceeding the Westpac trading facility limit.[10] He was cross-examined about loans from his brother of AUD $500,000 and $100,000. The latter loan was, according to his evidence under cross-examination, borrowed in or about late August or early September 2015. His evidence was that he had repaid the $500,000 loan over six months but the $100,000 loan remains outstanding. He stated that this was not a financing option but a last resort when there was a problem due to circumstances beyond his control and was taken to avoid the penalties which apply if he is outside the credit limit. He stated that he did not want to involve his brother in business propositions.
[10] Husband's trial affidavit filed 19 August 2015 at paragraph 137.
As to his cooperation with the unsuccessful attempted sale of the business the husband maintained that the selling agents had not asked him to attend meetings with prospective purchasers given the stage of negotiations reached; the husband indicated that he would have been willing to attend any such meetings had the selling agents considered it appropriate.
The evidence of the husband on this point was ultimately consistent with the evidence of Mr S.

Evidence of Mr S

The wife relies upon the evidence of the accountant who was engaged to sell the business of the Company, Mr S.[11] The evidence of Mr S was that, in his experience, in order to maximise the sale value for a business such as the Company, it was fundamental for the husband to undertake to prospective purchasers his willingness to remain in the business, at a commercially negotiated salary, for a period of two years as a minimum and for the husband to be restrained from working in the industry for a minimum of three years. It was his opinion that the continued involvement of the husband was crucial to ensure the transfer of intellectual property and to achieve the maximum sale value or any sale at all. This expert opinion was unshaken in cross-examination and conceded on the evidence of the husband.
[11] Affidavit of Mr S filed 18 September 2015.
In his affidavit, Mr S deposed that he discussed the concept of employment continuity for at least two years with the husband and that “this concept was included in communications to potential buyers, to which Mr Riley subsequently objected.”[12] Mr S deposed that:
[Mr Riley] did not expressly tell me he would agree to continue in the business for 2 years, but I had discussed and originally understood that [Mr Riley] was genuinely prepared to undertake the usual business arrangements to ensure a sale of the business to maximise the value achieved.[13]
[12] Affidavit of Mr S filed 18 September 2015 at paragraph 4.
[13] Ibid at 6.
In cross-examination he maintained that in original discussions with the husband he definitely discussed the two year employment period and at no point did the husband say three to six months. He went on to say that on or about 23 April 2014, the husband made it clear that he would only stay for a period of six months and that his recollection was “very clear on that”.
Mr S deposed that it was a necessary part of the sale process for him to put forward the expected minimum conditions as the vendor’s agent to maximise the prospect of achieving a sale. He deposed:
The circumstances that [Mr Riley] was not able to meet with interested purchasers and I was not able to stipulate any firm conditions as to period of employment after sale decreased the likelihood of achieving an offer of sale for the business. No offers were received.
In cross-examination Mr S conceded that the husband had not been asked to meet with any prospective purchasers and that another representative of his firm, Mr Wong, was conducting the ongoing discussions with the husband. He conceded that there was a strategy of providing a “teaser” for prospective purchasers which did not refer to the period of time the husband would be involved in the transition of the business but this was then followed up with more detailed proposals which included a reference to the two year period. He confirmed that the strategy of his firm in consultation with the husband was that the husband not meet with any prospective purchasers until there was an offer in writing. No offer in writing was ever received.
Mr S acknowledged in evidence that “the most significant aspect that affected the likelihood of a sale” was the period of the husband’s transitional employment, and that the circumstances that the husband was not able to meet interested purchasers was of “less relevance”. In cross-examination he conceded that “he didn’t mean” that the husband refused to meet interested purchasers, and stated that such meetings “just never happened as part of the process”.
He was cross-examined about an email of 23 April 2014 (Annexure PJR 29 of the husband’s affidavit filed 20 October 2015) which referred prospective purchasers to a two year transition period for the husband in the business. It is the wife’s case that the failure of the husband to commit to a two year transition period in the business decreased the likelihood of achieving an offer of sale for the business.
However the evidence of Mr S was that he could not recall whether the prospective purchasers were contacted and informed that the two year transition period had been retracted. He agreed that there was no record in the file of any communication of any sort retracting that proposition and conceded that if there was no copy of an email in the file then it was unlikely that such an email was sent. He agreed that the husband was cooperative in all respects in the proposed sale of the business apart from the matter of the transition period.

Evidence of Mr A

Chartered accountant, Mr A, on behalf the husband, completed four reports for the purposes of litigation between the parties since 2013. His First Report was not relied upon by the parties. However for context it is necessary to explain that in his First Report dated 13 August 2013 he adopted a future maintainable earnings methodology (“FME”) to value the business of the Company. In his First Report, Mr A concluded as at 30 June 2013 that the value of the Company was $3,137,476. In arriving at that valuation he adopted a capitalisation rate reflective of the observable risks in the industry and the risks identified that are specific to the business. He adopted a raw multiple range and further adjusted this multiple range after considering specific business risk factors. He ultimately adopted a multiple range of 1.50 to 3.00 times EBIT with a midpoint of 2.25 times EBIT.[14]
[14] First Report of Mr A dated 13 August 2013 at paragraph 84.
Mr A changed his approach in his Second Report (dated 18 September 2013) and by the time of his Fourth Report (dated 6 August 2015), ultimately moved to value the Company at $909,356 adopting a net asset based methodology based on a going concern.
In preparing the Fourth Report, Mr A attended the Company premises, interviewed Mr D, the husband and relied on the financial statements prepared by Q Consulting and the previous accountants.
In his Fourth Report, Mr A noted that the Company utilised two trade loans: a facility with Westpac of approximately AUD$5 million and another with Toyota of approximately USD$1.5 million.[15]
[15] Fourth Report of Mr A dated 6 August 2015 at paragraph 35.
He noted that because of the husband’s strong relationship with business suppliers and customers, the Company continues to trade on open accounts with some suppliers and customers. [16]
[16] Ibid at 37.
After considering a number of business risk factors, Mr A adopted a capitalisation rate of between 3.0 and 3.5 times EBIT with a midpoint of 3.25 times EBIT.[17]
[17] Ibid at 86.
In his Fourth Report, Mr A calculates the EBIT for the years 2011 through to 2015 and provides an adjusted EBIT for each year. He then concludes that to determine the future maintainable earnings of the Company, it is appropriate to rely on the adjusted EBIT for only the financial years 2013 to 2015. His explanation for this is as follows:
·     It is highly unlikely that the underlying trading economic conditions, which influenced the gross profit margin to increase during the 2009 to 2011 financial years will reoccur. Accordingly, it is reasonable to assume that the gross profit margins experienced during the 2013 to 2015 financial years will reflect a more accurate gross profit margin in the foreseeable future.
·     The husband has advised that trade terms with suppliers have shifted away from forward contracts and/or long positions. As Riley & Co [the Company] are restricted to negotiating the purchase of short positions, this does not allow the business to take on the risk of fixed prices over a longer period in anticipation of favourable market and economic conditions as experienced during the 2009 to 2011 financial years.
·     The enterprise value of Riley & Co [the Company] will be overvalued if the adjusted EBIT for the 2011 or prior financial year is relied upon.[18]
[18] Ibid at 20.
At paragraph 89 of his Fourth Report, Mr A refers to a number of adjustments to the book value of assets and liabilities which at June 2015 were reported in the balance sheet of the Company at $6.99 million. Included in those adjustments was an adjustment for the trade facilities with Westpac and Toyota which were allocated as a non-operating liability. Mr A states that the Company has insufficient strength in its balance sheet for the finance facilities to be secured by operating assets because he was instructed by the husband that these facilities have been secured over real property held by related entities and by the husband in his own name.
Mr A’s opinion after making adjustments and allocation considerations was that:
…the business generates a normalised EBIT that produces an insufficient rate of return on net operating assets to identify and measure goodwill. As a result of this outcome, I am of the opinion that the earnings valuation approach is not the appropriate method to value the business. Accordingly, I have valued the business on the net operating assets of the business.[19]
[19] Fourth Report of Mr A dated 6 August 2015 at paragraph 90.
In the Second Joint Report of Experts dated 21 September 2015, Mr A explains the reasons for adopting that methodology. He states the following:
The impact on earnings when interest is not adjusted or added back is substantial and material to the valuation and the valuation methodology to be adopted. The FME on the 2013 to 2015 average is only $390,782. As debt is now included in the valuation of the business, the capitalisation rate would also decrease materially. Adding $6 million of interest bearing debt into the valuation process increases the risk on the balance sheet significantly. Consequently, the multiple or capitalisation rate would be closer to 2.25 time [sic] earnings rather than 3.25 (midpoint between 3.0 and 3.5) on an ungeared basis. The inclusion of interest and debt as part of the value of the business will relegate the business value to be less than the net assets of the business. When the business net assets are greater than the assessed value of the business, the business and the equity should be valued on a net asset basis.
The proposition that the value of the business does not exceed the net assets required to operate the business is supported by the unsuccessful attempts by Mr S to sell the business on the open market … Mr S was unable to attract a purchaser at a price that included goodwill.[20]
[20] Second Joint Report of Experts dated 21 September 2015 at page 4.

Assumptions of the husband relied upon by Mr A

Mr A relied on the advice of the husband that the husband no longer expected the Company to enter into forward contracts or purchase long positions as a hedging mechanism against movements in foreign exchange and commodity prices.[21] Mr A relied upon the husband’s assertion that suppliers were averse to being exposed to the risks of forward contracts and long positions. Accordingly, he accepted that the husband expects the purchase of short positions of approximately 3 to 4 months from suppliers to continue in the foreseeable future.
[21] Fourth Report of Mr A dated 6 August 2015 at paragraph 38.
The husband was challenged on this matter in cross-examination. It was asserted that the information relied upon by Mr A was at odds with a statement in the husband’s affidavit to the effect that factors including “the uncertainty of reliable forward sales, the fixed costs and the risks, including currency variations, associated with forward contracts to purchase of overseas stock” led the husband to choose to reduce the quantity and value of forward purchase contracts of his own accord.[22] The husband appeared to suggest that forward purchase contracts were an issue for reasons both of supplier reluctance and his own reluctance, but ultimately conceded that the avoidance of forward purchase contracts was primarily his decision because of the risks of default.
[22] Transcript of proceedings of 8 March 2016 at page 32.
Mr A also accepted the advice of the husband that the market was:
…tighter causing customers to increase the volume of purchase orders and reduce the quantity of each purchase order. In doing so, customers reduced the risk of carrying excessive inventory. Accordingly, this is expected to further increase warehousing and logistic costs for the business.[23]
[23] Fourth Report of Mr A dated 6 August 2015 at paragraph 39.
The husband advised Mr A that competition within the market will continue to increase[24] and that there are now approximately 11 competitors in the marketplace compared to approximately 4 large competitors in 2001.[25] The husband was not challenged about this.
[24] Ibid at 40.
[25] Ibid at 30.
The husband advised Mr A that the trading of products in the foreseeable future will be assessed; he advised that this assessment will be necessary given that the nature of trading in such products led to increased storage costs of these products because of the nature of trading in them.[26] The husband told him that he had rationalised the business down to 15 core lines. This was because the estimated “cost of holding and handling in the … business is 2 to 3 times” that of the bulk the allied business. Whilst there were issues raised about figures not provided to Mr K about the stock which had been sold, the husband was not challenged about this matter.
[26] Ibid at 41.
I note that in cross-examination, the husband’s evidence about the reduction of the products referred to about 20 to 25 core lines rather than 15 but there were no submissions about this discrepancy and nothing would appear to turn on this particular detail. The husband’s responses to questions about this issue were confusing and at times unhelpful.[27]
[27] Transcript of proceedings of 8 March 2016 at page 37.
The relevant further facts and assumptions relied upon by Mr A for his valuation of the Company are detailed at page 11 of his Fourth Report. They are as follows:
·     The Company will continue to operate within the Australian economy as a going concern into the foreseeable future.
·     The Company will continue to source and purchase products from international markets as well as monitor the product range of condiments. The Company will continue to sell products to wholesalers, packagers and retailers.
·     Given the operating nature of the Company, the business will continue to be exposed to several economic and market risks including foreign exchange, commodity prices and interest rate risks.
·     Given the husband’s knowledge and expertise within the industry, the Company will continue to rely on the husband’s close relationships with suppliers and customers in order to remain competitive in the marketplace. Accordingly, the Company is highly reliant on the husband.
·     Mr A accepted the husband’s advice that it is highly unlikely the Company will be able to negotiate forward contracts or purchase long positions (as occurred during the 2009 to 2011 financial years) in the foreseeable future. For valuation purposes he assumed that the Company will be restricted to negotiating the price of short positions (as occurred during the 2012 and 2015 financial years).
·     Given the likelihood that the underlying trading terms and economic conditions influencing the gross profit margins experienced during the 2009 to 2011 financial years will not re-occur, it is highly probable that the gross profit margins experienced during the 2014 and 2015 financial years will reflect the gross profit margins in the foreseeable future.
·     This assumption is supported by the trend in the value of the Australian dollar against the US dollar during the financial years ending 2003 to 2013. (Appendix five of the report graphs the value of the Australian dollar against the US dollar for this period.) Accordingly, the value of the Australian dollar against the US dollar surged during the 2009 to 2011 financial years by $0.2548 or 34.24 per cent. The value of the Australian dollar was driven by the mining boom and growth in the resources sector of the Australian economy. Since this time, the resources sector is no longer in the growth phase causing the value of the Australian dollar to fall against the US dollar. At the time of valuation, one Australian dollar was worth $0.75 USD.
·     The husband did not receive market-based remuneration for his respective position and role performed in the business during the 2011 to 2015 financial years.
·     For valuation purposes, all fixed assets recorded on the Riley Trading Trust balance sheet as at 30 June 2015 are to be taken and read as market value in the absence of an independent valuation.
·     The Company paid market based rent during the 2011 to 2015 financial years. In the absence of the current rental agreement with regard to the trading premises, Mr A assumes that the Company will be able to renegotiate an extension on lease terms in the foreseeable future.
·     The Company will continue to rely on real property owned by related parties as collateral in order to maintain trade loan facilities with Westpac.
·     The Company operated profitably during the 2006 to 2015 financial year period. It is assumed that the Company will continue to operate profitably in the foreseeable future, based on the business trading history.
Mr A was asked why he chose to focus, in his analysis of the business, on the period of the past 3 years, rather than selecting a longer period of time as Mr K had done. He explained in re-examination that when he visited the premises of the Company and spoke with the husband and the financial controller of the Company, Mr D, he discussed the issue of the AUD as against the USD and how that related to long term positions for purchasing materials or product from overseas. This brought to mind, for him, the issue of how to treat the business over time. He sought out a Reserve Bank document outlining the exchange rate of the USD and AUD over the last 20 years, including the “abnormal” years of 2009-2011 and possibly 2012. These conditions combined with the long positions in the Company’s purchase contracts resulted in “a very abnormal level of gross profit”. He referred to p 15 of his Fourth Report, to the graph with revenue and gross profit margin identifying the extraordinary 2009-2012 conditions. He did include 2013 in his analysis, even though, according to Mr A, the AUD was around a level greater than 90 US cents, and was at 15 cents more than the long term average.
Mr A’s opinion was that if the 2009-2012 period was included, a lower multiplier for the capitalisation rate should be applied to identify the risk of maintaining (or the risk of failing to maintain) that level of profitability into the foreseeable future.
Mr A was firm in his evidence that, whereas debt in relation to trade creditors subject to ordinary non-interest trade-bearing terms should be considered part of the net operating assets of a business,[28] the debt for the Westpac trade finance facility should not be included as part of the net operating assets for the purposes of calculating the business’ EBIT.
[28] Transcript of proceedings of 10 March 2016 at page 7.
Cross-examination of Mr A did not result in any change of opinion and he was unshaken in his evidence.

Evidence of David K

The wife relied upon two reports prepared on her behalf by chartered accountant Mr K. These reports were referred to as the Second and Third Reports of Mr K. The evidence in the trial was focussed on the Second Report which included Mr K’s valuation of the Company. Mr K also made comments in the Second Joint Report of Experts (Exhibit C1) compiled by both experts.
Mr K had prepared an earlier report which was referred to as the First Report and this was dated 21 August 2013. The Second Report was dated 26 August 2015. The First and Second Reports contained a valuation of the Company. The Third Report was dated 15 September 2015 but dealt with the parties’ loan accounts.
For context only, in his First Report, which was not relied upon specifically for this hearing because it was overtaken by later reports, Mr K relied upon financial statements for the year ended 30 June 2013. He pointed out that he did not have access to the husband or any employees of the Company from whom he might have sought clarification of any matters or obtained any information in relation to the business operations, and the wife was not able to assist in this regard. He relied upon information that was available from public sources or information that was recorded in the husband’s affidavit material sworn 26 July 2013.[29]
[29] First Report of Mr K dated 21 August 2013 at paragraph 22.
Under the heading “Appropriate methodology” in his Second Report, Mr K records that he completed the valuation of the Company “with reference to the fair market value standard, separately assessing the value of the Business and the surplus assets and liabilities.”[30] He assessed the value of the business by application of the capitalisation of future maintainable earnings method in accordance with the instructions provided and assuming, among other things, the following factors:
·     The value to the owner standard would be principally the same as the value by application of the fair market value standard;
·     He had not been provided with any documentation to suggest that there existed a ‘special purchaser’ or that the value of the entities or Business would be more than fair market value;
·     He had not been provided forecast financial information; and
·     He had not been provided with any documentation to suggest that the entities are not a going concern and on that basis applied the going concern practice of valuation.[31]
[30] Second Report of Mr K dated 26 August 2015 at paragraph 3.2.
[31] Second Report of Mr K dated 26 August 2015 at paragraph 3.2.
At paragraph 4.18 c of his Second Report, Mr K notes the following:
I have treated amounts recorded as trade creditors by the Trading Trust as being related to the operation of the Business. I understand that these liabilities are subject to financing arrangements such that they are supported to ensure that the position of trade creditors is guaranteed, however it is my opinion that these arrangements do not impact on my opinion that trade creditors should be treated as a liability related to the operation of the Business.
Using a capitalisation of future maintainable earnings methodology and a capitalisation rate of between 3.0 and 3.5, Mr K valued the business of the Company as a going concern as follows:
· Second Report 26 August 2015 - a midpoint of approximately $2,925,000 (between $2,700,000 and $3,150,000);
· After conferring with Mr A in the Second Joint Report of Experts 21 September 2015 – a midpoint of approximately $2,686,467 (Low $2,481,467 and High $2,891,467

Cross-examination of Mr K

In cross-examination, Mr K conceded that a weakness of his analysis was the fact that he did not have access to the husband to ask him questions about the business and admitted that he could not recall if he had made any attempt to speak to the husband. He acknowledged that he relied heavily upon the report of Mr A, who set out the background in relation to the business. He maintained that he had read the affidavits of the husband but conceded that they were not listed in appendix B of his report which outlined the documents he relied upon; he said that this failure to list the affidavits was an error.
Mr K said that in his valuation he was not able to consider whether there should be an adjustment to the reported earnings for the negative impact of the sell down of slow moving stock because he was not provided with the relevant information. I accept on the basis of the chain of emails in Exhibit 5 that Mr K was not provided with this information regarding part of the business (being discounted sales of slow-moving stock and the costs and storage costs in the financial year 2014 and 2015). When asked how he could factor this in, given he didn’t have any real understanding of what happened in relation to this part of the business, Mr K said “while I couldn’t make specific adjustments to the individual years where that stock was sold, I did consider it as a factor in determining whether I applied an average over a longer period of time or an average over a shorter period of time.”[32] Mr K conceded that the lack of this information was a further weakness in the preparation of his report.
[32] Transcript of proceedings of 10 March 2016 at page 67, lines 21-24.
Mr K conceded that he had not conducted any retrospective analysis of the AUD versus the USD. He stated that the AUD has been very volatile over a number of years, certainly the last five or six years but had been particularly volatile during the period in relation to which the review of earnings had occurred. He conceded that he did not have the expertise to give an opinion about the future of the currency but that in his EBITA analysis he had done his best to forecast what would happen in the foreseeable future in terms of this business based on what had happened historically.
Ultimately Mr K conceded that Mr A was “at a great advantage” because Mr A had a lot of discussion with the husband and the Company’s financial controller, Mr D, about the forward contracts and the movement in the AUD. He conceded that the greater the information available, the more “beneficial and helpful in terms of the valuation assessment”.[33]
[33] Ibid at page 72.
Mr K conceded that importers of product into Australia in general have volatile earnings as a consequence of the impact that the foreign exchange has on business. He conceded that he had no specific experience in an industry similar to that of the Company but that he had researched businesses in the industry from “public available information.” He made reference to IBIS reports but conceded that they were not outlined in the appendix of his report which referred to the information he relied upon. He ultimately said that he did not refer to “those reports in specifically preparing this report”.[34]
[34] Ibid at pages 76-77.
He maintained that his capitalisation of future maintainable earnings methodology anticipated earnings for the foreseeable future, being a period of 5 to 10 years. He confirmed that for this he had relied “on the basis of what’s happened over the previous 5 to 10 years”.
Mr A had produced two documents incorporating two tables to demonstrate the approach to future maintainable earnings. These were Exhibit E describing EBIT and Exhibit F describing Earnings Before Tax (“EBT”) which were admitted into evidence. Exhibit E set out that:
For business valuation Purposes: The operating balance sheets must be consistent with the definition of earnings.
Earnings or profit is defined as profit before interest and tax. This means that the operating balance sheet should only include assets and liabilities that are used to generate EBIT. All other assets and liabilities are surplus to generating EBIT.
Exhibit F set out that:
For business valuation Purposes: the operating balance sheet must be consistent with the definition of earnings
Earnings or profit is defined as profit before tax. This means that the operating balance sheet should only include assets and liabilities that are used to generate EBT. All other assets and liabilities are surplus to generating EBT.
In cross-examination Mr K agreed with the EBIT and EBT analysis outlined by Mr A in Exhibits E and F.[35] In re-examination he conceded that Exhibits E and F involved another method of analysis that could be engaged in to value a business. He pointed out that this would be a valuation of the business where interest-bearing loans are incorporated as part of the operating liabilities. He said that in other words, “it’s an earnings before tax,” not an earnings before interest and tax which incorporated the loans as part of operating liabilities and any interest associated with those facilities would also be incorporated as an expense of the business in determining value. He also pointed out that the likelihood is that there would be a different assessment in terms of the capitalisation rate.
[35] Transcript of proceedings of 10 March 2016 at pages 78-79.
In cross-examination Mr K was asked if he agreed that the costs associated with letters of credit were in fact greater than the costs associated with the trade finance facility in place and he responded “quite possibly”.[36]
[36] Transcript of proceedings of 15 March 2016 at page 93.
Mr K was asked about Mr A’s evidence that amongst a number of errors the critical error made by Mr K was the inclusion of “trade facilities” as a liability in the balance sheet when he performed the EBIT analysis. Mr K did not admit that this was a critical error. He was asked whether the methodology fails if the EBIT number is capitalised at an appropriate rate and does not exceed the net operating assets. His response was “it doesn’t fail, it indicates that the value somebody would pay on an earnings basis is, in fact, less than what somebody would actually pay for the tangible assets.” He went on to effectively agree that in those circumstances he would adopt the net tangible assets methodology.[37]
[37] Transcript of proceedings of 10 March 2016 at pages 78-79.
In cross-examination Mr K conceded that if calculating on an EBIT basis, it was appropriate for the trade finance facility to be treated as a loan, but denied this was a fundamental change in his position. He was asked:
Now, if we just take a simplistic timeline in our mind as to how [Riley] & Co trade, when they receive an invoice from a supplier as yet unpaid, at that point you would say most certainly that supplier is a trade creditor, would you not? -- Assuming that the actual stock has passed title, one would assume the invoice is issued either at the time or after the ownership of the goods is transferred – yes, that’s correct.
But the moment [Riley] & Co draws on its trade finance facilities, they’re no longer a trade creditor, are they?--- That’s correct – legally.
And from an accountancy point of view?--- If the accounts---
For the purposes of your valuation?--- For the purpose of preparing accounts, it should then be treated as a loan.
Yes?--- That doesn’t necessarily – that’s the way it’s treated in the books by [Riley] & Co.
No. No. So in the books – in the [Riley] & Co books, it says trade creditors; yes?---Correct.
And if it was treated as a loan, you would agree that when you’re doing the EBIT analysis, it should then be disregarded, as it were?--- If you’re assessing on the basis of EBIT, yes.
So with your understanding now, having read [Mr Riley’s] affidavit about letters of credit and your discussions with [Mr A], do you agree that the nature of the way [Riley] & Co trades means that that trade finance facility or facilities ought more properly be characterised as a loan?--- Your Honour, that’s correct if you assess on the basis of EBIT.
So you, I imagine, are conceding that [Mr A’s] analysis on an EBIT basis is correct?--- On an EBIT the basis, yes.
And this is a fundamental shift, isn’t it, from you and the evidence you’re giving now from the joint report and from your affidavit of August last year?--- No.
But you most certainly in your affidavit, when you do your balance sheet for your EBIT analysis in your second report, deduct the trade finance facility?---Correct.
And that’s on the assumption that it is reflective of trade creditors?--- And its – and it’s financed through security, either in the form of letters of credit or the trade finance facility securing its – as I understood the trade finance facility at the time.
Yes, but you now understand it better; is that right?--- Correct.
And that that assumption is, in fact, not correct?---Correct.
Therefore the methodology you applied when you deducted the “trade creditors”– is not right?--- If you assume the only method by which to fund the trade creditors is through the trade finance facility, that’s correct.
Well, you can only value [Riley] & Co as ]Riley] & Co trades, can’t you?--- No. I’m valuing the business on the basis of – upon which a potential purchaser of the business would assess the value.
And when you discussed that in the joint report, you come up with letters of credit as being the ultimate method of trading that you would imagine that a purchaser might utilise?--- It’s one of the methods, yes.
Well, you don’t identify any other methods, do you?--- No, not in the joint report.[38]
[38] Transcript of proceedings of 15 March 2016 at pages 93-95.

When referred to the balance sheet at Appendix F of his Second Report at page 43, Mr K agreed that he had deducted the amount of 6,205,000, which represented the trade creditors, in determining his valuation. However, in understanding that the Company actually uses a trade facility and that this figure does not represent trade creditors, he appeared to accept that this figure should not be deducted in the balance sheet for the Company if valuing the Company on an EBIT basis.[39]
[39] Ibid at pages 96-97.
In cross-examination he accepted the basic proposition that where the “EBIT number” is capitalised at an appropriate rate and a number is reached that does not exceed the net operating assets, the net assets value should be adopted. He stated that this would indicate that “the value somebody would pay on an earnings basis is, in fact, less than what somebody would actually pay for the tangible assets … So therefore the value should be the tangible assets”[40].
[40] Transcript of proceedings of 10 March 2016 at pages 78-79.
Regarding the same point on another day in his cross-examination Mr K appeared to accept the same proposition.[41]
[41] Transcript of proceedings of 15 March 2016 at page 98.
This cross-examination appeared to effectively agree with Mr A’s opinion about the general principle of moving to a net assets valuation where the future maintainable earnings figure is less than the net operating assets.
However, in re-examination Mr K maintained that the net assets methodology is not the correct method for valuing this business.
In re-examination about the EBIT he said the following:
So my view… Is that with a trade finance facility in place, this business would be valued by a potential purchaser and equally by the seller of the business on the basis of the costs associated with operating the trade finance facility, be it incorporated in the assessment of EBIT, to be EBIT adjusted for the cost of the trade finance facility, and then, on that basis, the amount of the trade finance facility would be incorporated… as part of the operating liabilities.[42]
[42] Transcript of proceedings of 15 March 2016 at page 119.
In re-examination he clarified that a prospective purchaser of the business might utilise four options to finance trade creditors; cash by way of capital, letters of credit, a trade finance facility or by the payment of creditors at a higher price to enable longer payment terms.[43]
[43] Ibid at page 118, lines 25-40.
Mr K stated that he believed it was likely that a potential purchaser acquiring this business would put in place one of either a letters of credit facility or a trade finance facility. He acknowledged that he focused on the option of the letters of credit and allocated the costs associated with that particular form of finance in his valuation. He went on to say “Equally, you could value the business based on EBIT adjusted for the costs associated with the trade finance facility.”
In the Second Joint Report of Experts, Mr K stated that the fees for the utilisation of letters of credit would be substantially less than the rate of interest payable on a finance facility.[44] However, the effect of his cross-examination was that he had no cause to doubt the husband’s business prudence and that it was possible that the husband was correct in his assertion that there were cost disadvantages in using letters of credit rather than a trade credit facility.[45]
[44] Second Joint Report of Experts dated 21 September 2015 at page 5.
[45] Transcript of proceedings of 15 March 2016 at pages 15-16.

The second joint report of experts

Both experts conferred and produced a Second Joint Report of Experts dated 21 September 2015 (Exhibit C1). This report highlighted the differences of opinion between the experts.
Mr K revised his EBITA and produced a table of adjusted EBITA. His reasons for the revised assessment of adjusted EBITA were not entirely clear. His commentary under the heading “Assessment of adjusted EBITA” is confusing. He comments:
[Mr K] commented that as he understood the finance facilities of the [Company] they were facilities in place to secure payments to suppliers and not in the form of actual finance provided by the financial institutions. In these circumstances, the importer pays the supplier of goods in accordance with normal terms, between 30 and 60 days, but payment to the supplier is secured by a financial institution. These arrangements with financial institutions are called ‘Letters of Credit’.
In circumstances where this method of securitising purchases is applied, the liability to suppliers would be recorded as trade creditors in the balance sheet of the entity, which is the treatment of the trade facilities by the [Company].
This is the basis upon which [Mr K] has observed the vast majority of importation businesses operate and is the basis upon [Mr K] would expect any potential acquirer of the business operated by [the Company] would trade.
…
[Mr A] is correct when he says that in circumstances where this method of supplier payment structure is in place it is necessary to make allowance for the costs associated with the structure. [Mr K] notes that it is his experience that these costs are generally incorporated into the cost of purchasing stock for an entity that applied this methodology.
On the basis that that this is not the approach taken by [the Company], but is the approach that [Mr K] would expect a potential purchaser to apply, [Mr K] agrees that there should be an allowance for the additional costs associated with the use of Letter of Credit. However [Mr K] also observes that the cost of this form of security is substantially less than the interest being paid by [the Company] and from his experience would expect to the cost attributable to Letters of Credit to be between 0.35 per cent and 0.75 per cent of the total purchase amount. In extreme cases the cost could be approximately 1.0 per cent of the total purchase amount. On the basis of an expectation that not all supplier would require for their acquisitions, [Mr K] has made an adjustment to EBITA based on an additional cost of 0.5 per cent of the purchase cost.[46]
[46] Second Joint Report of Experts dated 21 September 2015 at page 5.
Mr K in the Second Joint Report of Experts goes on to explain his own opinion as follows:
… Based on the revised assessment of adjusted EBITA, [Mr K] has assessed future maintainable earnings as approximately $820,000.
…
On the basis of the revised assessment for future maintainable earnings, which adjusts for the costs associated with the provision of Letters of Credit, [Mr K] opines that it is appropriate to 100 per cent of the amount recorded in the balance sheet to be included as liability related to operation of the business and not as a part of debt of applied by [Mr A].[47]
[47] Second Joint Report of Experts at page 7.
Under the heading “Impact of change on the valuation of [the Company]”, Mr K revises his assessment of the value of the Company and states that he has “adjusted the assessed value for related party loans, loans with the Parties and employee entitlements payable to the Husband such that there is a consistent approach to that applied by [Mr A].”[48] Mr K produces a table with an assessment of enterprise value which refers to future maintainable earnings with a figure of 820,000. Applying a capitalisation rate of 3.00 for low and 3.50 for high, he attributes a ‘Business value’ of a low of 2,460,000 and a high of 2,870,000. The table makes a ‘Comparison to net tangible business assets’ and then provides an equity value, ultimately concluding that the value of the Company is a low figure of 2,481,467 and a high figure of 2,891,467.
[48] Ibid.
He ultimately appeared to maintain his opinion that an EBIT valuation was the proper approach but made some adjustment related to the costs of finance which was related to letters of credit. He maintained that the value of the business of the Company was a midpoint of $2,686,467.
Mr A maintained his opinion that a valuation using net asset based methodology based on a going concern basis was appropriate and that the value of the Company was $909,356.
A key difference between experts was the treatment of the interest expense of the business. Mr K was of the opinion that “it is a fundamental error to deduct 100 per cent of the interest expense in circumstances where part of the expense does not relate to the financing facility in question.”[49] His analysis was based on the assumption that any potential purchaser of the business would utilise letters of credit, rather than a banking institution, as a financing facility.
[49] Ibid at 6.
Mr A in the Second Joint Report of Experts was of the opinion that there is a critical error in Mr K’s approach because “In [Mr K’s] report, debt is included in the business valuation and not excluded as required by a pre interest valuation model.” He regards this error as “fatal to the credibility of the report.” Mr A maintains that “If [Mr K] was to include debt as a business or operating liability, he must also include interest incurred as an expense to form the FME. This would bring consistency between the definition of earnings and the balance sheet. On this basis, the level of profit after interest but before tax would be substantially different”. On his calculations, Mr A is of the view that “the inclusion of interest and debt as part of the value of the business will relegate the business value to be less than the net assets of the business. When the business net assets are greater than the assessed value of the business, the business and the equity should be valued on a net asset basis.” Mr A was also of the view that “the proposition that the value of the business does not exceed the net assets required to operate the business is supported by the unsuccessful attempts by [Mr S] to sell the business on the open market. …. [Mr S] was unable to attract a purchaser at a price that included goodwill.”[50]
[50] Second Joint Report of Experts at page 4.

Submissions for the husband

Essentially counsel for the husband pointed to deficiencies in the analysis and valuation of Mr K, submitting that the analysis undertaken by Mr A was superior and more informed because of the information obtained from the husband and in particular the information about the treatment of trade creditors. Counsel for the husband emphasised that there was no evidence from either expert witness or from Mr S that the husband had done anything other than manage the business prudently and efficiently since separation. He emphasised that the business had continued to generate profit in a challenging industry and foreign exchange environment.
He submitted that the evidence did not support the wife’s case that the attitude of the husband in specifying a limited time for him to remain in the business after a sale of the business had been responsible for the unsuccessful attempt to sell the business. He emphasised the lack of any contemporaneous file notes in the files relating to the sale attempt to support Mr S’s assertions, together with Mr S’s concession that a general strategy had been adopted that there would be no face-to-face meeting until an indicative offer had been received from the prospective purchaser. He also relied upon the lack of evidence that the husband’s complaint about the length of the transition period was ever communicated to prospective purchasers.
Counsel for the husband also relied upon the evidence of Mr S from the transcript of a previous hearing, where he acknowledged that the selling process was “a focused one within the industry and that in his opinion it would be very difficult to obtain an offer for the business in the general commercial market because of the highly specialised nature of its operations”.(Exhibit B) He also relied upon the evidence of Mr S that all potential purchasers had been approached and exhausted and that realistically the end of marketing had been reached and there was no point in further advertising on a wider market.
Counsel for the husband referred to the concessions made by Mr K in cross-examination at the outset that Mr A had more information available to him when preparing his report and that it was beneficial and helpful for valuations to be based on more information rather than less.
Counsel for the husband submitted that Mr K’s analysis and ultimate conclusion as to the earnings of the business were seriously lacking and flawed for the following reasons:
·   He had included earnings in years characterised by an exchange rate (AUD to USD) which was a one in 35 year event;
·   He had included years where the Company was able to take advantage of the favourable exchange rate because of the use of “forward contracts”;
·   The profit margin of the business had been in steady decline;
·   The earnings of the business had not been the equivalent of, or exceeded, either of the figures arrived at by Mr K for the last three years (being $900,000 in Mr K’s Second Report and $820,000 in the Second Joint Report);
·   The analysis used to arrive at both figures for the earnings of the business appeared to be different.[51]
[51] Outline of husband’s closing address at paragraph 41.
Counsel for the husband relied on the concession of Mr K in cross-examination that, in circumstances where the balance sheet of the business being valued indicates that the net operating assets of the business exceed the ‘value’ on an EBIT analysis, the valuer must revert to the net tangible assets. He submitted there is no goodwill value in the business. He emphasised that the figure of net tangible assets of $909,356 calculated by Mr A was agreed in evidence by Mr K.
Counsel for the husband also relied upon Mr K’s concession that the amount recorded in the Company’s balance sheet for “trade creditors” ought to be disregarded as Mr A had done in his Fourth Report.
Counsel submitted that the failure apparent in the report and analysis of Mr K was his presumption of a likely reliance upon letters of credit as a financing arrangement made in error because he had not obtained the correct information from the husband as to the financing arrangements for the Company.
Counsel for the husband submitted that the lack of any offer to purchase the Company significantly buttressed Mr A’s conclusion that the business has no saleable goodwill and that the appropriate methodology for valuation of this business is net tangible assets. He emphasised Mr K’s concession that, were the Court to find that the marketing of the Company for sale had not been impeded by the husband, this would tend to indicate there was no goodwill in the business.

Submissions for the wife

Counsel for the wife referred to a number of cases which he contended stood for the following principles:
·   There is no fixed rule in the Family Court for the methodology for determining the value of shares[52] or other property or commodities.[53]
·   The standard for the determination of a fair price for a business is generally that which a hypothetical prudent purchaser would pay a not over anxious vendor who desired to purchase it for the most advantageous purpose for which it was adapted. In this regard counsel referred to Nettler & Nettler [2009] FamCAFC 185 at [28], which identified this as the guiding standard in relation to the valuation of land, as articulated in Spencer v Commonwealth (1907) 5 CLR 418.
·   The fact that a business does not sell need not be taken as indicative of the value of shares of a business; the test laid down in Spencer v Commonwealth can only be applied where there is a ready market, and is “of no application” in a case where a market is lacking.[54] The fact that a business may be unsellable – that the value of its shares may be unrealisable through sale – does not necessarily render it valueless.[55]
·   The value to a hypothetical prospective purchaser is not necessarily the relevant figure when evaluating the value of shares in private companies in a family law context, and in fact this is an entirely inappropriate approach in a family law context.[56] The value to the owner, and the reality of that value, is the relevant figure,[57] and commercial valuation methods are not necessarily appropriate in a family law context, as the commercial valuation of shares in a proprietary company will not necessarily be reflective of the value to the spouse[58] (or other family member). In a family law property valuation context, shares in a company are valued differently depending on the value of the shares to each shareholder; the value is determined by considering, among other things, the shareholder’s relationship with the company and thus the different forms of benefit the shareholder can derive from the shares.[59] The value must be a realistic value, the reality of the worth to the shareholder party.[60]
·   Where a business is a long running business and there is no reasonable or realistic evidence to show it is to cease operations, it makes sense to look to the future maintainable earnings to determine the value of the business unless it is found that the net tangible assets are greater. Counsel relied on the decision of Scott & Scott [2006] FamCA 1379 at [55]. Counsel also relied on Georgeson & Georgeson[61] where capitalisation of future maintainable earnings was considered the most appropriate methodology for valuing certain shares in a business, because the business was an active trading entity.
·   It is necessary to look to the best value to which the business would be put. If a better value for a business is to be found by taking certain actions or viewing the business a certain way, then that is the valuation to be preferred. Counsel referred to the case of Nettler & Nettler,[62] suggesting that the judge at first instance in that case, in preferring the valuation derived by selling a business’ loan book rather than a valuation based on future maintainable earnings, was preferring the valuation methodology arrived at by considering the best value that could be derived from the business in the circumstances of that case. At first instance, the judge referred to the principle that it is most appropriate to refer to the “highest and best use” of an asset when its value is being determined, and the endorsement of this principle in numerous cases.[63]
·   The role of a judge is more nuanced than accepting one expert’s wholesale view or another’s. A judge can accept part of an expert’s view without accepting the entirety of the expert’s view,[64] and, in considering the evidence and coming to their own conclusions, is not necessarily under any obligation to accept the evidence of one expert witness about a matter relevant to a valuation merely because they have rejected the evidence of the other.[65] A judge can (and must) come to their own conclusions about valuation evidence,[66] including about whether a method of valuation is an appropriate one in the circumstances of a case,[67] and is to do so “by the application of established principles of valuation”.[68]
·   Referring to obiter comments by Mason J in Mallet v Mallet, counsel for the wife stated that there can be a risk, in examining methods of valuation, of losing sight of the true object of the exercise of valuation, which is to ascertain the real value of the shares, and focusing instead on the means of achieving that object.[69]
·   Counsel for the wife referred to the Court’s comments in Lenehan & Lenehan that “in ordinary circumstances the vendor’s borrowings are irrelevant” and are not a matter that a hypothetical purchaser would take into account, and “the question of the value of that business … is to be calculated independently of those factors, otherwise it would mean the value of the business would vary depending upon the particular circumstances of the individual vendor”.[70]
[52] Georgeson & Georgeson (1995) FLC 92-618 at 82,218.
[53] Hull & Hull (1983) FLC 91-360 at 78,410.
[54] Ibid
[55] Scott & Scott [2006] FamCA 1379 at [45], [74]; Hull & Hull (1983) FLC 91-360 at 78,410.
[56] Turnbull & Turnbull & Ors (1991) FLC 92-258 at 78,737.
[57] Scott & Scott (above) at [45], [74], referring to Reynolds & Reynolds (1985) FLC 91-632, Turnbull & Turnbull & Ors (above), and Harrison & Harrison (1996) FLC 92-682.
[58] Reynolds & Reynolds (above) at 80,111.
[59] Georgeson & Georgeson (1995) FLC 92-618; Harrison & Harrison (1996) FLC 92-682 at 83,087; see e.g. Scott & Scott [2006] FamCA 1379 at [45].
[60] Harrison & Harrison (above) at 83,087; Turnbull & Turnbull & Ors (1991) FLC 92-258 at 78,738.
[61] (1995) FLC 92-618.
[62] [2009] FamCAFC 185.
[63] Nettler v Nettler [2007] FamCA 1374 at [60]-[61].
[64] Wilde & Wilde [2007] FamCA 1044 at [173]; Lenehan & Lenehan (1987) FLC 91-814 at 76, 146; see also Sapir & Sapir (No 2) (1989) FLC 92-047 at 77,542.
[65] Lenehan & Lenehan (above) at 76,146.
[66] Wilde & Wilde (above) at [170], [173]; Scott & Scott (above).
[67] Georgeson & Georgeson (1995) FLC 92-618 at 82,218.
[68] Wilde & Wilde [2007] FamCA 1044 at [173].
[69] Mallet v Mallet (1984) 156 CLR 605 at 627.
[70] Lenehan & Lenehan (1987) FLC 91-814 at 76,146.

In the context of these principles, counsel for the wife submitted that it was appropriate to value the Company in terms of its value to the owner, rather than its value at sale, and that a valuation on the basis of future maintainable earnings rather than net tangible assets was appropriate given that the value of the Company to the husband derived from the fact that the business was a going concern and the husband derived benefits from the business well in excess of the salary he received, as demonstrated by the loan account movements captured in Mr K’s 15 September 2015 report. Counsel for the wife submitted that, when in the husband’s hands, the business is worth substantially more than its plant and equipment.
Counsel submitted that a valuation that excluded the bank debts while including the assets derived from those debts was an illusory valuation, given that, if the business operated by way of the suppliers extending trade credit directly, they would be included in the calculations as trade creditors.
Counsel submitted that Mr A’s rejection of the future maintainable earnings model in his Fourth Report amounted to following rules without regard to the actual reality of the Company, as any prospective purchaser acquiring the Company would require financing capacity behind them to the tune of around $900,000 in order to run the Company, but would be receiving a “good deal” if they were able to draw a salary and draw on lendings to the same degree as the husband. Counsel characterised Mr A’s exclusion of the trade finance facility as a “triumph of method over reason”.
Counsel for the wife noted the Company’s increased sales, including the exponential revenue increase over the last financial year from roughly AUD$26 million to roughly AUD$33 million, and noted that regardless of risks faced by the Company, the husband had been adept at managing such risks and causing the business to thrive.
Counsel for the wife criticised Mr A’s reports on a number of bases, suggesting that the theme of risk recurs throughout the reports because Mr A was, as the husband’s expert, attempting to minimise the value of the Company, and that Mr A took various steps to keep the valuation of the Company low in each report. Counsel pointed to the capitalisation rate in Mr A’s First Report, which counsel characterised as “markedly low”; the approach taken in the Second Report of considering the business in terms of a collapse and thus moving to a net assets-based evaluation while raising the capitalisation rate; the approach taken in the Third Report of again anticipating collapse due to a decline in trading and the failure to sell the Company at the time; and, in the Fourth Report, the exclusion of the trade finance facility.
Counsel for the wife submitted that Mr K had been constant in his reports regarding the appropriate method for determining future maintainable earnings, and that there was a choice in terms of how one might calculate the average. Counsel also submitted that Mr K had taken a broad view in relation to the business’ earnings over the years considering a number of different averages including averages with longer and shorter year ranges and ultimately coming to a synthesised figure representing the future maintainable earnings of the business, whereas Mr A, in considering only the more recent years, had attempted to minimise the impact of the Company’s particularly strong earning years, thus taking a shorter view and a more negative view.
Referring to Mr K addressing different financing options for the Company in his section of the Second Joint Report of Experts, counsel for the wife submitted that regardless of financing choices, the same methodology adopted by Mr K should be preferred.
Counsel for the wife submitted that it was appropriate for the Court to decide on the correct capitalisation rate, and that the figure given in Mr K’s Second Report, or the figure given by Mr K in the Second Joint Report of Experts, should be the figure used, as to use Mr A’s figure gives a figure less than the lowest figure one could get by selling the assets and assessing the Company’s trading as having no value, which was not a conclusion that should be comfortably drawn.
Counsel for the wife pointed out that, on the husband’s evidence, he has not discussed with the bank in any real detail the possible ways to restructure the Company’s finance in the event that a judgment debt must be paid.
Counsel for the wife submitted that the risks inherent in the financing of the Company outlined by Mr A in his First Report had not changed, that similar risks were outlined in his Fourth Report, and that these risks therefore do not explain the change in the capitalisation rate.
It was the wife’s position that the Company’s value to owner must be greater than the value of the net tangible assets, and that this supports preferring the future maintainable earnings figure as the value to owner. Counsel for the wife submitted that counsel for the husband produced no authority for the assertion that the net tangible assets methodology was sometimes used to value going concerns.

The approach

Valuation is an inexact science. The determination of the valuation is essentially a matter for the trial judge. The task here is to determine the valuation of the Company scrutinising and weighing the evidence as a whole including the husband’s evidence and in particular making an independent assessment of the expert witnesses, Mr A and Mr K, and of their approaches in order to reach an independent conclusion.
Ultimately, as I understand the submissions for the wife, which were clarified at the end of closing submissions, I am not being urged on the evidence here to find a different valuation from that of either expert. Each party argues for a finding which prefers the valuation of their own expert.
The expertise of both expert witnesses was not challenged. Both experts undertook their valuation in a professional manner. I am not bound to accept or prefer one expert over the other if there is evidence which on the balance of probabilities would support a different valuation by the proper application of established principles of valuation. However where there are competing methodologies for the valuation of the business, in exercising my discretion I am also entitled to prefer the evidence of one witness over another.[71]
[71] Scott & Scott [2006] FamCA 1379.
The issue as to whether the husband’s conduct impeded the attempted sale of the business is a matter for a finding on the facts applying the standard of proof referred to earlier.

Findings

I am satisfied on the balance of probabilities that the husband has continued to manage the business of the Company prudently and efficiently since separation. I am satisfied on all the evidence that the Company operates in a manner consistent with maximising profits. I am satisfied that the business continues to generate a profit.
Regarding the attempted sale of the business, I find that the husband followed the instructions of the selling agents until all avenues of potential sale were exhausted. The evidence of Mr S in cross-examination was ultimately consistent with the evidence of the husband. The husband did not agree to the two year transition period recommended by Mr S but preferred a six month period. There is no evidence that any period other than a two year transition period was communicated to any potential purchasers.
I find on the balance of probabilities that the husband’s proposal to commit to remain in the business for a six month period rather than two years was never communicated to the remaining prospective purchasers from April 2014. Thus it cannot be inferred that the conduct of the husband impeded the sale of the business. As Mr S conceded in re-examination, the prospective purchasers were advised of a two year transition period involving the husband and Mr S could not give evidence that this was retracted. There is no evidence that the husband was ever expected to meet with prospective purchasers at the stage of negotiations reached and thus no evidence that he obstructed the marketing process or made the business less appealing by failing to meet with prospective purchasers.
I do not accept that the husband’s conduct has adversely impacted on the attempted sale of the business.
I accept Mr S’s expert opinion that all prospective purchasers of the business had been approached in the course of the marketing period, that all potential purchasers had been exhausted and that realistically there was no point in further advertising on a wider market.[72]
[72] Transcript of proceedings of 28 April 2014 (Exhibit B) at pages 23, 29 (line 44), 32 (lines 30-45).
To the extent that it may have been asserted, I do not make the assumption that the fact that the business did not sell indicates or proves definitively that it has no value.
The business of the Company operates in an international environment. The very nature of the importation business means that foreign exchange rates are an important factor. Because the business involves importation of overseas product, the finance arrangements and the interest paid on borrowings are essential expenses of the business. I accept the evidence of the husband that trade finance is essential because of the nature of the overseas operation of the business and the demands of creditors overseas together with delays in transportation which may result in higher financing costs.
I find that the importation aspect of the business of the Company and the environment in which it operates are volatile because of the movements in the value of the AUD against the USD. I find that the business does not operate using letters of credit but has a trade finance facility with Westpac bank for AUD$5 million and a credit facility with Toyota of USD$1.5 million. There was no challenge to the husband’s evidence that letters of credit are not utilised as a financing arrangement for the purposes of the business of the Company.
I accept the evidence of the husband that he reluctantly resorted to borrowing significant sums from his brother because the trade finance facility was close to its limits. However, he repaid some $500,000. This is an example of the difficulties in managing both changes in the exchange rate and late delivery of shipments which impact on the finance arrangements.
I find that Mr A had a significant advantage over Mr K because his valuation was informed by more detailed information from the husband and the financial controller of the Company, Mr D, about the operation of the Company and the use of the trade finance facility. Mr K conceded that a weakness of his analysis was the fact that he did not have access to the husband to ask him questions about the business and he could not recall if he had made any attempt to speak with the husband.
I find Mr A to be a credible witness who had carefully analysed the operations of the business and had the advantage of being in possession of the information about the trade finance facilities utilised by the Company. Although his pessimism about the value of the Australian dollar against foreign currency must be regarded as speculative, it was based upon his consideration of the Reserve Bank currency movements for the last 20 years.[73]
[73] See transcript of proceedings of 10 March 2016 at pages 42-43.
I find the evidence of Mr A to be thoroughly researched. I accept the reasons provided by Mr A in his evidence for his change of opinion from his earlier reports (which were not relied on) to his Fourth Report as to the treatment of trade creditors. I accept that this was largely brought about by the further information obtained in detailed discussions with the husband and the financial controller, Mr D, about the operation of the business. Mr A’s opinion was unshaken in cross-examination. I accept the opinion evidence of Mr A about the treatment of trade creditors and the adjustments that should be made. This was to some extent ultimately conceded by Mr K.
I find that Mr K made an error in failing to list both the affidavits of the husband which were available at the time and the IBIS research in appendix B of his Second Report as material he relied upon in preparing his report. His evidence about this was not entirely clear because he ultimately acknowledged that he did not necessarily specifically rely upon the IBIS research in the Second Report. The affidavit of the husband filed 20 October 2015 provides detailed information which was not available to Mr K about the reasons why the husband does not utilise letters of credit when conducting import purchases for the business and has not done so for the last 10 years. I find that Mr K’s valuation is based upon an assumption that letters of credit are used by the Company as a financing option when in fact this is not the case. Even when Mr K became aware of the nature of the trade finance facility it is unclear in his comments at page 5 of the Second Joint Report of Experts as to the nature of the adjustment he made. I do not doubt the professionalism of Mr K or his accounting expertise but I found some of his responses and explanations in cross-examination to be ambiguous and lacking in clarity.
I find that Mr K’s valuation was restricted by lack of information as to the sale of underperforming stock of the business. I am satisfied that he made a reasonable number of attempts to obtain this information without success and that he ultimately proceeded to value the business without the information. It is apparent that there were a number of emails exchanged about this information but that Mr K concluded that it would not be provided. However, I accept that there were further emails from the accountant for the Company seeking a response from Mr K about any other information he required, to which Mr K conceded he did not respond. Although Mr K took into account that there was a negative impact on profitability as a consequence of the sell down of slow moving stock during the 2014 and 2015 financial years, he stated in his Second Report that he had not been provided with sufficient specific information to reach a conclusion on the impact.[74] Mr K conceded in cross-examination that the lack of this information was a further weakness in the preparation of his report.
[74] Second Report of Mr K dated 26 August 2015 at paragraph 4.8.
I accept the criticisms of Mr K’s analysis and conclusion outlined by counsel for the husband. In the Second Joint Report of Experts at page 6, Mr K states that he “assessed future maintainable earnings with reference to the real average of earnings for the previous four years which approximated the assessed weighted average earnings.” Based on the revised assessment of adjusted EBITA, Mr K assessed the future maintainable earnings as approximately $820,000.
I accept the evidence of Mr A in the Second Joint Report of Experts at page 4, which indicates that the adjusted EBT earnings of the business have not been the equivalent of or exceeded $820,000 for the last three years.
I accept Mr A’s reasons in his Fourth Report, as to why the valuation of the business should be based on the last three year period rather than the five year period or four year period used by Mr K. I accept Mr A’s evidence in his Fourth Report (demonstrated in a graph) at paragraph 66 and 67 that the influence of the robust AUD against the USD on the gross profit margin in the period 2008 to 2012 and the contrast in the growth in revenue in 2015 but the continued decline of gross profit margin in the period 2013 to 2015 demonstrates a “bubble effect” between 2009 and 2012. I accept his evidence about the impact of more favourable foreign exchange fluctuations in the earlier years which are unlikely to recur in the foreseeable future.
I accept, on the evidence of both experts, that it is appropriate to adjust the future maintainable earnings of the business to take account of the trade finance facility. I accept the adjusted EBT table produced by Mr A in the Second Joint Report of Experts at page 4.
I accept Mr A’s opinion in the Second Joint Report of Experts, that the future maintainable earnings on the 2013 to 2015 average is $390,782. I accept that calculation and accept that it is more appropriate to consider the last three years for the purposes of the valuation.
Both Mr A and Mr K took account of the borrowings of the Company but Mr K relied upon the use of letters of credit which are not used in the business and which, I accept, would be unlikely to be used by a prudent operator of the business.
Mr K’s report cannot be preferred over that of Mr A because the trade finance costs in his analysis were based on the hypothetical use of letters of credit and a lack of detailed information from the husband and the financial controller of the Company about the operation of the business.
The operation of the business by the husband necessarily requires the utilisation of trade finance facilities which incur costs as part of the operating liabilities. Mr K did not quantify the adjustments which would be required to take account of those costs associated with the trade finance facility as distinct from the costs he allowed for the use of letters of credit.
Ultimately, I could discern no dispute between Mr A and Mr K about the calculation of $909,356 being the value of the business of the Company based on the net operating assets approach. I find this calculation to be correct.
Mr A was unshaken in cross-examination regarding his opinion outlined in his Fourth Report and the Second Joint Report of Experts. He was clear in his responses in cross-examination. The assumptions which formed the basis for his opinion have not been demonstrated to be incorrect on all the evidence. Mr A has formed this opinion after examining the financial circumstances of the business of the Company and preparing reports of the business since 2013, a considerable period of time. Since 2013 he changed his view. His view has become more informed over time by discussions with the husband and financial controller of the Company.
I accept Mr A’s opinion evidence in his Fourth Report at paragraph 90, that after the adjustments and allocation considerations he outlined, the business generates a normalised EBIT that produces an insufficient rate of return on net operating assets to identify and measure goodwill. I accept his opinion that as a result of this outcome the earnings valuation approach is not the appropriate method to value the business. I accept that in those circumstances the valuation on the net operating assets of the business is appropriate.
I find on the basis of the evidence of the husband that it was his strategy in the past to purchase investment properties with the profits of the business to use as security for the borrowings on the basis that the increased value of those properties was likely to be more advantageous than to reinvest the profits into the business. This is also referred to by Mr A at the penultimate paragraph of page 3 of the Second Joint Report of Experts. Mr A says:
In my discussions with the husband, he has stated that the need for trade finance is a function of the investment decisions by the [Riley] family to invest past profits generated by the business into property assets rather than fund the business operations. The use and the level of interest bearing debt is a discretionary decision by the Husband and Wife. The alternative was to invest past profits in the business rather than into real property.
I accept the evidence of Mr A where he states in the first paragraph of page 4 of the Second Joint Report of Experts the following:
As debt is now included in the valuation of the business, the capitalisation rate would also decrease materially. Adding $6 million of interest bearing debt into the valuation process increases the risk on the balance sheet significantly. Consequently the multiple or capitalisation rate would be closer to 2.25 time earnings rather than 3.25 (midpoint between 3.0 and 3.5) on an ungeared basis. The inclusion of interest and debt as part of the value of the business will relegate the business value to be less than the net assets of the business. When the business net assets are greater than the assessed value of the business, the business and the equity should be valued on a net asset basis.

This principle that, where the future maintainable earnings appear to be less than the net operating assets, it is appropriate to value the business on a net operating assets basis, appeared to be ultimately conceded in cross-examination by Mr K, although there was a lack of clarity in his explanation. Mr K nevertheless did not change his opinion as outlined in the Second Joint Report of Experts.

Conclusion

There are competing valuations of the business of the Company made by the experts whose expertise was not seriously challenged. On the state of the evidence as it stands, it is not open to me to adopt a different valuation or approach from that of either of the experts. I do not accept Mr K’s midpoint valuation of $2,686,467 because of the deficiencies outlined above and prefer Mr A’s valuation.
I reject the submissions of counsel for the wife, so far as they were asserted, regarding the application of principles of “value to the owner” as being relevant for present purposes where I cannot accept Mr K’s valuation.
I also reject the submissions of counsel for the wife that the “highest and best use” of an asset principle should be adapted and applied in favour of Mr K’s valuation of the Company. The “highest and best use” analogy is not appropriate here and in circumstances where there are flaws identified in the valuation of Mr K because of the lack of information about the financing arrangements of the Company.
The conclusion reached by the Full Court on the facts of the case of Lenehan & Lenehan (“Lenehan’s case”) that “the vendor’s borrowings are irrelevant to the question of the value of that business which is to be calculated independently of those factors” and that it is not a matter which the hypothetical purchaser would take into account is distinguishable on the facts in this case.[75] Lenehan’s case involved the valuation of a pharmacy business where there were competing expert valuations based on capitalisation of future maintainable earnings. An importation business operating in international markets is very different from a pharmacy business because it is a business where borrowing and foreign exchange fluctuations are integral to the operation of the business. A hypothetical prudent purchaser of such a business would not enter into a purchase without factoring the costs of any trade finance arrangement into the equation. Any prudent purchaser must factor in the costs of borrowings in order to determine the value of the business.
[75] Lenehan & Lenehan (1987) FLC 91-814.
The foreign exchange fluctuations into the future remain within the realm of speculation but I am satisfied that the three year period of earnings considered by Mr A is reasonable having regard to the fluctuations in the value of the Australian dollar and the economic factors he outlined in his Fourth Report.
Taking into account overall that Mr K’s valuation was not informed by detailed information from the husband and the financial controller about the business of the Company, in combination with Mr K’s concessions outlined earlier, I find that Mr A’s adjusted EBT valuation of the Company is preferable to that of Mr K. I accept the expert opinion evidence of Mr A as a whole that in these circumstances where the “normalised EBIT” produces an insufficient rate of return on net operating assets, that the business should be valued on a net operating assets basis.
Mr K relied upon information provided by Mr A but took a different approach to the treatment of trade creditors. Mr K conceded that the business was volatile and significantly affected by foreign currency movements. His analysis took into account financial years when the Australian currency was high against the US dollar. He valued the Company without reference to the reality of the associated costs of the trade finance facility of the Company because he regarded this as a separate matter for the consideration of a prospective purchaser. He relied upon the incorrect assumption that the Company utilised letters of credit as a financing option. He did not provide any alternative calculation to take account of the reality of the trade finance facility.
I am accordingly satisfied on all the evidence and on the basis of the expert opinion of Mr A, that the value of the business of the Company is the net operating asset valuation of $909,356.

I certify that the preceding one hundred and eighty-six (186) paragraphs are a true copy of the reasons for judgment of the Honourable Justice Thornton delivered on 1 July 2016.

Associate:

Date: 1 July 2016

Appendix A

Documents relied upon by the applicant husband:

Husband’s Fourth Amended Initiating Application filed on 12 August 2015;
Affidavit of Mr RM A filed 19 September 2013 (referred to as the Second Report);
Affidavit of Mr Q filed 10 August 2015;
Affidavit of Mr RM filed 10 August 2015 (referred to as the Fourth Report);
Husband’s trial affidavit filed 19 August 2015;
Husband’s affidavit in reply filed 14 September 2015;
Husband’s affidavit filed 20 October 2015;
Husband’s updating affidavit filed 4 February 2016;
Husband’s financial statement filed 4 February 2016; and
Second Joint Report of Experts dated 21 September 2015 (Exhibit C1).

Documents relied upon by the respondent wife:

Wife’s Fifth Amended Response to Initiating Application filed on 31 August 2015;
Affidavit of Mr MS filed 10 August 2015;
Affidavit of Mr DA filed 10 August 2015;
Affidavit of Mr K filed 26 August 2015 (referred to as the Second Report);
Wife’s affidavit of evidence in chief filed 31 August 2015;
Affidavit of Mr S filed 18 September 2015;
Affidavit of Mr GH filed 21 September 2015;
Affidavit of Mr K filed 30 September 2015 (referred to as the Third Report);
Wife’s affidavit filed 18 February 2016;
Wife’s Further Updated Financial Statement filed 18 February 2016; and
Second Joint Report of Experts dated 21 September 2015 (Exhibit C1).

Exhibits tendered by the applicant husband:

A.Letter of costs dated 3 March 2016 (tendered 4 March 2016);
B.Transcript of proceedings of 28 April 2014 at 12.32pm (tendered 4 March 2016);
C.Westpac Bank Statement for the wife dated 9 October 2009 (tendered 7 March 2016);
D.Email sent on 27 August 2013 from Mr HG to Mr D (tendered 8 March 2016);
E.Future maintainable earnings - Earnings before Interest & Tax (EBIT) (tendered 10 March 2016);
F.Future maintainable earnings - Earnings before Tac (EBT) (tendered 10 March 2016); and
G.Email from Mr Q to Mr K dated 25 August 2015 (tendered 15 March 2016).

Exhibits tendered by the respondent wife:

Letter of costs dated 3 March 2016 (tendered 4 March 2016);
Email dated 7 November 2013 from Mr A (tendered 9 March 2016);
Assessment using Trade Facility (identification only) (tendered 10 March 2016);
Valuation of Riley & Co using Valuation Method (identification only) (tendered 10 March 2016); and
Two emails dated 24 August 2015 and 25 August 2015 (tendered 15 March 2016).

Court Exhibits:

C1.Second Joint Report of Experts dated 21 September 2015 (admitted into evidence on 3 March 2016); and
C2.Joint table of Assets and Liabilities dated 4 March 2016 (admitted into evidence on 4 March 2016).