Sinclair v Chandler MacLeod Group Pty Ltd
[2011] VCC 1346
•29 September 2011
| IN THE COUNTY COURT OF VICTORIA | Revised |
| AT MELBOURNE CIVIL DIVISION COMMERCIAL LIST EXPEDITED CASES DIVISION |
Case No. CI-10-04598
| CATHERINE MARGARET SINCLAIR | Plaintiff |
| v | |
| CHANDLER MACLEOD GROUP PTY LTD | Defendant |
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| JUDGE: | HIS HONOUR JUDGE ANDERSON |
| WHERE HELD: | Melbourne |
| DATE OF HEARING: | 5 & 6 September 2011 |
| DATE OF JUDGMENT: | 29 September 2011 |
| CASE MAY BE CITED AS: | Sinclair v Chandler MacLeod Group Pty Ltd |
| MEDIUM NEUTRAL CITATION: | [2011] VCC 1346 |
REASONS FOR JUDGMENT
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| Catchwords: | Contract – Agreement for the sale of shares in a business – Provision for further payments to the vendor depending on company’s performance – Calculation of further payments - Whether literal interpretation of the agreement accorded with commercial reality or had uncommercial or unreasonable consequences – Alternative claim for rectification. |
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| APPEARANCES: | Counsel | Solicitors |
| For the Plaintiff | Mr C G Juebner | Stewart Peters |
| For the Defendant | Mr N Hopkins | Norton Rose Australia |
| HIS HONOUR: |
1 Willis Management Consultants Pty Ltd (the Willis company) operated as a recruitment consultant in 2007. The principal of the company was Mr Greg Sinclair. The shares in the company were held by his wife, Mrs Catherine Sinclair.
2 In late 2007, negotiations commenced for the purchase of the Willis company’s business by Chandler MacLeod Group Pty Ltd (Chandler MacLeod). In April 2008, a written agreement was executed for the purchase of the shares in the Willis company by Chandler MacLeod. By that stage, Mr Iain Wilson had become involved in the operation of the company and was a shareholder.
3 The agreement provided a purchase price of $425,000 and the possibility of further payments depending upon the performance of the Willis company in the period of approximately two years following the purchase.
4 The relevant clauses of the agreement providing for the payment of the further consideration were as follows:
“4. Earn Out Amounts
Entitlement
4.1 Subject to clauses 4.6, 4.7 and 4.8, in addition to the Purchase Price, the Buyer will pay to or at the direction of the Sellers the Earn Out Amounts, calculated and payable in accordance with this
clause 4.
2009 Earn Out Amount
4.2 The 2009 Earn Out Amount is the amount derived from the
following formula:
((2 x 2009 EBITDA) less $175,000
where:
2009 EBITDA means annualised EBITDA for the period from the
Completion Date to 30 June 2009.
If the formula yields a negative number, the 2009 Earn Out
Amount is deemed to be nil and the negative amount shall be
carried forward and included in the calculation of 2010 EBITDA forthe purposes of clause 4.3.
2010 Earn Out Amount
4.3 The 2010 Earn Out Amount is the amount derived from the
following formula:
((2 x 2010 EBITDA) less $250,000
where:
2010 EBITDA means EBITDA for the period 1 July 2009 to 30 June
2010.
If the formula yields a negative number, the 2010 Earn Out
Amount is deemed to be nil”.
5 The agreement has given rise to disputes between the parties. The issues for determination in the proceeding are:
a.
whether the literal interpretation of the relevant clauses of the agreement dealing with the carrying forward of a negative 2009 Earn Out Amount accords with “commercial reality” or an alternative interpretation should be preferred;
b.
alternatively, whether the agreement should be rectified to correct a common mistake of the parties;
c.
consequential and incidental issues relating to the quantification of the plaintiff’s claim.
Background facts
6 The negotiations between the parties were essentially conducted on behalf of the Willis company, the Sinclairs and Mr Wilson by Mr Sinclair. In March 2008, the solicitors Lukaitis Partners were engaged by Mr Sinclair to finalise the agreement on his behalf. The negotiations on behalf of Chandler MacLeod involved a small group of senior management at the company. The documentation was prepared and negotiated with Mr Sinclair by Mr Jason MacArthur, a solicitor who was responsible for mergers and acquisitions on behalf of Chandler MacLeod and who in December 2008 became the company’s director of strategy (merger and acquisitions). Mr Sinclair and Mr MacArthur were the only witnesses to give evidence at the trial.
7 In late 2007, Mr MacArthur prepared draft Heads of Agreement – Sale of Business which provided for Chandler MacLeod to acquire “the business” of the Willis company. The Purchase Price was to “be comprised of the Initial Purchase Price and the Earn Out Amount”. The Purchase Price was specified and the Earn Out Amount was to be calculated as “4 x average annual EBITDA for the 30 month period from 1 January 2008 to 30 June 2010 less the Initial Purchase Price”. The Heads of Agreement was essentially an agreement to negotiate in good faith for the sale and purchase of the company’s business.
8 The document expressly provided that the critical provisions in the document, including the Initial Purchase Price and the Earn Out Amount, “are merely statements
of the current intention of the parties and may change, and are not intended to be
legally binding on the parties or to give rise to legal rights or obligations”. This
document was not executed by the parties.9 On 11 January 2008, Mr MacArthur sent Mr Sinclair revised Heads of Agreement. This document provided for the sale of the shares in the Willis company to Chandler MacLeod. The draft agreement had similar provisions as the earlier draft concerning the statement of “current intention” and its non-binding nature.
10 The draft recorded an Initial Purchase Price of “$375,000, subject to any agreed
adjustments, and the Earn Out Amount was to be calculated as follows:
2 x annualised EBITDA for the period from the Completion Date to
30 June 2009 less $250,000 (1st Deferred Payment); plus
2 x EBITDA for the 12 month period from 1 July 2009 to 30 June 2010
less $250,000 (2nd Deferred Payment).If the 1st Deferred Payment yields a negative number, the 1st deferred payment is deemed to be Nil, and the negative amount is carried forward to the beginning of the next financial year for the purposes of
calculating the 2nd Deferred Payment”.
11 This document is important; it noted the significant change in the nature of the transaction from a sale of business to a sale of shares. However, perhaps more significantly in the context of this proceeding, it recorded the parties’ “current intention” in relation to the calculation of the Earn Out Amount including the change from a single payment to two deferred payments of the Earn Out Amounts.
12 Different words were used in the final agreement executed by the parties. However, in evidence-in-chief Mr MacArthur was asked, “Is there a difference between the two clauses in the way you were attempting to draft them?” Mr MacArthur responded,
“Not at all … I say they achieve the same result. I sought to clarify it in the long form
of agreement”. This was a reference to the final agreement executed by the parties in
April 2008.13 The critical change from a single payment to two deferred payments and the calculation of the Earn Out Amounts was negotiated at around this time. A series of emails between Mr Sinclair and Mr MacArthur record the negotiations:
a.
Email 29 November 2007, 4.53pm from Mr MacArthur to Mr Sinclair which included the following passage:
“Further to recent correspondence, Iain has asked me to forward
our best and final proposal, which we believe is likely to secure
board approval.1. CM buys all shares in Willis @ 4 x EBITDA. Initial Purchase Price (IPP) of 50%, payable equally in cash/shares.
2. Earn out periods. 1st period starts Feb ’08 and ends 30/6/09. 2nd period starts 1/7/09 and ends 30/6/10”.
b.
Email 30 November 2007, 10.40am from Mr Sinclair to Mr MacArthur which included the following passages:
“Thank you for your proposal. I have a number of comments and
questions which I have set out below, and would request
clarification before we are able to accept the proposal: …4. The Earn Out Payments are confusing and look to be a move away from previous discussions. The Final Purchase Price was agreed to be 4 times the average annual EBITDA over the 29 month Earn Out period. Therefore the final payment should be FPP less all payments made previously. Your proposal comes up with a Final Purchase Price that will be much less than this (assuming as we do that the EBITDA will be increasing over the Earn Out period). Please review”.
c.
Email dated 30 November 2007, 11.18am from Mr MacArthur to Mr Sinclair which included the following passages:
“My initial responses, adopting your numbering: …
4. You have requested two Earn Out Periods, so each deferred payment represents 50% x (4 x EBITDA) less 50% x IPP. For example, if your numbers stayed at 200 per annum over the 30
months, you would be entitled to 800k in total, ie 400 IPP + 200
+ 200. Iain’s (bonus) payment is subject to recoupment of the
$50k sign on and 150k shares (which you don’t receive). The
main issue for you and Iain is whether we recoup the IPP
equally from both or 100% from you (since he doesn’t receive
the IPP). Similarly, should his sign on and shares be recouped
100% from him or equally from both. Note the IPP = $400k
whereas the sign on and loyalty shares = $200k. You need to
review the numbers and reconfirm the percentage split between
you”.
d.
Email dated 30 November 2007, 12.30pm from Mr Sinclair to Mr MacArthur which included the following passage:
“4. I have not requested two Earn Out Periods – I requested the
Earn Out be paid in two instalments. That is the difference in our
interpretations. I don’t care how you interpret it though as long as
the amount payable is the same, and currently your interpretation
would be significantly less”.
14 Mr Sinclair said in evidence that following the receipt of the first email, he asked Mr MacArthur for further details. He said, “Specifically I was confused about how two
Earn Outs equated to the one Earn Out that I had previously agreed with and wanted. I subsequently had a phone conversation with MacArthur. After that conversation I was comfortable that the two Earn Out scenario did equate to the same result as a single Earn Out … I believe we went through examples of how it would occur … of how the two Earn Outs would occur and how they would equate to a single Earn
Out.” Mr Sinclair agreed that, “The negotiations thereafter proceeded on the basis there were two Earn Out periods”.
15 telephone conversation occurred “after the execution of the first Heads of Agreement
in or about late 2007 or early 2008”. There seems to be an error. The first Heads of
Agreement (for the sale of business rather than the sale of shares) was never
executed by the parties. The revised Heads of Agreement were sent by MrThe particulars to paragraph 7 of the Statement of Claim suggested that the apparently executed by Mr Sinclair on 4 February 2008.
16 In cross-examination, it was put to Mr Sinclair “that there was no telephone
conversation which Mr MacArthur said to you that the two Earn Outs would be the
same as the single Earn Out [but that] there was a meeting with you and
Mr MacArthur at which Mr MacArthur put some examples up on a whiteboard foryou”. Mr Sinclair denied that there had not been a telephone conversation and said
that there had been a meeting with Mr MacArthur on 15 November 2007 although he
could not recall Mr MacArthur putting up examples on a whiteboard for him.17 Defendant’s counsel, Mr Hopkins suggested that, at the meeting Mr MacArthur “drew
up some examples on the whiteboard as to how the Earn Out amounts might work,
but that those examples were conditioned on your [ie Mr Sinclair’s] statement that …EBITDA would be positive”. Mr Sinclair said he could not recall such a discussion.
18 Mr MacArthur said that around the time of the emails in late November 2007, he and Mr Sinclair “had discussions about the purpose of breaking up the Earn Out period to
two periods. Mr Sinclair wished to facilitate a payment midway through the Earn Out
period for the benefit of one or both of the vendors. Chandler, at the same time,
wished to mitigate some of the risk it saw in the deal at the time [the upshot of whichwas that] we broke the single Earn Out period into two Earn Out periods”.
19 Mr MacArthur said that he had discussions with Mr Sinclair about “splitting the Earn Out into two payments rather than one” but said there was no discussion “in relation to the impact of that”. He said, “We didn’t have face to face discussions specifically on that issue”. Mr MacArthur said that, “We went over a number of issues, structural
issues, time and time again to try to make it very clear how this deal would work … we used figures which I then confirmed in an email to Mr Sinclair at some point. We showed him that splitting an Earn Out period into two periods in which he earned the
same amount would result in the same equation”.
20 In his evidence, Mr MacArthur referred to the emails exchanged with Mr Sinclair in late November 2007. On 21 December 2007, Mr Stephen Cartwright, the managing director of Chandler MacLeod Limited (the parent company of Chandler MacLeod) sent an email to Mr Sinclair which was copied to Mr MacArthur and other Chandler MacLeod employees.
21 The email read in part as follows:
“Attached for your review is a spreadsheet summary of our offer of 100% of the shares in Willis, and the employment of Iain Wilson, based on our recent meeting and our understanding of your requirements.
The key points: - IPP of $375k.
- IW to get sign on bonus ($50k), plus loyalty bonus ($75k shares) after
12 months.- Two Earn Out periods – after 17 and 29 months. - Sale and employment agreements to be entered into simultaneously
(CP).
- Each deferred payment equals (2 x EBITDA) less $250,000 … I am on leave from now until 21 January so please liaise with Jason and
Ian to ensure that we move this forward as quickly as possible”.
22 The attached spreadsheet set out a series of calculations including an “Initial Payment” on 30 January 2008, a “First Earn Out” on 30 June 2009 and a “Final Instalment” on 30 June 2010. There were four “notes” to the spreadsheet calculations. Note 3 read – “Each deferred payment equals (2 x EBITDA) less
$250,000. Nil payment if EBITDA less than $125,000. Any deficit in 1st period one
carried forward to start of 2nd period”.
23 On 11 January 2008, Mr MacArthur sent Mr Sinclair revised Heads of Agreement. A “final marked-up draft” was forwarded on 30 January 2008 and a settled version the following day. On 4 February 2008, Mr Sinclair executed the agreement although
apparently Chandler MacLeod did not do so.
24 Mr MacArthur said in evidence that, “at the time of drafting” the revised Heads of Agreement he did not discuss the term in the Heads of Agreement providing for the calculation of the second Earn Out period. Mr MacArthur said that in a later discussion between himself, Mr Sinclair and Mr Robert Johnston, the CFO of Chandler MacLeod Limited, “We discussed the impact of a negative result in year one”.
25 Mr MacArthur said that the discussions “took place in Mr Johnston’s office. We were
dealing with two aspects in particular. We were dealing with the two ways that guarantee from Mr Sinclair and Mr Wilson and the other being a carry forward of the negative sum from the first year … We said in simple terms you had to make money in year one, and that’s pretty much the theme of the discussion. You had to make money both years of the arrangement … [Mr Sinclair] was extremely confident. He was prepared to give a personal guarantee”.
26 Mr MacArthur said that at the meeting he wrote out an example on a whiteboard which was later transferred onto an Excel spreadsheet. The example was a “positive example” showing “a positive result [EBITDA] in each of years one and two”. It is not clear whether the spreadsheet referred to by Mr MacArthur is the spreadsheet attached to the email from Mr Cartwright dated 21 December 2007. That spreadsheet assumed a positive EBITDA in each of years one and two.
27 It is possible that Mr MacArthur had confused the chronology and this was the spreadsheet he was referring to. Mr Cartwright’s email does not, however, refer to a prior discussion between Mr MacArthur, Mr Johnston and Mr Sinclair. The details of the prior discussion were not put to Mr Sinclair in cross-examination, save for the general suggestion that at a meeting with Mr MacArthur, MacArthur had “put some examples on a whiteboard for you” and that “those examples were conditioned on your statement that earnings would be positive, EBITDA would be positive”.
28 There was further unfairness in the questioning of Mr Sinclair. Mr Sinclair, in the course of his evidence, referred to a meeting with Mr MacArthur on 15 November 2007. The questioning on this subject proceeded without any attempt to suggest that the meeting defendant’s counsel was referring to was at a later date and had occurred in Mr Johnston’s office.
29 provision of personal guarantees as to the EBITDA in the two years post-purchase
was not communicated to Mr Sinclair prior to an email dated 7 February 2008 fromFurther, it appears from the correspondence between the parties that the issue of in an updated due diligence review prepared by Mr Johnston and dated 6 February 2008. It is likely therefore that, in his evidence of the discussion in Mr Johnston’s office with Mr Sinclair, Mr MacArthur has conflated and confused separate and distinct conversations.
30 Before the final agreement was executed by the parties in early April 2008, there were extensive negotiations between them. These discussions were important as they resulted in significant changes to the terms under consideration, including the
reduction of the Initial Purchase Price to be paid and the requirement for guarantees
concerning the EBITDA in the period of about two years following the purchase.
However, as Mr MacArthur said in evidence, the terms in relation to the calculation of
the two Earn Out amounts were essentially concluded shortly after the emails in late
November 2007.31 It is appropriate to summarise the subsequent events.
a. Mr Sinclair executed the Heads of Agreement on 4 February 2008. b.
On 5 February 2008, Mr Cartwright sent Mr Sinclair a copy of an internal Chandler MacLeod preliminary due diligence review which was sceptical about the value of the Willis company and the proposed share purchase.
c.
On 6 February 2008, Mr Johnston, in an updated due diligence review, suggested “having GS [Greg Sinclair] provide a guarantee of up to $125,000 in
each of the Earn Out years where the calculation of the Earn Out under the
Share Sale Agreement delivers a negative figure”.
d. On 7 February 2008, Mr Cartwright informed Mr Sinclair of this suggestion. e.
On 7 March 2008, Mr MacArthur sent Mr Sinclair a draft agreement. Mr Sinclair forwarded the document to Lukaitis Partners on 13 March 2008.
f.
On 12 March 2008, Mr MacArthur proposed to Mr Sinclair that “the first Earn Out amount would be 2 x 2009 EBITDA less $175k” rather than the previously discussed $250,000. This reflected a change in treatment of a $75,000 ‘loyalty bonus two part consideration’.
g.
On 14 March 2008, a second draft of the agreement was sent by Mr MacArthur to Mr Sinclair. This included marked-up amendments, including the change in Clause 4.2 reducing the figure of $250,000 to $175,000 in the calculation of the 2009 Earn Out amount. The provision for Mr Sinclair and Mr Wilson to guarantee that the 2009 and 2010 EBIDTA “will be at least $125,000” was left unchanged from the first draft.
h.
In advice given by Lukaitis Partners to Mr Sinclair in an email dated 14 March 2011, it is recorded, “I confirm you agree to carry forward negative ebit”.
i. Mr MacArthur sent further drafts of the agreement to Mr Sinclair on the following dates: 25 March 2008 (third draft), 26 March 2008 (fourth draft), 27 March 2008 (fifth draft), 27 March 2008 (final draft).
j.
The agreement was executed by the parties in early April 2008 and $425,000 was paid by Chandler MacLeod to the Sinclair and Wilson interests.
32 The agreement was executed by Chandler MacLeod after a resolution of the Board of The board was provided with a board recommendation dated 28 March 2008 signed by Mr Cartwright. The document noted that, “The acquisition EBIDTA multiple is 4,
therefore the purchase price for the goodwill is within our normal price range, and the
deal with be earnings accretive for shareholders this year”.
33
the heading “valuation”, “Principle is 4 x EBITDA (approx $1m)”. On 28 March,
Chandler MacLeod Limited announced to the Australian Stock Exchange that “it has
reached agreement to acquire” the Willis company. The announcement noted that,A document headed, “Board of Directors Transaction Proposal Brief”, noted beside of an initial cash consideration for goodwill on settlement of $425,000. The total consideration would include an Earn Out component, consisting of cash and CHD
[Chandler MacLeod Limited] shares, which is directly linked to the performance of theWillis business over the next 27 months”.
Calculation of the 2010 Earn Out Amount
34 There was no dispute between the parties that the 2009 EBITDA was negative $105,488 and that therefore the 2009 Earn Out Amount was negative $385,488 (although Chandler MacLeod had previously asserted that the relevant figures were
$105,852 and $386,704 respectively). Accordingly, no further payment was due to
Mrs Sinclair or Mr Wilson, as the Willis company share vendors, for the period to
30 June 2009. In the year to 30 June 2010, there was a substantial turnaround in the
profitability of the Willis company. The 2010 EBITDA was $630,460.35 The dispute arose in the calculation in the 2010 Earn Out Amount and how the 2009 Earn Out Amount should be carried forward. Chandler MacLeod, in a letter dated 7 October 2010, asserted that the 2010 Earn Out Amount should be calculated in accordance with clause 4.3 of the agreement as follows:
“The 2010 EBIDTA was the sum of 2010 EBIDTA of $630,460 and the
negative 2009 Earn Out Amount of -$386,704 which equalled $243,756.
The 2010 Earn Out Amount calculated in accordance with the formula in the agreement was 2 x the 2010 EBIDTA (2 x $243,756 = $487,512, less $250,000 = $237,512)”.
36 Mrs Sinclair disputed the calculations claiming that the 2009 Earn Out Amount should not be deducted in calculating the 2010 EBIDTA, but should be deducted in the final calculation to ascertain the 2010 Earn Out Amount. The calculation she relied upon was as follows:
(2 x $630,460) - $250,000 - $385,488 = $1,260,920 - $250,000 - $385,488 = $625,432
37 The difference in the calculations was conveniently described by counsel as, whether the 2009 Earn Out Amount was deducted “inside the brackets” (Chandler MacLeod’s contention) or “outside the brackets” (Mrs Sinclair’s contention). Chandler MacLeod
relied upon a “literal” reading of clause 4.2 of the agreement. The clause specifically
states that any negative 2009 Earn Out Amount “shall be carried forward and
included in the calculation of 2010 EBIDTA …”. Accordingly, in the formula in clause
4.3, the reference to 2010 EBIDTA must be the 2010 EBIDTA, less the negative 2009
Earn Out Amount carried forward.38 Mr Juebner, counsel for Mrs Sinclair, submitted that this construction should be rejected for three reasons:
a. It defied commercial common sense as: i. the effect of a negative 2009 Earn Out Amount was doubled by carrying that figure into the formula for 2010 as part of the 2010 EBIDTA. This was an unrealistic and harsh penalty for a poor performance in the first of the two years for which further consideration may be payable under the agreement;
ii. Chandler MacLeod’s commercial interests would have been appropriately and adequately protected by carrying forward the first year’s negative Earn Out Amount into the calculation of the following year’s Earn Out Amount in a way that averaged out the profitability of the Willis company over the whole of the further period;
iii the interpretation conflated “two distinct and separate concepts in the
formula”: a “payment” being the 2009 Earn Out Amount and an “earnings”
figure, being the 2010 EBIDTA.
b.
It placed too much emphasis on the literal words “included in the calculation of 2010 EBIDTA” and was inconsistent with other parts of the agreement. In clause 2.3, immediately after the formula is set out, the words “2010 EBIDTA” are defined for the purposes of the formula as meaning “EBIDTA for the period 1 July 2009 to 30 June 2010” and are not defined as the 2010 EBIDTA “less any negative 2009 Earn Out Amount”.
c.
It ignored the surrounding circumstances including the genesis and purpose of the transaction, as follows:
i the initial negotiations were based on a single Earn Out period of about
29 months and the possibility of a second payment after 30 June 2010 if the
earnings of the company justified that result. The objective evidence
suggested that the parties in moving to two further possible payments and two
further possible payments and two Earn Out periods were not intending to
alter the possible return to the vendors or to give any greater significance to
the earnings of the Willis company in the first period rather than the second
period or over the whole period;ii the basis of the calculation of the payments to the vendors of the shares was
four times annualised EBITDA. The Chandler MacLeod interpretation of
clauses 4.2 and 4.3 was inconsistent with this approach, whereas Mrs
Sinclair’s suggested construction was consistent with a return to the vendor’s
equivalent to four times the annualised EBIDTA in 2009 and 2010;iii Mr MacArthur said that the words used in clause 4.3 were not intended to
alter equivalent provision in the Heads of Agreement – Share Purchase
document as there was no “difference between the two clauses” and they
were intended to “achieve the same result”. He was simply seeking to “clarify”
the issue in the drafting of the final agreement. In the equivalent provision in
the Heads of Agreement (executed by Mr Sinclair and, although not executed
by Chandler MacLeod, relied upon by it), it was provided that “the negativeamount is carried forward to the beginning of the next financial year for the
purpose of calculating the second deferred payment” (emphasis added).
d. The reference in clause 4.2 to carrying forward any negative 2009 Earn Out Amount and including it in the calculation of the “2010 EBIDTA” is an obvious drafting error and the reference should have been to the calculation of the “2010 Earn Out Amount”. Clauses 4.2 and 4.3 should be interpreted accordingly. 39 In response, Mr Hopkins, Chandler MacLeod’s counsel, submitted that:
a.
The bringing of the alternative rectification claim was an “acknowledgement” that the construction of clauses 4.2 and 4.3 contended for on behalf of Mrs Sinclair was “an impermissible rewriting of clause 4.2”.
b.
Although the definition of “2010 EBITDA” in clause 4.3 was “slightly clunky” it must be read “in a meaningful way with clause 4.2, otherwise clause 4.2 would have no work to do at all”. There would be no deduction of the 2009 negative sum as such deduction was not otherwise provided for in the clause 4.3 formula.
c.
The court cannot rewrite clause 4.3 or impermissibly read it down as contended for on behalf of Mrs Sinclair.
d.
The antecedent negotiations do not reflect the “actual intentions and expectations” of the parties or establish “objective background facts which were known to both parties” and accordingly are inadmissible and were “superseded by and merged in the contract itself” (Codelfa Constructions Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337 per Mason J at 352).
e.
There was no discussion between the parties as to how clauses 4.2 and 4.3 might operate if there were a negative Earn Out Amount in 2009. Mr Sinclair had not even considered that possibility.
f.
Mr MacArthur’s evidence was that “he drew the clause to have the very effect contended for” by Chandler MacLeod.
g.
If the relevant clause in the Heads of Agreement – Share Purchase (clause 8 of the summary term sheet, major commercial terms for the contracts) has any relevance, it is consistent with Chandler MacLeod’s interpretation as it refers to any negative 2009 Earn Out Amount being carried forward to the “beginning of
the next financial year for the purposes of calculating the second deferred
payment”. This is only consistent with the negative 2009 amount being deducted
from the 2010 EBIDTA as it “is expressly referred to in the same clause by
reference to the next financial year”.
Legal principles – construction issue
40 It is important for the Court, in considering questions of construction, to apply the appropriate legal principles and to have regard to the evidence which is admissible on those issues. Different issues of fact and law will be relevant to the issue of rectification.
41 The relevant principles of law to apply in the construction of the parties’ agreement are as follows:
a. the rights and liabilities of the parties are to be determined by “the principle of objectivity [and] it is not the subjective beliefs or understandings of the parties
about their rights and liabilities that govern their contractual relations” (Toll
(FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165 at 179 per GleesonCJ, Gummow, Hayne, Callinan and Heydon JJ);
b. the meaning of the terms of a contractual document “is to be determined by what a reasonable person would have understood them to mean. That, normally,
requires consideration not only of the text, but also of the surrounding
circumstances known to the parties, and the purpose and object of thetransaction” (Toll at 179);
c. therefore, the determination of the objective meaning requires "the ascertainment of the meaning which the document would convey to a reasonable person having
all the background knowledge which would reasonably have been available tothe parties in the situation in which they were at the time of the contract
(Maggbury Pty Ltd v Hafele Aust Pty Ltd (2001) 210 CLR 181 at 188 per Gleeson
CJ, Gummow and Hayne JJ quoting with approval Lord Hoffmann in Investors" at 912; [1998] 1 All ER 98 at 114);
d. in relation to commercial agreements, this means that “the essential question is what would reasonable business people in the position of the parties have taken
the clause to mean” (Schenker & Co (Aust) Pty Ltd v Maplas Equipment and Services Pty Ltd [1990] VR 834 at 840 per McGarvie J, with whom Kaye and Ormiston JJ agreed).
e. whilst “evidence of prior negotiations and of the parties' intentions, and a fortiori the intentions of one of the parties, ought not to be received, evidence restricted
to the factual background known to the parties at or before the date of the
contract, including evidence of the ‘genesis’ and objectively of the ‘aim’ of thetransaction, was admissible” (Codelfa Construction Pty Ltd v State Rail Authority
of NSW (1981-1982) 149 CLR 337 at 348 per Mason J);f. evidence of prior negotiations are admissible if it tends “to establish objective background facts which were known to both parties and the subject matter of the
contract [but are not receivable if] they consist of statements and actions of the parties which are reflective of their actual intentions and expectations” (Codelfa per Mason J at 352);
g.
in construing a contract, “words may be supplied, omitted or corrected in order to avoid absurdity or inconsistency” (Fitzgerald v Masters (1956) 95 CLR 420 at 426-7 per Dixon CJ and Fullagar J).
h.
commercial contracts must be construed in that way “so as to accord with commercial reality or business common sense” and to avoid the “uncommercial or unreasonable consequences” which would follow from a literal reading (Murray Goulburn Cooperative Co Ltd v Cobram Laundry Service Pty Ltd [2001] VSCA 57 at paragraphs 18 and 26, and also All State Exploration NL v QBE Insurance (Aust) Ltd [2008] VSCA 148 at para. 7).
Credibility of Mr MacArthur’s evidence
42 Mr MacArthur gave evidence that at the time he drafted the agreement, he intended clauses 4.2 and 4.3 to operate in the way afterwards contended for by Chandler MacLeod. This evidence was inadmissible on the issue of the construction of the agreement. In any event, I would not accept that evidence as, if that had been his intention, simple amendments by Mr MacArthur to the document would have made the position clear and put the issue beyond doubt.
43 Further, I did not regard Mr MacArthur as a witness whose oral testimony could be relied upon without support from either Mr Sinclair’s evidence or the contemporaneous documentation. I refer in particular to the following aspects of his evidence:
a.
His lack of accurate recollection of the chronology of discussions involving Mr Sinclair relating to the effect of changing from one to two Earn Out periods.
b.
The unwarranted emphasis he put on certain aspects of his evidence, for example, that the proposed agreement was not advantageous for Chandler MacLeod because of the financial position of the Willis company, that the need for Chandler MacLeod to reduce the risk to it had some relationship to the drafting of the clauses differentiating between the first and second Earn Out periods, that certain clauses in the agreement were only included because Mr Sinclair wanted them, the failure by Mr MacArthur to concede that there was an apparent inconsistency between the percentages in clauses 4.6 and 4.9, his failure to provide an adequate explanation for the differences and his reluctance to concede that the basis of the purchase price being four times the EBIDTA had any application to the calculation of the Earn Out Amounts in 2009 and 2010.
44 I do accept Mr MacArthur’s evidence that he did not intend to change the effect of the clause in the Heads of Agreement – Share Purchase, relating to the carrying forward of a negative 2009 Earn Out Amount, when he drafted clauses 4.2 and 4.3 of the
agreement. I accept the evidence of Mr Sinclair of the discussions around the time of
the relevant email exchanges at the end of November 2007. Mr Sinclair’s evidence
that these emails, the email with the attached spreadsheet on 21 December 2007
and the absence of any later inconsistent instructions confirmed that no change was
intended when Mr MacArthur drafted clauses 4.2 and 4.3 in the agreement.
Conclusions on the construction issue
45 The parties were aware that the object or purpose of the aspect of the transaction dealing with the calculations of the Earn Out Amounts, was based on four times the EBIDTA and that any negative 2009 Earn Out Amount would be carried forward and averaged with the 2010 results. This makes commercial sense and is consistent with there being no reason discussed by the parties to alter the effect of the financial results on the purchase price for the single period than would be the case when two payment periods were substituted.
46 The later concerns of Mr Johnston, expressed in writing for the first time in the preliminary due diligence review dated 5 February 2008, that the Willis company’s financial prospects were limited, did not result in any attempt to alter the basis for calculating the Earn Out Amounts, particularly if the first period’s result was negative. The concerns of Mr Johnston were dealt with by putting into effect the suggestion in his updated due diligence review the following day, of requiring Mr Sinclair (and also Mr Wilson) to provide guarantees for minimum performance in the two earn out periods.
47 Mr Hopkins suggested in final submissions that it was more important to Chandler MacLeod that the Willis company should perform well in the first earn out period than in the second period. That submission had no basis in the evidence.
48 In the present proceeding, it would not be appropriate for the court to simply adopt what Chandler MacLeod asserts is the literal meaning of clauses 4.2 and 4.3. I generally accept the submissions made by Mr Juebner on behalf of Mrs Sinclair. This is such a case where, in construing the parties’ agreement, appropriate words must be “supplied, omitted or corrected in order to avoid absurdity or inconsistency”.
49 Notwithstanding his denial in evidence, I consider the mistake of Mr MacArthur in the drafting of clause 4.2 is obvious. To give effect to the parties’ objectives, the clause should have made it clear that any negative 2009 Earn Out Amount was to be carried forward and included in the calculation of the 2010 Earn Out Amount. The clause must be construed in that way “so as to accord with commercial reality or business common sense” and to avoid the “uncommercial or unreasonable consequences” which would follow from a literal reading.
Rectification
50 An alternative claim is made on the basis of rectification. The purpose of the remedy of rectification is “to make the instrument conform to the true agreement of the parties where the writing by common mistake fails to express that agreement accurately”. Rectification may be granted where the instrument recording the agreement of the parties “does not reflect their common intention” (Maralinga Pty Ltd v Major Enterprises Pty Ltd (1973) 128 CLR 336 at 350 per Mason J).
51 Mr Hopkins submitted that the fact that such a claim was made indicated that the relevant clauses should, on a literal reading, be given the meaning contended for by Chandler MacLeod. Mr Hopkins further submitted that this fact did not, however, provide any basis for an order that the agreement be rectified.
52 Mr Hopkins submitted that Mr Sinclair had conceded in evidence that, “He never even turned his mind [to] how clauses 4.2 and 4.3 might operate if there was a negative Earn Out Amount in 2009”. Therefore, it was submitted, “There can be no common intent if Mr Sinclair had no intent at all”.
53 I consider that the submission involves a misreading of the evidence. Mr Sinclair’s solicitor, Mr Lukaitis of Lukaitis Partners, noted in an email dated 14 March 2008 that one matter discussed between the solicitor and Mr Sinclair was Mr Sinclair’s agreement “to carry forward negative ebit”. Mr Sinclair said that he told Mr Lukaitis that he was “comfortable” with the relevant clause of the agreement as, “That was
consistent with my understanding of the four times earning, so I was happy to carry forward the negative EBIT or the negative amount which was to be subtracted from
the amount payable in the second period”.
54 Mr Sinclair said that at the time, he had looked at the EBITDA “being less than 125,000 in both situations or both periods, but not as it ever being a negative”. If the 2009 EBITDA had been less than $125,000, as Mr Sinclair said he had “looked at”, then the 2009 Earn Out Amount may have been a negative figure. In fact, an EBITDA in 2009 of less than $87,500 would have yielded a negative Earn Out Amount.
55 If I am wrong on the construction of clauses 4.2 and 4.3, and the literal interpretation contended for Chandler MacLeod is to be preferred, then in my view the agreement should be rectified in the manner suggested by Mr Juebner, namely by substituting for the words “2010 EBITDA” at the end of clause 4.2, the words “2010 Earn Out
Amount”.
56 The inclusion of the words “2010 EBITDA” in clause 4.2 was a mistake common to both parties as their intention was that:
a.
the change to the possibility of two further payments to the vendors, from a single further payment, was not to affect the basis for calculating that payment;
b.
the further payments were to be calculated on the basis of four times the relevant EBITDA;
c.
as the earlier Heads of Agreement stated, a negative Earn Out Amount in 2009 was “to be carried forward to the next financial year for the purposes of calculating the second deferred payment”;
d.
no change to the meaning or effect of that clause was intended by the words adopted by Mr MacArthur when he drafted the equivalent clause (clause 4.2) in the final agreement.
Further issues
57 There are two consequential issues which require consideration in order to determine Mrs Sinclair’s entitlement:
a.
whether the 2010 Earn Out Amount is payable in a monetary sum or partly in shares;
b. if there is an entitlement to shares, the dividends which are payable. 58 Clause 4.4 of the agreement provides for the “method of payment” of the Earn Out Amounts, as follows:
“4.4 Each of the Earn Out Amounts is payable, at the Buyer’s election in its discretion, as follows:
4.4.1 100% in same day cleared funds, or 4.4.2 50% in same day cleared funds and 50% by an issue of CHD [Chandler MacLeod Ltd] shares to or at the direction of the Sellers”.
59 By letter dated 7 September 2010, Chandler MacLeod advised the Sinclair and Wilson interests that in relation to the “payment of 2010 Earn Out Amount” and “pursuant to clauses 4.4, 4.5 and 4.9.2 of the Agreement”, “the Buyer hereby elects
to pay the 2010 Earn Out Amount by way of cash (50%) and shares (50%, to be held
in escrow) in accordance with clause 4.4.2”.
60 On 30 September 2010, Chandler MacLeod arranged for the issue of 104,988 shares in its parent company to Mrs Sinclair, representing 50% of her entitlement for the 2010 Earn Out Amount, as Chandler MacLeod had calculated it.
61 In the circumstances, Chandler MacLeod made an election in accordance with the agreement and arranged for the issue of shares. Dividends were later paid on those shares to Mrs Sinclair. Chandler MacLeod cannot now resile from that election. The proportions of 50% cash and 50% share issue will apply in respect of the whole of the monies to which Mrs Sinclair was entitled under the agreement.
62 Chandler MacLeod Ltd declared a dividend of one cent per share with a record date of 30 September 2010 and a payment date of 14 October 2010. Chandler MacLeod alleged in its Defence that the shares allotted to Mrs Sinclair were allotted on 30
September 2010 “after the closure of the register”. It is asserted that this disentitles
Mrs Sinclair from being paid the dividend declared on that date.63 Clause 4.5 of the agreement provides that the 2010 Earn Out Amount “shall be payable, on or before” 30 September 2010. Clause 4.4.2 provides that payment could be made, as Chandler MacLeod elected to do, by “50% in same day cleared funds and 50% by an issue of CHD shares”.
64 In these circumstances, it is appropriate that any shares to be issued to Mrs Sinclair should have been issued on 30 September 2010 and have been entitled to share in dividends declared on that day. It is not apparent on the evidence at what time on
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that day the shares were issued, when the dividend was declared or the relevance of
the “closure of the register” referred to in the Defence.
Proposed orders
65 I will hear further submissions from the parties on the appropriate orders to be made in accordance with my findings and in relation to questions of interest and costs.
66 There are two consequential issues which require consideration in order to determine Mrs Sinclair’s entitlement:
a. whether the 2010 Earn Out Amount (EOA) is payable in a monetary sum or partly in shares; b. if there is an entitlement to shares, what dividends are payable? 67 Clause 4.4 of the agreement provided that:
“Each of the Earn Out Amounts is payable, at the buyer’s election in its
discretion, as follows:
4.4.1 100 per cent in same day cleared funds; or 4.4.2 50 per cent in same day cleared funds and 50 per cent by an issue of CHD [Chandler MacLeod Limited] shares to or at the direction of the Sellers.”
68 By a letter dated 7 September 2010 Chandler MacLeod stated in respect of payment of the 2010 earn out amount that:
“Pursuant to clauses 4.4, 4.5 and 4.9.2 of the agreement;
The Buyer hereby elects to pay the 2010 Earn Out Amount by way of cash (50 per cent) and shares (50 per cent), to be held in escrow in accordance with clause 4.4.2.”
69 Chandler MacLeod issue 104,988 shares in its parent company to Mrs Sinclair. This represented 50 per cent of the calculation made by Chandler MacLeod of the 2010 Earn Out Amount.
In the circumstances Chandler MacLeod has made an election in accordance with with that decision. Chandler MacLeod cannot now resile from that election and the proportion of 50 per cent cash and 50 per cent share issue will apply in respect of the whole of the payments to which Mrs Sinclair is entitled under the agreement. Chandler MacLeod Limited declared a dividend of one cent per share with a record date of 30 September 2010 and a payment date of 14 October 2010. Chandler MacLeod assets in its defence that the shares allotted to Mrs Sinclair were allotted on 30 September 2010 “after the closure of the register” for the purposes of determining her entitlement to be paid the dividend declared on that day. Clause 4.5 of the agreement provided that the 2010 Earn Out Amount “shall be payable, on or before” 30 September 2010. Clause 4.4.2 provided that payment could be made, as Chandler MacLeod elected to do, “50 per cent in same day cleared funds and 50 per cent by an issue of CHD shares”.
71 In the circumstances it is appropriate that any shares to be issued to Mrs Sinclair should have been issued on 30 September 2010 and she would therefore have been entitled to share dividends declared on that day. It is not apparent on the evidence at what time Mrs Sinclair’s shares were issued, when the dividend was declared or the relevance of the “closure of the register” referred to in the defence”.
72 I will hear further from the parties in relation to the appropriate form of order and questions of interest and costs.
Certificate
I certify that the previous 19 pages are a true copy of the reasons for decision of His Honour
Judge Anderson delivered on 29 September 2011.
Dated: 29 September 2011
Hannah Christensen
Associate to His Honour Judge Anderson
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