Tomanovic v One Australia Pty Ltd
[2015] NSWCA 11
•16 February 2015
|
New South Wales |
Case Name: | Tomanovic v One Australia Pty Limited |
Medium Neutral Citation: | [2015] NSWCA 11 |
Hearing Date(s): | 28 August and 4 September 2014 |
Decision Date: | 16 February 2015 |
Before: | Bathurst CJ at [1]; Barrett JA at [220]; Emmett JA at [221] |
Decision: | (1)Leave to amend the notice of appeal refused; |
Catchwords: | APPEAL – civil - pleadings - amendment - grounds of appeal - refusal to allow amendment - amendment sought shortly prior to hearing - opportunity to raise ground at hearing - evidence could have been led at hearing |
Legislation Cited: | Corporations Act 2001 (Cth), ss 232 and 1305 |
Cases Cited: | Abrahams v The Federal Commissioner of Taxation [1944] HCA 32; (1944) 70 CLR 23 |
Category: | Principal judgment |
Parties: | Zoltan Tomanovic (First appellant) |
Representation: | Counsel: |
File Number(s): | 2014/3845 |
Decision under appeal: | |
Court or Tribunal: | Supreme Court of New South Wales |
Citation: | Re Global Mortgage Equity Corporation Pty Ltd (ACN 105 108 469) [2013] NSWSC 1586; (2013) 97 ACSR 30 and [2013] NSWSC 1818 |
Date of Decision: | 01 November 2013 |
Before: | Black J |
File Number(s): | 2008/282203 |
[Note: The Uniform Civil Procedure Rules 2005 provide (Rule 36.11) that unless the Court otherwise orders, a judgment or order is taken to be entered when it is recorded in the Court's computerised court record system. Setting aside and variation of judgments or orders is dealt with by Rules 36.15, 36.16, 36.17 and 36.18. Parties should in particular note the time limit of fourteen days in Rule 36.16.]
JUDGMENT
BATHURST CJ: The first appellant (Mr Tomanovic) and the second respondent (Mr Sayer), through their respective entities, Australian Financial Services Corporation Pty Limited (AFS) and One Australia Pty Limited (One Australia) were engaged from 1999 up to 30 June 2010 in a financial services business carried on through a corporate entity, Global Mortgage Equity Corporation Pty Limited (GMEC). They were also involved in the ownership of two properties, the registered proprietor of which was a company, Argyle HQ Pty Limited (AHQ), as trustee for the 9 Argyle Street Unit Trust (9 AS Trust).
As at 30 June 2010, One Australia held 55% of the issued capital of GMEC, with AFS holding the other 45%. The shareholding in AHQ and the beneficial interest in 9 AS Trust were held equally by Mr Tomanovic and Mr Sayer.
A number of disputes arose between Mr Tomanovic and Mr Sayer. As a result, the Tomanovic interests brought statutory oppression proceedings under s 232 of the Corporations Act 2001 (Cth) against the Sayer interests, alleging oppression in the conduct of the affairs of GMEC and AHQ (the oppression proceedings).
On 30 August 2011 this Court made the following orders (the Court of Appeal’s Orders) in the oppression proceedings (Tomanovic v Global Mortgage Equity Corporation Pty Ltd (No 2) [2011] NSWCA 256; (2011) 86 ACSR 119):
“(4) In lieu thereof order:
(a) Provided that Zoltan Tomanovic elects that such purchase should occur, making that election by notice in writing delivered to the solicitors for Kenneth Sayer no later than 30 days after the net value is ascertained and accepted by the court as applicable for the purpose of these orders, or within such further time as a Judge or Associate Judge of the Equity Division might hereafter permit, that Kenneth Sayer purchase free from encumbrance the shares owned by Zoltan Tomanovic in Argyle HQ Pty Ltd (‘Argyle HQ’) at a price of 50% of the net value of Argyle HQ as at 30 June 2010;
(b) That One Australia Pty Limited (‘One Australia’) purchase free from encumbrances the shares owned by Australian Financial Services Corporation Pty Limited (‘ASFC’) in Global Mortgage Equity Corporation Pty Limited (‘GMEC’) at a price equal to 45% of the net value as at 30 June 2010 of GMEC, plus an amount equal to the amount of interest that has accrued on the judgment in proceedings 297497 of 2009 from and including 1 July 2010, minus the net value as at 30 June 2010 of any shares and units in the following entities that have been transferred to AFSC either by One Australia or Kenneth Sayer:
(i)Multiown Loans Pty Limited (ACN 108 999 024);
(ii)Multiown Realty Pty Limited (ACN 110 556 397);
(iii)Multiown Pty Limited (ACN 106 117 104);
(iv)Multiown Goods and Services Pty Limited (ACN 109 629 530);
(v)Multiown Members Pty Limited (ACN 109 629 549)
(vi)Multiown Trust;
(vii)Multiown Loans Trust;
(viii)Multiown Realty Trust; and
(ix) Multiown Goods & Services Trust.
(c) The valuations referred to in (a) and (b) above to be:
undertaking by reference to the market value of the whole share capital in Argyle HQ and GMEC, respectively;
undertaken subject to an adjustment with respect to any net liabilities of Argyle HQ and GMEC (respectively) or their subsidiaries to any of Kenneth Sayer, One Australia, Zoltan Tomanovic, or AFSC;
not subject to any adjustment with respect to oppressive conduct; and
ascertained after making an adjustment, of such amount as is necessary for the net value of GMEC as at 30 June 2010 not to be decreased by reason of any sums that have been paid by either GMEC, Argyle HQ or any subsidiary of either company prior to or on 30 June 2010 in relation to the conduct of Proceedings 282203/2008, 282201/2008 and 2009/297497 and these proceedings.
…
(g) The amount owing by:
(i) Zoltan Tomanovic and AFSC, to Kenneth Sayer, Ken Sayer Investments Pty Ltd and Mortgage House Australia Pty Ltd, pursuant to the judgment (including interest, and excluding costs) in the Supreme Court proceedings 2009/297497; and
(ii) One Australia, pursuant to the buyout order in paragraph 4(b),
be set off against each other, such that only the net amount after set-off is liable to be paid.
…
5. Matter 6278 of 2008 and matter 6280 of 2008 be remitted to the Equity Division for ascertainment, in accordance with the direction of a Judge or Associate Judge of that Division, of the values referred to in order 4.”
Mr Tomanovic did not make the election referred to in par 4(a) of the Court of Appeal’s Orders.
The judge hearing the remitted proceedings (the primary judge) accepted the evidence of a valuer called by Mr Sayer and One Australia, a Mr McGuiness, that the equity value of GMEC ranged between $2.7 million and $3.1 million: Re Global Mortgage Equity Corporation Pty Ltd (ACN 105 108 469) [2013] NSWSC 1586; (2013) 97 ACSR 30 (the primary judgment). In reaching this conclusion the primary judge rejected the evidence of the valuer called by Mr Tomanovic and AFS, a Mr Meredith, who valued the whole share capital of the company at $12,515,000.
After making the adjustments which the primary judge considered were required by the Court of Appeal’s Orders, the primary judge calculated that the amount payable by One Australia to purchase the shares owned by AFS in GMEC was $1,870,043: primary judgment at par [104]. After the set-off required by Order 4(g) of the Court of Appeal’s Orders, the primary judge concluded that a net amount of $510,924 was payable by Mr Tomanovic and AFS to One Australia and Mr Sayer.
In the result, the primary judge ordered that AFS transfer its shares in GMEC to One Australia and that the judgment referred to in par 4(g) of the Court of Appeal’s Orders could be enforced in the amount of $510,924.
GMEC
As I indicated, GMEC was a financial services company. In an affidavit filed in the remitted proceedings, Mr Sayer stated that GMEC was the holding company of a number of companies. The subsidiaries carried on two principal trading activities. The first was a retail mortgage broking business carried on primarily through Mortgage House of Australia Pty Limited (MHA) (the brokerage business).
The second activity was that of a mortgage lending and origination business (the lending and origination business) carried out through a trust, Paladin Mortgage Trust (No 1) (the Trust), of which Perpetual Trustee Company Limited was the trustee and MHA the principal beneficiary. Mr Sayer indicated that the Trust did not act as a mortgage broker or engage in mortgage broking activities. In these circumstances, commissions recoverable and commissions payable were attributable to third party funded loans rather than loans by the Trust.
Mr Sayer also gave evidence that he supplied to Mr McGuiness GMEC’s budgets for the financial years ended 30 June 2009 and 30 June 2010, together with extracts for the year ended 30 June 2011. His evidence, which was unchallenged, was that GMEC did not prepare a costs analysis to attribute operating costs or overheads to the brokerage business or to the lending and origination business. He stated that if it had, none of the costs would have been allocated to the lending and origination business as these costs were covered by the management fee payable to Perpetual Trustee Company Limited.
Mr Sayer also gave unchallenged evidence that GMEC did not expect any significant growth in settlements written through the Trust. He said the ability of the Trust to lend money depended on its ability to borrow money at competitive rates. He said that as at June 2010 its only source of funds was under a Senior Note Facility with the Commonwealth Bank of Australia. He said the Senior Note Facility was initially $750 million, which was reduced to $400 million in January 2009, and following a review in April 2010, was further reduced to $230 million.
Mr Sayer gave evidence that as at 30 June 2010 the Senior Note Facility was drawn down to $223 million. In addition, the Commonwealth Bank had increased its margin such that the Trust’s mortgage products had become uncompetitive. He said that by June 2010 the Trust was advising borrowers who wished to refinance, to refinance elsewhere. He stated his expectation was that there would be a decline in settlements made through the Trust after the valuation date.
Mr Sayer also indicated that the cash of $3,394,844 in the audited balance sheet of the Trust was mainly required to meet Trust obligations.
The balance sheet of GMEC for the financial years ended 30 June 2009 and 2010 treated trailing commissions received by the company differently. Trailing commissions may generally be described as commissions payable from lenders over the life of a settled loan based on the loan book balance outstanding.
In the 2009 year the net present value of such commissions was not recognised as fair value on loan settlement but rather accounted for as revenue in the financial year in respect of which they were received. The effect of such accounting treatment is to increase the profitability of the entity (assuming the trailing commissions received exceed the trailing commissions payable) but adversely affect the balance sheet position. Thus in 2009 the statement of financial position showed a deficiency in equity of $1,231,406 with a net loss after tax of $1,831,836 (after taking into account the writing-off of bad debts of $7,468,248). By contrast the restated 2009 accounts, which brought to account the net present value of the trailing commissions, showed a net equity of $12,384,140 but a loss for the year in question of $4,588,436.
The financial statements for the 2010 year were prepared on the basis that the net present value of the trailing commissions would be treated as an asset of the company in the balance sheet. In that year the accounts of GMEC showed total equity of $12,515,127 and a net profit of $130,987.
The accounts were prepared on a going concern basis. However, the notes to the accounts made the following comments:
“The Paladin Mortgage Trust No 1 and Mortgage House of Australia Pty Ltd (MHA) both of which are within the consolidated group, are dependent upon the ongoing renewal of their respective financing facilities. As described in Note 13 the working capital facilities have been extended for 364 days to 26 October 2011 and the warehouse facility extended to 14 April 2011. Whilst the group expects the facilities to be further renewed beyond these dates, this is not certain.
The financial statements have been prepared on a going concern basis and do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or to the amounts and classification of liabilities that might be necessary should the Trust or MHA not continue as a going concern.”
The accounting policies and the effects they had on the accounts were explained in the notes to the special purpose accounts for the year ended 30 June 2010. Note 1(c) for the accounts dealt with revenue and expense recognition. It gave the following explanation:
“c. Revenue and expense recognition
The economic entity provides loan origination services and receives origination commission on the settlement of loans. Additionally, the lender will normally pay a trailing commission over the life of the loan. Commission revenue over the estimated life of loans written is recognised on the settlement of the loans.
Origination commissions received are recognised as revenue on loan settlement. Commissions ‘clawed back’ by the lender at a later date are netted against revenue as incurred.
On origination, trailing commissions are recognised as revenue at fair value on loan settlement, being the expected future trailing commission receivable discounted to their net present value. In addition, an associated payable and expense to other brokers or branches are also recognised, on origination at fair value, being the expected future trailing commission payable to other brokers or branches discounted to their net present value.
Subsequent to initial recognition and measurement, both the trailing commission asset and trailing commission payable are measured at amortised cost. The carrying amount of the trailing commission asset and trailing commission payable are adjusted to reflect actual and revised estimated cash flows by recalculating the carrying amount through computing the present value of estimated future cash flows at the effective interest rate. The resulting adjustment is recognised as income or expense in the income statement.
The above represents a change in accounting policy for the recognition of trailing income and comparative year results have been re-stated to reflect the new accounting policy. Previously trailing commission was recognised as income on receipt.”
The notes also explain that the basis upon which the commissions are brought to account is a matter for the judgment of the directors:
“Key judgments – Trailing commissions
The Company receives trailing commissions from lenders on settled loans over the life of the loan based on the loan book balance outstanding to which the group is entitled. The Company also makes trailing commission payments to other brokers and branches based on the loan book balance outstanding.
The fair value of trailing commissions receivable and the corresponding payable to other brokers and branches is determined by using the discounted cash flow valuation technique. These calculations require the use of assumptions. The key assumptions underlying the fair value calculations of trailing commissions receivable and the corresponding payable to other brokers and branches at balance date include the average loan life and the discount rate. These assumptions are determined by management based on internal data and comparisons with similar companies.”
The financial effect of the change was also set out in the notes:
“2 Financial effect of change in accounting policies
Recognising trailing commission receivable & payable at fair value on loan settlement has:
increased net assets at 30 June 2008 by $17,393,600 after providing $7,934,400 for deferred tax
reduced commissions received by $6,325,000 and reduced commissions paid by $2,387,000 for 2009
consequently increased the loss before tax for 2009 by $3,938,000 and $2,756,600 after tax
reduced commissions received by $2,787,000 and reduced commissions paid by $1,147,000 for 2010
consequently decreased the profit before tax for 2010 by $1,640,000 and $1,148,000 after tax.”
The accounts disclose a current liability with respect to borrowings of $7,050,000. The notes to the accounts contain the following comments in relation to that liability:
“The Bank facility provided by the Commonwealth Bank of Australia is supported by the value of future trailing commissions and is subject to a repayment schedule linked to the value of this future trailing commission. On 28 October 2010 the Group entered into an agreement with the Commonwealth Bank of Australia whereby in addition to the capital repayment of $500,000 made on 20 August 2010 an additional capital repayment of $550,000 would be made on 29 October 2010. The Group will also make minimum monthly repayments of $100,000 to ensure that the facility is fully repaid by 30 June 2015. The amended facility is initially for a period of 364 days, when the balance is due for repayment, unless the facility is extended for further periods of 12 months by the Commonwealth Bank of Australia at the request of the Group. The Bank facility is secured by a guarantee provided by members of the Group and the Director, Kenneth Sayer.
The Notes to Paladin Mortgage Trust No 1 are provided by The Commonwealth Bank of Australia as part of a $230 million Warehouse Facility which on 29 October 2010 was extended until 14 April 2011 unless extended for a further period at the request of the Group.”
It should be noted that the accounts disclose an increase in cash held at the end of the financial year ending 30 June 2010 of $488,641. However, the cash flow from operating activities was a negative $133,860.
There are a number of matters arising from these accounts. First, the accounting policy adopted had a marked effect on the shareholders’ equity as disclosed in the balance sheet and on the profitability of the company. This tends to cast some doubt on the proposition advanced by Mr Meredith, the valuer engaged by the appellants, that it was appropriate to value the shares in the company by reference to the total equity in the balance sheet or for that matter by reference to any particular line item.
In this context, it should be noted that the auditor’s report stated that there was material uncertainty whether the Trust and MHA, which carried on the brokerage business, could continue as a going concern and, therefore, whether they would realise their assets at the amounts stated in the financial report. The report was in the following terms:
“Without qualifying our opinion, we draw attention to Note 1 and Note 13 in the financial report which indicates that The Paladin Mortgage Trust and Mortgage House of Australia Pty Ltd (‘MHA’), both of which are within the consolidated group, are dependent upon the ongoing renewal of their respective financing facilities. As described in Note 13, on 29 October 2010, the warehouse facility was extended until 14 April 2011, and the working capital facility has been renewed for a period of 364 days. As a result of these matters there is significant uncertainty whether the Trust and MHA will continue as going concerns beyond this date, and therefore whether they will realise their assets and extinguish their liabilities in the normal course of business and at the amounts stated in the financial report. The financial report does not include any adjustments relating to the recoverability and classification of recorded asset amounts or to the amounts and classification of liabilities that might be necessary should the Trust or MHA not continue as a going concern.”
The other thing that should be noted is that, consistent with the opinion of Mr McGuiness, the valuer engaged by the respondents, it is clear from the notes to the accounts that the net present value of the trailing commissions does not take into account any operating expenses incurred in the carrying on of the business.
The judgment of the primary judge and the parties’ submissions on appeal focused primarily on the differing views of Mr McGuiness and Mr Meredith. It is necessary in those circumstances to set out their evidence in some detail.
The first report provided by Mr McGuiness
Mr McGuiness stated that there were two fundamental premises of valuation – a going concern basis which holds that the business is a sustainable enterprise and the valuation could have regard to the future economic benefits associated with the business and a liquidation or orderly realisation of assets basis which holds that it is more economical to realise the assets and liabilities of the business than to continue to operate it.
Mr McGuiness explained that a discounted cash flow method is appropriate to use in certain circumstances including where the business has a limited life. He pointed out that such a valuation required determination of the nature and timing of future cash inflows and outflows at a discount rate or cost of capital to be applied to those cash flows.
Mr McGuiness explained that under a capitalisation of earnings method of valuation an expected level of earnings is estimated and capitalised by the application of a suitably chosen multiple. He explained that an orderly realisation of assets method valued the entity on the likely amount that will be distributed to shareholders if the assets were realised in an orderly manner. He said it was an appropriate method to use if the business was to cease operations or where the profitability of the company was not sufficient to sustain an earnings valuation.
Mr McGuiness stated that he valued the brokerage business of GMEC by a primary method of capitalisation of earnings and the lending and origination business by a discounted cash flow method. He said this involved two assumptions. First, that the mortgage interest revenues and borrowing costs on the Senior Note Facility are attributable to the lending and origination business, whilst the net present value of trailing commissions receivable and the net present value of trailing commissions payable are attributable to the brokerage activities.
Mr McGuiness said he reviewed the financial performance of GMEC with reference to the accounts of the company for the years ending 30 June 2007, 2008, 2009 and 2010. He noted the change in accounting policy to which I have referred above. He noted that the company had grown its revenues from 2007 to 2009 but they had fallen to approximately $27 million in 2010. The revenue had in fact declined by approximately $8.5 million in 2010 compared to the previous financial year.
Mr McGuiness pointed out, by reference to the statement of financial position for the year ended 30 June 2010, that GMEC had net assets of approximately $12.5 million but negative or marginal net assets on the application of the former accounting policy. He also noted the business had not generated significant cash flows in the 2009 and 2010 financial years.
In dealing with the lending and origination business, Mr McGuiness pointed to the significant decline in new mortgages through the Trust, which was consistent with an expectation that the Trust did not expect to write significant levels of business after June 2010. He also noted the value of all mortgages originated by the brokerage business had reduced from $3.5 billion to $2 billion over four years.
Mr McGuiness conducted an analysis of the brokerage business. He estimated earnings before interest, tax and depreciation (EBITDA) was negative $103,237 for the year ended 30 June 2010. This comprised $12,249,688 revenue less $12,352,925 operating costs. However, he noted that EBITDA averaged $2,011,355 over the 2008, 2009 and 2010 financial years. He accepted there were limitations in this presentation as there was no allocation of costs to the lending and origination business.
Mr McGuiness undertook an analysis of GMEC’s loan book valuation model. He noted that the loan book valuation model’s estimate of net trailing monthly income, for what was described as the branded portfolio, was $595,422 from gross commissions payable of $170,831, whilst in respect of the third party portfolio the estimated net trailing monthly income was $86,674 from gross commissions payable of $45,527. He noted that the loan book valuation model gave a net present value of the net trailing commissions, receivable for the year ended 30 June 2010, of $20,848,504.
In his evidence at the trial Mr McGuiness pointed out that although the figure of $20,848,504 was described in the loan book valuation model as the estimate of the net present value of trailing commissions receivable and took into account gross commissions receivable and gross commissions payable, it made no allowances for other operating expenses, which amounted to $6 million to $8 million. He pointed out that if these figures were accounted for in the loan book valuation model it would not mean that there was required a deduction of $8 million but rather that the net present value of that amount would need to be reflected. Mr Meredith agreed with the latter comment. Mr Meredith also agreed that there should be accounting for future liabilities.
Mr McGuiness also took into account the budgets of GMEC for the years ended 30 June 2009 to 30 June 2011. These budgets showed net commission income and expenses separately for the years in question. The expenses ranged from $6.7 million in the year ended 30 June 2009, $6.4 million in the year ended 30 June 2010 to $8.146 million in the year ended 30 June 2011. It was these figures of $6 million to $8 million which Mr McGuiness stated were not taken into account in the loan book valuation model.
Mr McGuiness also explained how those costs could be derived from the June 2010 accounts. He took the total expenses of $26,904,276, disclosed in the accounts, deducted operating expenses for the lending and origination business of $12,688,361 (borrowing costs-notes) and made the adjustments referred to in par 4.3.2 of his report of $1,882,990. After the deduction of these expenses, which, on Mr McGuiness’ calculation totalled $14,551,621 (the correct figure is in fact, $14,571,351 but the difference is immaterial), he attributed the balance of the operating expenses of $12,352,925 to the brokerage business. He concluded, as did Mr Meredith, that to the extent these expenses included trailing commissions payable, they were included in the net present value of the commissions. This left a balance of $7,832,329. Mr Meredith did not contest any part of this analysis save to assert costs of the nature suggested would not be incurred in collecting the trailing commissions.
These costs were used by Mr McGuiness in his calculation of EBITDA. Similar calculations were done for the previous two years providing an average EBITDA of $2,011,355. The EBITDA for the year 2010, however, was negative $103,237.
From this information Mr McGuiness valued the brokerage business using a capitalisation of earnings model, concluding that the value was within the range of $3.7 million to $4 million. Mr McGuiness also conducted a discounted cash flow analysis which also indicated a range of value of $3.7 million to $4 million. In doing this, he calculated the average EBITDA at 10.5% of revenue, which he noted when giving evidence, was more generous than the ratio for the year ended 30 June 2010.
Mr McGuiness conducted a valuation of the lending and origination business using a discounted cash flow model. He estimated cash flows for the business taking no account of the expenses allowed for in the budget to which I have referred. Whilst Mr McGuiness said in his evidence that he did not have information to express a view as to what part of the costs of the brokerage business were attributed to the lending and origination business, he stated he did not consider it would be material. He pointed out that if there was an allocation of 10% of those costs to the lending and origination business, it would exhaust the whole of the cash flows of that business. At the time of this report Mr McGuiness did not have the affidavit of Mr Sayer.
Mr McGuiness concluded that the value of the lending and origination business based on a discounted cash flow valuation ranged between $0.72 million to $0.73 million.
Mr McGuiness then considered the value of the loans made by GMEC to AHQ and 9 AS Trust. He concluded that, based on his valuation of AHQ and 9 AS Trust, the receivables should be valued at $2,256,193, as distinct from the book value of $6,718,464. This was to reflect the inability of AHQ and 9 AS Trust to repay the advances.
After making adjustments for surplus assets, Mr McGuiness concluded that the market value of the shares in GMEC ranged between $2.7 million and $3.1 million. This figure took into account adjustments, which he believed were necessary as a result of the Court of Appeal’s Orders.
The report prepared by Mr Meredith
Mr Meredith valued the share capital of GMEC at $12,515,000, an amount equivalent to the net asset value of GMEC disclosed in the audited financial accounts for the year ended 30 June 2010. He then adjusted this amount, by an amount referable to liabilities of GMEC to Mr Sayer, One Australia, Mr Tomanovic and AFS and certain legal expenses, to reach a net value for GMEC of $17,306,530.
Mr Meredith then calculated 45% of this amount and deducted from it monies due by Mr Tomanovic and AFS to Mr Sayer under the judgment referred to in Order 4(g) of the Court of Appeal’s Orders. He then added certain costs said to be payable by the appellants to the respondents to arrive at a total purchase price payable by One Australia of $6,686,869.
Mr Meredith opined that a capitalisation of earnings methodology was not appropriate for valuing GMEC as it was best suited to a company with relatively stable historical earnings, which he said was essential for a reliable estimate of future maintainable earnings. He also concluded that a discounted cash flow method of valuation was appropriate for a company expected to have a finite life, currently in a start-up phase, having the prospect of significant growth and able to provide reliable long term cash flows. He said that GMEC did not fall into any of those categories.
Mr Meredith stated that an assets valuation method was appropriate where, relevantly, an indication is required of the minimum value a vendor might be prepared to accept for its shares or for companies operating at a low return inconsistent with the level of net assets employed.
Mr Meredith stated that an assets based methodology was usually completed on either a going concern basis or on the basis of an orderly realisation of assets or on a distressed sale basis. He stated that on a going concern basis, carrying or book value is usually taken to be representative of market value. He provided no supporting material for this statement. Mr Meredith concluded that, as the other suggested means of valuing GMEC were inappropriate, it was appropriate to value the company on this basis.
In relation to AHQ, Mr Meredith stated that the management of GMEC had advised him that of the $4,799,626 shown as due to that company by various related entities, only $1,327,522 was recoverable. He said that as a consequence, the audited balance sheet of AHQ was materially misstated. He ultimately concluded that the shares and the units in 9 AS Trust had no value.
Mr Meredith’s reason for adopting book value in his valuation of GMEC was summarised by him in the following terms:
(a)The financial reports were prepared in accordance with accepted accounting standards.
(b)The annual report was prepared on a going concern basis.
(c)It was audited by one of the largest and most competent auditing firms in the world.
(d)The auditor received a representation letter from management as to the accuracy of the accounts.
(e)The auditors and management would have been aware that the accounts would have been relied on by financiers and creditors.
(f)The director’s report stated that the changes in the accounting policies had strengthened the balance sheet.
(g)The declaration by the director that the accounts were true and fair.
Mr Meredith sought to do a cross-check on value by reference to what he described as a price/book ratio method of valuing shares in a listed financial services company. The method involves dividing the price of a share by the net asset value of the company per share. After adding a premium for control of 25%, he concluded that the application of that methodology to GMEC produced a comparable result to that which was arrived at by applying a similar methodology to a listed company, HomeLoans Limited. This was a company which he stated, without elaboration, was comparable to GMEC. No reliance was placed on this approach by the appellants on the appeal.
Mr McGuiness’ report in response
In a report filed in response to that of Mr Meredith, Mr McGuiness pointed out that Mr Meredith accepted the book value of GMEC as its market value, making no separate analysis of the expected revenues, costs, profits and cash flows attributable to the brokerage business and the lending and origination business respectively. He stated that an approach which simply accepts the book value of the entity was not appropriate given there were two different businesses, the brokerage business was to continue over the long term and the lending and origination business was in a state of decline.
Mr McGuiness stated that an asset based method is not generally accepted as the primary valuation methodology. In an appendix to his report he provided a number of text references which supported that conclusion.
Mr McGuiness further stated that, in his opinion, Mr Meredith’s use of book value was in error and not consistent with the standard of fair market value, as Mr Meredith made no attempt to restate the assets and liabilities to their fair market value. In his evidence he stated that his consideration of the value of each of the businesses conducted by GMEC effectively restated the value of those assets to fair market value.
Mr McGuiness stated that if, contrary to his opinion, book value was to be used, it needed to be reduced from $12.52 million to $9.62 million, to take account of the non-recoverable nature of the loans to AHQ and 9 AS Trust and legal fees.
Mr McGuiness said his use of the GMEC budget was appropriate because it provided information indicative of the expected performance of the businesses post-valuation date. He said that Mr Meredith ignored this material. He stated that the approach adopted by Mr Meredith was flawed. He indicated that if it was credible, there would never be a need for an independent valuation and it would produce significantly different results depending upon the accounting policy adopted.
Mr McGuiness criticised Mr Meredith for making no adjustment for the non-recoverable loans, which he said led to a $4.46 million overstatement of the recoverability of loans from AHQ and 9 AS Trust. He also identified what he said were the errors made by Mr Meredith in his valuation of AHQ, arising from the use of book value. These were, the inclusion of a success fee of $1.03 million given an instruction it was irrecoverable, the use of the book value of a loan to Mortgage House and Land Pty Ltd of $1.25 million given an instruction that the recoverable value was $0.55 million and the use of book value in respect of a loan to Sayer Family Trust of $1.27 million given an instruction the recoverable value was $0.68 million.
In relation to 9 AS Trust, he indicated Mr Meredith erred in adopting the book value of a loan receivable from related entities, known as Multiown Entities, of $0.22 million, from Trinity Legal of $0.1 million and from MH Property Connect Pty Ltd of $212 given instructions that they were irrecoverable.
Mr McGuiness also stated that in respect of a loan made by 9 AS Trust to AHQ, Mr Meredith erred in adopting a book value of $1.14 million given that on Mr Meredith’s own analysis AHQ had a deficiency of assets over liabilities of $1.08 million. Thus, he said, even on Mr Meredith’s approach, the amount of the loan which was recoverable was $0.06 million. Mr McGuiness pointed out that an adjustment arising out of loan receivables being wholly or only partly recoverable is a generally accepted valuation practice and was adopted by Mr Meredith in his analysis of AHQ and 9 AS Trust but not in relation to GMEC.
Mr McGuiness further pointed out that Mr Meredith provided no assessment of a cost of capital, an earnings multiple or expected earnings for GMEC. However, he stated that Mr Meredith’s valuation of $17.14 million implied an earnings multiple in the range of 11.8 times, which he said was inconsistent with valuation fundamentals. In fact Mr Meredith’s valuation was $17,306,530. However, it should be noted Mr Meredith reached that figure by making adjustments to the book value of $12.515 million which he believed was required by the Court of Appeal.
Mr McGuiness also referred to the different approach that he and Mr Meredith took to the value of the properties owned by AHQ. Mr Meredith valued these properties in an amount which was $0.89 million greater than the value attributed to them by Mr McGuiness. In valuing these properties, Mr McGuiness adopted a valuation of them by MJ Davis Valuations Pty Ltd, dated 10 May 2012, which valued the properties as at 30 June 2010 in an amount of $5,250,000. Mr Meredith relied on a valuation of 9 December 2010 prepared by the same valuer, valuing the property at $6,010,000. Mr McGuiness stated that in relying on the value of the properties as at 9 December 2010 Mr Meredith incorrectly relied on material not available at the valuation date. Mr McGuiness also pointed out that Mr Meredith made no allowance for the realisation costs of the property, even though he was conducting a valuation on an orderly realisation basis.
Mr McGuiness finally stated that it was inappropriate to take account of a deferred tax asset on an orderly realisation of assets method of valuation as a hypothetical purchaser would have no use for it.
The joint report
In a joint report dated 21 August 2013 Mr McGuiness and Mr Meredith largely adhered to the positions they had adopted in their respective reports. However, in relation to GMEC, they agreed that, in principle, the book value of an entity’s assets and liabilities are not representative of market value and that an orderly realisation of assets method of valuation begins with an assessment of the book value for the assets and liabilities, which are adjusted to “a relevant standard of value”.
The valuers also agreed that, in principle, the application of a discounted cash flow methodology provides the net present value of the expected cash flows of an enterprise and a discounted cash flow based on cash flows to the entity provides a value of the operating business or enterprise value.
The valuers also agreed that, in principle, a capitalisation of estimated future earnings valuation is a proxy or short form analysis for a discounted cash flow analysis and is useful in providing a valuation of expected cash flows. They also agreed, in principle, that where an orderly realisation of assets method is used, it is “applicable” to restate the assets and liabilities to a relevant standard of value such as fair market value. However, they disagreed that for GMEC such a restatement from book value was required.
The valuers also agreed that, in principle, it was “applicable” for a valuer to review the financial position, financial performance, budgets, forecasts and other information for the purpose of a discounted cash flow or capitalisation of earnings analysis. However, the valuers disagreed that the material in the present case was adequate for such a review. Finally, they agreed that a going concern premise of valuation was appropriate for GMEC.
The valuers disagreed on the values of the integers to be used in a capitalisation of earnings or discounted cash flow analysis. However, Mr Meredith provided no alternative to those values suggested by Mr McGuiness. Subsequently, in the joint report Mr Meredith stated that the integers used were within the range which might be expected. The valuers also disagreed that, in relation to GMEC, it was appropriate to restate loan receivables and surplus assets to estimates of their recoverable value. However, in contrast, they agreed it was appropriate to do so in arriving at the equity value of AHQ and 9 AS Trust on an orderly realisation of assets basis, which they agreed was the appropriate method of valuing those entities.
The valuers adhered to their different positions in the method of assessing the value, to GMEC, of the loans made by that company to AHQ and 9 AS Trust.
In the joint report, Mr Meredith expressed the opinion that the most applicable method of valuing GMEC was a discounted cash flow valuation. However, he said that the foundation for such a valuation is “a long term cash flow forecast, preferably covering a period of 10 years, prepared by those persons tasked with stewardship of an enterprise”. He said such information was not available so it was not possible for a valuer to prepare such a valuation. He also said it was not possible to apply a future maintainable earnings methodology as it can only be applied where there has been stability of earnings over a three to five year period.
Mr McGuiness disagreed that there were such limitations and stated that the GMEC budget models provided information as to the nature, timing and extent of the integers that are relevant to the expected revenues, costs, profitability and cash flows.
In support of his contention that an asset based method of valuation was appropriate, Mr Meredith placed some reliance on comments made in a KPMG valuation of certain regulated assets prepared for Queensland Treasury. However, as Mr McGuiness pointed out, the valuation in fact was done on a discounted cash flow basis.
Mr Meredith stated that the budget models could not be used for valuation purposes because they were not supported by a strategic plan or a comprehensive set of clearly elucidated assumptions or “framed within a clarifying narrative”. Mr McGuiness by contrast stated that the budget models provided sufficient information for a valuer to understand the integers used. He said that the budget models were more detailed than those which are regularly found in businesses of a comparable scale.
So far as recoverability of the AHQ and 9 AS Trust loans were concerned, Mr Meredith stated that, given the valuation had to be completed in the context of it being retrospective, no regard should be paid to the write-off of $4,893,420 in the 2011 year when the loans were included in full value in the 2010 financial accounts. Mr McGuiness stated that the fact that the loans were written off was “inapplicable”, he instead adjusted their value having regard to the deficiency of the net assets of the debtors.
Mr Meredith did not deny the deficiency per se, but stated that he would determine the issue of recoverability using a cash flow test as it is not uncommon for enterprises with apparent deficiencies in assets to have access to cash resources, not shown in the accounts, to pay the debts.
There are other minor matters dealt with in the joint report. To the extent that they are relevant I have dealt with them subsequently in this judgment.
The evidence given by the valuers at the trial
Mr Meredith repeated his view that in the absence of a long term cash flow forecast for the company and in the absence of a business plan it was not possible to value the shares in the company using a discounted cash flow method.
Mr Meredith stated that his understanding was that the operating costs of $6 million to $8 million, referred to by Mr McGuiness, would have been taken into account in forming a view whether the net assets reflected a true and fair view of the net assets of the company. He also pointed to the fact that the accounts were audited.
Mr Meredith stated he did not recall if the operating costs were included in the loan book. He said he had lost faith in the loan book when it produced a different net present value of the trailing commissions to that shown in the accounts. He said net present value in his belief was gross commissions received less the expenses of earning those commissions.
Mr Meredith also suggested that a hypothetical purchaser might not take the additional expenses into account because the purchaser might have the capacity to avoid any such expenses in getting in the commission.
In relation to the loans from GMEC to AHQ and 9 AS Trust, Mr Meredith acknowledged that the unaudited balance sheets for the latter two entities showed a deficiency of assets over liabilities but said funds could be obtained from other sources to pay the debts. Mr Meredith identified a possible source as cash from shareholders. He did not indicate why shareholders would make that cash available to an incoming purchaser. He said that he felt sure that the director responsible for preparing the GMEC accounts, who did not write down the loans, would have considered this issue.
In cross-examination, Mr Meredith acknowledged that he had had communication with the Chief Financial Officer of GMEC in the course of preparing his valuation. However, he said he did not make inquiries as to whether there was any business plan or strategic plan for the company. He said that such documents would have been given to him if they had been available. He acknowledged that the Chief Financial Officer asked him whether he needed any further information to prepare his valuation and that he did not request any further material.
Mr Meredith said he prepared a discounted cash flow valuation for the business. He described it as “internal rough workings” to see if he had all the information available to properly apply that methodology. He ultimately said to prepare a cash flow forecast he would have to rely on information provided by Mr Sayer and that would be difficult as he was the buyer of the shares. He said he was concerned that such material would not be impartial. It should be noted that no criticism was made of the material supplied by Mr Sayer.
Mr Meredith said that until he completed his report he did not look at valuations prepared by Mr McGuiness stating he felt “that that was not the thing to do”. He said that he had not read Mr McGuiness’ report in response although he had scanned it. He said he didn’t see any point in reading Mr McGuiness’ report.
Mr Meredith was referred to his evidence that he had lost faith in the loan book because it was inconsistent with a stated value of the commissions in the accounts. It was pointed out to him that the only difference was that a discount rate of 10.9% was used in the loan book compared to a rate of 12% in the accounts. He said he did not contact the Chief Financial Officer to ask him to explain the difference between the two amounts.
In his evidence Mr McGuiness explained his reports in detail. I have summarised these reports above.
Mr McGuiness agreed with Mr Meredith that the allocation of fixed costs was a matter of subjective assessment. He pointed out that if there was an allocation of costs in the lending and origination business, the business would produce a negative cash flow. He said his understanding was that the company did not have the information to attribute that part of the costs which may be attributable to the lending and origination business. In that context the evidence of Mr Sayer to which I have referred in par [11] above is of importance.
In cross-examination Mr McGuiness stated that the valuation task was to value 100% of the entity. He pointed out that in acquiring 100% of the entity the various financial benefits would consist broadly of the levels of revenue, costs, profitability, cash flow and at some time in the future perhaps dividends.
In relation to the accounts Mr McGuiness pointed out that the financial statements put readers on notice that there were going concern considerations.
The judgment of the primary judge
The primary judge stated that the first matter which he was required to determine was the market value of the shares in GMEC. He referred to the fact that each of Mr McGuiness and Mr Meredith agreed that market value was to be assessed by reference to the value a hypothetical prudent purchaser who is a willing but not anxious buyer would be prepared to pay to a willing but not anxious vendor. He rejected the contention of the appellants that regard should be had to wider concepts of value, stating that the Court of Appeal’s Orders defined the task as to assess not “the ‘value’ of the relevant shares in a broader sense but their ‘market value’”. He said that that necessarily depended upon the saleable value of the shares on the relevant market.
The primary judge referred to the evidence of Mr Sayer (which I have summarised in pars [10]-[14] above) and to his evidence that GMEC prepared rolling two year budgets for management purposes.
The primary judge summarised the evidence of Mr McGuiness and Mr Meredith. He pointed out that although Mr Meredith stated that the financial information supplied was insufficient for a discounted cash flow or capitalisation of earnings analysis to be conducted, in cross-examination he indicated there was nothing he could recall about the information which caused him to question its reliability.
The primary judge referred to the fact that Mr Meredith had commenced a discounted cash flow valuation and there was nothing to suggest that the GMEC’s Chief Financial Officer was unwilling to provide such information as was required to assist in that task. He noted that Mr Meredith did not seek any such information (see pars [83]-[84] above). The primary judge stated that it did not seem to him that the information provided to the valuers by GMEC in itself raised any question as to its veracity. He referred to the evidence of Mr Meredith that it was important to remain impartial but said he found it impossible to see how an expert could prejudice his independence and impartiality by seeking necessary information.
The primary judge referred to the evidence of Mr Meredith that because of the difference in the net present value of the trailing commissions contained in the loan book as compared to the accounts, he lost faith in the loan book (see pars [80] and [86] above). The primary judge pointed out that had he asked the Chief Financial Officer the discrepancy would have been resolved as a difference due to a change in the discount rate. He repeated his view that asking for such an explanation could not be seen to compromise the independence of the expert.
In these circumstances the primary judge did not accept the criticisms made by Mr Meredith of the use made by Mr McGuiness of a discounted cash flow methodology in valuing the lending and origination business. He pointed out that Mr Meredith did not point to any academic or professional commentary supporting his view that to undertake such a valuation it was necessary to have 10 to 20 year forecasts prepared by management. The primary judge accepted that an earnings based valuation not based on such forecasts may have a greater level of uncertainty but said it did not seem to be worthless or impossible to undertake.
The primary judge also referred to the evidence of Mr Meredith that the unstable patterns of earnings experienced by GMEC made it impossible to use a capitalisation of earnings methodology to value the shares in the company. He again expressed the view that that assertion was not supported by any academic or professional literature and stated that he was not persuaded by Mr Meredith’s contention.
The primary judge rejected the appellants’ submission that the forecasts used by Mr McGuiness in his valuation amounted to sheer speculation. He said the fact that a valuation is not a matter of exact science is not a reason to not adopt an accepted valuation process. The primary judge accepted that any forward looking exercise, such as an estimate of future cash flows, is potentially less certain than an exercise based on historical facts. He pointed out that a fundamental difficulty with the appellants’ approach is that it would exclude the use of a discounted cash flow or capitalisation of earnings methodology in many or all circumstances. A similar comment had been made by Mr McGuiness (see par [58] above).
The primary judge also noted the appellants’ submissions that different growth rates could provide different results. He said that merely demonstrated that any expert assessment would depend on the inputs, which will often be a matter of expertise. He said it was open to the appellants to apply a sensitivity analysis to demonstrate the effect of different rates of growth and ask the Court to adjust the valuation on that basis. He noted that the appellants chose not to do so.
The primary judge rejected the criticism of Mr McGuiness’ valuation on account of the fact it was based on material supplied by Mr Sayer. He pointed out that a willing but not anxious purchaser would seek information in relation to the business to be acquired from a vendor. He also pointed out that the information was provided by the Chief Financial Officer rather than by Mr Sayer and there was no particular aspect of it which was said to be inaccurate or distorted. He also pointed out that Mr Meredith himself relied on the balance sheet.
The primary judge referred to the appellants’ contention that the result of Mr McGuiness’ valuation was that One Australia would acquire assets of $12.5 million net (including future trailing commissions having a value of nearly $20 million and access to a source of remuneration in excess of $900,000 per year) at a valuation of $2.7 million to $3.1 million. The primary judge pointed out that that assumes the value of future trailing commissions are at the figure stated notwithstanding the evidence that such a figure did not take into account the cost of earning such commissions, the qualification to the financial reports and the question whether GMEC could continue as a going concern.
The primary judge pointed out that in supporting his assets based valuation, Mr Meredith observed that book value was a true and fair value. He stated that that observation required at least three qualifications. First, neither the director nor the auditor stated that the balance sheet was presented either at market value or fair market value. Second, the reports themselves stated the accounts did not comply with Australian accounting standards. Third, the proposition had to take account of the nature of the audit set out in the auditor’s report to members. The primary judge accepted the respondents’ submission; namely, that the appellants’ assumption that auditors, when conducting a special purpose audit, in some ways satisfy themselves as to the market value of the assets of the company, overstated the position. His Honour accepted the evidence of the auditor, Mr Stevenson, that he was not qualified to perform and did not perform a valuation of GMEC’s assets.
The primary judge referred to the evidence of Mr Meredith that the proposition that book value is representative of market value is “entrenched in valuation practice and there is myriad empirical evidence and literature to support this view”. He pointed out that Mr Meredith produced no material to support that proposition. The primary judge referred to the commentary supplied by Mr McGuiness to the effect that the use of book value in that fashion is not generally a proper basis for valuation and that the literature did not support the view that the value of a business enterprise will necessarily be equal to book value.
The primary judge accepted the appellants’ submission that financial statements based on historical costs may have more utility where the relevant assets in question are future commissions based on net present value. However he stated this was not a complete answer, referring to the impairment to the loans owed by related parties and the failure to take into account the costs involved in delivering the earnings.
The primary judge pointed out that even if it was accepted that a discounted cash flow or capitalisation of earnings method of valuation was inappropriate, it did not follow that the balance sheet value should be accepted. He referred to the agreement between the valuers that an assets based method of valuation begins with an adjustment of book value to the relevant standard of value.
The primary judge referred to the evidence given by Mr McGuiness that Mr Meredith’s approach to book value did not take into account assets and liabilities not disclosed on the balance sheet. The judge stated that this was of particular importance where ongoing costs may be reflected as an expense in a company’s income statement rather than in its balance sheet.
The primary judge criticised Mr Meredith for failing to read the response report of Mr McGuiness. He stated that that fell well short of what would be expected of an expert.
The primary judge accepted the evidence of Mr Sayer as to the allocation of costs to which I have referred in par [11] above. He referred to the evidence of Mr McGuiness that the valuation attributed to trailing commissions in the loan book only took into account commissions payable and no allowance was made for other costs. He accepted the view, expressed by Mr McGuiness that it was necessary to take into account $6 million to $8 million of operating costs (see pars [37] and [38] above). In particular he accepted the evidence of Mr McGuiness that he had reviewed the loan book valuation model and that that model did not account for the operating expenses.
The primary judge rejected the submission that it was inconceivable that the auditor would fail to provide for these expenses in fixing the net present value of future trailing commissions. First, he stated that the evidence was that the value was fixed by reference to the loan book model and that the operating costs would be reflected in the statement of financial performance (profit and loss) contained in the accounts. He pointed out that the expenses would not be missing when brought to account in the profit and loss statement. He stated that no reason was given to suggest that the auditor would have any difficulty with the inclusion of operating expenses in the profit and loss account.
The primary judge also pointed to the evidence of Mr McGuiness as to the effect the change in accounting policy had on the net asset position (see par [33] above). The primary judge concluded that the substantial change caused by the adoption of that methodology indicated a fundamental deficiency in Mr Meredith’s approach, namely, a failure to adjust values to take account of expenses.
Undoubtedly it is correct that stability of earnings and the availability of long term cash flow forecasts diminish the uncertainty inherent in the valuation based on an estimate of earnings or cash flows. So much was acknowledged by the primary judge. However, this does not mean the absence of such factors precludes the use of such methods of valuation if the valuer believes that he or she has sufficiently reliable material to undertake the task.
In the present case the evidence of Mr McGuiness, an experienced valuer, was that he had sufficient information to undertake the valuation using earnings and cash flow based methodologies. Mr Meredith, apart from the general assertion that the preconditions he said were necessary for the use of methodologies were absent, did not point to any material relied on by Mr McGuiness as being inaccurate or unreliable. Nor did he criticise any of the integers used by Mr McGuiness in carrying out his valuation.
In these circumstances it does not seem to me that the primary judge erred in principle in accepting that the methodology used by Mr McGuiness was appropriate. However, the question remains whether the result arrived at was self-evidently erroneous such that the valuation could not be accepted. This involves two questions. First, could the valuation be supported having regard to the differences between the result arrived at and the book value of the company as disclosed in the statement of financial performance for the year ended 30 June 2010? Second and aligned to this issue, did Mr McGuiness err in taking into account costs of between $6 million to $8 million in his estimate of earnings for the brokerage business? It is convenient to deal with the second issue first.
In valuing the brokerage business, did Mr McGuiness wrongly take into account costs of between $6 million to $8 million?
I have set out the method by which Mr McGuiness derived the operating costs in pars [38]-[39] above. Mr McGuiness relied in part on a loan book valuation model in that analysis. He was justified in doing so. Although Mr Meredith said he had lost faith in that model because of the different net present value of the trailing commissions derived from it, compared to the figures stated in the accounts, he failed to observe that this was due to a different discount rate. The primary judge was correct in rejecting Mr Meredith’s criticism of the model in these circumstances.
The appellants’ submissions focused on the proposition that there was nothing to suggest costs of the nature of $6 million to $8 million would be incurred in collecting the trailing commissions. The appellant submitted these costs related to the generation of new business and criticised the primary judge and Mr McGuiness for not identifying the costs said to be involved in their collection. They submitted that Mr Sayer did not identify such costs and an inference could be drawn that there were none.
The difficulty with that submission is that Mr McGuiness was not attempting to calculate the value of the trailing commissions in isolation. Rather, he was valuing the brokerage business as a going concern. Once that is understood, it is apparent that Mr McGuiness did identify the costs in question. The costs in question were the operating costs, after removal of the borrowing costs, which Mr McGuiness attributed to the lending and origination business. This was consistent with the evidence of Mr Sayer that other costs of the lending and origination business were covered in the management fee paid to Perpetual Trustee Company Limited (see par [11] above). It was also consistent with the budget for the 2009, 2010 and 2011 years, which identified such costs.
It follows that in valuing the brokerage business as a going concern it was necessary to take these costs into account. Indeed, had they not been attributed to the brokerage business but to the lending and origination business, as Mr McGuiness pointed out, the cash flow of that business would have been exhausted by 10% of those costs.
It was not suggested that the costs were unreasonable, rather they should have been ignored in the valuation as there was insufficient evidence that they would in fact be incurred. In my opinion they could not be ignored in the application of the methodology used by Mr McGuiness. Whether that methodology produced a result which could be said to be reflective of the value of the company is considered below.
Was the valuation plainly erroneous?
The primary submission made by the appellants was that having particular regard to the total equity of the company of $12,515,127, disclosed in the statement of financial position for the year ended 30 June 2010, a value of GMEC between $2.7 million and $3.1 million was plainly erroneous. As I indicated, senior counsel for the appellants referred to s 1305 of the Corporations Act, pointing out that the effect of that section was that the value of assets set out in the statement of financial performance was prima facie evidence of their value. He also pointed to the fact that the Director’s statement accompanying the accounts said that they presented a true and fair view of the company.
However, in considering the accounts it must be borne in mind that they had been prepared on a going concern basis in circumstances where there was material uncertainty as to the ability of the company to continue as such. Both the notes to the accounts and the auditor’s report expressed a concern as to whether in those circumstances assets would be realised in the amount stated in the accounts.
It is important to remember that Mr Meredith in his orderly realisation of assets model simply assumed that assets could be realised in their orderly fashion at book value and gave no consideration to the overall financial position of the company as at the balance date. The submissions of the appellants adopted the same approach.
There was no evidence to suggest that there was a market for the trailing commission, whether their disposal would result in a default either under the loan facility or the Senior Note Facility or for that matter how any orderly realisation could take place. As Mr McGuiness agreed in the joint report, if a company is to be valued on an orderly realisation of assets basis, the book value would need to be adjusted to reflect market value. In this context a prudent purchaser of the company as a going concern would consider whether in fact any of its assets could be realised without significant financial consequences to the company.
Acceptance of the appellants’ proposition, that a willing but not anxious purchaser would pay an amount equivalent to the book value of the assets of the company for its shares, ignores the factors to which I have referred. It also ignores the fact that the company’s profit to the 30 June 2010 financial year was $187,124 before tax and $130,987 after tax and that it had a negative cash flow of $133,860. In these circumstances it does not seem to me that the primary judge erred in declining to adopt the approach suggested by Mr Meredith or in concluding that Mr McGuiness’ valuation was unreasonable.
As I indicated above at par [140], the appellants submitted that Mr McGuiness’ valuation was flawed because it did not take into account future earnings from net trailing commissions. This submission was not put in the Court below, was not the subject of evidence from Mr Meredith, who did not criticise any of the integers in the valuation and Mr McGuiness was not cross-examined on it. In these circumstances it cannot be relied on in this Court.
Similarly, the submission of senior counsel that the increase in working capital to $26,878,129 in the discounted cash flow analysis used by Mr McGuiness as a secondary method of valuing the brokerage business was inconsistent with a business worth $3.7 million to $4.1 million was not put in the Court below. The figure for working capital was calculated by Mr McGuiness on the basis that working capital was 160% of revenue. He explained that this was unusually high but was the effect on the changes in accounting policy in 2010. He stated it was “applicable” to have regard to the high levels of working capital relevant to revenues in 2010 for determining estimates of expected future profit and in turn expected cash flows. This methodology was not disputed and it was not suggested to Mr McGuiness or for that matter put to the primary judge that it followed that the valuation arrived at by Mr McGuiness was erroneous for that reason.
It does not seem to me that the fact that Mr Sayer said he would not wind-up the company had any bearing on its value. It was not suggested to Mr Sayer that he believed the value of the company was in excess of $12,515,000. Even if it had been put and could be said to be relevant, it would have very little weight.
Nor do I think that the fact that Macquarie Bank sold its 10% shareholding for $750,000 in 2008 demonstrated that the valuation arrived at by the primary judge was erroneous. The appellants submitted that the financial position of the company had improved since that date. There was no analysis to demonstrate that this was the case. In fact the position of the company showed a marked deterioration in 2009 due to the writing off of bad debts of $7,468,248. For this reason alone the submission cannot be accepted. Further, the pre-tax profits for the 2009 year, adjusted as I have indicated in par [121] above, were $815,759, compared with $187,124 for the 2010 year, showing a decline in the position of the company rather than an improvement.
In these circumstances it cannot be said that the valuation arrived at by the primary judge, although significantly lower than book value, was erroneous.
Did the primary judge err in accepting the valuation of the AHQ and 9 AS Trust loans propounded by Mr McGuiness in his valuation?
The appellants were correct in submitting that the primary judge erred to the extent he relied on the fact that the accounts stated that the impairment provisions in the auditing standards had not been complied with. As the appellants submitted, the notes to the account and the Representation Letter signed by Mr Sayer indicated the loans were fully recoverable.
However, the hypothetical prudent purchaser for the purpose of the valuation would be considered to be fully informed as to all matters known as at 30 June 2010 which would affect the value of the shares in question: Spencer v The Commonwealth of Australia [1907] HCA 82; (1907) 5 CLR 418 at 441. That would include, in my opinion, information relating to the recoverability of the loans, which were a significant asset of the company.
Each valuer agreed that the loan receivables should be valued in accordance with the orderly realisation of assets methodology. The loans were shown in the accounts of GMEC in an amount of $6,718,464. Mr Meredith assumed them to be fully recoverable. It should be noted however that in valuing AHQ and 9 AS Trust, Mr Meredith indicated that the management of GMEC had instructed him that of the related party debts due to AHQ, shown in the balance sheet at a value of $4,799,626, only $1,327,522 was recoverable. However, Mr Meredith did not take the diminution of the value of AHQ and 9 AS Trust into account in assessing the recoverability of the loans due by those entities to GMEC.
By contrast, Mr McGuiness took those matters into account and as a consequence wrote down the recoverability of the loans from $6,718,464 to $2,256,193.
The adjustments to the loans due by AHQ and 9 AS Trust were consistent with the information provided by the Chief Financial Officer, which was tendered in evidence and admitted without objection.
It seems to me that this information would be taken into account by a prudent purchaser in assessing the value of GMEC. As I indicated, Mr Meredith did not contend to the contrary but stated there may have been other sources from which the loan could be repaid. It is unlikely that a prudent purchaser would rely on such speculation. Further, if what was being referred to by Mr Meredith were sources available to the existing owners of the entity, a prudent purchaser would not take them into account in considering the value of the receivables.
The other differences between Mr McGuiness and Mr Meredith in their treatment of AHQ and 9 AS Trust were not the subject of submissions on the appeal.
It follows that the primary judge did not err in accepting as correct the valuation of shares in GMEC arrived at by Mr McGuiness.
The application to amend the notice of appeal
Although it may be arguable that Order 4(b) of the Court of Appeal’s Orders in the oppression proceedings (see par [4] above) was wide enough to encompass prejudgment interest and interest from 5 March 2010 to 30 June 2010 the matter was not raised below.
A consideration of the issue would involve, first, the construction of the earlier order of the Court and second, whether the loan to Mr Tomanovic was recoverable and the effect this would have on the calculation of the amount due pursuant to that order or for that matter the valuation of the shares in GMEC. The matter was not dealt with in the written submissions. It was quite inappropriate to raise it shortly prior to the hearing of the appeal and as the respondents point out, there at least would have been the possibility that evidence concerning the recoverability of the judgment debt could have been led had the matter been raised at the hearing. For these reasons the application should be refused.
Conclusion
In these circumstances leave to amend the notice of appeal should be refused and the appeal should be dismissed. The appellants should be ordered to pay the respondents’ costs of the appeal.
BARRETT JA: In Gold Coast Selection Trust Ltd v Humphrey (Inspector of Taxes) [1948] AC 459 at 473, Viscount Simon LC said, "Valuation is an art, not an exact science"; and, "Mathematical certainty is not demanded, nor indeed is it possible". As the Chief Justice explains, the primary judge proceeded according to an objectively reasonable method of valuation and reached a conclusion that, having regard to the evidence before him and the submissions put to him, does not exhibit error. For the reasons stated by the Chief Justice, the appeal should be dismissed with costs.
EMMETT JA: This appeal is concerned with the valuation of shares in Global Mortgage Equity Corporation Pty Ltd (GMEC). The valuation was necessary for the purposes of determining the price to be paid by the first respondent, One Australia Pty Ltd (One Australia), to the second appellant, Australian Financial Services Corporation Pty Ltd (AFSC), in consequence of orders made in an oppression suit brought under s 232 of the Corporations Act 2001 (Cth). An order was made that One Australia purchase the shares owned by AFSC in GMEC at a price equal to 45 per cent of the net value as at 30 June 2010 of GMEC, plus an amount of interest minus the net value as at that date of other assets that had been transferred to AFSC by either One Australia or the second respondent, Mr Kenneth Sayer. A judge of the Equity Division concluded that the amount payable by One Australia for the purchase of the shares in GMEC owned by AFSC was $1,870,043.
AFSC and its principal, the first appellant, Mr Zoltan Tomanovic, appealed from the orders made by the primary judge. They contended that his Honour erred in arriving at a valuation of the shares in GMEC, and that his Honour should have determined a valuation in the order of $12,500,000, which would have resulted in a price payable by One Australia of 45 per cent of that sum.
I have had the advantage of reading in draft form the proposed reasons of the Chief Justice for concluding that the appeal should be dismissed with costs. The appellants sought leave to file an amended notice of appeal. I agree with the Chief Justice, for the reasons proposed by his Honour, that leave to amend should be refused. Accordingly, as the Chief Justice indicates, four questions raised in the appeal require resolution.
The first question was whether the primary judge was justified in accepting the valuation approach adopted by Mr McGuiness, the valuer called by One Australia, in preference to that of Mr Meredith, the valuer called by AFSC. I agree with the Chief Justice that the primary judge did not err in principle when accepting that the methodology used by Mr McGuiness was appropriate.
The second question was whether Mr McGuiness wrongly took into account costs between $6,000,000 and $8,000,000 in valuing the brokerage business of GMEC. I agree with the Chief Justice that in valuing the brokerage business as a going concern, it was necessary to take those costs into account.
The third question was whether, having regard to the shareholders’ equity disclosed in the balance sheet of GMEC, the valuation by Mr McGuiness was plainly erroneous. I agree with the Chief Justice that, although the valuation arrived at by the primary judge was significantly lower than book value, it could not, in the circumstances, be said to be erroneous.
The final question was whether the primary judge erred in accepting the valuation propounded by Mr McGuiness in his valuation of certain loans made by GMEC. I agree with the Chief Justice that, while the primary judge erred to the extent that he relied on the fact that the accounts stated that the impairment provisions in the auditing standards had not been complied with, the hypothetical prudent purchaser of the shares in GMEC must be assumed to be fully informed as to all matters known as at 30 June 2010 that would affect the value of the shares, including information relating to the recoverability of the loans, which were a significant asset of GMEC. The adjustments to the value of the loans made by Mr McGuiness were consistent with information provided by the chief financial officer of GMEC, which was admitted into evidence without objection. Such information would be taken into account by a prudent purchaser in assessing the value of the shares in GMEC. Any error by the primary judge was therefore immaterial.
I agree with the Chief Justice, for the reasons proposed by his Honour, that the primary judge did not err in accepting as correct the valuation of shares in GMEC arrived at by Mr McGuiness. It follows, as the Chief Justice proposes, that the appeal should be dismissed and that the appellants should pay the respondents’ costs of the appeal.
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Amendments
06 May 2015 - Par [125] "$7,5000,000" changed to $7,500,000"
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