Hertli v Herzog HC Blenheim CIV-2009-406-106
[2011] NZHC 295
•6 April 2011
IN THE HIGH COURT OF NEW ZEALAND BLENHEIM REGISTRY
CIV-2009-406-106
IN THE MATTER OF an Application for Orders under Section
174 of the Companies Act 1993
BETWEEN BALZ HERTLI AND WERNER ROKITZKY
Plaintiffs
ANDHANS HERZOG AND THERESE HERZOG
First Defendants
ANDHERZOG WINE COLLECTION LIMITED
Second Defendant
Hearing: 6-8 December 2010 and 31 March 2011 (Heard at Wellington)
Counsel: Mr P Radich and Mr L Radich for plaintiffs (Mr J Upton QC for 31
March 2011 hearing)
Mr Q Davies and Mr P Gibson for defendants
Judgment: 6 April 2011
JUDGMENT OF MALLON J
Contents
Introduction ....................................................................................................................................... [1] The facts ............................................................................................................................................. [4] Alleged oppressive/unfairly prejudicial conduct .......................................................................... [19] Assessment of fair value.................................................................................................................. [21] The legal test ................................................................................................................................ [21] The experts and their valuations .................................................................................................. [26] Two sets of accounts ..................................................................................................................... [29] Difficulties with financial information.......................................................................................... [32] The asset values ............................................................................................................................ [34] The liabilities ................................................................................................................................ [39]
Mr Gemmell’s approach in more detail ........................................................................................ [40] Mr Davis’ approach in more detail............................................................................................... [78] Which methodology ...................................................................................................................... [94] Discount because shares are non-voting? .................................................................................. [113] Conclusion on fair value of shares ............................................................................................... [131] Application for leave to admit second set of accounts ................................................................ [133]
HERTLI v HERZOG HC BLE CIV-2009-406-106 6 April 2011
Result .............................................................................................................................................. [156]
Introduction
[1] This is a claim for relief under s 174 of the Companies Act 1993. The claim is brought by Mr Hertli and Mr Rokitzky (the plaintiffs). They are minority shareholders in Hertzog Wine Collection Limited (“the Company”) (the second defendant). Mr Herzog and Ms Herzog (the first defendants) are the directors and majority shareholders of the Company.
[2] The Herzogs concede that the affairs of the Company have been conducted with unfair prejudice to Mr Hertli and Mr Rokitzky. They accept that, as Mr Hertli and Mr Rokitzky seek, they should purchase the shares held by Mr Hertli and Mr Rokitzky for “fair value” as at 30 June 2007. The issue is to determine the fair value of the shares in the context of an order for relief under s 174.
[3] Prior to the hearing, with the parties‟ consent, I ordered that the parties‟ respective accounting experts meet to confer on the issue of fair value and to report to the Court. They did so and their joint report was submitted to the Court. It was envisaged that this process might assist the parties to reach a mutually agreeable settlement. That outcome was not achieved and so the issue of “fair value” for the shares falls to be determined by the Court.
The facts
[4] The Company grows grapes, makes and sells wine, provides accommodation and owns and operates a restaurant and a bistro.
[5] The Company‟s business was established by Mr and Mrs Herzog. In the
1980s and 1990s Mr and Mrs Herzog were winemakers and restaurateurs in Switzerland. In mid-1994, the Herzogs, on behalf of the Company which was yet to be formed, purchased an apple orchard, house and buildings at Rapaura (near Blenheim) with a view to establishing a vineyard on the property. The Company was incorporated on 13 September 1994. The Herzogs proceeded with establishing the vineyard, initially while still living in Switzerland and travelling from time to time to New Zealand.
[6] The Herzogs decided they needed further funds to develop the property. They received advice that the Company adopt a Constitution and that their shareholder advances be represented as 600,000 ordinary shares and that a further
200,000 shares be issued. The advice was that the 200,000 shares could be ordinary shares with no voting rights (but the shareholders could “participate equally in any dividend policy and would also be equal in value to the voting shares as far as a wind-up of the company is concerned”) or Specified Preference Shares. The advice favoured the first of these two options.
[7] Consistent with that advice, on about 12 December 1996 the Company adopted a new Constitution. That Constitution distinguished between Ordinary shares and Ordinary A shares. The Constitution provided that the Ordinary A shares were non-voting shares (specifically that the holder of them “shall have no voting rights on a poll at a meeting of the company on any resolution”). It also provided that Ordinary and Ordinary A shares ranked equally as to dividend and on distribution in a winding-up of the Company.
[8] In 1996 the Herzogs discussed the Company with potential investors in Switzerland. The potential investors included Mr Hertli, Mr Rokitzky and Mrs Ganz. All three were Swiss nationals. The discussions were with each of them individually (they did not know each other). The Herzogs proposed to each of them that they purchase 50,000 shares in the Company for $50,000. All three accepted the offer and each transferred the purchase money to the Company‟s Blenheim solicitors. The parties in this proceeding have different views as to what was discussed as to the nature of these shares (see below at [16] and [114]).
[9] On 19 May 1997 share certificates were issued for these shares. The heading on the certificates was “Share Certificate for ordinary A shares”. The certificates referred to the Issued Capital as being “600,000 Ordinary shares of $1 each” and “200,000 Ordinary „A‟ shares of $1 each”. The certificates were each for 50,000 shares. The certificates described the holder as being “the registered holder of
$50,000 fully paid Ordinary A shares of $1 each in Herzog Wine Collection Limited subject to the Constitution”. This was sent to Mr Hertli, Mr Rokitzky and Mrs Ganz
under cover of letter from the Company‟s accountant which stated “you are now the legal and beneficial owner of 50,000 ordinary „A‟ shares in the company”.
[10] The annual return dated 1 September 1997 referred to the two classes of shares. The financial accounts for the year ended 31 March 1997 (audited in September 1997) also referred to the two classes of shares. The resolution adopting these financial statements was signed by Mr Hertli and Mr Rokitzky in October and November 1997 respectively. However none of these documents set out the nature of the rights that attached to these shares (as set out in the Constitution).
[11] From the time Mr Hertli and Mr Rokitzky became shareholders, Mr and Mrs Herzog held the 600,000 ordinary shares and were the sole directors. Through their majority shareholding and their position as directors they had effective control of the Company. The minority shareholders became unhappy with their position in the Company. At least part of the reason for this was that the new shareholders considered they were not being kept informed about the Company.
[12] As a consequence there were discussions between the parties in 2004 and
2005 about selling their shareholdings. In 2005 Mrs Ganz sold her shares to Mr and Mrs Herzog but no agreement was reached in relation to Mr Rokitzky‟s and Mr Hertli‟s shares. Correspondence between the parties and/or their solicitors continued in 2006. This included a request, on behalf of Mr Rokitzky and Mr Hertli, for information under s 178 of the Companies Act. Mr Hertli and Mr Rokitzky considered the reply to this request to be inadequate. More generally they considered they were being improperly excluded from the Company‟s operations.
[13] On 12 May 2007 Mr Hertli and Mr Rokitzky issued a Transfer Notice to the Company in respect of their shares. The Transfer Notice offered the shares to Mr and Mrs Herzog at $3 a share. The Transfer Notice, if valid, triggered pre- emptive rights provisions in the Constitution. Mr and Mrs Herzog took the position that the Transfer Notice had not been validly served. They did not accept the offer but did make a counter-offer to buy the shares at $1.40 a share. Subsequent correspondence ensued between the parties without resolution on whether the
Transfer Notice was valid and therefore had triggered the pre-emptive rights provisions.
[14] In October 2007 Mr and Mrs Herzog issued High Court proceedings against Mr Rokitzky and Mr Hertli. The proceedings alleged that Mr Hertli and Mr Rokitzky were not beneficial shareholders in the Company, but rather each held the shares as security for an interest free loan of $50,000 given in 1996. The proceedings sought a mandatory injunction ordering Mr Hertli and Mr Rokitzky to transfer their shares to the Herzogs for $50,000 (plus an allowance for some wine) and an injunction preventing the Company from registering any transfer of Mr Hertli‟s and Mr Rokitzky‟s shares to any third party.
[15] The proceedings were heard in the High Court (Gendall J) in early March
2009. The judgment was delivered later that month.1 The Court declined the relief sought by the Herzogs and awarded costs in favour of Mr Hertli and Mr Rokitzky. The Judge held that the advances of $50,000 were investments in the equity share capital of the Company, rather than loans. He reached that view “by a very wide margin”2 commenting that Mrs Herzog‟s evidence, though she genuinely believed it to be accurate, was “clouded by imperfect recollection”.3
[16] As to the nature of the shares, the Judge commented:4
The defendants were not told in that letter that the “A” shares had no voting rights, and their evidence was that they never knew of this until the proceedings were issued. They believed they were misled. Mrs Herzog said she told them of the limitation. Resolving the conflict is not necessary, because the case is not about voting rights.
[17] As to the Transfer Notice, the Judge viewed that as a valid notice under the pre-emptive rights provisions in the Constitution.5 However it was not necessary to order any relief on this aspect of the case. This was because the Company had
declined to act on the Transfer Notice and there was no likelihood of the Company
1 Herzog v Hertli HC Blenheim CIV 2007-406-000251, 23 March 2009.
2 At [106].
3 At [55].
4 At [84].
5 At [115].
doing otherwise (when Mr and Mrs Herzog were the sole directors of the Company and the Company would only act through them).6
[18] On 1 May 2009 Mr Hertli and Mr Rokitzky filed this proceeding seeking relief under s 174 of the Companies Act.
Alleged oppressive/unfairly prejudicial conduct
[19] Mr Hertli and Mr Rokitzky allege that the oppressive or unfairly prejudicial conduct was as follows:
(a) in relation to the High Court proceeding referred to above: refusing to acknowledge the Transfer Notice as valid, issuing the proceeding, and seeking to exclude relevant information from the High Court proceeding;
(b)providing misleading or inadequate information: misrepresenting the financial state of the Company in 2004 and 2006, advising in 2006 that annual general meetings had occurred when they had not, inadequate responses to information requests in 2006 and 2009,7 failing to have a proper Interests Register and any Share Register;
(c) failing to include Mr Hertli and Mr Rokitzky in the operation of the Company: allowing the Company‟s accountant and lawyer to not acting neutrally as between the majority and minority shareholders, failing to hold annual meetings prior to March 2009 and failing to allow Mr Hertli and Mr Rokitzky to participate in annual meetings,8 selling assets to the Company without appropriate independence or consultation, and treating the Company as though it was the Herzogs‟
sole property;
6 At [118].
7 A date subsequent to the date at which fair value is to be determined.
8 The particulars refer only to requests made in relation to the 2009 meeting (a date subsequent to the date at which fair value is to be determined).
(d)nature of the shares: being treated as non voting shareholders when they ought to have been treated as voting shareholders.
[20] The Herzogs formally deny these allegations. They have not, however, filed affidavit evidence in response to the allegations. Without itemising which particular items of alleged oppression or unfair prejudice are or are not accepted, they accept that there has been unfair prejudice (in terms of s 174) and that the appropriate remedy is for them to buy the plaintiffs‟ shares at fair value. They are agreed with Mr Hertli and Mr Rokitzky that this should be determined as at 30 June 2007 (this date being related to the Transfer Notice that was disputed by the Herzogs and which led to the High Court proceeding).
Assessment of fair value
The legal test
[21] The Court has power to grant relief under s 174 where it considers it “just and equitable to do so”. Relief can take the form of requiring a person to acquire the applicant‟s shares.9 The Companies Act does not specify how the price for the shares is to be determined. However the established test is that the Court determine a “fair” price for the shares in all the circumstances of the case.10 Generally speaking a fair price is the market value of the shares at the relevant date. That is because it is not the purpose of s 174 to put a shareholder in a better position than they would have been in the absence of the oppression or unfair prejudice. An exception to valuing the shares at their market value is where the oppression or unfair prejudice has depressed the value.11
[22] As was said in Holt v Holt:12
If there is no established market, such as a stock exchange on which the shares in question can be brought, and liquidation at the instance of the
9 Section 174(2) of the Companies Act.
10 M Yovich & Sons Ltd v Yovich (2001) 9 NZCLC 262,490 at [35].
11 Thomas v H W Thomas Ltd [1984] 1 NZLR 686 at 697 per Somers J; Vujnovich v Vujnovich
[1988] 2 NZLR 129 at 148 (per Henry J in the High Court).
12 Holt v Holt [1987] 1 NZLR 85 at 89-90 (CA).
holder of the shares or a purchaser is not a serious possibility, then as North J put it [in the Hatrick case] “... the court must ascertain as best it can what a man desiring to buy the shares would have had to pay for them on the day to a vendor willing to sell them at a fair price, but not desiring to sell”.
Money value is simply what is obtainable in an actual or notional market. In some cases, such as shares quoted on the stock exchange, it is easily ascertained. At the other extreme are cases where the valuer can do little more than identify the factors likely to influence the parties in bargaining for a fair price in a friendly negotiation, and then arrive at a discretionary judgment.
[23] In considering the price that would be agreed as between a willing but not anxious buyer and a willing but not anxious seller, valuation methods are an “aid to ascertain the market value”.13 However it remains for the Court to determine what
sum would be paid in the hypothetical negotiation.14
[24] In some circumstances the criteria of fairness can override general principles of valuation, reflecting that the fixing of the price occurs in the context of an ordered buy-out under s 174.15 An example of this is that the Courts generally do not discount the value of the shares because it is a minority shareholding that is being acquired16 even though such a discount would likely be applied in a hypothetical negotiation between the seller and a third party buyer.
[25] The starting point is therefore the market value of the shares as to which the expert evidence as to value assists. It is then necessary to consider whether, in fairness in the circumstances of the case, there should be any adjustment to the market value in a willing buyer/willing seller negotiation because there is an ordered buy-out in the s 174 context. Any such adjustment must be considered in light of the
unfair prejudice which is the basis for the relief.17
13 Hatrick v Commissioner of Inland Revenue [1963] NZLR 641 (CA) at 661; Multiply Ltd v Old
Mill Farm Ltd (1995) 7 NZCLC 260,746 (HC) at 260,765.
14 Hatrick at 660; Multiply at 260,770.
15 M Yovich & Sons Limited v Yovich at [57].
16 M Yovich & Sons Limited v Yovich at [55].
17 M Yovich & Sons Limited v Yovich at [29].
The experts and their valuations
[26] The evidence in this case as to value came from two accounting experts: Mr Davis for the plaintiffs and Mr Gemmell for the Herzogs. Mr Gemmell has experience in relation to vineyards and wineries in the Marlborough and Canterbury region. Mr Davis does not, but he has valued many other primary industry assets as well as restaurants and bistros and, as he commented, he relied on the Hadley & Lyall valuation (discussed below) and the general principles of valuation apply across all businesses and industries.
[27] The valuation is of the shares in the Company, but the experts were agreed that this should be done on a net assets approach. They disagreed whether net assets should be valued on the basis of an orderly realisation of assets (Mr Gemmell‟s approach) or on a going concern basis (Mr Davis‟ approach). Regardless of the methodology to be applied, they also disagreed on whether there should be an “incentive to purchaser” discount and any discount because the shares are non-voting shares.
[28] The difference in their approaches leads to a significantly different value per share. Mr Gemmell‟s assessment results in a value of $2.64 per Ordinary A share. Mr Davis‟ assessment results in a value of $6.38 per Ordinary A share. They were working off different sets of the Company‟s accounts for the 30 June 2007 year but this does not account for the majority of the difference between them.
Two sets of accounts
[29] Both the experts worked off the Company‟s financial statements in assessing fair value. There are two sets of financial statements for the Company for the 2007 financial year. One set was the financial statements included in the Common Bundle for the earlier High Court proceeding referred to above (at [14]). Those statements are dated 22 November 2007. The second set of accounts are dated 19 December
2007. The second set of accounts were the accounts filed with Inland Revenue.
[30] The second set of accounts reported a worse financial position for the Company than the first set of accounts. That is because they made two adjustments from the first set of accounts. One adjustment was a reduction in the carrying value of stock by over $400,000. The explanation provided for this is mentioned in the joint report which the experts prepared for the Court but, at the time of the substantive hearing in December 2010, was not the subject of sworn evidence. The other was the inclusion of shareholders‟ salaries of $188,000 taken (which in turn adjusted Mr and Mrs Herzog‟s shareholder current account by this amount). The resolution for the shareholders‟ salaries is included in the evidence before this Court.
[31] The second set of accounts are the subject of a leave application which I discuss below - [133] to [154]). My order is that the second set of accounts are admitted as evidence. That is not say, however, that the level of stock in the second set of accounts was an accurate reflection of its value. I consider the admissibility of the accounts and the accuracy of the figures in those accounts to be separate questions.
Difficulties with financial information
[32] Apart from there being two sets of accounts, more generally Mr Davis had concerns about the reliability of the financial accounts. One of Mr Davis‟ concerns was that the Herzogs incurred personal expenditure which was charged as company expenditure. He also had concerns about the value at which capital introduced by the Herzogs has been determined. Mr Davis (and his firm) sought further information to address these concerns. He considered that the response on behalf of the Herzogs was inadequate and that much of what was provided was too late to be considered for the purposes of the hearing. The Herzogs did not accept this. Their position was that requests for information could have been made earlier and the information would have been provided had they been given sufficient time. They also considered that the issues Mr Davis raised were not material.
[33] It is not necessary for me to get into the detail of this. Mr Gemmell proceeded on the assumption that the financial statements were reliable noting that his role did not extend to verifying the accuracy of that information. Mr Hertli and
Mr Rokitzky also decided to proceed on the basis of the first set of financial accounts despite the concerns raised by their expert. In these circumstances I too proceed on the basis of the financial statements, but noting that Mr Hertli and Mr Rokitzky do not accept the stock adjustment made in the second set of 30 June 2007 accounts and that there is only limited information before the Court about that stock adjustment.
The asset values
[34] The Company‟s assets are made up of two properties (Jeffries Road and Kowhai Drive), plant and equipment, working capital, investments and intangibles. The properties were valued as at 30 June 2007 by Hadley & Lyall in a valuation dated 20 October 2010. Both experts adopted the Hadley & Lyall values in their respective methodologies. For the other items both experts started with the values as stated in the 30 June 2007 financial statements.
[35] As to the properties, Hadley & Lyall‟s valuation for Jeffries Road was
$4,530,000 (compared with a 30 June 2007 value in the accounts of $3,232,000). Their valuation for Kowhai Drive was $307,000 (compared with a value in the accounts of $213,000).
[36] The plant and equipment is made up of vineyard plant and equipment, motor vehicles, office furniture and equipment, winery plant and equipment, restaurant plant and furniture. Both experts started with a value for the plant and equipment of
$454,000. This was the book value of the plant and equipment in the 30 June 2007 accounts (both sets) once the items in the Hadley and Lyall valuations are excluded.
[37] The working capital figures in the two sets of accounts are different. Mr Gemmell used the figure of $1,633,000 which was the amount recorded in the second set of accounts. Mr Davis used the figure of $2,077,000 which was the amount recorded in the first set of accounts. Mr Davis also carried out a separate calculation using the working capital figure from the second set of accounts. The difference between the two sets of accounts is the stock write down. Primarily the stock is wine (bottled, in tanks or in barrels). Mrs Herzog‟s explanation (as recorded in an appendix to the experts‟ joint report to the Court) was that the stock was written
down because it did not reflect market prices. She also referred to the difficulties in selling a particular Bordeaux blend. This explanation was not confirmed by any evidence from the Herzogs or the Company‟s accountant at the substantive hearing.
[38] Investments (being shares in a local co-operative) were valued in the 30 June
2007 accounts at $2000 and intangibles (protecting a trade mark in the United States) were valued in the 30 June 2007 accounts at $24,000. These amounts were applied in each expert‟s methodology.
The liabilities
[39] The Company‟s liabilities as at 30 June 2007 were made up of shareholder advances, shareholders‟ loans and bank loans. The shareholders‟ loans and bank loans were recorded in the accounts (both sets) as $496,000 and $66,000 respectively. There is a difference in the two sets of accounts for the shareholder advances because the Herzogs resolved to pay themselves salaries which was credited as capital introduced. Mr Davis used the sum recorded in the first set of accounts ($2,044,000). He completed a separate calculation with the sum recorded in the second set of accounts ($2,232,000). Mr Gemmell used the sum from the second set of accounts.
Mr Gemmell’s approach in more detail
(a) Methodology
[40] Mr Gemmell prepared a report providing the detail of his approach to the valuation of the shares. In that report he set out the various available valuation methodologies. Under the “net asset value” approach he listed the three options of “going concern”, “orderly realisation” and “notional liquidation or fire sale”. He used the orderly realisation approach. He considered that the Company was not making a sufficient return on its asset base to use a going concern approach. He considered a notional liquidation or fire sale to be inappropriate as the business was not distressed.
[41] He said that the orderly realisation approach assumes that the assets will be realised (either individually or as a group) in such a way as to maximise the proceeds. He took the market value of the assets under an orderly realisation process less the market value of the liabilities under an orderly realisation process. He deducted the estimated cost of undertaking the orderly realisation process. The costs included real estate and other commissions, and legal, accounting and other professional fees. These costs included liquidator‟s administration costs. Mr Gemmell also deducted an “incentive to purchaser” amount. He also discounted the value of the shares to reflect that the shares to be sold were non-voting shares.
[42] I start by considering Mr Gemmell‟s realisable values for the assets and liabilities on an assumed orderly realisation identifying where Mr Davis has a different view if this approach were to be applied.
(b) Land and Buildings
[43] Mr Gemmell applied a 3% discount to the Hadley & Lyall valuations for Jeffries Road and Kowhai Drive (being the assumed agent‟s commission on their sale in an orderly realisation). He also took into account that if the land were sold there would be tax payable on depreciation recovered. This left a net realisable value for the properties of $4,294,000 and $288,000 respectively. If the orderly realisation approach were to be taken, Mr Davis had no issue with the 3% discount applied to the land valuations or the amounts allowed for the liability on depreciation recovery.
(c) Plant and equipment
[44] The book value of the plant and equipment (as per both sets of 30 June 2007 accounts) is $454,000. Mr Gemmell grouped the items of plant and equipment into categories applied varying percentage realisations to each category. The percentage was for the estimated discount to sell the asset (incorporating the cost of sale and the amount that would be paid for the asset). He took a realisable value for vineyard plant and equipment of 50% (some at 25% and the rest at 80%), for motor vehicles
of 95%, for winery plant and equipment of 40% (some at 0% and the rest at 50%), for restaurant plant of 35%, and furniture of 29% and 32%. He derived an overall net realisable value for the plant and equipment of $248,000.
[45] The 95% discount on the vehicles was viewed by Mr Davis as reasonable. In relation to the 35% realisation applied to restaurant plant, Mr Davis said that this “seems quite a low percentage to me”, especially given his understanding that the Herzogs had said that a large portion of those assets were assets from their Switzerland operations and that they had been brought on to the register at well below market value. Mr Davis also considered that the discounts Mr Gemmell applied to vineyard plant and equipment, winery plant and equipment and office furniture and equipment to be “relatively low” or “low”. Without having had an opportunity to look at the particular assets Mr Davis could not be categorical about this.
[46] Mr Gemmell did not accept Mr Davis‟ critique of the discounts he had applied. He said that he relied on information as to realisation of assets in the hospitality industry over the last five years. He noted that he and those assisting him in valuing the assets had a better view of the assets. He said that they looked through most of the assets line by line and then applied a percentage to each class of assets. When cross-examined as to a particular item in the assets schedule he said that within a class of assets there might be “overs and unders”.
[47] Mr Hayward is a Blenheim valuer with specialist expertise in valuing wine industry assets including the plant and equipment used in vineyard and winery operations. He prepared an affidavit for Mr Hertli and Mr Rokitzky in which he assessed “likely in situ values to the plant and equipment employed in the going concern” enterprise of the Company. He worked off the 30 June 2006 plant and equipment schedule because he understood that a schedule as at 30 June 2007 had not been made available to Mr Rokitzky and Mr Hertli. His view was that the realisable value of the plant and equipment was likely to lie closer to their book value than Mr Gemmell‟s value of $248,000 as at 30 June 2007.
[48] The Herzogs consider that Mr Haywood‟s evidence is not helpful because he worked off the 2006 asset list. I do not think this point is of any significance as the Herzogs did not point to any material differences between the 2006 and 2007 schedules of assets. The Herzogs also say that Mr Haywood‟s evidence is not helpful because it was concerned with a going concern value, he had not inspected the plant and equipment and it proffered only a general opinion. I consider that Mr Haywood‟s opinion is useful. It is evidence from someone with particular expertise in this type of plant and equipment. It provides some comfort that the book values were about right in terms of their realisable market value. That said, even if the assets were to be sold as a part of a going concern, Mr Haywood was not able to say that the full book value would be achieved. If the assets were sold individually or in groups under an orderly realisation, lesser values would likely be achieved (as Mr Gemmell‟s methodology indicates).
[49] Overall it is apparent that the discounts Mr Gemmell applied in relation to the plant and equipment are quite arbitrary, albeit they are based on his experience. On the other hand, Mr Davis‟ critique was really only to the effect that they seemed like “low” net realisable values. Mr Davis prepared his own schedule using Mr Gemmell‟s methodology where he attributed no discount to the plant and equipment from the book values. That seems unrealistic, especially given that even on Mr Davis‟ going concern methodology counsel for Mr Hertli and Mr Rokitzky accept that there would be costs (see below at [85]). Whether the plant and equipment were to be sold collectively with other assets as a going concern, or in classes or individually, it seems likely that there would be a commission (or similar) payable on their sale and achieving full book value seems optimistic. However Mr Gemmell‟s net realisable values may err on the conservative side especially as it was common ground that in 2007 the Marlborough wine industry was still booming.
[50] Although somewhat arbitrary, but to allow for a less conservative approach, Mr Gemmell‟s percentages could be increased by say 10% (with the exception of the motor vehicles which is at 95% and accepted). If that were done the overall net realisation value of the plant and equipment would be $280,375.
(d) Working capital
[51] The working capital (stock of $795,000, cash of $790,000, accounts payable of $71,000 and accounts receivable of $119,000) had a book value (as per the second set of 30 June 2007 accounts) of $1,633,000. Mr Gemmell gave this a realisable value of $1,396,000.
[52] In Mr Gemmell‟s calculation stock was assumed to be realised at 75% of book value. Mr Davis understood that Mrs Herzog had referred at some stage to relatively high mark ups on wine and that therefore “intuitively” it did not seem right that in an orderly realisation occurring over a period of months that the wine would be sold below cost.
[53] Putting to one side the write down of the stock as recorded in the second set of accounts, with the limited evidence I have on this topic my assessment is that in an orderly realisation the liquidator would be doing very well if all stock was sold at full book value. The bottled wine might be more likely to be sold at or above book value, but the wine in barrels and tanks might be less likely to. A purchaser would presumably incur costs in completing the wine making process, and bottling and selling it, and this would have uncertainties and risks around it. I do not have any more detail about the breakdown of the stock or how the wine in barrels and tanks might be sold. On the information I have I am not persuaded that Mr Gemmell‟s
75% realisation rate is inappropriate.
[54] The question then is whether the write down of the stock, that did in fact occur in the 30 June 2007 accounts as filed with Inland Revenue, is relevant. A hypothetical purchaser considering what to pay for the shares, might make enquiries about the value of the stock. If the negotiations were taking place on or about
30 June 2007 the stock write down would not yet have occurred. It is, however, conceivable that, on enquiry of the Company, the hypothetical purchaser would be informed of an intended write down of the stock. The vendors of the shares (Mr Hertli and Mr Rokitzky or a hypothetical vendor) would not necessarily have accepted the validity of the write down in negotiations with the purchaser. I say that because there is no reliable evidence before me to support its validity. The stock
write down occurred at a time when the Herzogs knew that Mr Hertli and Mr Rokitzky wanted to sell their shares and the Herzogs had issued proceedings claiming that they were not shareholders. In the hypothetical negotiation there may have been a downward adjustment of the stock but, on the information before me, I do not think it can be assumed that it would have been adjusted down to the level in the second set of accounts
[55] I consider that the negotiated realisable fair value of the stock is likely to have been less than 75% of the stock as valued in the first set of accounts. I say that because of the prospect of some downward negotiation in view of the intended stock write down. I also consider that the negotiated realisable fair value of the stock is likely to be more than 75% of the stock as valued in the second set of accounts. That is because, if the write down was accurate then its realisable value is more likely to have been closer to 100% of that book value (on the basis that there is less risk that the book value is too optimistic). I therefore consider that the negotiated fair value of the stock is likely to have been somewhere between 75% of the stock as valued in the first set of accounts and 100% of the stock as valued in the second set of accounts.
[56] As to accounts payable, Mr Gemmell assumed they would be realised at
120% of book value, on the basis that there would be an interest cost incurred on the debt during the period of time taken to sell the business. Mr Davis commented that the interest component assumes that the accounts would not be paid immediately. He said that this was wrong for two reasons. First there was nothing that he had seen which showed that the Company‟s terms of trade with its creditors involved interest charges for delayed payment. Secondly there was $790,000 of cash in the bank. The accounts payable would be cleared with this cash. Mr Gemmell responded by saying that a significant amount of cash would be required to ensure an orderly realisation: because the assets would need to be kept in good working order and because it would be good business practice to continue to operate the assets in the meantime. However, given the small level of accounts payable as against the available cash, I accept Mr Davis‟ evidence that they would be cleared with the available cash without incurring interest. I would therefore take realisable value of the accounts payable to be 100%.
[57] In Mr Gemmell‟s calculation accounts receivable are assumed to be realised at 80% of book value. Mr Davis commented that the it would be surprising if they were realised at only 80% of book value when the company had a very low experience of bad debts (less than $15,000 in it entire operation). Mr Gemmell said that it was not correct that the Company had not had any bad debts. He also said that once a company is in the process of realising its assets, people take the opportunity to advantage themselves and that as a result there is an increase in the occurrence of bad debt. I accept that this can occur, but it is not known whether that would occur in an orderly realisation of the Company‟s assets and, if it did, to what extent. All I know about the Company‟s experience of bad debts is that the experts have different views about this. Because the accounts receivable are relatively small and I have no specific information about them I proceed on the basis that they will be realised at
100% of their book value.
[58] Overall on an orderly realisation I consider that the realisable value of the working capital would be somewhere between $1,633,000 (i.e. 100% of the amount in the second set of accounts) and $1,767,250 (i.e. 75% of the stock as per the first set of accounts and 100% for the other items). A middle figure would be $1,700,000.
(e) Investment and Intangibles
[59] Mr Gemmell attributed a nil value to intangibles shown in the accounts of
$24,000 (which relates to expenditure on the development of a trademark in the United States). Mr Davis agreed with this on an orderly realisation valuation approach.
(f) Shareholder advances, shareholders loan and bank loan
[60] Mr Gemmell applied 108% to each of these liabilities to determine their realisable values. This is because he assumed a 10% interest charge for a nine month period for the assumed time between deciding to wind down the business and paying these liabilities. Taking the shareholder advances figure of $2,232,000 as per the second set of 30 June 2007 accounts this resulted in a realisable liability for
shareholder advances of $2,400,000. The same approach was taken with a shareholders‟ loan of $496,000 to arrive at a realisable liability of $535,000. Likewise with a bank loan of $66,000 to arrive at a realisable liability on the loan of
$71,000.
[61] Mr Davis considered that no deduction for interest should be included. He noted that the cash in the bank would repay the shareholders‟ loan and the bank loan (as well as the accounts payable discussed above). He also said that many of the assets would be sold within a matter of weeks and that there would be cash derived from this to repay debt.
[62] It seems to me that the $790,000 would cover the shareholders‟ loan, the bank loan and the accounts payable while still leaving a significant sum to run the assets pending their sale. As well there would presumably be cash coming in from the accounts receivable and from sales while the Company continued to operate. Therefore I consider that under Mr Gemmell‟s orderly realisation approach, the realisable liability of the shareholders‟ loan would be $496,000 and the realisable liability of the bank loan would be $66,000 (rather than the $535,000 and $71,000 which Mr Gemmell calculated).
[63] Mr Davis queried whether interest would be charged on the shareholder advances by the vendor of the shares to the person who was acquiring the minority shares. Mr Davis did not object to an interest charge on the shareholder advances per se, but was querying whether that was an appropriate charge in a s 174 claim. At this stage I am considering a hypothetical market value in a transaction between a willing buyer and willing seller under Mr Gemmell‟s methodology (see above at [21]
– [25] and below at [105] – [108]) and so interest is relevant.
[64] Mr Davis prepared his own calculation using the orderly realisation methodology. He applied 10% interest for one month to the shareholder advances to give a realisable liability of $2,249,000 (using the $2,232,000 from the second set of accounts)18 (which compares with Mr Gemmell‟s sum of $2,400,000). Mr Davis did
not work out the realisable liability of the shareholder advances using the first set of accounts. If he had, the sum would have been a little lower because of the $188,000 capital introduced.
[65] Which of these figures (ie as between Mr Gemmell or Mr Davis) better represents the realisable liability of the shareholder advances depends on the assumptions about period to sell. Counsel for the Herzogs put to Mr Davis that there might be difficulty in selling the business given that it was a relatively small operation (11 hectares), and had 22 grape varieties (which was a large number for the size of the property) and some of the grape varieties were very uncommon in the New Zealand context. That there are features of the business that might make it
unattractive to buyers is referred to in the Hadley & Lyall valuation.19
[66] Counsel for the Herzogs also put to Mr Davis that one month to sell the business would be unrealistic given that you would need a purchaser interested in this specific combination of assets (vineyard, winery, accommodation, restaurant and bistro) and there would presumably need to be time to put in place a marketing strategy and for due diligence, and possibly too for Overseas Investment approval. Mr Gemmell said that the majority of investment in Marlborough is from overseas. Mr Gemmell said that in his experience, even with a business which is easy to sell in a buoyant market, it could still take 6 months to sell from the beginning of the process. Here the business was different and was likely to attract less potential buyers and more time was likely to be needed. Mr Davis‟ response was that the one month he allowed, if too short, impacted on his incentive to purchaser calculation (discussed below) and his implied interest component and that the overall impact of allowing a further time period would not be particularly high.
[67] My view, in light of this evidence, is that the one month assumption is optimistic (for the reasons put to Mr Davis) and the 9 month period is conservative (because of the buoyant market at that time). Therefore the realisable liability of the shareholder advances under this methodology should be taken to be something in between Mr Davis‟ calculation and Mr Gemmell‟s calculation. A midpoint would be
$2,324,500. Taking this sum with the shareholders loan of $496,000 and the bank loan of $66,000 would give a total net realisable value for these items of $2,886,500.
(g) Total net realisable value before other deductions
[68] Mr Gemmell‟s calculations gave a total net realisable value for the assets (realisable value of assets less realisable value of liabilities) of $3,222,000. This figure is too low given that the realisable value of the plant and equipment is probably conservative, the working capital realisable value would likely be higher and the realisable value of the shareholder advances, shareholder loans and bank loans would likely be lower than the figures Mr Gemmell used. Adjustments for these things in total are not, however, hugely significant. This is shown by Mr Davis‟ calculation using the orderly realisation methodology and the second set of accounts. He worked out a total net realisable value for the assets of $3,856,000. That figure, however, needs to be revised downwards because he applied a 100% realisation rate to the plant and equipment and he applied interest on the shareholder advances for only one month.
[69] On the basis of the adjustments I have adopted, the total net realisable value for the assets, before other deductions, would be $3,677,875.
(h) Incentive to purchaser
[70] From the total realisable asset value Mr Gemmell made three deductions. The first deduction was for “incentive to purchaser”. This discount is the purchaser‟s incentive to undertake the risk of an orderly realisation.20 That is to say that if a purchaser bought the shares to recover their net asset value in an orderly realisation there has to be an incentive to take this on. Mr Gemmell applied a 20% discount as the incentive to purchase. This resulted in a deduction of $645,000 from his total realisable asset value of $3,222,000. Mr Davis accepted that on this methodology an incentive to purchaser would be paid. He considered, however, that
Mr Gemmell‟s 20% discount for this was too high. In his calculation using the
orderly realisation methodology, Mr Davis applied a 5% discount.
[71] It is difficult for me to assess who is more likely to be correct about this. Given my views on other aspects of their evidence Mr Gemmell‟s discount may be too high and Mr Davis‟ too low. The market was buoyant. That would suggest some competition for the assets which in turn would be relevant to the discount that would be necessary to get the sale. Expert evidence from Mr Stark (discussed below)
supports this although I took his evidence as more directed to a going concern sale.21
Moreover, it was general evidence about the market rather than evidence about the specific combination of assets that made up the Company in this case. On the evidence before me I can do no better than to assume a discount of something in between the two figures from the experts. I would therefore apply a (mid-point)
12% discount to the total net realisable asset figure.
[72] On the total net realisable asset value that I have reached that would be a deduction of $441,345 which in turn would reduce the net realisable asset value to
$3,236,530.
(i) Liquidator costs
[73] Mr Gemmell‟s next deduction was for liquidators‟ administration costs of
$100,000. This was deducted from the total asset realisable value less the incentive to purchaser to arrive at a net realisable value of $2,477,000.
[74] Mr Davis accepted that if Mr Gemmell‟s methodology was to be used, a deduction for liquidators‟ administration costs would be made. Mr Davis considered, however, that the amount for liquidators‟ costs was too high. His calculation using Mr Gemmell‟s methodology deducted $30,000 for this. He said that $100,000 was “a lot” of liquidators‟ hours. He said that this would be possible if
a liquidation were assumed to be carried out over a nine month period and at the sort
21 The other sales he refers to for 2006 and 2007 appear to be of other winery and vineyard operations as a whole rather than a sale of winery and vineyard assets in an orderly realisation or liquidation.
of charge out rates charged by the firms that Mr Davis and Mr Gemmell are from. However his view was that nine months was unrealistically long in the middle of
2007 when the assets would probably have sold relatively speedily.
[75] Mr Gemmell did not agree that the liquidators‟ costs were too high. He said that the nature of the assets involved complexity and that $30,000 to $50,000 would not go very far in this day and age.
[76] As discussed above, the 9 month period assumed for the orderly realisation may be on the long side in the market at that time. On the basis of a shorter time period and potentially lower charge out rates I would allow $60,000 for liquidators‟ costs. This would give a net realisable value of $3,176,530 (compared with Mr Gemmell‟s $2,477,000). Across the 750,000 total number of shares this would equate to $4.24 per share. This compares with Mr Gemmell‟s figure of $3.30 per share (before the non-voting discount – discussed below). It compares with Mr Davis‟ calculations of $4.86 per share using the orderly realisation method and the second set of accounts. It compares with Mr Davis‟ calculation using the orderly realisation methodology of $5.40 per share and the first set of accounts (although this is approximate as Mr Davis did not adjust the shareholder advances when doing this calculation).
(j) Discount for non-voting shares
[77] Mr Gemmell‟s valuation discounted the net realisable value by 20% because the Ordinary A shares are non-voting. Counsel for Mr Hertli and Mr Rokitzky submit that this discount is inappropriate. Whether this discount should be applied is not dependent on which valuation methodology is adopted. I will therefore come back to whether such a discount is appropriate (see below at [113] to [130]).
Mr Davis’ approach in more detail
[78] Mr Davis‟ going concern basis assumes that the business continues to operate. The price paid for the shares is assumed to be the value of the assets less
liabilities as stated in the 30 June 2007 accounts, except that the Hadley & Lyall valuation for the land and buildings is used rather than the value stated in the accounts. Mr Davis made no deductions for the cost of realisation of the assets nor for any liability for tax depreciation recovered on the sale of the lands and buildings (which is taken into account under Mr Gemmell‟s methodology). There were also no deductions for incentive to purchaser, liquidation costs or because the shares are non- voting.
[79] Using this approach Mr Davis calculated a value per share of $6.38 (ie
$638,000 for the plaintiffs‟ 100,000 shares) using the first set of June 2007. Using the second set of accounts he calculated the value as being (slightly less than) $5.61 per share (because it was agreed that, in calculating the $5.61, the book value of the plant and equipment has been overstated by around $53,000).
[80] Mr Gemmell‟s view was that a purchaser would be “paying far too much” for the shares on the basis of Mr Davis‟ approach. He said that looking at it from the other way he would consider it “a wonderful outcome” if he were advising the Herzogs to sell their shares, if they received an offer at Mr Davis‟ $6.38 per share and that this would be “way in excess” of his expectations for this business. Partly this was because Mr Gemmell considered that the going concern methodology was not appropriate. He said that, while he was familiar with a going concern valuation based on net assets “you very rarely see it applied in any circumstance”.
[81] Even if a going concern methodology were to be applied, Mr Gemmell considered that Mr Davis‟ valuation was inflated. This was partly because Mr Davis had assumed that the plant and equipment would be purchased as a going concern at their full book value. Mr Gemmell said that you would ordinarily advise a purchaser to pay no more than the price at which you could ordinarily buy these assets. He would therefore look at the value of each individual asset or class of asset. He gave the example of a painting that hangs on the wall in the restaurant. He said that its value on a going concern basis was its realisation value.
[82] I agree that Mr Davis has overstated the total value of the assets by taking the
full book value of the plant and equipment. Even the plaintiffs‟ expert,
Mr Haywood, did not go so far as to say that the full book value would be paid. He said only that the market value was likely to be closer to the book value than the value Mr Gemmell calculated under the orderly realisation methodology.
[83] It seems likely that, even in a buoyant market, some negotiation would take place over the value of the plant and equipment. In such a negotiation the price at which those assets were available in the market would be relevant. However, it also seems to me that such a purchaser, buying a going concern, would place some value on buying the assets as a bundle and with the land and buildings that make up the Company‟s assets. That is, overall the market value of the assets as a going concern is likely to be higher than the market value of assets sold/purchased individually or by class under or orderly realisation of the assets.
[84] Similarly, in a hypothetical negotiation it could be expected that the purchaser would wish to satisfy themselves as to the accuracy of the book value of the working capital. A purchaser buying the shares as at 30 June 2007 might not have available to them either version of the 30 June 2007 accounts given that they were finalised in November and December 2007 respectively. In a willing buyer/willing seller scenario the purchaser may have made enquiries with the Company about the stock, the level of the accounts payable and the likely recoverability of the accounts receivable. The major item in the working capital is, however, the stock. As discussed above at [54] and [55] the purchaser may have negotiated a downward adjustment of the stock from that which ended up in the first set of June 2007 accounts.
[85] Further the methodology still assumes a hypothetical sale (with the assets being sold as a going concern) to which there would be transaction costs. This is accepted by counsel for Mr Hertli and Mr Rokitzky who suggested that 3% be applied across all the assets (3% being the assumed commission on a sale of the land and buildings).
[86] Assuming that the market value of the plant and equipment would be somewhere between the book value and their value on an orderly realisation, and in the absence of any more specific evidence on the point, 80% applied to the book
value of $454,000 seems reasonable. It seems likely that the negotiated value of the stock would have been less than that stated in the first set of accounts. To reflect some negotiation over working capital, and in the absence of any better evidence, I assume a value for working capital of $1,700,000 (being the amount I used under Mr Gemmell‟s methodology). This would give a total asset value of $4,193,200.22 I would then apply 3% across all the assets (for the cost of sale), to reach a net asset value of $4,067,404 (which compares with the $3,677,875 net asset value using the orderly realisation methodology).
[87] Mr Gemmell said that on a going concern basis he would still include an incentive to purchase discount to the net asset value. He said that a purchaser would need to enhance the earnings of the business in some way or discount the value of the assets to a point where the return is adequate for the risk being taken. He said that accepting that the Herzogs are “running the business at the level that they are capable of...the assets are overvalued in terms of making an adequate return”. He said that the incentive to purchase would get the asset value to the right level to make an adequate return. Mr Gemmell would therefore still apply his 20% incentive to purchaser.
[88] Mr Davis said that the Hadley & Lyall valuation was an expert view on what the land and buildings are worth. He considered that a purchaser would not necessarily be concerned about low income because, as is the case with dairy farming assets, “investors purchase ... with the belief that the capital value of the asset will continue to increase and that on sale there is a tax-free gain from that asset.” Mr Gemmell disagreed. He said that the dairy analogy was not appropriate because that industry has a single buyer and a commodity price set by world markets. This gave the investor greater certainty than with a vineyard and winery.
[89] Mr Davis‟ view that no incentive to purchaser would be paid was supported by an affidavit from Mr Stark. He is a Blenheim valuer who has worked in Marlborough since 1990. His valuation experience includes specialist viticulture
properties as well as the range of other uses to which Marlborough properties are
22 In calculating this I have used shareholder advances as per the second set of accounts because there is a resolution to support the salaries that were taken.
put. His evidence was that in 2007 in Marlborough the real estate market generally, and viticulture assets particularly, were at or near their peak. His evidence was that the demand for winery and vineyard assets was high. He said that there was active competition among purchasers (reflected in high land values at that time) and there was no need to discount the value of winery and vineyard assets to encourage purchasers to complete a sale. His evidence was that vineyard and winery assets sold in 2007 at full value, with no discount for any purchaser‟s incentive.
[90] Counsel for the Herzogs submit that this opinion fails to take into account that there was also a restaurant and accommodation business. That point does not seem to me to be of much significance. More significantly, however, it is general evidence about the market. Mr Gemmell said that his experience was that investors would look at the type of vineyard they are investing in, and the ones proven to be attractive in the Marlborough area were the single variety vineyards and primarily sauvignon blanc. He said these things are relevant to a purchaser and that the Hadley & Lyall valuation gave the land based value but did not take this into account. He said “we used to talk about a good sound commercial vineyard/winery being in the order of 30,000 cases, now we‟re talking 100,000 cases to make it work” and the Company here produced 2500 cases. He said that the Company was at the higher end of the risk level for vineyard operations and that to suggest that someone would in 2007 “walk in and pay book value...is just incorrect”.
[91] I accept Mr Gemmell‟s evidence that in a negotiation between a willing buyer and willing seller even in a buoyant market an incentive to purchaser would be negotiated in respect of the shares in the Company. In the short term at least, the assets will not be realised and so any return from capital gains in land value may be some distance off. In the meantime, the return on the assets from their operation is
makes the admission of the evidence outside the Court‟s jurisdiction.
42 Section 98(1) and (2) of the Evidence Act 2006.
[152] I am not satisfied that admitting the second set of accounts gives rise to any unfairness to Mr Hertli and Mr Rokitzky. I acknowledge that their counsel might have sought an adjournment of the hearing if an application for leave had been made. The plaintiffs were concerned about the validity of the stock write down and that concern was not an unreasonable one. Had the adjournment application been made and granted the Herzogs would have had the opportunity to give evidence in support of the validity of the stock write down. Had this occurred it is more likely than not that the outcome of fair value at a later hearing would have been no better for Mr Hertli and Mr Rokitzky and potentially worse for them. I say that because the substantive hearing proceeded before me on the basis that the validity of the stock level in the second set of accounts had not been established by any reliable evidence.
[153] Further, the case proceeded with the issue of the two sets of accounts having been raised by the plaintiffs but not having been determined by me. Knowing that the defendants‟ evidence proceeded on the basis of the second set of accounts, counsel for the plaintiffs could have sought a ruling on the issue before proceeding. They chose not to, taking the risk that an application for leave would be made at some point and a ruling made in favour of their admission. By choosing to proceed the plaintiffs knew that there was no evidence before the Court establishing the validity of the stock as recorded in the second set of accounts.
[154] Finally, it can be seen from my calculations that the difference in stock as between the first and second set of accounts makes very little difference to the calculation of fair value. With the accountants unable to agree on the methodology or the net value of the assets under either methodology, my assessment of fair value does not involve precision as to the true market value of the stock.
[155] For these reasons the application for leave to admit the second set of accounts is granted.
Result
[156] I order that the first defendants are to acquire the plaintiffs‟ shares in the
second defendant at the price of $4.55 per share.
[157] The parties are to endeavour to reach agreement on costs within 21 days of this judgment. If that is not possible then brief submissions are to be filed within a further 21 days.
Mallon J
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