Field Group Limited v Walia HC Dunedin Civ-2007-412-187

[2007] NZHC 1925

IN THE HIGH COURT OF NEW ZEALAND DUNEDIN REGISTRY

CIV-2007-412-000187

UNDER  the Arbitration Act 1996

IN THE MATTER OF     an appeal pursuant to Clause 51(a) of

Schedule 1 to that Act

BETWEEN  FIELD GROUP LIMITED Appellant

ANDLEENA WALIA AND REENA CHOUHAN

Respondent

Hearing:         7 June 2007

Counsel:         J E St John for Appellant

C J Mundy-Smith for Respondents

Judgment:      28 June 2007

JUDGMENT OF PANCKHURST J

Issues of share value and expenses

[1]      For a period Field Group Limited and Ms Walia and Ms Chouhan were the shareholders in Subway Wanaka Limited.  The company traded as a Subway outlet in Wanaka.  Differences arose as to the performance of the company.  Field Group exercised a power in the shareholder agreement whereby it could acquire the 49% shareholding of Ms Walia and Ms Chouhan.  The sum payable for that shareholding became a matter of dispute.

[2]      The dispute was referred to an arbitrator.   He determined that on a plain reading of the relevant clause in the shareholder agreement on amount calculated on the basis of EBIT (earnings before interest and tax) x 4 was due in payment for the

share interest.  The resulting figure was $167,816.

FIELD GROUP LTD V L WALIA AND R CHOUHAN HC DUN CIV-2007-412-000187  28 June 2007

[3]      Field Group challenges this finding as erroneous in law.  It contends that the correct formula is EBIT x 4 x .49.  Otherwise, it is said, the payment for the outgoing share interest represents the value of the total shareholding, not 49% of the shares. The approach favoured by the Arbitrator is criticised as giving rise to an outcome which defies business common sense.

[4]      A second ground of appeal concerns who is liable for certain costs which were outstanding, or incurred, at the time of the takeover.   The relevant figure is

$46,926.55.  In part, the Arbitrator doubted that he had jurisdiction to consider this aspect, but still concluded that the amounts claimed comprised expenses of Subway Wanaka Limited, or costs of the dispute.  The claim advanced by Field Group that Ms Walia and Ms Chouhan were personally liable for the expenses was described as “misconceived”.   Accordingly, the Arbitrator ruled that the payment for the share interest should not be subject to a deduction for the expenses claimed by Field Group (save as to an amount of $9,960.02, which was an agreed deduction).

Some further background

[5]      Mr Julian Field operated a Subway franchise at Wanaka from about March

2002.  Mr Field entered into a franchise agreement with Subway International and obtained  a  sub-lease  from  Subway Real  Estate  Limited  in  order  to  operate  the Wanaka business.

[6]      In May 2005 Mr Field incorporated Subway Wanaka Limited.  He became a director of the company.

[7]      On 21 June 2005 a shareholders’ agreement was concluded in relation to the company.  The parties to the agreement were Field Group Limited and Leena Walia and Reena Chouhan as shareholders, Subway Wanaka Limited and Mr Julian Field in his capacity as the franchise holder.  In terms of the agreement the shareholders agreed to subscribe for, and take, a transfer of shares in Subway Wanaka Limited, which company was thereafter to operate the Wanaka business. The initial share issue in Subway Wanaka Limited was 100 $1.00 shares of which Field Group took

51 shares, Ms Walia 25 shares and Ms Chouhan 24 shares.  Contemporaneously that

business was sold by Mr Field to Subway Wanaka Limited for $500,000 plus stock at valuation.  To fund the purchase price of the business the shareholders agreed to make advances to Wanaka Subway Limited totalling $500,000 plus the value of stock at valuation.  Such advances were proportionate to the share split (51%, 25% and 24%).

[8]      The shareholder agreement included the following additional terms:

[a]     Wanaka Subway Limited would be controlled and managed by a board of up to two directors, one  appointed by Field Group (being Mr Julian Field) and one appointed jointly by Ms Walia and Ms Chouhan (being Ms Walia): clause 6.1,

[b]   the franchise agreement with Subway International and the sublease from Subway Real Estate Limited would continue to be held by Mr Julian Field, but for the benefit of Wanaka Subway Limited, until the company called for a transfer of the agreement and/or sublease: clause 8,

[c]     board meetings were to occur at least monthly with the Board to have responsibility for business operations and overseeing the accounts of Subway: clause 9,

[d]    after a three year period Ms Walia and Ms Chouhan could, on written notice, purchase Field Group’s shares in Subway, failing which the business was to be placed on the open market for sale: clause 10.1,

[e]     in the event of a shareholder wishing to sell its shareholding or Ms Walia and Ms Chouhan exercising the right to acquire Field Group’s shareholding,  the shares in Subway were to be valued in accordance with an agreed formula, without deduction in relation to a minority shareholding: clause 11,

[f]     day to day management of Subway would lie with Ms Walia and Ms Chouhan,  on  defined  terms,  including  a  requirement  that they each assume an active role as managers of the business and

enter into employment contracts, which secured a wage of $580 per week for a minimum of 40 hours per week: clause 13.1,

[g]    for the first 18 months of operation Ms Walia and Ms Chouhan would meet defined performance criteria, failing which Field Group could acquire their 49% shareholding at a price based on another defined formula: clause 13.2,

[h]the shareholders’ agreement constituted the entire agreement between the parties, which they entered into upon their own judgment and without reliance on any representation or warranty made by any other party, and with the benefit of independent legal advice: clauses 21.1, 26 and 34.1.

[9]      I shall in due course refer to the valuation or price formula set out in clauses

11 and 13.2, since these are of central importance to the first ground of appeal.

[10]     On 31 July 2005 Ms Walia and Ms Chouhan commenced operation of the business at Wanaka.   About 10 months later, on 1 May 2006, Field Group gave notice that it considered the managing shareholders were in breach of their performance criteria and requested that remedial action be taken.  An improvement was not achieved.

[11]     On 4 July 2006 the shareholders met, but a resolution was not reached.  Field Group exercised its right to purchase the 49% interest.   On 2 August 2006 Field Group took possession of Subway Wanaka and continued to operate the business.

[12]     On 31 October 2006 the shareholders entered into an arbitration agreement. The agreement included this:

12.    The  Company’s  net  turnover  excluding  GST  for  the  year  ending

31 March  2006  was  $511,320.00,  and  from  1  April  2006  until possession date was $185,583 excluding GST.

13.    The Company had a loss of $9,174 for the year ending 31 March

2006, and a loss of $5,478 from 31 March 2006 until possession date.

14.    The Company’s annual profit (EBIT) was $40,517.00.

15.     [Field  Group  Limited]  has  not  to  date  paid  [Ms  Walia]  and

[Ms Chouhan] for their shares.

[13]     The arbitration agreement identified the issues in dispute as:

[a]     what amount should be paid by Field Group for the purchase of the   49%   shareholding   pursuant   to   clause   13.2   of   the shareholders’ agreement,

[b]    what deductions should be made from that figure “in respect of amounts  owed  by  [Ms  Walia  and  Ms  Chouhan]  to  [Field Group]” and

[c]     what interest was payable upon the outstanding figure. The Arbitrator was Mr Bob Lawrence.

[14]     Clause 11 of the arbitration agreement conferred a right of appeal to this Court with reference to questions of law which materially affected the rights and obligations of the parties.

[15]     The arbitration was conducted on the basis of an agreed statement of facts, supplemented by two affidavits sworn by Mr Julian Field and written submissions from counsel for both parties.   In addition the Arbitrator held a telephone hearing with counsel.

[16]     The award was issued on 1 December 2006.   Subsequently, Field Group initiated the appeal to this Court.

Are the performance based buy-out options in clause 13.2 subject to a factor of

.49?

[17]     This is the essential question, and point of difference, between the parties. The relevant part of clause 13.2 provides:

In the event that such [performance] standards are not met [Field Group] shall be entitled to give notice to [Ms Walia and Ms Chouhan] requiring them to sell their shares and advances to [Field Group] its nominee at a price

based on the lower of what they paid or calculated based on 75% of net turnover (excl GST) or 4 times the annual profit (EBIT).

Field Group contends that, read in the context of the shareholder agreement as a whole  and  in  the  interests  of  commercial  commonsense,  the  options  based  on turnover and EBIT (whichever is the lower) must be multiplied by a factor of .49. Otherwise, Field Group would pay an amount indicative of the total shareholding, not the 49% interest which it acquired.

The Arbitrator’s decision

[18]     Having  identified  the  issue  for  determination,  the  Arbitrator  found  at paragraph 6 of his decision that the language of clause 13.2 was “plain and unambiguous”.   Given it was common ground that EBIT was the lowest of the available options he considered EBIT x 4 was payable.

[19]     After reference to certain contentions advanced in support of Field Group’s case, the Arbitrator continued at paragraph 8:

If I reach the conclusion that the phrase has a clear meaning, I am asked nevertheless to treat the result which this produces as absurd.   Clearly a value judgment is asked of me.  I do not have in my power to do this and substitute my subjective judgment; however even if I did have that power I cannot see how the ability to re-purchase at two thirds of the [purchase] price after one year can be said to be absurd and that I must imply a term to avoid this absurd result.

These observations reflected the arithmetic of the exercise.  EBIT x 4 was $167,816, whereas the initial cost to Ms Walia and Ms Chouhan was $250,000 (comprising the share price and an advance to the company), plus a proportionate share of the stock value.

Field Group’s arguments on appeal

[20]     Ms  St  John  made  quite  intricate  submissions  directed  to  this  ground  of appeal.    She  argued  that  the  Arbitrator  had  failed  to  bring to  account  relevant considerations, namely internal aids to the interpretation of clause 13.2 contained elsewhere in the shareholder agreement.  Put another way, the effect of the argument

was that the Arbitrator had not construed clause 13.2 in the context of the agreement as a whole.   This, it seems to me, was the principal argument, which was lent emphasis by the contention that the failing led to a result which defied commercial logic, or was absurd.

[21]     An alternative argument was advanced to the effect that clause 13.2 must be read subject to there being an implied term (EBIT x 4 x .49), and that the wrong test was applied with reference to the implication of a term into a contract.  This issue was closely analysed by reference to the five point test established in BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 16 ALR 363 (PC). Instead of applying that well-established test, Ms St John argued that the Arbitrator applied a test of absurdity in the passage I have already quoted (see para [19]).

What would a reasonable person in possession of all background facts make of clause 13.2?

[22]     In my view the meaning of clause 13.2 is to be found upon a conventional application of the settled principles for the construction of contracts.  It is necessary to go no further than Boat Park Limited v Hutchinson [1999] 2 NZLR 74 (CA), in which the Court adopted the principles set out by Lord Hoffmann in Investors Compensation Scheme Limited v West Bromwich Building Society [1998] 1 All ER

98 (HL) at 114-5.  I think it unnecessary to set out the five principles in full.  The first  principle is:

Interpretation  is  the  ascertainment  of  the  meaning  which  the  document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

The remaining principles define the extent of background knowledge and exclude from it the “previous negotiations of the parties and their declarations of subjective intent”, emphasise that the meaning of a document is not a matter of dictionaries and grammar, and also counsel against departure from the natural and ordinary meaning of the words used save where from the background it is plain that something must have gone wrong with the language of the contract.

[23]     While accepting the appropriateness of a submission based on BP Refinery, I very much doubt that in the circumstances of this case there is scope for implication of a term if that same term is not found to be present on a Boat Park assessment of the contract.  The thrust of Ms St John’s argument as to the proper meaning of clause

13.2 was that, reading the agreement as a whole, it was obvious that a .49 factor formed part of the pay-out formula.  It was something which went without saying.  If this is so, I cannot see a need to imply a term which is obvious as to its nature and necessary to give business efficacy to the agreement.

[24]     I consider that the factual analysis contained in Boat Park is helpful, because it suggests the approach which is required in the present instance.  The agreement in Boat Park provided for the sale and purchase of land, including a term that the vendor would leave in on second mortgage an amount up to $500,000 provided the first and second mortgage indebtedness did not exceed 75% of “a registered valuer’s valuation of the property”.  The dispute between the parties centred on a valuation report obtained by the purchasers, which was founded on a hypothetical subdivision of the land.  The Court held that the valuation contemplated by the clause must be a proper valuation in the sense that it had been prepared by a valuer in accordance with basic  valuation  principles  and  methods.    Reference  was  made  to  the  seminal valuation text (Jefferies - Urban Valuation in New Zealand 12 ed 1991) in order to elucidate those principles and methods.   Value was to be assessed on the basis of market  value  from  a  willing  seller/willing  buyer  standpoint.    In  the  event  the valuation based on a hypothetical subdivision analysis was rejected, not because that methodology  was  inappropriate  in  the  particular  context  (as  the  Judge  at  first instance had held), but because the valuation did not reflect current market value (the land not being ripe for subdivision).

[25]     Unlike Boat Park, the present case does not impress me as one where it is self-evident that the formula contained in clause 13.2 is intended to reflect an established methodology for the valuation of the shares in a small business.  Indeed, this was the thrust of Mr Mundy-Smith’s argument in opposition to this ground of appeal.  In his written submission he contended that:

… clause 13.2 is not concerned with a valuation of the business at all.  Its design and structure are indicative of [a] clause designed purely for the purpose of punishment.

The gist of the argument was that, if the managing shareholders failed to meet the performance criteria, Field Group could buy them out at a figure representing the lower of three options.   The options were the incoming price paid by the 49% shareholders, 75% of net turnover or 4 x EBIT.   The argument continued that the price identified in terms of the formula was not likely to be fair, or a reflection of market value (it was too simplistic to achieve that), but the formula was perfectly clear and there was no call to read into it a further factor.

[26]     At the heart of Ms St John’s argument was the fundamental proposition that clause 13.2 must be read in the context of the agreement as a whole.  Counsel began with clause 5 which, under the heading Capital And Funding, provided that the agreed value of the Subway business was $500,000 plus stock and that, accordingly, Ms Walia and Ms Chouhan were required to pay a total of $245,000 for their 49% share interest, being $49 for the shares and the balance by way of an advance to Subway Wanaka.  There was also a further proportionate payment for the stock taken over at purchase.

[27]     Next, counsel focused upon clause 11, which relevantly provided:

11.      VALUATION OF SHARES ON SALE

11.1Notwithstanding the  provisions in  clause  10  hereof,  and notwithstanding   anything   to   the   contrary   contained   in   the Constitution in the event of any Shareholder otherwise wishing to sell its shareholding in the Company, the value shall be assessed on the value of all ordinary shares in the Company and shall not recognise any lower value because of a minority shareholding.

11.2Subject to cls 13.2 and 17 such valuation of any shareholding or the business shall be undertaken based on total value at 75% of turnover or    four    times    the    net    profit    whichever    is    the    greater. (emphasis added)

Clause 17 is a force majeure provision which I need not quote, since it does not directly assist in relation to the present issue.

[28]     Finally,  counsel  drew  attention  to  Schedule  A  of  the  agreement  which recorded  the  initial  issue  of  100  shares  at  $1.00  each  and  noted  the  initial shareholders by name and amount.  The schedule continued:

It is specifically agreed that any further sums necessary to establish and conduct the business shall be contributed in the same proportions and that any repayments of such advances shall only be made on the same basis unless unanimously agreed otherwise.

[29]     Drawing on these various terms of the agreement, Ms St John submitted that they provided “internal evidence that the concept of proportionality was intended to apply  to  the  Agreement  generally,  and  to  valuation  issues  particularly”.     It necessarily followed, therefore, that the latter two options in clause 13.2 must necessarily be read as subject to a factor of .49.  Otherwise, the payment to Ms Walia and Ms Chouhan following their failure to achieve the defined performance criteria and an election by Field Group to buy them out, would reflect the market value of the entire shareholding, not a 49% share.

[30]     As can be seen, the lynch-pin of the argument is that clause 13.2 contains a mechanism by which shares in the company are to be valued in the event of a forced buy-out.  But, that is not how the clause is worded.  Unlike clause 11.2 the reference in clause 13.2 is not to “valuation” or “value” but to “price”.

[31]     Two further aspects of the agreement are significant.  First, unlike clause 11.2 where the extent of the shareholding to be valued could vary (depending on which of three shareholders is selling out), the shareholding at issue under clause 13.2 is fixed. The clause is self-contained, and only provides for the acquisition of the 49% interest of Ms Walia and Ms Chouhan.   It follows there was no necessity to identify and bring to account the extent of the shareholding being purchased.

[32]     Second, the price based on EBIT is ultimately established by applying a multiple of 4.  That multiple is of pivotal importance.  It impacts greatly on the price established by application of the formula.   The clause is susceptible of the interpretation that the parties, in selecting a multiple of 4, thereby took into account the extent of the shareholding to be acquired.

[33]     In light of these factors I am unpersuaded that the EBIT formula is intended to effect a valuation method for valuing the shares in this small business.   To the contrary I regard the formula as simplistic and also consistent with the view that the parties chose their own formula with reference to establishing price in the buy-out situation, rather than seeking to import a conventional share valuation methodology. Had they done so, I accept, the appellant’s argument would have been a strong one.

[34]     For completeness, I record my agreement with the Arbitrator’s observation that the price arrived at by EBIT x 4, $167,816, does not seem to be an absurd result, given the incoming price of $245,000 paid about 13 months before the buy-out occurred.

[35]     Nor have  I overlooked the affidavits sworn by Mr Julian Field.   I have considered  them,  but  to  my  mind  they  contain  little  in  the  way  of  admissible evidence in relation to the interpretation point.   Much of the content comprises reference  to  the  negotiation  process  or  to  Mr  Field’s  subjective  intentions  and opinion as to the proper meaning of the pivotal clause.  The affidavit evidence does indicate that Mr Field was instrumental in constructing the terms of the shareholder agreement, with the help of his professional advisors.  There was subsequent input from Ms Walia’s and Ms Chouhan’s solicitor, but I think it remains the case that the agreement was largely framed by, or on behalf, of Mr Field.

[36]     For these reasons I am not persuaded that the Arbitrator erred in law in relation to the conclusion he reached concerning this ground of appeal.

Deductions from the buy-out figure

[37]     Field Group advanced three arguments in support of this aspect of the appeal. The  first  was  that  the  Arbitrator  erred  by  not  taking  into  account  uncontested evidence of a collateral contract by which Ms Walia and Ms Chouhan accepted liability for the relevant expenses which are the basis for the suggested deduction. Second, is an argument that the Arbitrator failed to take into account post-contractual conduct of the parties which evidenced that Ms Walia and Ms Chouhan were liable for the expenses claimed.   The third argument was based upon the constitution of

Subway Wanaka, by which shareholders who forfeit shares remain liable to the company for all money payable in respect of forfeited shares.

The Arbitrator’s decision

[38]     At paragraph 14 of his award the Arbitrator said this:

[Field Group’s] claim to recover expenses – Except for three specific instances dealt with separately below these are either expenses incurred by or for Subway Wanaka Limited or costs in this dispute.   [Field Group’s] claim against [Ms Walia and Ms Chouhan] for the expenses I find to be misconceived.  It has not proved that it has suffered any direct loss through Subway Wanaka Limited having incurred those expenses.   [Ms Walia and Ms  Chouhan’s]  failure  to  meet  the  agreed  management  criteria  entitled [Field Group] to repurchase the shares at a substantial discount.  Had [Field Group] sought to claim damages for breach of contract between it and [Field Group] it seems to me that on the information before me it would have had difficulty in proving loss after taking into account that it had elected to buy back the shares at a substantial discount.   It is conceivable that Subway Wanaka  Limited  has  a  claim against  [Ms  Walia  and  Ms  Chouhan]  but Subway Wanaka Limited is not a party to this arbitration and possibly could not be a party to an arbitration on the issue because of legal restrictions applicable to employee dispute resolution.   Any determination of liability would also require examination of the Board’s responsibility for the conduct of the business and affairs of  Subway Wanaka  Limited.   [Field  Group] cannot withhold payment because damages may be due to Subway Wanaka Limited.

I am far from persuaded from any of the material presented to me, that any such claim for damages would succeed.

The second reference to Field Group in the fifth sentence should, it seems to me, be a reference to Ms Walia and Ms Chouhan if this sentence is to make sense.

[39]     The Arbitrator then referred to the expenses which were undisputed, being an expense, interest arising from the late payment of that expense and an amount to cover a banking or accounting error; which sums totalled $9,960.02.  Otherwise, no deduction from the buy-out figure was allowed by Mr Lawrence.

Failure to bring to account a collateral contract

[40]     Mr Julian Field’s affidavit evidence included reference to a meeting said to have  occurred  after  notice  of  the  buy-out  was  given,  at  which  Ms  Walia  and Ms Chouhan, in company with their solicitor, agreed to meet the various amounts.  I

note that in introducing this topic Mr Field said that Field Group “for reasons of commercial pragmatism” sought to have the various expenses deducted from the share payment due to Ms Walia and Ms Chouhan.  There was no affidavit in reply to that of Mr Field.  Hence, Ms St John argued, clear evidence of a collateral agreement had been overlooked by the Arbitrator.

[41]     As I understand it it was in relation to this aspect that the Arbitrator doubted he had jurisdiction.  He interpreted the arbitration agreement as raising issues within the confines of the shareholder agreement itself, meaning that a claim based on a collateral agreement was beyond his jurisdiction.   I need not concern myself with that point.

[42]     I agree with  Mr  Mundy-Smith’s  submission  that  even  taking Mr  Field’s affidavit at face value, it does not establish the existence of a collateral agreement. Further, as counsel pointed out, if a binding agreement to pay the expenses had been reached and in the presence of solicitors, one would have expected the agreement to be documented.  It was not.  For these reasons I am satisfied that this argument must fail.

Failure to bring to account post-contractual conduct

[43]     The gist of this argument was that throughout the period prior to the buy-out Ms Walia and Ms Chouhan paid all costs associated with operating the business. This course of  conduct, it was submitted, was consistent with the  terms  of  the shareholders’ agreement.   Moreover, because Ms Walia and Ms Chouhan were entitled to the profits of the business, if any, it necessarily followed that they were personally liable for the operating expenses.   In ignoring this course of conduct Mr Lawrence had, it was said, fallen into legal error.

[44]     I disagree.  I adopt the analysis of the Arbitrator quoted above (see para [38]). Of course Ms Walia and Ms Chouhan paid the operating expenses during the currency of their management and operation of the business.  But that they did this (and in doing so may have employed a bank account which was styled in their personal names), does not indicate that they were, and remained, personally liable

for expenses of the Subway business.  Such expenses were met for and on behalf of

Subway Wanaka.

[45]     When Field Group exercised its power of buy-out it acquired a 100% interest in the business as a going concern, including current operating expenses which were outstanding at that point in time.   As I understand it, the expenses which are the subject of this claim are in the nature of normal operating expenses and what were described by Mr Julian Field as costs associated with the takeover.  In my view the former are liabilities of the business (or put another way, of Subway Wanaka), and the takeover expenses are liabilities of either that company or of Field Group itself.

[46]     With reference to the argument that because Ms Walia and Ms Chouhan were entitled to profits of the business, operating expenses were their personal liability, I again disagree.   They were employees of the business, which remained under the ultimate control of the directors of Subway Wanaka.  Had there been profits, these would have represented a return on their share interest.  I note that Field Group, in terms of the shareholder agreement, received a return on its shareholder advance to the company, being interest at 15% p.a. payable at monthly rests.   But these arrangements do not detract from the essential point, namely that operating expenses of the business were liabilities of Subway Wanaka.

Failure to take into account the company constitution

[47]     I can deal with this argument quite briefly.  Clause 3.6 of the constitution, the effect of which I have already quoted (para [28]), renders shareholders who forfeit shares liable to the company for all money payable in respect of the forfeited shares. Plainly, this clause concerns liabilities associated  with  the shares,  not  operating expenses or Field Group’s expenses incurred in relation to the buy-out.  Accordingly, I reject this argument as well.

Conclusion

[48]     The appeal is dismissed.  Costs are reserved.  My tentative view is that costs should follow the event and that a 2B award is justified.   However, if the parties

cannot resolve the issue in light of that indication, memoranda may be filed.

Solicitors:

Anderson Lloyd Caudwell, Dunedin for Appellant

Wills & Associates, Christchurch for Respondents