Zwanenberg Australia Pty Ltd v Moira Mac's Poultry and Fine Foods Pty Ltd
[2014] FCA 1072
•6 October 2014
FEDERAL COURT OF AUSTRALIA
Zwanenberg Australia Pty Ltd v Moira Mac’s Poultry and Fine Foods Pty Ltd
[2014] FCA 1072
Citation: Zwanenberg Australia Pty Ltd v Moira Mac’s Poultry and Fine Foods Pty Ltd [2014] FCA 1072 Parties: ZWANENBERG AUSTRALIA PTY LTD (ACN 130 900 015) v MOIRA MAC’S POULTRY AND FINE FOODS PTY LTD (ACN 006 929 102) File number: VID 706 of 2013 Judge: JESSUP J Date of judgment: 6 October 2014 Catchwords: CONTRACTS – Construction
CONTRACTS – Contract for the supply of goods, on order, at unit prices – Prices based on manufacturing and capital costs, with mark-up – Provision for regular adjustment – Whether buyer in breach of obligation to calculate adjustment – Provision for coverage of seller’s fixed manufacturing costs at minimum production – Whether limited by estimate or based on actual costs – How costs referable both to manufacture of products and to seller’s other business to be apportioned – Provision for review of model for coverage of minimum costs – Whether buyer in breach of obligation to review
CONTRACTS – Breach – Whether breach constituted by mere threat that fundamental obligation under contract would not be observed.
CONTRACTS – Repudiation – Whether repudiation established by party’s intimation that it would not observe fundamental obligation unless other party made payment which it was not required to make under contract – Affirmation – Whether constituted by continued dealing under contract in conjunction with the issue of proceedings alleging repudiation
CONTRACTS – Implied Terms – Contract for the supply of goods, on order, at unit prices – Whether buyer’s own decision to cease dealing in goods amounted to breach of implied term of co-operation – Whether term implied on facts of case requiring buyer to continue actively seeking business in relevant area – Whether term should be implied requiring seller to mitigate its costs under the contract
TRADE AND COMMERCE – Negotiation of long-term contract for the supply of goods at prices referable to seller’s costs – Seller giving estimate of costs – Whether representation as to future matter – Whether reasonable grounds existed for making of representation – Whether representee suffered or likely to suffer loss
PRACTICE AND PROCEDURE – Setoff – Whether debtor entitled to set off debt owed by creditor to debtor’s parent company
Legislation: Competition and Consumer Act 2010 (Cth); Sch 2 ss 4, 18, 236, 237 and 243 of the Australian Consumer Law
Evidence Act 1995 (Cth), s 69
Federal Court of Australia Act 1976 (Cth) s 54ACases cited: BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266
Electricity Generation Corporation v Woodside Energy Ltd (2014) 306 ALR 25
Immer (No 145) Pty Ltd v The Uniting Church in Australia Property Trust (NSW) (1993) 182 CLR 26
Koompahtoo Local Aboriginal Land Council v Sanpine Pty Ltd (2007) 233 CLR 115
Murphy v Overton Investments Pty Ltd (2004) 216 CLR 388
O’Connor v SP Bray, Ltd (1936) 36 SR (NSW) 248
Sargent v ASL Developments Ltd (1974) 131 CLR 634
Secured Income Real Estate (Australia) Ltd v St Martins Investments Pty Ltd (1979) 144 CLR 596
Terrell v Mabie Todd & Co Ltd (1952) 69 RPC 234
Velik v Steingold [2013] NSWCA 303Date of hearing: 14-17, 22-24 April, 1, 2 & 7 May 2014 Place: Melbourne Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 406 Counsel for the Applicant: A Kelly SC with D Morgan Solicitor for the Applicant: Wainwright Ryan Eid Counsel for the Respondent: P Santamaria SC with R Peters Solicitor for the Respondent: Mason Black Lawyers
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 706 of 2013
BETWEEN: ZWANENBERG AUSTRALIA PTY LTD (ACN 130 900 015)
ApplicantAND: MOIRA MAC’S POULTRY AND FINE FOODS PTY LTD (ACN 006 929 102)
Respondent
JUDGE:
JESSUP J
DATE OF ORDER:
6 OCTOBER 2014
WHERE MADE:
MELBOURNE
THE COURT ORDERS THAT:
1.The proceeding be listed at 10:15 am on 30 October 2014 for the purpose of receiving the parties’ submissions as to –
(a)the orders to be made conformably with the reasons of the court published this day; and
(b)the directions to be given for the further conduct of the proceeding.
2.Costs be reserved.
Note:Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
IN THE FEDERAL COURT OF AUSTRALIA
VICTORIA DISTRICT REGISTRY
GENERAL DIVISION
VID 706 of 2013
BETWEEN: ZWANENBERG AUSTRALIA PTY LTD (ACN 130 900 015)
ApplicantAND: MOIRA MAC’S POULTRY AND FINE FOODS PTY LTD (ACN 006 929 102)
Respondent
JUDGE:
JESSUP J
DATE:
6 OCTOBER 2014
PLACE:
MELBOURNE
REASONS FOR JUDGMENT
This proceeding concerns a contract, made on 3 December 2012 between the applicant, Zwanenberg Australia Pty Ltd and the respondent, Moira Mac’s Poultry and Fine Foods Pty Ltd, for the production by the latter of snack foods for sale to the former over a period of seven years. On the applicant’s case, the commercial relationship sustained by the contract had irretrievably broken down by about the beginning of July 2013 (ie about seven months into the term of the contract), largely as a result of the respondent insisting on being paid sums well in excess of those to which it was entitled under the contract. The applicant alleges that the respondent thereby repudiated the contract. The applicant also sues under s 18 of the Australian Consumer Law (“the ACL”), Sch 2 to the Competition and Consumer Act 2010 (Cth), alleging that it was caused to enter into the contract by a misleading representation made by the respondent. The respondent takes the position that the contract remains valid and effective, and should be enforced. It defends the monetary claims which it has made on the applicant and, by cross-claim, seeks remedies against the applicant to which it claims to be entitled under the contract.
This is only the barest of outlines of what is a rather complex case, and one in which mutually interdependent allegations and claims are made by the parties against each other. The relationship which the contract sought to establish was an unusual one, and the contract itself presents a number of constructional difficulties.
THE NEGOTIATION AND EXECUTION OF THE LETTER AGREEMENT
The applicant is a wholly-owned subsidiary of Zwanenberg Food Group BV (“ZFG”), a Dutch company which specialises in the production and sale of processed meat products and chilled meat products. Included in ZFG’s range of chilled food products are “processed snack products”, which can be offered for sale at supermarkets, for instance. In about October 2010, ZFG decided to explore the potential for the production and sale of snack food products in Australia, and the general manager of the applicant, Hendrik Willem (“Dick”) Koops, was instructed by the executive chairman of ZFG, Aldo van der Laan, and the chief executive officer of ZFG, Ronald Lotgerink (both of whom were then in Australia for other reasons), to investigate the relevant market. This he did over the next six months or so, and it appears that, on the production side, his focus was on finding a suitable chicken processing facility in Victoria.
Mr Koops’ inquiries brought him to the respondent, a manufacturer of cooked and fresh poultry products from its premises in Bendigo. On 6 June 2011, Mr Koops travelled to Bendigo and met with Dean Russell, the sole shareholder and director of the respondent. They undertook a tour of the respondent’s manufacturing plant, exchanged Powerpoint presentations relevant to their respective businesses, and discussed generally the proposal for the respondent to produce snack food products for the applicant, for sale into the Australian market. Both parties were attracted to that proposal. They met again (at Mr Koops’ office in Surrey Hills) on 23 June 2011. On 24 June, Mr Koops sent an email to Mr Lotgerink attaching some brief notes of what had been discussed at the meeting, and noting that “the impression on both sides was once again highly positive”. By return email, Mr Lotgerink said that he agreed with Mr Koops’ proposal (ie to do business with the respondent), adding “please go ahead”.
On 12 July 2011, Mr Russell sent Mr Koops an email which contained the following text:
Key Issues:
1.Can the principals establish trust and empathy?
2.Are the products appealing to the Australian consumer?
3.Is there enough profit in snack foods to provide margin for two enterprises working the one project?
4.Are key customers in Australian retail and food‑service prepared to commit to snack foods?
5.Is there a market beyond Australia?
6.Will a collaboration be more productive than each business working independently?
My thoughts:
1. A meeting in Australia with Aldo or Rodney and myself asap.
2. Prepare 6 test kitchen samples of both Entertaining (3) and Snacking (3) style products for consumer testing.
3. Develop cost models on 6 proposed lines, include margins for both Moira Mac’s and Zwanenberg / Plumrose.
4. Present 6 products to Coles, WW, Aldi, Bidvest, PFD and a mix of independent distributors.
5. Consult with Austrade on opportunities in Vietnam, S. Korea, China, India, Hong King, Singapore and Japan.
6. Suck it and see, one step at a time.
Mentioned in this email, “Aldo” was Mr van der Laan, and “Rodney” was probably a reference to Mr Lotgerink. “Plumrose” was a brand name under which the applicant already sold some (non-snack) food products in Australia.
On 27 July 2011, Mr Koops sent Mr Russell an email to which were attached four diagrams showing factory layout options for the production of snack foods at the respondent’s plant at Bendigo. Much of the specialised machinery to be used in the production of snack foods was to be supplied by ZFG which had experience of the kind of industrial operations that were contemplated. The diagrams had been prepared by Twan Peters, a production manager employed by ZFG who had been responsible for the operations of one of its processing factories in The Netherlands. In the email, Mr Koops indicated which of the four was Mr Peters’ preference. However, Mr Koops noted that, in every option, it was necessary to make use of some space in the corridor, including, under the preferred option, for packaging of final product. This was, it seems, an early indication of issues that might arise due to space limitations at the respondent’s factory.
On 13 and 14 September 2011, Messrs Koops and Peters met with Mr Russell and Shannon Simpson, the respondent’s factory manager, at Bendigo. The four men inspected the factory, and observed the respondent’s existing operations. Amongst the things that Mr Russell told Mr Koops was that the respondent’s production line was designed to produce 40,000 kg per week, based on 1½ shifts per day of eight hours each. They had discussions with the respondent’s landlord, Leon Scott, on the subject of alterations to the factory that might be needed to accommodate a snacks production line. They also looked at an adjacent area under the control of a concern identified as “Pasta Master” (but, it seems, part of Mr Scott’s freehold) which was not being used at that time and which, therefore, might have been available for the snacks line if it could not be installed within the respondent’s existing tenanted area. Mr Peters prepared a report for the applicant on these two days of meetings and inspections, and, while the detail of it is now of no particular importance, it was, to say the least, encouraging as to the prospects of the respondent being able to undertake the kind of production operation which the applicant had in mind.
On the business, as distinct from the operational, side, Mr Russell had, on 12 September 2011, prepared a schema on a computer program called “Mindjet” which he showed to the representatives of the applicant when they were at Bendigo over the following two days. It set out what was one idea as to how the parties’ relationship might be structured, and (at a high level) how it might operate. The proposal was for there to be a joint venture company in which the applicant and the respondent would have equal shareholdings, and that the respondent would second staff to that company at cost. The following was proposed on this schema:
Structure: 1 ZA and MM enter into a 50/50 Joint Venture, by issuing 2 shares in a new company (1 each). 2 Partnership Agreement needs to be drawn up and signed off. 3 Capital Plant and Equipment supplied by ZA to partnership at cost, with repayments, by JV, starting after 12 months. 4 MM takes on head lease of rental space. 5 JV subleases on 12 monthly basis.
On 26 October 2011, Mr Lotgerink sent Mr Koops an email in which he noted that he had had “feedback” from Mr Peters (presumably including the report to which I have referred) and from the applicant’s technical expert in factories of this kind, Willem Versantvoort. Mr Lotgerink’s email continued:
Our position is now as follows:
1.Moira Mac’s is potentially a strong candidate.
2.The line appears to be readily installable, they have the basic know-how required.
3.We’re prepared to commit to a transfer of knowhow and start-up support.
4.However we’re not in favour of a shared factory
a.In a single factory there can only be one boss
b.Constant discussion on investment, rent costs, maintenance, etc.
5.The way forward has to lie in a preparedness on MOIRA’S part to invest in renovation and the line.
6.We will then provide him with a sales guarantee, on the basis of which he can (partly) run the operation.
7.We will also set down what has been agreed in a co-packers agreement.
So the core question is, is MOIRA prepared to invest in expansion and the line on the basis of a sales guarantee and a co-pack agreement.
Can you discuss this with MOIRA?
This email contained a clear indication, to Mr Koops, that ZFG was not interested in a joint venture as such, but preferred some arrangement under which it would purchase the produce of the proposed undertaking from the respondent, coupled with a “sales guarantee”. As will be apparent from what follows next, however, the prospect of such a guarantee was not part of the applicant’s discussions with the respondent.
By November 2011, Mr Koops and Mr Russell were exchanging financial models for the proposed snack production operation. The court knows that Mr Koops sent a model to Mr Russell on 8 November, but the copy of the spreadsheet on which the details of it were set out tendered (by the respondent) in the case had, by the time of its reproduction for that purpose, been altered by Mr Russell in his response to Mr Koops of 22 November 2011. A focus of Mr Russell’s concerns was the level of sales which the respondent would be likely to achieve, particularly in the early days of what would be a new offering on to the Australian retail market. In that response, Mr Russell said that he had put in some “very conservative figures” for sales in the first two years, namely of 250 t and 500 t respectively. In years 3, 4 and 5, Mr Russell had used the figures previously suggested by Mr Koops, which were based on sales of 1000 t/year. In his response of 22 November, Mr Russell referred to the risk of a slow take-up of the new snacks product by retailers, saying “clearly it would have a major impact on cash-flow”. He continued:
Perhaps to mitigate this risk, we need some pre‑commitment from the retailers. O & G would need to investigate at the strategic management level.
Moira Mac’s won’t be able to fund equipment and cash flow losses – we would need some certainty to take to the bank.
I need to get the financial viability clear before I can get the Memorandum.
There is no evidence of whether, and if so how, Mr Koops responded to Mr Russell’s concerns. “O & G” was a reference to a company affiliated with the applicant called “Orange & Green” which conducted a number of services for the applicant including “administration, supply chain [and] quality assurance”.
Whether or not prompted by Mr Russell’s concerns, the fact is that, by about November 2011, the applicant had secured in-principle understandings with two of the larger retailers, Coles and Woolworths, that they would, in Mr Koops’ words, “stock and trial the snack products”.
On 19 December 2011, Mr Koops sent Mr Russell a first draft of a memorandum of understanding to articulate the parties’ intentions in the period prior to them entering into formal contractual relations. After identifying the parties, the memorandum proceeded in the following terms:
Purpose
The parties agree to work together on the planning, development, operation and management of a snacks operation to be built in the facilities of Moira Mac’s.
This memorandum merely constitutes a statement of the mutual intentions.
Moira Mac’s and Zwanenberg Food Group acknowledge the following are intentions vital to a successful partnership:
a) Both parties intend a long-term business relationship
b) Both parties need to work together in good faith
c) Confidentiality
Key Principles
a) Moira Mac’s will invest in machinery and any specific building upgrade requirements
b) Zwanenberg offers Moira Mac’s a guaranteed minimum value of contract
c) Zwanenberg and Moira Mac’s share knowledge and experience
d) Zwanenberg and Moira Mac’s work exclusively together in this production facility
e) Both parties work on basis of “open cost calculations”, with regards to
–Recipe costs
–Direct labour costs
–Overhead
–Interest, depreciation/write offs and profits
Objectives
The project opens a window of opportunity for Moira Mac’s to start up production in a wide range of products. These must not compete with Zwanenberg’s range.
Zwanenberg offers Moira Mac’s security by offering guaranteed compensation for volume or investment.
With respect to item e) under “Key principles” in this passage, Mr Koops gave the following evidence in chief:
Mr Russell said in the early stages that he questioned or was wondering if there’s a profit in it for both parties and we agreed in the early stages to share information and make all our calculations open to each other, have no secrets, and that only had the purpose to make calculations more accurate and transparent to each other, but that requires a level of trust as well, which was important for both parties as well.
In a return email sent to Mr Koops on 20 December 2011, Mr Russell placed the following comment alongside the passage which would preclude the respondent from competing with the applicant’s “range”: “Define range”.
Under Mr Koops’ draft memorandum, the anticipated contract would have a term of five years. The memorandum dealt with the subject of intellectual property, and continued:
Financials
Estimated investment in Machinery $1,500,000
Estimated investment in building $500,000
Write off period 5 years
Moira Mac’s invests in machinery and building upgrade requirements.
Should the project fail or was to be terminated prematurely, Zwanenberg will buy the machinery back from Moira Mac’s at the residual fiscal value at that point in time.
The investment in the building is at Moira Mac’s risk.
Proposal
Variable fee per kilo TBC
Minimum value of contract $400,000 per annum
Non Competition
During the contract period Moira Mac’s will not use any of the snacks production equipment or Thermopack/MAP equipment for contractors other than Zwanenberg Australia.
Moira Mac’s will not manufacture products in the snacks facility, whether branded or private label, for any retailer in the same categories as Zwanenberg is active in.
Zwanenberg will not enter the foodservice industry with snacks products. Moira Mac’s will have exclusive access to the industry.
If volume grows over the expected volume production of 20 Mt per week (and free production capacity becomes more scarce), Moira Mac’s will prioritize Zwanenberg production up to 25Mt per week (10 week average) at agreed rates.
Moira Mac’s is allowed to produce non conflicting products on the production line. Moira Mac’s will be charged a contribution rate that will be deducted from the Zwanenberg fee.
Again, in his reply of 20 December 2011, Mr Russell inserted a number of comments into the text set out above, including the following alongside the passage “40 Mt per week”: “Assume 20 ton per 40 hour shift with notional capacity of 40 ton per week”.
Over the period 15-19 January 2012, Mr Russell visited the ZFG operations at Corby in the United Kingdom and at Aalsmeer, Borculo and Almelo in The Netherlands, where he observed snack food production of the kind that was anticipated for Bendigo, should the proposed arrangement go ahead. Accompanied by Mr Koops, Mr Russell met, and had discussions with, Mr van der Laan, Mr Lotgerink, and Sjoerd van der Laan, Mr Aldo van der Laan’s son, being Mr Koops’ direct report in the management of ZFG. In the course of those discussions, Mr Lotgerink said that he wanted to develop a business based (and here I refer to the evidence of Mr Koops) on “additional costs”, that is costs which were “additional to the existing business” of the respondent. Mr Koops referred to this approach as “incremental costing”. Mr Russell agreed with that approach. In his evidence in chief in this case, Mr Russell said that, at the conclusion of this trip, he was “very interested in pursuing the arrangement with ZFG”.
During the next few months of 2012 the applicant was, it seems, occupied in what Mr Russell described as “extensive due diligence” on the respondent. The applicant was provided with the respondent’s profit and loss statements, and with its balance sheet as at 31 December 2011. According to Mr Russell, the applicant “was interested in analysing [the respondent’s] financial position and costs of producing its own products”. I would add that this level of interest in such matters arose because of two principles embodied in the parties’ then understanding: first, that of “open cost calculations”, which meant, in effect, that the respondent would be completely open with the applicant about its current level of costs, and secondly, that of “incremental costing”, as referred to in the previous paragraph. The applicant would know how much it would cost the respondent to produce one additional unit of output, a circumstance which, of itself, would give the relationship between the parties a feature which would normally not be found in conventional buyer/seller price negotiations.
In early May 2012, the applicant had its Melbourne solicitors prepare a first draft of what would have been the written contract which governed the parties’ relationship for the production of snack foods by the respondent at Bendigo. Although, ultimately, nothing came of that draft, the facts that it was sent to Mr Russell and, I infer, that it was on his solicitor’s desk when he (the solicitor) prepared the first draft of the agreement which the parties executed later in 2012 are important, even if only very high-level, aspects of the background.
The applicant’s draft proposed that, for the manufacture of products in accordance with the contract, the respondent would be paid a “fee” made up of the sum of three “components”: a “standard manufacturing cost price”, an amount to cover interest and repayments payable by the respondent for the acquisition and establishment of the capital infrastructure which would be used to make snack products for the applicant, and a profit margin of 3%. As to the first of these components, the draft contract provided as follows:
Zwanenberg will pay the Manufacturer the manufacturing cost price for Products manufactured pursuant to a Purchase Order.
Principles:– Initial manufacturing cost price based on preproduction costing
– Corrections to manufacturing cost price based on postproduction costs
Manufacturing cost price consists of:
– Materials (raw materials and packaging) – at cost
– direct labour – at cost
– Overhead (indirect costs for snacks production, excluding depreciation and interest):
· Total sum overhead to be maximized
· Based on preproduction estimates overhead is maximized at $700,000 per annum over a volume of 1,000 Mt produced product
· Correction based on postproduction costs
It was also provided as follows:
For the avoidance of doubt, other than the Fee no monies are payable by Zwanenberg to the Manufacturer in respect of the manufacture or delivery of the Products.
Although nothing further was seen of a provision in terms like those just set out, it is useful to note its existence in this early draft provided on behalf of the applicant, as it demonstrates the starting position, as it were, from which the applicant commenced negotiations with the respondent.
When Mr Russell received this draft from the applicant, he did not favour it. In his view, the draft did not reflect the memorandum of understanding prepared in the previous December. It was “written very much in legal language and [Mr Russell] wanted the deal to be expressed more in language that [he] was comfortable with.” Under cross-examination, Mr Russell was challenged on the genuineness of this explanation for his reservations about the draft, but nothing turns on the matter. The fact is that, because of those reservations, the draft was taken no further.
Instead, on 17 May 2012, Mr Russell forwarded his own draft to Mr Koops. This was written on the respondent’s letterhead, and was in the form of a letter addressed to the applicant. Between the parties, it came to be referred to as the “letter agreement”, and I shall follow that convention. After the greeting, the letter was headed “Australian manufacturing arrangements for Zwanenberg snack products”. The letter was over the hand of Mr Russell, but not at that stage signed by him: indeed, it was transmitted to Mr Koops electronically, and referred to in the covering email as a “draft”. The letter concluded by inviting the addressee, the applicant, to sign in the space provided at the foot of the last page if it agreed with the terms and conditions set out in it. In point of content, the letter agreement owed much to the applicant’s draft contract referred to in the previous paragraph, but a number of provisions had been introduced to protect the respondent’s interests. In his covering email, Mr Russell said, rather optimistically as matters turned out, that there were “some small revisions needed for this draft, but should finalise in the morning”.
The first section of Mr Russell’s draft was headed “Background”, and served as a kind of preamble to the letter agreement. Clause 1.4 was as follows:
Under this arrangement:
(a) Moira Mac’s agrees to invest in new machinery and building upgrades required to manufacture the products;
(b) Zwanenberg will purchase the manufactured products based on an “open cost calculation” plus agreed profit margin;
(c) Zwanenberg agrees to order minimum quantities of the manufactured products;
(d) each party agrees to make available their respective know-how on a non‑exclusive basis solely for the purpose of the manufacture of the products under this letter agreement and not for any other purpose;
(e) Moira Mac’s agrees to exclusively manufacture products for Zwanenberg,
on the terms and conditions of this letter agreement.
Alongside para (c) of this subclause, Mr Russell himself had inserted the electronic comment: “pay a minimum fee based on the cost of principal and interest financed for machinery and factory set-up”.
Section 3 of Mr Russell’s draft was headed “The deal”. Clauses 3.1 and 3.2 provided as follows:
3.1(Term) This letter agreement shall commence on the date of this letter agreement and continue for a period of seven (7) years unless terminated earlier in accordance with this letter agreement (Term). This letter agreement may be extended by mutual agreement of the parties.
3.2(Investment in Machinery) Moira Mac’s agrees to invest in the machinery (Machinery) and building upgrade requirements relating to the Machinery (Building Upgrades) as set out in Annexure A. Moira Mac’s shall finance the purchase of the Machinery and Building Upgrades with its financiers.
The remaining provisions of section 3 dealt with knowledge sharing, confidentiality and non-competition. Section 4, headed “Manufacturing”, ultimately lay at the centre of the letter agreement, but the only further thing which needs to be said about it here is that it contemplated that there would be an Annexure A to the letter agreement, dealing with product specification. That annexure was not then included.
The provision, ultimately agreed, which was based on section 5 of Mr Russell’s draft is, however, most controversial. The whole of the section as it appeared in that draft provided as follows:
Financial matters
5.1(Fees) From the Commission Date, Moira Mac’s shall invoice a fee for each delivery of Products based on a variable fee per kilo (Fees). Zwanenberg agrees to pay the Fees to Moira Mac’s. The Fees shall consist of three components:
(a) manufacturing costs (including materials, packaging, labour and overhead) as set out in Annexure B to this letter agreement (Manufacturing Costs). Manufacturing Costs shall be calculated at the commencement of each calendar quarter;
(b) capital costs (comprising principal and interest on the loan for Machinery (including any commission costs) and building upgrade requirements) (Capital Costs). For the avoidance of doubt, the Capital Costs include any payments on the loan prior to the Commission Date required for pre‑commissioning activities. Any government grants for the manufacturing using the Machinery shall be used to reduce the Capital Costs. Capital Costs shall be forecast at the commencement of this letter agreement until 30 June 2013 (and, thereafter, each financial year ending 30 June) based on the forecast finance costs divided by the forecast production volume for that period. At the end of each period, the Capital Costs shall be adjusted against the actual finance costs paid by Moira Mac’s in that period and Moira Mac’s shall be entitled to invoice an adjustment equal to this adjustment amount; and
(c) an agreed profit margin of five percent (5%) applied to all of the above;
5.2(Payment terms) All payments are due within 30 days of the end of the month in which the products are manufactured an delivered;
5.3(Minimum Fees) At the end of each calendar month, Moira Mac’s shall be entitled to invoice an adjustment to Zwanenberg equal to the amount of the actual Capital Costs for that calendar month (regardless of the quantity of Products ordered and invoiced in that month) less the total cumulative Capital Costs component of the Fees invoiced to Zwanenberg for Products during that calendar month.
5.4(Security) Zwanenberg’s parent company must provide, within 7 days of request by Moira Mac’s, an irrevocable letter of credit from a reputable bank in favour of Moira Mac’s financiers as security for the financing required for the machinery (Letter of Credit). The investment in the Building Upgrades is at Moira Mac’s risk.
5.5(Charge) Zwanenberg shall be entitled to a charge over the specific Machinery provided that the charge shall be released when the Letter of Credit is released by Moira Mac’s financiers.
5.6(Purchase of Machinery) If Zwanenberg terminates this letter agreement under clauses 8.1 or 8.2, Zwanenberg may purchase the Machinery from Moira Mac’s at the residual fiscal value at that point in time.
5.7(Insurance) Moira Mac’s shall maintain adequate insurance to cover general (product) liability they may incur in regards to the agreement.
In his draft, Mr Russell had placed an electronic comment alongside para (c) of cl 5.1, as follows: “2% will be set aside to reinvest in capital improvements during the term, allocated annually with both parties’ agreement. Any surplus capital would be split equally at the end of the term or carried over into a new term.” Nothing further came of that suggestion, the profit margin having been agreed, at a fairly early stage, at 3%. The controversial aspect of section 5 was cl 5.3, which became a frequent subject of the correspondence subsequently passing between the parties. It should also be noted, at this stage for the sake of the narrative only, that cl 5.1(a) contemplated that there would be an Annexure B to the letter agreement, dealing with the matter of manufacturing costs.
On 21 May 2012, Mr Russell sent a further email to Mr Koops, attaching what he described as “some formats that could be attached” to the proposed agreement. One of the attachments was a schedule of the “annual estimated cost”, as the heading to the schedule stated, for each item of expense that would be involved in the production of snack products for the respondent. Each item of cost had been converted into a “per kg” figure, based on the assumption that annual production would be 1,000,000 kg, ie 1,000 t. The total came to $10.97 per kg, including the 3% profit margin. The respondent’s evidence-in-chief was that this schedule was a “template [which] estimated a cost of $10.96 per kg to produce a processed meat product”. Under cross-examination, Mr Russell said that the schedule was merely “a copy of our general ledger ... as it was at that time”, that he was not “attempting to estimate cost”, that the schedule was “the logical total for those items”, and that he was “merely reflecting a template as it appeared within the Moira Mac’s business”.
Mr Russell’s schedule was not well received by ZFG in The Netherlands. In an email sent to him on 22 May 2012, Mr Koops said that the schedule had “caused quite a bit of commotion”, adding that “your cost model is very different to what we have worked with thus far”. One of the matters to which Mr Koops drew specific attention was “factory overhead”, which he said was “much higher”. He said that total overhead was $1.7m, “where we advised earlier that overhead should be maintained at 880K”. Mr Koops concluded his email by proposing that he and Mr Russell should have a telephone or video meeting the following day.
They did have a meeting on 23 May, but it was face-to-face, at a café somewhere in Tooronga. At that meeting, Mr Koops informed Mr Russell of the poor reception which his (Mr Russell’s) email sent the previous day had received in The Netherlands. According to Mr Koops’ evidence, Mr Russell’s response was in the following terms:
You were not supposed to send that through to The Netherlands. That was just for you to understand what I think … the costs incurred in that snacks operation would be. So it was more a – an example of a costs model rather than the cost that I think would be incurred.
Mr Koops then reminded Mr Russell that he (Mr Koops) worked for the applicant, and that it should be expected that he would send any document he received on to The Netherlands. Mr Koops attempted to explain to Mr Russell what he meant by “incremental costs”, namely, “the additional out-of-pocket costs to [the respondent’s] business by setting up that snacks factory” but, still according to Mr Koops’ evidence, Mr Russell did not “give [him] the opportunity to finish [his] explanation”. Mr Russell said that Mr Koops did not have to lecture him on accounting, to which Mr Koops responded that, if Mr Russell got his numbers right, he would not have to lecture him. Mr Koops described this as a very unpleasant meeting. Taken to the meeting in cross-examination, Mr Russell was unable to recall it with anything like the detail given by Mr Koops. He said that he did not recall the use of the word “incremental”, but I accept Mr Koops’ evidence that the word was used; and I accept his evidence generally about the meeting, in preference to the very limited, uncertain, evidence given by Mr Russell.
On 25 May 2012, there was a video conference involving Mr Russell for the respondent and Mr van der Laan, Mr Lotgerink, Mr Baan, Mr Koops and Mr Sjoerd van der Laan for the applicant. Although Mr Sjoerd van der Laan’s presence at the conference was not clearly recalled by Mr Koops, an email from the latter to Mr Russell on 26 May 2012 makes it clear that he was there. At this conference, Mr Russell first outlined his reasons for not wanting to use the manufacturing agreement that had been prepared by the applicant’s Melbourne solicitors. The representatives of the applicant said that they were happy to work with Mr Russell’s letter agreement.
It was at this video conference that Mr Russell and Mr Baan first met. Mr Lotgerink said that he proposed to have Mr Baan involved in developing the cost model for the proposed snacks operation on behalf of the applicant, because he had a lot of experience in that field. Mr Baan, who had recently seen Mr Russell’s schedule of estimated costs of 21 May 2012, and been told by Mr Koops (subsequent to the unpleasant meeting at Tooronga) that the figures in that schedule had “no substantive value”, told Mr Russell that he would “rather use [his] own cost pricing model to calculate a proper cost price”. Mr Russell had no objection to that. Mr Koops recalls Mr Baan asking Mr Russell: “Are you willing to open your books so we can have a good look and develop a cost model that we are all happy with?”
The importance of getting the cost model right, of course, lay in the circumstance that the proposed arrangement was, on one view of it, to be a hybrid of a conventional arms-length contract and a joint venture. The respondent was to produce goods for sale to the applicant, but the agreed price for those goods was to be such as would cover the costs involved in their manufacture. The “costs” in question – under a firm requirement of the applicant which was accepted by the respondent – were to be the additional costs incurred by the respondent in running the snack foods operation alongside its existing business. In order to determine what those costs were, the applicant considered it to be necessary for the respondent to accept an “open books” approach to the parties’ negotiations on the subject, and that was accepted by the respondent. From this point forward, the calculation of the unit price of the goods to be produced by the respondent was effectively driven by Mr Baan. The experience of the few days leading up to this video conference on 25 May 2012 had left neither him nor his colleagues in The Netherlands with any great confidence in Mr Russell’s capacity to handle, unassisted, the concepts or the detail involved in calculations of the kind that would be required.
Those attending the video conference on 25 May 2012 also discussed various amendments to the draft letter agreement which Mr Russell had sent to Mr Koops on 17 May 2012. In Mr Koops’ email to Mr Russell of 26 May 2012 to which I have referred, the former asked the latter for confirmation that he would send an updated version of the letter agreement, with all the additions which had been discussed with Mr Sjoerd van der Laan and Mr Lotgerink at that conference. That was necessary, he said, because a signed manufacturing agreement was a condition of the guarantee which the applicant’s bank proposed to provide in relation to the debt the respondent would incur for the purchase of the machinery to be used in the snacks production line at Bendigo.
On 28 May 2012, Mr Russell sent Mr Koops an electronic copy of his then draft of the letter agreement. The draft contained some changes compared with the 17 May version, and Mr Russell also had inserted more marginal comments which, he said in his covering email to Mr Koops, related to the “Friday discussion” (ie, I infer, the video conference). Mr Russell said that he would send the draft to his solicitor “for a re-write”, he asked Mr Koops to “comment asap”, and he added: “Please don’t forward until we discuss.” The draft of 28 May 2012 contained what were, in effect, no more than blank placeholders for the foreshadowed Annexures A and B.
Mr Koops responded to Mr Russell’s draft letter agreement on the same day. He made a number of comments on the draft, one of which was headed “Costprices” and read:
Both parties will make a list of cost components that make up the cost price.
Comparison will show the differences which both parties will discuss.Mr Russell’s response by return included the comment that “my next cost model will have to be compared against yours before it is ready to [be] put on the table for negotiation”.
That next cost model was in fact sent by Mr Russell to Mr Koops at 6 pm that very day, 28 May 2012. It was a development of the so-called template sent by Mr Russell on 21 May 2012. The original figure of $10.97 per kg had come down to $10.82. Some additional cost items were included, as were Mr Russell’s explanations, in some cases, of items on the list. Of particular present significance was the inclusion of a new column setting out the respondent’s “annual fixed” costs. These were stated as annual, not unit, figures. The items concerned were superannuation and wages for direct staff, electricity, gas, audit fees, cleaning/rubbish removal, rent, accountancy, bank charges, computer supplies, consultant fees, insurance, laundry, licence fees, minor equipment under $100, pest control, printing and stationery, council rates, water rates, machinery consumables, samples, staff amenities, staff training, telephone, internet, mobiles, and travel. The total of these annual fixed costs was $644,150. Mr Russell’s endorsement alongside that total was “MM LIKELY COSTS REGARDLESS OF VOLUME”. A note made by Mr Russell at the head of the table read: “Fixed costs per kg are vulnerable to sharp increase with low volumes”.
Mr Koops sent Mr Russell’s cost model to Mr Baan in The Netherlands. Mr Baan re-arranged, but did not alter, Mr Russell’s figures to make them comparable with the costs incurred by ZFG in the production of a Dutch snack product, chicken satay. He calculated that the overhead cost shown in Mr Russell’s figures was $1.76 per kg, based on an annual production of 1,000 kg, whereas the corresponding Dutch figure was $1.50. Mr Baan sent his cost comparison to Mr Koops, but there is no suggestion that it was sent on to Mr Russell.
Mr Baan found, however, that true comparability as between Australian and Dutch costs was difficult to achieve. In his witness statement, Mr Baan said:
For this reason, I knew that the next stage of analysis of the feasibility of the Moira Mac’s proposal would require me to analyse Moira Mac’s financial information, such as its payroll records, rent costs, and accounts. I understood from Mr Koops that Mr Russell had told him that he had over 30 years experience in the industry and had been the CEO and financial controller of Moira Mac’s. I therefore expected that he would have a detailed knowledge of his business and of the costs incurred in conducting it. I relied heavily on this knowledge and what he told Zwanenberg, because no one from the Zwanenberg side knew the conditions in Australia. For this reason, the cost model that I intended to create to determine if the proposed arrangement would be profitable would involve a combination of Zwanenberg and Moira Mac’s input.
Mr Baan was taken to this passage in cross-examination, but not in any way that involved a substantial challenge to what he said.
The parties’ objective had been to execute the letter agreement in May 2012 and, with that in mind, Mr van der Laan and Mr Lotgerink came to Australia in late May, with a view to participating in a formal signing at the respondent’s premises at Bendigo. They did come to Australia on 29 May 2012, but the parties’ agreement had not matured to the extent that would be necessary for the execution of a written document at that stage. In the result, these men, accompanied by Mr Koops, used the occasion to discuss unresolved issues with Mr Russell, and to inspect the Bendigo factory. As to the latter aspect, it was in May 2012 that it became apparent to Mr Russell that the Pasta Master area would be available to rent if he wanted it, and thenceforth the applicant and the respondent formulated their plans on the assumption that that area would be used for the proposed snacks operation. It seems to have been resolved during Mr van der Laan’s visit that the Pasta Master area would be used.
In the days following the visit of Mr van der Laan and Mr Lotgerink, Mr Peters and Mr Versantvoort visited Bendigo to deal with engineering and technical arrangements for the installation and later operation of the required equipment and machinery in the former Pasta Master area. It was, it seems, during the visit of Mr Peters and Mr Versantvoort that the subject of the remuneration to which the respondent would be entitled for the labour costs involved in meat preparation was first raised, and discussed as between them and Mr Koops and Mr Russell. The “meat preparation” phase of the operation would take place after the meat had been received from the respondent’s supplier, but before the commencement of the snacks process as such. I shall return to this subject in due course.
On 7 June 2012, Mr Koops wrote to Mr Russell informing him that Mr Lotgerink had asked Mr Baan “to make a full, detailed analysis of the cost model”. The analysis would proceed conformably with the following “starting principles”:
· Open cost information
· Open cost calculation, based on incremental costs
· Look for opportunities for cost savings for Moira Mac’s based on benchmarking with Zwanenberg
Mr Koops proposed a “cost type analysis”, suggesting a classification of costs by direct costs (recipe and labour), indirect factory costs (overheads of different kinds), lease and rent, depreciation and indirect financing costs (interest). He asked Mr Russell to provide his costs, based on his financial statements for 2011 and 2012, by reference to that classification. He asked: “Can you give me your estimate on incremental costs to run the snacks production?” He added that Mr Lotgerink would like this information “asap”. In a number of tranches, Mr Russell provided at least some of the information requested over the period 11-12 June 2012.
On 15 June 2012, Mr Baan sent an email to Mr Koops, identifying the financial information that Mr Russell had not supplied to that stage, stating that the respondent’s average overhead rate was $2.60 per kg (which Mr Koops, in an email to Mr Lotgerink on 18 June 2012, considered to be “reasonably in line with [the applicant’s] figure of EUR2.15/kg for snacks”) and attaching his “calculation model”. That model indicated that the incremental overhead cost to the respondent for having to produce an additional 1000 t of products would be $709 (ie $0.71 per kg). Over the ensuing fortnight or so, Mr Baan continued to refine his calculations as more information became available from Mr Russell. Save to provide information as requested, and to clarify things from time to time, Mr Russell was not part of this process.
On 4 July 2012, Mr Russell sent Mr Koops a revised version of the draft of the letter agreement. The draft of 17 May had been amended in a number of respects, including by the insertion of the passage “plus the fixed component of the Manufacturing Costs (Annexure B)” after the words “actual Capital Costs” in cl 5.3. Annexures A and B, as such, remained blank. On 5 July 2012, Mr Koops replied to Mr Russell, noting, in relation to the amendment to cl 5.3:
Speaks of “plus the fixed component of the Manufacturing Costs (Annexure B)”
Albert has finished his pre production cost calculations which he’ll share with us soon. We need to make sure this fixed component is described carefully in this overview as well.As to what happened next, Mr Russell gave the following evidence-in-chief:
Following Koops’ email I spoke to him about the subject of fixed costs. I said to Koops that I had made it clear to he and Aldo during their visit to Australia in May that Moira Mac’s could only proceed with the joint venture of [sic] Zwanenberg would guarantee our monthly costs for operating the snacks business. I said that clause 5.3 would need to be amended. I said to Koops that Moira Mac’s would only proceed if it was entitled to recoup its fixed costs (bank principal and interest, fixed component of its manufacturing costs, such as rent and insurance regardless of the amount of product that [Zwanenberg] ordered. Where volumes of product were of sufficient quantity to cover Moira Mac’s costs, there would be no issue. However, if the volume of orders was small, Moira Mac’s would not recover its fixed costs and would end up subsidising [Zwanenberg’s] sales to its customers. I said to Koops that clause 5.3 had to be amended to address that situation.
The “Aldo” referred to was Mr van der Laan. I take it that the missing closing parenthesis in about the middle of this passage was intended to come after the word “ordered”.
By email of 10 July 2012, Mr Koops accepted the amendment to cl 5.3 of the letter agreement proposed by Mr Russell on 4 July. He added that he had discussed the matter with Mr Baan, and that his (Baan’s) estimate for the total costs, per annum, was, approximately, $384,000 by way of interest and repayment fee, $50,000 for rent and $50,000 for insurance, which Mr Koops proposed might be rounded off at $500,000 pa. He said that, if that was in line with Mr Russell’s thoughts, they could “add these estimated costs to Annexure B”. By return email the same day, Mr Russell told Mr Koops that he had “a much broader view of what comprises ‘fixed components’”, and that he would send Mr Koops “a list of what [he thought] should be included”.
Also on 10 July 2012, Mr Koops sent an email to Mr Russell and Mr Peters, to which was attached a cost price model prepared by Mr Baan, on which he had been working for a number of weeks. For each of several product/size categories, the model stated the price, per kilogram, that the applicant would pay the respondent for producing the items in question; and it gave a breakdown of the components in that price. Taking the 600 g pack of meatballs as an example, the model showed the following:
MEATBALLS Bulk Pack 600 gr Meat Prod Loss Spices Oil Packaging Labour 0.51 Overhead 0.81 Interest and repayment fee 0.25 Copackers margin 0.05 1.62
As will be apparent, there were some missing figures in this model, but of particular present interest is the overheads figure of $0.81 per kg. This figure for overheads was part of the model for all product/size combinations.
In his email to which Mr Baan’s cost price figures were attached, Mr Koops said:
In the attachement [sic] you’ll find the costprice elements for labour, overhead, interest and repayment and copackers fee.
Can you both help me finalize this cost model? What we’ll end up with is a pre-production cost model that we will use in the costmodelling, invoicing etc. Final costs will be based on post production costs, but it would be nice if the pre production costs come close to the real thing.
Twan,
Can I please ask for your input on:
· Meat components and ratio per recipe: ie. 50% breast, 30% Thigh, 20% MDM
· Yield per product.
· Costs of spices (using Dutch costs as starting point, assuming costs are similar here in OZ and not the most important cost component)
· Cost of Oil per product
· Costs for packaging (I struggle matching Arjan’s costs for packaging with Albert’s recipes)
Dean,
· Can you give us the actual costs for the meat components?
Together, we should be able to finish the cost calculations and finalize this part of the Manufacturing Agreement.
We’re almost there, I can smell it!
Mr Russell’s response to Mr Koops was to ask him to send a breakdown of the overhead cost, adding, “it seems very low”.
It may be observed that, on the afternoon of 10 July 2012, Mr Russell had communicated his concerns about the adequacy of the overhead cost recovery for which Mr Baan was allowing in his then calculation of the respondent’s entitlement under the intended contract in two separate, but related, emails. The first, sent at 4.29 pm, was that referred to in para 41 above, and related to Mr Baan’s estimate of the total fixed manufacturing costs over the course of a year. The second, sent at 4.48 pm, related to the per kilogram figure of $0.81 for overheads, to which I have referred in para 43 above. How the respondent’s overhead costs would be covered under a contract which provided for its income flow to be based on volume was clearly a concern for Mr Russell at the time; and it was a concern which he made known to Mr Koops.
At 8.49 am on 11 July 2012, Mr Koops attempted to send Mr Russell an email which had two attachments. For some reason, the email refused to be sent, and it was not until 2.49 pm that day that Mr Koops’ sixth attempt to send this email proved successful. The attachments were two spreadsheets which set out Mr Baan’s workings with respect to the respondent’s unit and other costs in the year to 30 June 2011 and in the nine months to 31 March 2012 (although the latter spreadsheet seemed to have used 2010/2011 figures in a number of places). In each spreadsheet, the first worksheet was a summary which showed, amongst other things, the respondent’s total indirect production costs, or overheads, in the year concerned.
Taking the 2010/2011 spreadsheet as indicative of the nature of Mr Baan’s calculations, there were three high-level categories of overheads: staff, depreciation and “other”. The third category was the subject of a separate detailed spreadsheet from which the first sheet was populated with data. The total of all three categories was $2,975. In that year, the respondent’s total production, by mass, was 1,229 t. A calculated cell in the spreadsheet indicated that this represented a total overhead cost of $2,420 per 1,000 t. Three further columns were headed “Additional”, and set out the additional overhead costs which the respondent would incur for the production of an additional 1,000 t, 1,500 t and 2,000 t respectively. In the case of an additional 1,000 t, the additional overhead cost would be $709. The spreadsheet made it clear that, while the respondent’s overall average overhead cost associated with producing 1,000 t of food products was $2,420, the additional costs to which it would be exposed if it increased its production by 1,000 t would be only $709. The corresponding figure calculated from the respondent’s data in respect of the succeeding part-year was $674. The 2010/11 spreadsheet was the same, with the same per additional 1,000 t overhead figure, as had been sent by Mr Baan to Mr Koops on 15 June 2012 (see para 38 above).
So far as the evidence shows, it was not until Mr Koops’ email of 11 July 2012 that Mr Russell was exposed to Mr Baan’s workings, but he undoubtedly was then. Counsel for the respondent, presumably on instructions, put it to Mr Koops under cross-examination that the figure $709 in the attachment to Mr Baan’s email of 15 June 2012 was the “provenance” of the figure of $0.71/kg ultimately used as a basis for the unit overhead costs in Annexure B, and there is no reason to suppose that Mr Russell himself did not similarly understand the figure of $709 which he received in the attachment to Mr Koops’ email of 11 July 2012. It is here that one may most clearly discern the principle of incremental costing: its object was to identify the cost of producing an additional – or “incremental” – unit of output.
The text to Mr Koops’ email of 11 July 2012 was as follows:
See attached files.
Please note that the overhead in the 2011/2012 file is even lower then [sic] used in the cost price calculation.
Reason is that in the cost price calculation the overhead is based on 2010/2011, in the attached file the overhead is based on July 2011 – March 2012 (with higher volume).
Over 2010/2011 you[r] overhead was $2.48 per kilo. Your total Overhead over July 2011 – March 2012 was $2.01 per kilo, this is lower because your volume rose from 1200 Mt (2010/2011) to 1600 Mt (2011/2012) on annual basis.
I have asked Albert to update the Cost price file, to match the latest overhead calculations.
Please have a look, because it’s important we are all agree[d] on the outcome.With respect to the fixed annual operating costs, Mr Koops responded to Mr Russell on 12 July 2012. He said:
I discussed the fixed operating costs with Albert.
Albert advises to run with your approach and use your estimate for these costs. We agree on principles, any differences between pre production cals and post production actual will be evened out.Based on our discussion, this was my translation of your estimate.
Rent 75K Insurance 50K Core permanent labour 70K Core permanent QA 60K Utilities 20K Overall management fee/admin ?? Safety gear / Laundry / Materials/ ?? Schoonmaak/ sundries If you can fill in the ?? we can work with that number and add that to Annexure B.
The “Albert” referred to was Mr Baan.
Also on 12 July 2012, Mr Koops sent Mr Russell what he described as the latest version of the cost model on which Mr Baan was then working. It had the same format as the model mentioned in para 42 above. Taking the 600 g meatball product as an example, the model showed the following:
MEATBALLS Bulk Pack 600 gr Meat Prod Loss Spices Oil Packaging Labour 0.51 Overhead 0.71 Interest and repayment fee 0.38 Copackers margin 0.05 1.65
It will be seen that the unit overhead component had been adjusted from $0.81 to $0.71. That constituted, in effect, a reversion to the figure used by Mr Baan on 15 June 2012: see para 38 above.
On 16 July 2012, Mr Russell responded to Mr Koops’ email of 12 July. The text of the email itself was “cost models attached for discussion”. There were two attachments, one, which I shall call the first attachment, dealt with the unit price for snack foods produced by the respondent, but this time (for, I think, the first time) the calculations were based on an assumed production of 500 t per annum. The overhead figure was $1.62. It seems uncontroversial that this was a computer-generated figure resulting from the halving of the denominator in a previous calculation by Mr Baan that had the overhead figure at $0.81 per kg (that is to say, Mr Russell had not incorporated the adjustment to $0.71 the subject of Mr Koops’ email of 12 July 2012).
The other attachment to Mr Russell’s email of 16 July 2012, which I shall call the second attachment, was the precursor of what has become the most controversial document in this case. It read as follows:
Minimum costs to run snacks operation Rent $ 75,000.00 Rates/Water $ 8,500.00 Management $ 50,000.00 Supervisor $ 70,000.00 QA Officer $ 60,000.00 Insurance $ 50,000.00 Utilities $ 30,000.00 Maintenance $ 10,000.00 Cleaning $ 10,000.00 Accountancy $ 10,000.00 Bank fees $ 3,000.00 Safety/Laundry/Materials $ 20,000.00 Laboratory $ 10,000.00 Audit fees $ 6,000.00 Pest Control $ 5,000.00 Office Costs $ 6,000.00 Sundry $ 20,000.00 Subtotal $ 443,500.00 Finance Costs $ 384,000.00 Total $ 827,500.00
It is the non-finance sub-total of $443,500, and the items which made it up, which became most controversial in the case. In part those items were based on the estimates of Mr Baan forwarded to Mr Russell in Mr Koops’ email of 12 July 2012 (see para 49 above). The figures for rent, insurance and “QA” were unchanged. The figure for utilities had been increased from $20,000 to $30,000. In part Mr Russell had modified the description of an item: where Mr Baan had provided for $70,000 in relation to “core permanent labour”, Mr Russell had used the same figure, but described the item as “supervisor”. In part Mr Russell had filled in the spaces occupied only by question marks in Mr Baan’s list. And, it seems, in part Mr Russell had added new items, probably not referable to anything that Mr Baan had in mind.
The second attachment to Mr Russell’s email of 16 July 2012 may also be compared with the template attached to his email of 28 May 2012: see para 32 above. The subject of both was the fixed, unavoidable, costs which the respondent would incur regardless of the volume of production which it was achieving.
For the sake of the narrative, I mention next a development at about this time which did not relate to the parties’ negotiations on costs. As mentioned above, Mr Russell’s draft of 17 May 2012 contained a provision which would oblige the respondent to invest in the necessary machinery for the operation of a snack foods production line at its factory at Bendigo. This investment was to be financed with the respondent’s “financiers”. On 10 July 2012, the respondent received an invoice from ZFG for what was, in effect, a deposit on specialised machinery to be supplied for this purpose. The invoice was in the sum of €550,000 and, in an email on the same day to the respondent’s bank, Mr Russell said that he expected to be invoiced for an additional €775,000, and that he had budgeted for an additional $500,000 for factory set-up costs.
When Mr Baan saw the second attachment to Mr Russell’s email of 16 July 2012, he was not impressed with it. By email to Mr Koops on the same day, he said that he could see “99k in costs here that would not be incurred at zero production”. He had in mind the items for utilities, accountancy, bank fees, safety/laundry/materials, laboratory, office costs and sundry.
As mentioned previously, one issue upon which the parties were working was the allowance to be made for the costs that would be incurred by the respondent in the preparation of the meat that was to be used in the production of snack foods. By about the stage of the narrative which I have reached here, Mr Baan had decided that $0.25/kg would be the figure for this item to be proposed to the respondent. He so informed Mr Koops by email of 19 July 2012, attaching an amended form of his model which showed, for all snack products, an overhead figure of $0.96/kg, which resulted from the addition of this $0.25 to the $0.71 previously communicated. These matters were the subject of a video conference in July 2012 involving Mr Koops, Mr Russell and Mr Baan, following which, on 27 July 2012, Mr Koops sent to Mr Russell the cost model which they had discussed, which included the following figures in respect of the 600 g meatball product:
Meat R511T HLT (NL recipe 2.51 % p/kg Flakes 70-30 49.79% $3.20 $ 1.59 Cheeks without rind 11.01% $2.45 $ 0.27 Trim 95-5 16.51% $3.90 $ 0.64 Prod Loss 0.23 Spices 0.73 Oil 0.00 Packaging 0.52 Labour 0.69 Overhead 0.96 Interest and repayment fee 0.34 Copackers margin 0.18 Rendement/Yield Production 6.15
On 24 July 2012, Mr Russell informed Mr Koops that his bank had asked for “an estimate of the fixed component of the manufacturing costs referred to in the Agreement”. By return email, Mr Koops referred to Mr Baan’s queries as to the appropriateness of some $99,000 of the estimated fixed costs previously suggested by Mr Russell. Mr Koops proposed that they “pick a number halfway”, which he thought could be $390,000, to give to the bank, and that they could have “a more detailed discussion” with Mr Baan on the subject later.
On 2 August 2012, Mr Russell sent Mr Koops what was then the latest draft of the letter agreement, which incorporated amendments upon which the parties had agreed in their discussions to that point. Clause 5.1(a) was now expressed as follows:
5.1(Fees) From the Commission Date, Moira Mac’s shall invoice a fee for each delivery of Products based on a variable fee per kilo (Fees). Zwanenberg agrees to pay the Fees to Moira Mac’s. The Fees shall consist of three components:
(a)manufacturing costs (including materials, packaging, labour and overhead) as set out in Part A of Annexure B to this letter agreement (Manufacturing Costs). Part A of Annexure B sets out the model for calculating Manufacturing Costs as at July 2012. The actual Manufacturing Costs shall be calculated at the commencement of each calendar quarter based on this model with adjustments to be made for any increases or decreases in actual Manufacturing Costs….
It will be seen that this provision now contemplated that there would be a “Part A” of Annexure B to the letter agreement.
Clause 5.3 was now expressed as follows:
(Minimum Fees) At the end of each calendar month, Moira Mac’s shall be entitled to invoice an adjustment to Zwanenberg equal to the amount of the actual Capital Costs, plus the actual fixed component of the Manufacturing Costs (calculated in accordance with the model in Part B of Annexure B) for that calendar month (regardless of the quantity of Products ordered and invoiced in that month) less the total cumulative fixed component of the Manufacturing Costs and Capital Costs component of the Fees invoiced to Zwanenberg for Products during that calendar month.
Here it was contemplated that there would be a “Part B” of Annexure B to the letter agreement.
Annexures A and B were now, for the first time, populated with content. There is no need to say anything about Annexure A. Annexure B, by contrast, lies at the centre of the controversy in the present case.
Parts A and B of Annexure B were now, for the first time, populated with content. Part A was headed “Costprice Calculations MM”, and subheaded “1000 MT/yr”. It contained the unit cost price model upon which the parties had agreed, and was substantially the work of Mr Baan. The 600 g meatball example sent to Mr Russell on 27 July 2012 was part of this model and, to the extent presently relevant, was typical.
Part B of Annexure B was as follows:
Minimum indicative costs to run snacks operation.
Fixed component of Manufacturing Costs
Rent $ 75,000.00 Rates/Water $ 8,500.00 Management $ 50,000.00 Supervisor $ 70,000.00 QA Officer $ 60,000.00 Insurance $ 50,000.00 Utilities $ 30,000.00 Maintenance $ 10,000.00 Cleaning $ 10,000.00 Accountancy $ 10,000.00 Bank fees $ 3,000.00 Safety/Laundry/Materials $ 20,000.00 Laboratory $ 10,000.00 Audit fees $ 6,000.00 Pest Control $ 5,000.00 Office Costs $ 6,000.00 Sundry $ 20,000.00 Sub total (fixed component of Manufacturing Costs) $ 443,500.00 Capital Costs $ 384,000.00 Total $ 827,500.00 These items (based on actual) will make up the actual fixed component of Manufacturing Costs and the actual Capital Costs for the purposes of calculating the Minimum Fees, referred to in the Agreement.
On the same day, Mr Koops responded. To the extent presently relevant, he said that the wording of cl 5.3 confused him, and that he was not sure that he understood it correctly. He said that the clause should state that the respondent was entitled to invoice the applicant “equal to the amount of the actual capital costs plus the manufacturing costs with a minimum as calculated in the model in Part B of Annexure B for that calendar month”. Mr Koops said that this was “a very important part of the agreement”, and asked Mr Russell to have another look at it, or “maybe rephrase”. Mr Russell responded immediately with the comment: “I will rephrase”.
So far as the documentary record shows, the next thing to happen was an email from Mr Russell to Mr Koops on 6 August 2012. Attached to it was what Mr Russell described as “a first draft of an invoicing model”. This was divided up into three examples. Example 1 was headed “zero production”. The first column in this example contained the items listed in Part B of Annexure B to the then latest version of the letter agreement sent by Mr Russell on 2 August 2012. The second column was headed “estimated annual”, and contained the dollar figures exactly as they appeared in Part B of Annexure B. The third column was headed “actual monthly 0”, and contained figures which were one-twelfth of the figures in the second column. The fourth column was headed “actual monthly 1000”, and it showed how the cost figures set out in the third column would change if the annual production were 1,000 t as contemplated in the model upon which Mr Baan had been working. Some of the figures in it were the same as those in the third column, recognising the fact that the costs concerned would not change with increases in volume over zero – rent, management and insurance, for example. Other figures had risen – utilities, maintenance and laboratory, for example. The fifth column was headed “actual monthly 20000”, and it made corresponding adjustments to the relevant cost figures if annual production were to be 20,000 t – a wildly optimistic possibility at the time.
Of importance in this first example were the total monthly figures for non-financial overhead costs, and recognised as such by Mr Koops when he received the email: at zero production, the figure was one-twelfth of the corresponding figure in Part B of Annexure B as sent by Mr Russell on 2 August 2012, $36,958.33. At 1,000 t and 20,000 t annual production levels, the figures were $40,623.94 and $55,124.67 respectively.
The second and third examples appeared to be of situations in which 800 kg and 8,000 kg of bulk packs were sold, respectively. However, they were not explained in the evidence, and the meaning intended to be conveyed by their contents is not self-evident.
On 9 August 2012, Mr Koops met with Mr Russell. They discussed the terms of the amended letter agreement which had been sent by Mr Russell on 2 August 2012. Late in the day on 9 August, Mr Koops sent Mr Russell an email which summarised the points on which they had agreed. With respect to cl 5.3, the email recorded that they had agreed on the following:
The rules with regards fixed component of the Manufacturing Costs resolves possible negative coverage on overhead if forecasted volumes are not met. If production is higher than the 83 mT per month (1000 annual) the overhead contribution would lead to excess coverage on overhead, which results in a credit payment to [be] deducted from the total cumulative fixed component of the Manufacturing Costs and Capital Costs.
Also, all costs are subject to the quarterly review / post production corrections of the Manufacturing costs.
For the avoidance of doubt I suggest to describe both scenarios and review as mentioned in 5.3.a calculate actual Manufacturing Costs at the commencement of each calendar quarter.Mr Koops noted that “this wording covers/replaces the Excel examples of the fixed manufacturing costs at lower volumes than the forecasted volume of 1000 mT per annum”. The “Excel examples” were, I presume, the attachments to Mr Russell’s email of 6 August 2012.
Mr Russell sent Mr Koops’ email to his solicitor (who had been the drafter of the letter agreement), with a request to modify the agreement accordingly. On 13 August 2012, the solicitor responded to Mr Russell with the following comment about cl 5.3: “I was not sure what these comments precisely related to, other than to say the model in Part A of Annexure B might need to be reviewed based on actual volumes. Please see my revised drafting.” That drafting produced a new cl 5.3 in the following terms:
(Minimum Fees) At the end of each calendar month, Moira Mac’s shall be entitled to invoice an adjustment to Zwanenberg equal to the amount of the actual Capital Costs, plus the actual fixed component of the Manufacturing Costs (calculated in accordance with the model in Part B of Annexure B) for that calendar month (regardless of the quantity of Products ordered and invoiced in that month) less the total cumulative fixed component of the Manufacturing Costs and Capital Costs component of the Fees invoiced to Zwanenberg for Products during that calendar month. The model in Part B of Annexure B is based on 1,000 tons of Products being produced per annum. The model will be reviewed at the commencement of each calendar quarter and if volumes are less or greater than that assumed volume, the parties agree to review the model and adjust it accordingly.
On 13 August 2012, Mr Russell sent a version of the draft of the letter agreement, containing the changes made by his solicitor, to Mr Koops.
Despite what may now be discerned as the significance of the wording of cl 5.3 of the letter agreement, from the evidence before the court it was not until 31 August 2012 that Mr Koops responded to Mr Russell’s latest draft. He had some further suggestions, which Mr Russell sent to his solicitor on 13 September 2012. On 25 September 2012, the solicitor sent his redraft of cl 5.3 to Mr Russell “as discussed”. It was in the following terms:
(Minimum Fees) At the end of each calendar month, Moira Mac’s shall be entitled to invoice an adjustment to Zwanenberg equal to the amount of the actual Capital Costs, plus the actual fixed component of the Manufacturing Costs (calculated in accordance with the model in Part B of Annexure B) for that calendar month (regardless of the quantity of Products ordered and invoiced in that month) less the total cumulative fixed component of the Manufacturing Costs and Capital Costs component of the Fees invoiced to Zwanenberg for Products during that calendar month. For the avoidance of doubt, it is intended by the parties that the Minimum Fees cover Moira Mac’s overheads comprising the Capital Costs and the fixed component of Manufacturing Costs (Covered Overheads) each calendar month only where those Covered Overheads are not otherwise covered in the Fees paid that calendar month. It is not intended that Moira Mac’s receives more than what is needed to cover those Covered Overheads. Accordingly, after each quarter, if the amounts received by Moira Mac’s as Minimum Fees in that calendar quarter are more than Moira Mac’s actual Covered Overheads during that quarter, a credit will be brought forward in the following quarter for that excess amount and any brought forward credit at the end of the financial year will be paid by Moira Mac’s to Zwanenberg. The model in Part B of Annexure B is based on 1,000 tons of Products being produced per annum. The model will be reviewed at the commencement of each calendar quarter and if volumes are less or greater than that assumed volume, the parties agree to review the model and adjust it accordingly.
The letter agreement was dated 25 September 2012, probably because that was when the then final version was sent electronically to Mr Russell by his solicitor, with the instruction to print it and sign it. Mr Russell sent it immediately to Mr Koops, stating that he was “happy to sign tomorrow”. As it happens, he signed the letter on the day he received it, 25 September 2012. It was not until 2 October 2012 that Mr Koops sent the letter agreement to his principals in The Netherlands.
Mr Baan travelled to Bendigo in early November 2012. In an email to Mr Russell on 31 October 2012, Mr Baan referred to the following “planned activities” for the visit:
– check calculated cost price during test-production next week, measurement on material-usage and labour-usage
– evaluate the registration of your flow of goods, we need this for efficiency-reports on material
– evaluate the registration of used hours per production department, we need this efficiency-reports on hours
– evaluate a format I made for a report on efficiency results and needed materials and hours (based on production planning)
– we have to agree upon the way we calculate the fixed costs according to the contract, make a setup for your general ledger
– evaluate the registration and the monitoring of the stock (raw materials an [sic] packaging), long lead-times, guarantee continuity of production
During his visit to Bendigo, Mr Baan worked with someone whom he perceived to be a kind of “financial controller” then employed by the respondent, Daniel Holland. At some point, Mr Baan provided Mr Holland with an electronic version of a revised cost/price model which followed the format of Part A of Annexure B for the letter agreement, but which departed from it in two respects at least: the individual products were not always the same, and it was based on an assumed total annual production of 500 t (not 1000 t, as was the case under Part A itself). As to the latter aspect, it seems that the only respect in which the revised model reflected the change was that the allowance for “interest and repayment fee” had been increased from $0.34 to $0.68 per kg. The allowance for “overhead” remained at $0.96 per kg.
Mr Baan gave evidence that, at the end of his visit to Bendigo, he met with Mr Russell and Mr Holland, when they “went through all the calculations and the reports and … agreed that they were ok.” At no stage did either Mr Russell or Mr Holland tell Mr Baan that there were any difficulties with his estimate of $709,000 as the respondent’s fixed cost of producing 1000 t of product per annum, or with the “overhead” figure of $0.96 in Part A of Annexure B, or with the $443,500 figure in Part B of Annexure B. Under cross-examination, Mr Baan was not challenged on this evidence, and Mr Russell said nothing of any value about it in his evidence. Mr Holland was not called.
By late November 2012, the machinery for the production of snack foods at Bendigo had been installed and was being commissioned. The evidence is unclear as to exactly what had been achieved by when in this respect, but I note that Mr van der Laan was present at the factory for activities which included a tasting on 27 November 2012.
The letter agreement was executed on behalf of the applicant on 3 December 2012. The form of the agreement which was executed was that which had been signed by Mr Russell on 25 September 2012. The figures in Part A of Annexure B did not reflect those given to Mr Holland by Mr Baan in November. The November figures were, however, those upon which the parties operated, to the extent that they did operate, under the letter agreement in 2013.
THE TERMS OF THE LETTER AGREEMENT
Although I shall have to refer to particular terms of the letter agreement in detail in various sections of my reasons which follow, for reference I now set out so much of the agreement as has become relevant in this proceeding, and some other provisions for the sake of context.
1. Background
The background to the intended arrangements is as follows:
1.1Zwanenberg carries on the business of promoting, advertising and selling the Plumrose range of food products in Australia. Zwanenberg is the owner of the certain know-how relating to machinery, processing, operation, product development and quality control relating to certain food products which it manufactures overseas. Zwanenberg does not manufacture these food products in Australia.
1.2Moira Mac’s carries on business in Australia of manufacturing food products. Moira Mac’s is the owner of the certain know-how relating to machinery, processing, operation, product development and quality control relating to manufacturing food products for Australian local requirements.
1.3Zwanenberg and Moira Mac’s wish to enter into a long-term business arrangement where Moira Mac’s manufactures certain food products for supply to Zwanenberg.
1.4Under this arrangement:
(a)Moira Mac’s agrees to invest in new machinery and building upgrades required to manufacture the products;
(b)Zwanenberg will purchase the manufactured products based on an “open cost calculation” plus agreed profit margin;
(c)Zwanenberg agrees to pay a minimum fee based on the cost of principal and interest financed for machinery and factory set-up;
(d)each party agrees to make available their respective know-how on a nonexclusive basis solely for the purpose of the manufacture of the products under this letter agreement and not for any other purpose;
(e)Moira Mac’s agrees to exclusively manufacture products for Zwanenberg, on the terms and conditions of this letter agreement.
….
2.1(Definitions) In this letter agreement:
(a)Capital Costs means principal and interest on the loan for Machinery (described as “interest and repayment fee” in Part A of Annexure B to this letter agreement) together with any commissioning costs and building upgrade requirements. Part A of Annexure B sets out the model for calculating the interest and repayment fee component of Capital Costs as at July 2012. The actual Capital Costs shall be calculated at the commencement of each calendar quarter based on this model with adjustments to be made for any increases or decreases in actual Capital Costs.
….
(h)Manufacturing Costs means the materials, packaging, labour and overhead costs as set out in, and described as “meat”, “product loss”, “spices”, “oil”, “packaging”, “labour costs” and “overhead” in, Part A of Annexure B to this letter agreement. Part A of Annexure B sets out the model for calculating Manufacturing Costs as at July 2012. The actual Manufacturing Costs shall be calculated at the commencement of each calendar quarter based on this model with adjustments to be made for any increases or decreases in actual Manufacturing Costs.
….
(j)Profit Margin means three percent (3%). The Profit Margin is described as Copackers Margin in Part A of Annexure B of this letter agreement. Part A of Annexure B sets out the model for calculating Profit Margin.
….
3.1(Term) This letter agreement shall commence on the date of this letter agreement and continue for a period of seven (7) years unless terminated earlier in accordance with this letter agreement (Term). This letter agreement may be extended by mutual agreement of the parties.
3.2(Investment In Machinery) Moira Mac’s agrees to invest in the machinery (Machinery) and building upgrade requirements relating to the Machinery (Building Upgrades) as set out in Annexure A. Moira Mac’s shall finance the purchase of the Machinery and Building Upgrades with its financiers.
3.3(Knowledge sharing)
(a)Zwanenberg will make available to Moira Mac’s its know-how relating to machinery, processing, operation, product development and quality control relating to the Products which it manufactures overseas (Zwanenberg IP) on a non-exclusive basis solely for the purpose of the manufacture of the products under this letter agreement and not for any other purpose. Zwanenberg shall retain all intellectual property in its Zwanenberg IP.
(b)Moira Mac’s will make available to Zwanenberg its know-how relating to machinery, processing, operation, product development and quality control relating to manufacturing food products for Australian local requirements (Moira Mac’s IP). Moira Mac’s shall retain all intellectual property in its Moira Mac’s IP.
(c)Moira Mac’s shall make available to Zwanenberg any improvements developed by Moira Mac’s to either Zwanenberg IP or Moira Mac’s IP. Moira Mac’s shall retain all intellectual property in such improvements.
….
4.1(Manufacturing of Products) Moira Mac’s shall manufacture the Products for Zwanenberg using the Machinery from the Commission Date.
4.2(Factory Design) Moira Mac’s agrees to consult with Zwanenberg on all aspects of factory design relating to use of the Machinery. Zwanenberg will provide guidance using its engineering and construction know-how.
4.3(Forecasts and orders) Zwanenberg must, at all times, provide to Moira Mac’s forecasts/orders on the following basis:
(a)Rolling forecasts to be prepared based on discussions with retailers;
(b)Adjustment to forecasts based on information received from retailers;
(c)Moira Mac’s will, wherever possible, produce to actual orders on a Just in Time basis; and
(d)The parties will work together to assist Moira Mac’s meet any delivery performance or other KPIs set by retailers.
….
5.1(Fees) From the Commission Date, Moira Mac’s shall invoice a fee for each delivery of Products based on a variable fee per kilo (Fees). Zwanenberg agrees to pay the Fees to Moira Mac’s. The Fees shall consist of three components:
(a)manufacturing costs (including materials, packaging, labour and overhead) as set out in Part A of Annexure B to this letter agreement (Manufacturing Costs). Part A of Annexure B sets out the model for calculating Manufacturing Costs as at July 2012. The actual Manufacturing Costs shall be calculated at the commencement of each calendar quarter based on this model with adjustments to be made for any increases or decreases in actual Manufacturing Costs;
(b)capital costs (comprising principal and interest on the loan for Machinery (including any commissioning costs) and building upgrade requirements) (Capital Costs). Additional Capital Costs may be added during the term of the letter agreement for the purpose of continuous improvement in the production process and exploiting new product opportunities. These must be agreed by both parties. For the avoidance of doubt, the Capital Costs include any payments on the loan prior to the Commission Date required for precommissioning activities. Any government grants for the manufacturing using the Machinery shall be used to reduce the Capital Costs. Capital Costs shall be forecast at the commencement of this letter agreement until 30 June 2013 (and, thereafter, each financial year ending 30 June) based on the forecast finance costs divided by the forecast production volume for that period. At the end of each period the Capital Costs shall be adjusted against the actual finance costs paid by Moira Mac’s in that period and Moira Mac’s shall be entitled to invoice an adjustment equal to this adjustment amount; and
(c) the Profit Margin applied to all of the above.
5.2(Payment terms) All payments in respect of Products are due within the same payment terms agreed with the major retailers for the Products (that is, Coles and Woolworths). These payments are usually 30 days of the end of the month in which the Products are manufactured and delivered. Any variation to these usual payment terms must only be made with the written agreement of both parties. All other payments (including Minimum Fees) shall me made within 30 days of date of invoice.
5.3(Minimum Fees) At the end of each calendar month, Moira Mac’s shall be entitled to invoice an adjustment to Zwanenberg equal to the amount of the actual Capital Costs, plus the actual fixed component of the Manufacturing Costs (calculated in accordance with the model in Part B of Annexure B) for that calendar month (regardless of the quantity of Products ordered and invoiced in that month) less the total cumulative fixed component of the Manufacturing Costs and Capital Costs component of the Fees invoiced to Zwanenberg for Products during that calendar month. For the avoidance of doubt, it is intended by the parties that the Minimum Fees cover Moira Mac’s overheads comprising the Capital Costs and the fixed component of Manufacturing Costs (Covered Overheads) each calendar month only where those Covered Overheads are not otherwise covered in the Fees paid that calendar month. It is not intended that Moira Mac’s receives more than what is needed to cover those Covered Overheads. Accordingly, after each quarter, if the amounts received by Moira Mac’s as Minimum Fees in that calendar quarter are more than Moira Mac’s actual Covered Overheads during that quarter, a credit will be brought forward in the following quarter for that excess amount and any brought forward credit at the end of the financial year will be paid by Moira Mac’s to Zwanenberg. The model in Part B of Annexure B is based on 1,000 tons of Products being produced per annum. The model will be reviewed at the commencement of each calendar quarter and if volumes are less or greater than that assumed volume, the parties agree to review the model and adjust it accordingly.
5.4(Security) Zwanenberg’s parent company must provide, within 7 days of request by Moira Mac’s, an irrevocable letter of credit from a reputable bank in favour of Moira Mac’s financiers as security for the financing required for the Machinery (Letter of Credit). The investment in the Building Upgrades is at Moira Mac’s risk.
5.5(Charge) Zwanenberg shall be entitled to a charge over the specific Machinery provided that the charge shall be released when the Letter of Credit is released by Moira Mac’s financiers.
5.6(Purchase of Machinery) If Zwanenberg terminates this letter agreement under clauses 9.1 or 9.2, Zwanenberg may purchase the Machinery from Moira Mac’s at the residual fiscal value at that point in time.
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9.1(Termination for material breach) Either party may terminate this letter agreement if the other party materially breaches the letter agreement and does not remedy such breach within 14 days of notice of the breach from the firstmentioned party.
9.2(Termination for insolvency) Either party may terminate this letter agreement if the other party is or becomes Insolvent.
9.3(Termination for change in control or assignment) Zwanenberg may terminate this letter agreement if:
(a)there is a change in Control of Moira Mac’s such that an entity, which does not, either solely or jointly, Control Moira Mac’s as at the date of this letter agreement, attains Control of Moira Mac’s; or
(b)there is an assignment of this agreement by Moira Mac’s to an assignee,
without the prior consent of Zwanenberg, such consent not to be unreasonably withheld or delayed.
9.4(Consequences of termination) Upon termination of this letter agreement, Zwanenberg shall be entitled to all then manufactured Product subject to payment of all Fees in full for the Products.
In my view, $75,000 cannot be regarded as a reasonable estimate, even on an indicative basis, of an annual rent believed at the time to be of the order of $87,060. We are not here dealing with a representor which was ignorant of the actual rent which it was likely to pay, and made its best estimate on the information then available to it. We are dealing with a representor which had had detailed discussions with its landlord, and which knew, to the dollar, the rent which the landlord intended to charge for premises which were then reasonably expected to be used in the industrial operation concerned. On the evidence to which I have referred, I would hold that the respondent did not have reasonable grounds to represent to the applicant that its rent for the first year would be, indicatively, $75,000.
With respect to rates and water, the representation was that the respondent’s annual outgoing would be of the order of $8,500. In his evidence-in-chief, Mr Russell said:
Both council rates and water rates would increase in proportion to the increase in tenancy area. Moira Mac’s was paying council rates of $9,503 and water rates of $22,999 on its existing core business for approximately 3000 square metres of area. I estimated the snacks area would be around 750 square metres; that meant the snacks area would incur rates of around $34,000 divided by 4 = $8500.
Mr Russell was not cross-examined on this evidence.
Notwithstanding that omission, there is evidence, led by the respondent, which establishes that Mr Russell did not have reasonable grounds to make that representation. In the correspondence of 22 September 2012 to which I have referred, he was informed that the total area under consideration was 1136 m2. That was also the area to be let to the respondent under the draft lease sent to it on 23 November 2012. By basing his representation upon the supposition that the leased area would be about 750 m2, Mr Russell acted contrary to information of which he is reasonably assumed to have been aware. I would hold, therefore, that the respondent did not have reasonable grounds to represent to the applicant that the costs to be incurred in respect of rates and water for the first year would be, indicatively, $8,500.
With respect to management, the representation was that the respondent’s annual outgoing would be of the order of $50,000. In his evidence-in-chief, Mr Russell said:
Moira Mac’s management team in 2012 (consisting of myself, Darren burgess, Shannon Simpson and Judith Shuter) cost approximately $500,000 per annum. I estimated that the additional management tasks in operating the snacks line would be 10% of this cost ($50,000 p.a.) assuming that once it was established and employees were satisfactorily trained.
Mr Russell was not cross-examined on this evidence.
Unlike a number of other elements of Mr Russell’s representation, this one did not involve a prediction of the costs that would be imposed on the respondent by an external agency. Rather, it involved a judgment by him of the extent to which members of his existing management team would be required to occupy themselves in the snack foods business. He was challenged neither on the correctness of the total management cost figure of $500,000 nor on the reasonableness of his 10% estimate. It is inevitable, in the circumstances, that I should hold that the respondent did have reasonable grounds to make this representation.
With respect to insurance, the representation was that the respondent’s annual outgoing would be of the order of $50,000. In his evidence-in-chief, Mr Russell said:
I included the figure of $50,000 for insurance after consulting Mr. David Bakes of the Bendigo firm, Bendigo Insurance Brokers. I informed Bakes that Moira Mac’s would be acquiring an additional $2m worth of plant and equipment. He said that if Moira Mac’s existing policy cover was increased (rather than a separate policy being created and issued) the policy would cost an additional $50,000. (In fact the insurance cost was $32,000).
Mr Russell was not cross-examined on this evidence.
Nothing in the evidence was drawn to my attention, and I am not aware of anything otherwise, which would cast doubt on the reasonableness of the basis offered by Mr Russell for making his estimate of the additional insurance costs which the respondent would incur upon the establishment of the snacks line. I would hold that the respondent had reasonable grounds to make this representation.
With respect to utilities, the representation was that the respondent’s annual outgoing would be of the order of $30,000. In his evidence-in-chief, Mr Russell said:
The annual estimated cost of electricity and gas in Moira Mac’s core business was $82,387 and $34,890 respectively. Moira Mac’s was averaging $2,500 per month simply to have the electricity and gas connected. So that at 0 production, the minimum cost to Moira Mac’s was $30,000 per annum. I did not know what actual electricity and gas prices would be in circumstances where I had not had experience in cost of operating a snack line (for example, which used electric fryers) and the carbon tax had not been introduced, but was anticipated to increase electricity charges by 20%. The utilities price would be adjusted to conform with actuals once these contingencies were known.
Mr Russell was not cross-examined on this evidence.
It is clear from that evidence, however, that Mr Russell’s estimate was based entirely on the annual connection charge for the utilities concerned. As I have held above, I do not accept that these cost representations made by the respondent were based on an assumption that the new snacks operation would lie idle, or that the applicant would reasonably have so understood them. The content of the utilities representation was that, even at low production levels when the costs concerned would not be covered by the unit-based fee which the respondent would charge for goods produced for the applicant, the respondent would incur costs of the order indicated. Clearly, the annual connection charge alone did not provide a reasonable ground for the respondent to have made the representation. Further, the drift of Mr Russell’s evidence set out above is that, where electricity prices were “anticipated” to increase by 20% as a result of the introduction of a carbon tax, he ignored that in his estimate forwarded to the applicant. In this respect, the respondent had reasonable grounds to believe that that estimate would prove to be wrong. For these reasons, I would hold that the respondent did not have reasonable grounds to make the utilities representation.
With respect to maintenance, the representation was that the respondent’s annual outgoing would be of the order of $10,000. In his evidence-in-chief, Mr Russell said:
The maintenance expenses in Moira Mac’s existing core business were substantial: I believed maintenance was costing approximately $234,000 annually. This was because in most cases the plant and equipment was older and required high levels of maintenance. In the case of the equipment being acquired by Moira Mac’s from ZFG, I was informed that the equipment if not new had been refurbished as new. In fact, as I address later in this statement, the ZFG machinery malfunctioned with regularity at substantial expense. My estimate of $10,000 was a minimum figure required to keep the snacks line and factory in running order at 0 production regardless of use, and involved greasing and oiling as part of scheduled maintenance, wall surface repair and corrosion removal. I anticipated this maintenance would involve 1 worker, on 1 day per month costing $3,600 in labour and the balance in consumables. I did not make allowances for breakdown and repairs as I assumed, on what ZFG had told me, that new and refurbished machinery would require minimal maintenance.
Mr Russell was not cross-examined on this evidence.
There is nothing self-evidently unreasonable about Mr Russell’s evidence about his estimate of maintenance costs. Although here too he appears to have based that estimate on an assumption of zero production, the position differs from that with which I dealt above in the area of utilities in that the court cannot take judicial notice, in effect, of the circumstance that maintenance costs would necessarily be higher than the modest levels estimated by Mr Russell if the snacks line were running, but at minimal production levels. Without the matter having been tested by counsel for the applicant, I am in no position to reject the reasonableness of Mr Russell’s estimation. I would hold that the respondent had reasonable grounds to make this representation.
With respect to cleaning, the representation was that the respondent’s annual outgoing would be of the order of $10,000. In his evidence-in-chief, Mr Russell said:
I adopted the figure of $10,000 as a minimum estimate to keep the snacks line presentable with 0 production. The snacks production area was about ¼ of the size of the existing business, but it would need to be kept sterile. It would be subject to regulatory audits and factory visits. The grease traps would require regular cleaning. The cleaning/rubbish removal costs in Moira Mac’s core business was $22,000. I estimated that 1 labourer on 1 day per month at a cost of $2,500, plus 2 contractor visits to clean the grease traps (at $1,5000 [sic] each) together with consumables of around $4,500 (hand towels, sterile masks and gloves, detergents, disinfectants and sterile feet washers).
Mr Russell was not cross-examined on this evidence.
The facts in respect of this item are relevantly indistinguishable from those dealt with above in the area of maintenance. I would apply the same reasoning as I did in that area, and hold that the respondent had reasonable grounds to make this representation.
With respect to all the other items listed in Mr Russell’s representation – supervision, QA officer, accountancy, bank fees, safety/laundry/materials, laboratory, audit fees, pest control, office costs and sundry – the respondent led no evidence of the grounds upon which the estimates in question were based. Although the applicant’s case was not conducted with any particular attention being given to these items, that case did include the proposition that what the applicant called “the fixed cost representation”, as a whole, first made on 16 July 2012 and carried through into Part B of Annexure B to the letter agreement, was made without reasonable grounds. In relation to these miscellaneous items on the list, I am bound by the terms of s 4(2) of the ACL to uphold that case.
It follows from the terms of s 4(1) of the ACL that the representations referred to above which were made without reasonable grounds were misleading, and that the applicant has made good its case of a contravention, or possibly of a series of related contraventions, of s 18 of the ACL.
Turning to the question whether the applicant relied on the representation, it was submitted on behalf of the respondent that the court should be wary of a party who, having made an unwise business decision, seeks to use a finding of the kind that I have made above to avoid the natural consequences of that decision. For a party to act in such a way, it was submitted, amounted to opportunism to which the court should give no support. That was an appropriate submission for the respondent to have made at a high level, and I propose to approach the applicant’s reliance case with the degree of scepticism which the submission implies. Even under that approach, however, there can be no doubt but that the applicant relied on Mr Russell’s fixed cost estimates in making its decision to execute the letter agreement.
Originally, the applicant’s proposal contained no fixed cost guarantee for the respondent. It was the respondent which introduced the need for such a guarantee into the negotiations. Mr Baan’s early suggestions were too limited for Mr Russell’s liking, and he came up with his own list. Although I have, in a number of respects, found that Mr Russell did not have reasonable grounds for the figures which he included on his list, the applicant would reasonably have assumed otherwise. Only four days before Mr Russell’s list was first forwarded to the applicant, Mr Koops informed him that Mr Baan had advised “to run with your approach and use your estimate for these costs”. Mr Koops asked Mr Russell to “fill in the ??”, and he did so. The list which Mr Russell sent on 16 July 2012 was accepted by the applicant, and was uncontroversial as between the parties thenceforth.
The importance of Mr Russell’s estimates for the applicant was given a sharper edge by the amendment of cl 5.3, and of Part B of Annexure B, of the draft to entitle the respondent to recover its actual costs. Had there never been any suggestion of the applicant being obliged to cover the respondent’s fixed manufacturing costs regardless of volume, as was the case under the draft agreement prepared by the applicant’s solicitors in early May 2012, the absence of broadly reliable estimates of those costs would have been irrelevant to the applicant’s liability and, therefore, irrelevant to its decision to execute the letter agreement. However from 2 August 2012 the applicant knew that it would have to reimburse the respondent its actual manufacturing costs, subject only to them having been calculated in accordance with the model in Part B of Annexure B. Objectively, this would have given the applicant concerns in two areas: first, the need to avoid double payment by ensuring that it was given credit for overhead cost recovery under product invoices, and secondly, the need to have a reliable approximation of what its exposure would be whatever the extent of that recovery. The first concern was dealt with by the amendments to the draft of the letter agreement done on 25 September 2012.
It was the purpose of the respondent’s representation, now taking the form of the amounts set out in Part B of Annexure B, to allay the second concern. That the applicant would have executed the letter agreement, knowing what it did about the operation of cl 5.3, without an estimate of the kind made in Part B, would, in my view, have been a most unlikely outcome. It would have implied a cavalier approach to its own monetary exposure in the area of a significant investment that would have been wholly at odds with the otherwise careful and meticulous approach which it took to such matters.
Favourably to the respondent, I am prepared to infer that there were many other aspects of the business case for entering the snack foods market in Australia that the applicant took into account. I am satisfied, however, that keeping its own exposure to production costs under control was a critical consideration. It is also true that the impact of cl 5.3 was to be felt only at low production volumes, such that, once volumes reached a certain level the respondent’s claim under that clause would be effectively cancelled out by the overhead cost component of the prices which it had charged for products in the month in question. But the operation of cl 5.3 was limited only by the size of the costs which the respondent was entitled to claim under it: the more the respondent’s actual costs exceeded those set out in Part B of Annexure B, the higher production volumes would need to be before this cancelling out process cut in. That is to say, the applicant was exposed under cl 5.3 not only at “low production volumes” defined exogenously: its exposure was tied to the level of the respondent’s actual fixed manufacturing costs.
For the above reasons, I am satisfied that the applicant relied on the respondent’s representation as a significant element in the decision it made to enter the letter agreement.
What are the consequences of these findings of contravention and reliance? As noted above, the applicant seeks an order under ss 237(1) and 243(a) of the ACL that the letter agreement is void, an order under ss 237(1) and 243(d) directing the respondent to return the machinery which was purchased from ZFG and damages pursuant to s 236(1). Both s 236 and s 237 require that the person claiming the remedies to which they refer have suffered – or, in the case of s 237, be likely to suffer – loss or damage because of the conduct found to have been contravening. I shall deal with remedies as such in a later section of these reasons. Here, I propose to consider whether the applicant has established that it suffered, or is likely to suffer, loss or damage, and if so, how that arose, or would arise, and what is the nature thereof.
It was submitted on behalf of the applicant that its “true loss” was “being tied to a loss-making contract”. Whether the letter agreement was loss-making for the applicant in some general sense was not, however, the subject of its evidentiary case. To the contrary, it made it clear that its only claimed loss, and thus the only loss which it sought to establish for the purposes of the ACL, was the amount which (as it was put in the applicant’s outline) it “may have to pay on [the respondent’s] invoices, on top of those amounts it should properly have to pay”. What “properly” means in this context, it seems (and here I quote from another paragraph of the applicant’s outline), is “properly chargeable under the letter agreement”. In final oral submissions, the focus of counsel for the applicant was on the additional outlays to which it would be exposed under claims of the kind foreshadowed in Mr Smith’s model of 24 May 2013 and actually made in invoice No 88. It was also submitted that the applicant was, in effect, locked into the losses implied by the need to make these outlays once it executed the letter agreement, which it did in reliance on the respondent’s contravening representation.
With respect to those involved, I would have to say that this way of putting the matter of loss for the purposes of the ACL is a most curious one. The dispute about the respondent’s entitlement under cl 5.3 of the letter agreement has been agitated in this case. The applicant was never exposed to the need to make payments to the respondent greater than the latter’s entitlement under the letter agreement, properly construed. I have held that this entitlement was not reflected in invoice No 88. The applicant’s loss cannot be measured by the necessity to make outlays greater than those for which the letter agreement provided because, by definition, there was no such necessity.
On the other hand, to the extent that it is put that the applicant is locked into a contract which does require the making of outlays higher than those the subject of the respondent’s representation, the applicant’s case is intelligible. Conceptually, I consider that such a case is one that should be accepted. Had the representation not been made, the applicant would not have entered into the letter agreement and, subject to appropriate findings of fact at the level of detail, would not have been subject to such a requirement.
The difficulty is that the answer to the question whether the applicant has suffered, or would be likely to suffer, loss under the operation of the letter agreement depends substantially on a calculation of the respondent’s monthly entitlement under cl 5.3. The approach which I have decided to take in that area of the case has been dealt with at paras 279-280 above. The applicant’s case on the merits under s 18 of the ACL has been made good not in the sense that the costs chargeable under cl 5.3 are more than was represented by the respondent, but in the sense that the respondent did not have reasonable grounds for making the representation. It remains an open question, therefore, whether the applicant has suffered loss or damage because of the representation. This is not merely a question of the quantification of damage: it is also the anterior question of whether an action lies under ss 236 or 237 at all.
DISPOSITION OF THE PROCEEDING
Based upon the reasons which I have given above, there are some orders which may, and should, now be made in final disposition of this proceeding. There are, in addition, some matters which will require to be addressed by the parties in the light of those reasons, and liberty to apply will need to be reserved in some instances.
I propose to dismiss the respondent’s claims (as cross-claimant) that the applicant breached cll 5.1(a) and 5.3 of the letter agreement by failing to make the calculation, and to undertake the review, there referred to.
The respondent is entitled to judgment in respect of its unpaid production invoices.
I propose to reject the respondent’s claim to payment of the invoiced sum under invoice No 88. I have made sufficiently clear my reasons for adopting this course. The final determination of its entitlement under this invoice will be stood over. I have not dealt specifically with the respondent’s minimum fee invoices subsequent to No 88, and I anticipate that the answers to such questions as may arise in this respect will fall into place once the position under that invoice has been resolved.
I propose to dismiss the applicant’s claim under cl 9.1 of the letter agreement.
I am prepared to make a declaration that the respondent repudiated the letter agreement on 1 July 2013, but I shall do so only if the applicant, on the settlement of the orders, undertakes to accept that repudiation within 48 hours of the making of the declaration.
The respondent (as cross-claimant) has succeeded in establishing a breach of the implied term of co-operation. It will be necessary to give directions for the assessment of the damages to which the respondent is entitled. I shall hear the parties on that issue.
The applicant has succeeded in establishing a contravention of s 18 of the ACL. The primary remedy sought by the applicant in this area of the case is not damages but the voiding of the letter agreement by an order under ss 237(1) and 243(a). I could not contemplate taking that step until it has been established that the applicant suffered loss or damage because of the respondent’s representation. Not only would the basis for the exercise of the court’s jurisdiction then be established, but the court would know the extent of the divergence, if any, between the costs represented by the respondent in the lead up to the execution of the letter agreement and its contractual entitlements under cl 5.3 in respect of the early quarters of the operation of the agreement. That would, of course, be a matter relevant to the exercise of the court’s judgment under s 237 of the ACL.
Also relevant to the judgment whether to void the agreement under s 237 would be the result of the applicant’s decision whether to accept the respondent’s repudiation, which I have held it is entitled to do. An affirmative decision in that area would presumably foreclose any suggestion of voiding taking effect after the acceptance, but there may still be a question whether it was open, or appropriate, for the court to take such a step with effect from some earlier date.
Although not its primary case under s 18 of the ACL, I do not understand the applicant to have abandoned its claim for damages in that area, save with respect to future loss and damage. That is to say, the applicant appears only to seek damages – and then only in the alternative – to compensate it for the losses which it has sustained under the operation of the letter agreement to date. The court (and the parties, for that matter) will be in a better position to assess such damages as the applicant may be entitled to after final determination of issues arising under cl 5.3 of the letter agreement.
For these reasons, I shall stand over the finalization of the applicant’s case under the ACL pending the determination of those issues and the applicant’s decision on the repudiation aspect.
In the event that the finalisation of the case conformably with the reasons set out above involves each party having an entitlement to money outcomes at the expense of the other, the applicant proposed that comprehensive set-offs should be allowed, and I did not understand the respondent to resist that proposal. Even at this stage it is clear that the applicant is in debt to the respondent under the latter’s unpaid production invoices, and the respondent will need to account to the applicant in relation to the $200,000 government grant and other capital items. Once the quantification aspect of the case has been concluded, I shall permit the parties to make such further submissions as they consider necessary on any set-off issues that remain outstanding.
There are some respects in which the applicant has sought declarations marking the extent of such success as it was able to achieve in the proceeding. Save with respect to its repudiation case, I have not decided, at this stage, to grant any such claim. Generally, I take the view that the remedy of declaration should not be used simply as a statement of the factual or legal basis of some other remedy which has been granted or refused. However, I am not inflexible in this approach, and would be prepared to receive such submissions as the parties may wish to make, on the settlement of the orders, on this issue.
Although something of a sidebar to the issues in the proceeding, the fate of the machinery purchased by the respondent from ZFG for installation at Bendigo would become an issue if certain of the relief which the applicant has claimed were to be granted. It sought to deal with the machinery in two different circumstances, either of which had the potential to arise in the many-pronged case which it ran. The first circumstance would arise under cl 5.6, operating in combination with cl 9.1, of the letter agreement. The applicant sought a declaration that it may purchase the machinery under cl 5.6. However, since I have rejected the applicant’s case of breach under cl 9.1, nothing further needs to be said about this claim.
The second circumstance would arise under s 243 of the ACL. As a condition of the court making an order voiding the letter agreement from a specified date, it was proposed that the court should also order the applicant to purchase the machinery from the respondent at its “residual fiscal value”, calculated as the balance of the loan account as between the respondent and its banker. Because I have stood over the applicant’s case under s 243, I shall take the same approach to the matter of the purchase of the machinery.
I note that the applicant’s case did not deal with the consequences, if any, of an accepted repudiation for the disposition of the machinery purchased by the respondent from ZFG.
The detailed drafting of orders to be made at this stage is better done after the parties have brought in their short minutes, which they will be invited to do.
I certify that the preceding four hundred and six (406) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Jessup. Associate:
Dated: 6 October 2014
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