Bay of Plenty Pharmacy Services Limited v Chemworks Limited
[2019] NZHC 785
•11 April 2019
IN THE HIGH COURT OF NEW ZEALAND TAURANGA REGISTRY
I TE KŌTI MATUA O AOTEAROA TAURANGA MOANA ROHE
CIV-2018-470-000051
[2019] NZHC 785
BETWEEN BAY OF PLENTY PHARMACY SERVICES LIMITED
PlaintiffAND
CHEMWORKS LIMITED
First Defendant
Hearing: 25 March 2019 Appearances:
J Burt for Plaintiff
D M Fraundorfer and P R Allan for Defendants
Judgment:
11 April 2019
JUDGMENT OF ASSOCIATE JUDGE ANDREW
This judgment was delivered by me on 11 April 2019 at 3:00 pm pursuant to r 11.5 of the High Court Rules 2016.
Registrar/Deputy Registrar
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BAY OF PLENTY PHARMACY SERVICES LIMITED v CHEMWORKS LIMITED [2019] NZHC 785 [11 April 2019]
Introduction
[1] These proceedings relate to the sale and purchase of the Smartmed Pharmacy, which services rest homes in the Bay of Plenty. Smartmed operates a robotic prescription dispensing system.
[2] The plaintiff, Bay of Plenty Pharmacy Services Ltd (BPPSL) contends that it was induced to enter a sale and purchase agreement of the Smartmed Pharmacy because the defendant, Chemworks Ltd (Chemworks), made false or misleading representations in respect of Smartmed’s turnover and profitability. It also contends that the robotic dispensing system that it took possession of was not in good working order. It sues in contract and for breach of the Fair Trading Act 1986.
[3] Chemworks has made an application pursuant to r 5.45 of the High Court Rules 2016 for security for costs in the sum of $50,000. Chemworks says it has a genuine fear that a poorly resourced plaintiff will not be able to meet a costs award in unwarranted litigation.
[4] BPPSL opposes the application on the basis that the jurisdictional threshold in r 5.45(1) has not been met, namely that Chemworks has not produced sufficient evidence from which it may reasonably be inferred that BPPSL will be unable to pay the costs.
[5] The critical issue I must determine is whether the jurisdictional threshold has been met.
Relevant legal principles
[6] The general approach is well established. As held by the Court of Appeal in A S McLachan Ltd v MEL Network Ltd1 whether or not to order security and, if so, the quantum, are at the discretion of the Court. In accordance with Busch v Zion Wildlife Gardens Ltd (in Rec and in Liq) it is necessary to address the following steps:2
1 A S McLachan Ltd v MEL Network Ltd (2002) 16 PRNZ 747 (CA).
2 Busch v Zion Wildlife Gardens Ltd (in Rec and in Liq) [2012] NZHC 17 at [2].
(a)Has the applicant satisfied the Court of the threshold under r 5.45(1)?
(b)How should the Court exercise its discretion under r 5.45(2)?
(c)What amounts should security for costs be fixed at?
(d)Should a stay be ordered until any order is met?
[7] In order for the defendant to satisfy the threshold under r 5.45(1) there should be credible (ie, believable) evidence of surrounding circumstances from which it may reasonably be inferred that the plaintiff will be unable to pay the costs.3 The Court will give due weight to a plaintiff’s sworn assertion that it will be able to meet costs awarded, although that will not be decisive.4
[8] Kos J in Highgate on Broadway Ltd v Devine held that the words “will be unable” do not apply to financially capable but constitutionally unwilling persons.5
[9] In the exercise of its discretion the Court must balance two competing interests, the defendant’s interest in being protected from a barren costs order and the plaintiff’s right of access to the Court.6 As part of this enquiry, as far as possible, the Court will endeavour to assess the merits and prospects of success of the claim.7
[10] Other factors that are relevant to the exercise of the discretion include whether the defendant’s actions, being the subject of the litigation, caused any impecuniosity.8 As Kos J held in Highgate,9 this involves the consideration of linkage rather than any further examination of the merits and the conduct by the party.
[11] The amount of any security ordered is also discretionary rather than being the subject of a mathematical calculation.10 The amount of the security is not necessarily
3 Concorde Enterprises Ltd v Anthony Motors (Hutt) Ltd (No. 2) [1977] 1 NZLR 516 at 519.
4 Nikau Holdings Ltd v BNZ (1992) 5 PRNZ 430 at 436.
5 Highgate on Broadway Ltd v Devine [2012] NZHC 2288, [2013] NZAR 1017 at [8].
6 Clear White Investments Ltd v Otis Trustee Ltd [2016] NZHC 2837 at [4].
7 Ambrose v Pickard [2009] NZCA 502 at [32]-[33].
8 Bell-Booth Group Ltd v Attorney-General & BCNZ (1986) 1 PRNZ 457 at 461.
9 Highgate on Broadway Ltd v Devine [2012] NZHC 2288, [2013] NZAR 1017 at [23].
10 Sharp v Pillay [2017] NZHC 647 at [17].
fixed by reference to a likely costs award, but instead is an amount the Court thinks fit in the circumstances.11 The circumstances to consider are:
(a)the amount or nature of the relief claimed;
(b)the nature of the proceeding, including the complexity and novelty of the issues, and therefore the likely extent of interlocutories;
(c)the estimated duration of trial; and
(d)probable costs payable if the plaintiff is unsuccessful.
Background
[12] The sale and purchase agreement for the Smartmed Pharmacy was entered into in October 2015. The vendor, Chemworks, warranted and undertook that the turnover warranty for $1,169,577 (excluding GST) correctly disclosed the turnover of the business for the period stated.
[13] The agreement for sale and purchase lists as intangible assets (goodwill) the sum of $250,000.
[14] Clause 26.3 provided that the vendor shall assign, and the purchaser BPPSL, shall accept an assignment of the agreement to lease the premises at 49 Farm Street, Bayfair, Mt Maunganui, “presently between the vendor and Farm Street Development Ltd (the landlord) at Settlement Date”.
[15] Further terms of sale included a two-stage due diligence process which provided for the purchaser to carry out a due diligence investigation of all aspects of the business including the overall financial suitability and commercial viability, and the statutory and regulatory requirements affecting the business.
[16]From settlement date the purchaser agreed to employ Ms McArthur (a director
of Chemworks) as a contractor in a new position entitled “Facilities Business and
11 AS McLachlan Ltd v MEL Network Ltd (2002) 16 PRNZ 747 (CA) at [27].
Service Manager”. The purpose of the position was to liaise with and maintain an “excellent working relationship with all existing clients, and to expand the Purchaser’s business …”.
[17] There was subsequently a dispute between Ms McArthur and BPPSL. Chemworks then brought a claim in the Disputes Tribunal for unpaid services (by Ms McArthur) for the sum of $6,217.92. Chemworks was successful in both the Disputes Tribunal and on appeal to the District Court.12
[18] BPPSL did not make payment of the judgment award of $6,217.92 until 15 March 2019. Costs of $2,419 were not paid for three months despite demands by Chemworks.
[19] Chemworks’ application for security for costs was filed on 14 December 2018. In a minute dated 17 December 2018, I directed that any notice of opposition by BPPSL to the application for security should be filed and served by 15 February 2019.
[20] The notice of opposition by BPPSL was not filed and served until 5 March 2019.
[21] The case management conference of 17 December 2018 was called at the instigation of the Court. Prior to the conference, counsel for Chemworks filed a memorandum expressing concern that four months had passed since it filed its statement of defence and that in the interim, the plaintiff, BPPSL, had taken no formal steps to move the matter forward. In that minute I set the interlocutory application for security for costs down for hearing on Monday 25 March 2019.
[22] On 6 March 2019, I issued a further minute making amendments to the timetable for the filing of submissions for the interlocutory hearings, including security for costs. At that time the plaintiff was in default of the timetable directions I had made in my minute of 17 December 2018. I awarded costs against the plaintiff on a 2B basis in the sum of $892 (for wasted costs) and made various adjustments to the timetable for the filing of submissions. Those costs have not to date been paid.
12 Bay of Plenty Pharmacy Services Ltd v Kenworks [2018] NZDC 20239.
The application for security for costs
[23] Chemworks submits the proceedings will involve a substantial trial involving nine causes of action and multiple defendants. It contends that there is reason to believe that BPPSL would fail to meet either of the two limbs of the solvency test in s 4 of the Companies Act 1993 (ie both the liquidity and the balance sheet test). It submits:
(a)no accounting framework or policies were provided by BPPSL in support of its financial statements;
(b)there is a lack of information to complete a detailed and adequate assessment of the carrying value of the goodwill, said to be $4,485,700. Goodwill of that sum is significantly greater than what could reasonably or ordinarily be expected; and
(c)normally goodwill will be in the range of three to four times free cashflow which, if applied to BPPSL, is unlikely to result in goodwill at the recorded value.
[24] Chemworks also submits that BPPSL owed an outstanding judgment debt to it which BPPSL had continually failed to make payment of until very recently. Chemworks says that it has strong prospects of success in the substantive proceedings.
Analysis and decision
[25] In support of its contention that the jurisdiction threshold in r 5.45 has not been met, BPPSL submits that the sole pleaded basis in Chemworks’ application for security for costs (14 December 2018) is that BPPSL has not paid the Disputes Tribunal award of $6,217.92. That amount has of course since been paid, and there is no evidence that BPPSL was unable to pay that amount as, opposed to it being simply unwilling to do so.
[26] Mr Burt further submitted that while Chemworks has also sought to impugn the financial position of BPPSL, as disclosed by its financial statements, there is no
onus on the plaintiff to satisfy the Court of its ability to pay. It is argued that the Court must be alert to a defendant effectively seeking to reverse the onus imposed by r 5.45(1) by allowing a defendant to make a meritless application, the effect of which is then a fishing expedition as to the plaintiff’s financial circumstances. In any event, BPPSL says that the defendants’ criticism of its financial position is unfounded; BPPSL is both profitable and solvent on a balance sheet basis.
[27] There is no dispute that BPPSL has been reluctant and unwilling to pay the Disputes Tribunal award and the two related costs awards. Mr Kardaman on behalf of BPPSL has candidly acknowledged as much. However, as Mr Burt submitted, the test is not one of unwillingness, but rather, whether there is credible evidence of surrounding circumstances from which it may reasonably be inferred that the plaintiff will be unable to pay the costs.
[28] I reject the submission that the evolving nature of Chemworks’ application has in this case effectively reversed the burden of proof, requiring BPPSL as plaintiff to satisfy the Court as to its ability to pay. There has been no improper fishing expedition as alleged.
[29] Against the background of BPPSL’s failure to pay the outstanding Disputes Tribunal award and costs, and BPPSL’s failure diligently to prosecute its claim, Chemworks had good reason to raise the issue of security for costs in its December 2018 correspondence with BPPSL. BPPSL did not respond to Chemworks’ letter and the application for security for costs was then filed. Despite my direction of 17 December 2018, BPPSL did not file a notice of opposition until 15 March 2019.
[30] When the notice of opposition was received by Chemworks, together with the accompanying financial information in the affidavit of Mr Kardaman, Chemworks responded with an affidavit in reply by Mr Gray, Chartered Accountant, dated 22 March 2019, squarely addressing the issue of ability to pay. I accept that evidence was filed late, but it was done so against the backdrop of significant delay by BPPSL, leading to a revised and truncated timetable. In any event, in light of the late filing of the evidence I gave BPPSL a further seven days to file a submission addressing Mr Gray’s evidence.
[31] I turn now to consider the critical issue of whether sufficient evidence has been adduced from which it may reasonably be inferred that BPPSL will be unable to pay the costs.
[32] Chemworks relies, of course, on the evidence of Mr Gray to discharge the jurisdictional threshold. Mr Gray, an independent expert, while candidly acknowledging that he did not have all the information necessary to reach a definitive assessment, concluded that the carrying value of goodwill (carried in both sets of financial statements at $4,485,700) is recorded as significantly greater than what one might ordinarily expect. The goodwill is the only asset of any real value and would normally be in the range of three to four times free cashflow. If goodwill were reduced to more realistic levels then in Mr Gray’s view it is likely that BPPSL will be insolvent under the second limb of the solvency test contained in s 4 of the Companies Act 1993. In referring to Mr Gray’s evidence, Mr Fraundorfer submitted that there is no evidence underlying the goodwill, that the cash reserves are negative and the profits have fallen. He also submitted that the assets are hypothetical and non-tangible whereas the liabilities are very real.
[33] Mr Gray also concluded that in the financial statements of BPPSL as at 31 December 2018, the company reported current assets of $1,417,525 and current liabilities of $1,100,597. However, both numbers include balances with related parties. Current assets include loans to related parties of $656,280 and current liabilities include loans from related parties of $248,702. If related party balances are ignored, then the working capital available (current assets less current liabilities) reduces from $370,928 to a negative working capital of $36,650. In these circumstances Mr Gray raised concerns about whether BPPSL would be able to meet its debts as they fall due without the support of the bank.
[34] While there may be some merit to the concerns that Mr Gray has raised, I find that on the facts here, the jurisdictional threshold has not been met. This is a case
where the Court should give due weight to the plaintiff’s sworn assertion that it will be able to meet a costs award. My reasons for this conclusion are as follows:
(a)BPPSL operates a substantial business, the total assets exceeding $6.25 million as at 31 December 2018, being an increase of almost $2 million (over 45 per cent) since 2016. BPPSL operates three pharmacies in the Bay of Plenty, but they are only one part of a substantial group operating a total of 13 pharmacies in total. Excluding the Auckland region, the group is the second largest provider of pharmacy services in the regions in which it operates. I accept the submission of Mr Burt that such scale may justify a higher goodwill than a stand-alone pharmacy business.
(b)Mr Gray makes no reference at all to BPPSL being part of a substantial group totalling 13 pharmacies and it would appear that a number of these key facts are unknown to him.
(c)BPPSL’s financial statements show that the growth in total assets has been driven primarily by growth in current (i.e. readily realisable) assets. At the same time, non-current liabilities have declined each year.
(d)Mr Gray says in his affidavit that he had been instructed by the defendant to provide his opinion as to the solvency of BPPSL. However, in his exhibit A, which contains the substantive analysis of his review, he records as follows:
You have requested that I provide an assessment of the financial statements for [BPPSL] for the year ended 31 March 2018 in the nine months ended 31 December 2018. Specifically, you have requested my view as to whether the financial statements would provide sufficient comfort to allow Chemworks Limited to forego security for costs in proceedings brought by [BPPSL] against Chemworks Limited.
There is merit to Mr Burt’s submission that Mr Gray does not conclude that the financial statements’ evidence an inability to pay costs in the
event that BPPSL were unsuccessful in the proceedings. Rather, Mr Gray only concludes that the financial statements are insufficient by themselves to provide comfort of BPPSL’s ability to pay.
(e)Mr Gray further acknowledged that he had not had the opportunity to discuss the financial statements with the persons responsible for the preparation of them, or to request further information.
(f)I accept that Mr Gray is a very experienced chartered accountant. However, it is not clear from his evidence whether he has previously prepared financial statements for, or analysed the financial statements of, a pharmacy business. This is said by the plaintiff to contrast with Moore Stephens Markhams (the plaintiff’s accountants) who have recognised expertise in pharmacy accounting and are endorsed as the preferred supplier of accounting services by the Pharmacy Guild of New Zealand.
(g)BPPSL’s financial statements show that the growth in total assets has been driven primarily by growth in current (i.e. readily realisable) assets. Non-current assets are carried at their acquisition cost or, in the case of property, plant and equipment, are being depreciated. At the same time, non-current liabilities have declined each year.
(h)BPPSL currently has bank funding of approximately $4.84 million (including term loans and an overdraft facility). I accept Mr Burt’s submission that it can be inferred from BNZ’s total exposure to the plaintiff, and the terms usually applicable to such lending, that BNZ would regularly be seeking information regarding BPPSL’s financial performance and position and would take action if BNZ’s investment were at risk. There is no evidence of default by the plaintiff.
(i)With the exception of the year ended 31 March 2016, BPPSL has been profitable each year. The return on equity (net profit divided by average
total equity) is 31.5 per cent in the year to 31 March 2018 and 28.5 per cent in the nine months to 31 December 2018.
(j)BPPSL’s net profit is positive but it also understates cashflow due to the inclusion of depreciation (a non-cash expense). Depreciation was
$71,482 and $114,669 for the financial years ended 31 March 2017 and 2018 respectively, and $79,909 for the nine months to 31 December 2018. Reversing those figures gives a positive cash profit of:
(i)$265,538 for the year ended 31 March 2017;
(ii)$164,731 for the year ended 31 March 2018; and
(iii)$140,109 for the nine months to 31 December 2018 (an annualised cash profit of $186,812).
(k)It appears that Mr Gray’s analysis also fails to account for the fact that BPPSL pays management fees and travel expenses to related entities which are controlled by BPPSL’s principals. These amounts were
$155,482 and $162,758 for the financial years ended 31 March 2017 and 2018 respectively, and $110,519 for the nine months to 31 December 2018. Adding those amounts to those at (j) above results in a net cash profit for BPPSL’s business as follows:
(i)$421,020 for the year ended 31 March 2017;
(ii)$327,489 for the year ended 31 March 2018; and
(iii)$250,628 for the nine months to 31 December 2018 (an annualised cash profit of $334,171).
(l)BPPSL contends that the comparative figures used by Mr Gray at paragraph 3 of his report of 22 March 2019 and in relation to goodwill, are misleading. In the absence of full evidence on that issue I am not in a position to determine the matter. However, in light of the concerns
raised about this comparison by BPPSL, and bearing in mind that the defendant carries the burden of discharging the jurisdictional threshold, I cannot in the circumstances place much weight on Mr Gray’s contention. I also note that Mr Gray accepts that he has not completed a detailed assessment of goodwill.
[35] There may well be merit to some of the further submissions that Mr Burt makes in relation to Mr Gray’s analysis. However, in my view those matters should properly be addressed by expert evidence. In the absence of such evidence it is difficult for me to reach any conclusion. I would note, however, that the points raised do give rise to further doubt and uncertainty as to the extent to which I can place any weight on Mr Gray’s affidavit.
[36] Having concluded that the defendant has failed to establish the jurisdictional threshold, it follows that the application for security for costs must be dismissed.
[37] It is not of course necessary for me to address the discretionary factors, including an assessment of the merits of the plaintiff’s claims. I note, however, Mr Fraundorfer’s submission that there is an element of “make weight” in the amount of damages claimed, and that this litigation should be heard in a less expensive forum of the District Court. I make no determination on this issue, but it would appear to be in the interests of all parties for some sensible discussion to take place as to whether this proceeding should remain in this Court.
Result
[38] The application by the defendant, Chemworks Ltd, for security for costs is dismissed.
[39] In the ordinary course, the plaintiff, Bay of Plenty Pharmacy Services Ltd, having succeeded, would be entitled to costs on this application on a 2B basis. However, in the circumstances here where the plaintiff failed to pay the Disputes Tribunal award and the various costs orders in a timely fashion, failed to progress the proceedings themselves in a timely fashion, and failed to respond to the defendant’s letter raising the issue of security for costs, I am inclined to the view that costs to be
awarded to the plaintiff should be reduced by 33 per cent. The actions of the plaintiff did give rise to some legitimate concerns by the defendant and in my view this ought to be reflected in any costs determination. If the parties cannot agree on costs, then memoranda are to be filed within 14 days.
Associate Judge P J Andrew
Solicitors/Counsel:
Mr J Burt, Barrister, Auckland Wynyard Wood, Auckland Holland Beckett, Tauranga
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