Short v Gray HC Auckland CIV 2008-404-2232
[2010] NZHC 1113
•9 June 2010
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV-2008-404-2232
BETWEEN DAVID GOULD RUSSELL SHORT, TIMOTHY JOHN BURCHER, RONALD JOHN MACDONALD AND TIMOTHY STEPHEN CARNACHAN
First Plaintiffs
ANDDAVID GOULD RUSSELL SHORT, TIMOTHY JOHN BURCHER AND RONALD JOHN MACDONALD Second Plaintiffs
ANDJOHN ANDREW GRAY Defendant
Hearing: 17 - 22 May 2010
Appearances: DF Dugdale for Plaintiffs
RB Stewart QC and S Hunter for Defendant
Judgment: 9 June 2010 at 4:30 pm
JUDGMENT OF ASHER J
This judgment was delivered by me on 9 June 2010 at 4:30 pm pursuant to Rule 11.5 of the High Court Rules
………………………………………..
Registrar/Deputy Registrar
………………………………………..
Date
Solicitors:
J MacDonald, Short & Partners, Auckland
S Hunter, Gilbert Walker, AucklandCopy:
DF Dugdale, Barrister, Auckland
RB Stewart QC, Auckland
SHORT & ORS V GRAY HC AK CIV-2008-404-2232 9 June 2010
Table of Contents
Paragraph
Number Introduction [1] Background [2] The issues [15] The loan [19]
Clause 11 [21] Notice of demand [27] Interest rate following demand [35]
Goodwill [39] Breach of fiduciary duty [54] The amount of the overpayment of rent [54]
The nature of the fiduciary duty [60] Result [73] Costs [75]
Introduction
[1] This proceeding relates to certain specific sums of money claimed between the partners of the dissolved partnership of Short & Co. Some of the matters were resolved during the hearing, and there are now three issues of mixed law and fact for determination.
Background
[2] The firm of Short & Co. was initially formed in 1983 as a partnership between David Short, John MacDonald and Tim Burcher (“the Short & Co. partners”). They were joined in partnership by the other first plaintiff, Tim Carnachan, in 1987. The practice in Auckland had as its premises 18 Turner Street, Auckland, in the Auckland central business district. The building at Turner Street by
1987 was owned by Messrs Short, Burcher and MacDonald, and Short & Co. as a firm leased the building from them.
[3] The defendant, John Gray, had been practising as a solicitor in South Auckland since 1969. He had a significant client base and connections in the area. On 1 July 1987, he formed an association with Short & Co., whereby he was employed as a consultant to run an office at 120 Great South Road, Takanini. There were some oral arrangements put in place in July 1987 as to the terms on which Mr Gray was to work for Short & Co. These were reduced to writing on
12 May 1988.
[4] On that date two associated documents were signed between John Gray on the one part, and Messrs Short, Burcher, MacDonald and Carnachan on the other. In a document called “the agreement” John Gray sold and Short & Co. purchased John Gray’s goodwill as a solicitor together with his deeds and rights of access for the sum of $1. John Gray was retained by Short & Co. from 1 July 1987 as a consultant for a term of two years on certain conditions, including an agreed consulting fee and various benefits. The parties agreed on a number of terms, which involved John Gray folding his practice into that of Short & Co. Clause 11 of the
agreement provided for termination of the agreement in certain circumstances, which will be referred to later at [21]-[27]. Clause 12 provided that at any time before the expiry of the two year period Short & Co. could offer and John Gray could accept a partnership with the firm.
[5] This agreement referred to a loan to Mr Gray by Short & Co. of $34,100, to partially off-set his debt balance in his current account with a firm with which he had earlier been associated. It stated at Recital E of the agreement that “the terms of the loan are set out in the annexed Deed of Covenant”. The separate Deed of Covenant, dated the same day, recorded the advance of $34,100 and various relatively standard lender/borrower terms, together with a schedule setting out disclosure under the Credit Contracts Act 1981.
[6] There was a further advance subsequently made of $10,500 pursuant to the terms of that deed, making the total advance $44,600.
[7] On 14 March 1989, Short & Co. opened a third office, this time in the rural town of Warkworth. The firm took over an existing practice of a branch office of the Auckland law firm Webster, Malcolm & Kirkpatrick. A partner of that firm, Mr Brian Jones, stayed on as an associate.
[8] On 1 April 1989, John Gray was admitted into partnership at Short & Co. The partnership at all material times operated as an equal partnership. No written partnership agreement was entered into at this time or later.
[9] In 1992 Mr Carnachan left the partnership, reducing the number of partners to four, including Mr Gray. Mr Carnachan is still a first plaintiff because he was one of the lenders. Brian Jones left the firm in December 1993. At that point Mr Gray took over supervision of the Warkworth branch office, as well as the Takanini branch office. His assumption of responsibility for that office dated from December 1993.
[10] In his evidence Mr Gray referred to a number of matters concerning the partnership that he was not entirely happy with. The details of these differences are
not of importance to the matters at issue between the parties. What is significant is that in December 2003 Mr Gray learned that the Turner Street premises had been sold by Messrs Short, Burcher and MacDonald. He received formal notice of this in March 2004. In April 2004, there was a partners’ meeting to discuss the issue of relocation of the city premises. Mr Gray attended that meeting with Messrs Short, Burcher and MacDonald. There were discussions about purchasing another building. In the course of those discussions Mr Gray alleges that Mr Burcher made a comment indicating that the partners who had owned Turner Street had enjoyed a generous rental. Mr Gray then looked into the Turner Street rental arrangements. He says up to that point he had always assumed that the rent that was being paid was market rent. He asserts that his inquiries showed that the firm had in fact been paying significantly above market rent for a considerable period of the time during which he had been a partner. He obtained an historical rental valuation from Seager & Partners, which indicated that the rent had been paid on an over-market basis.
[11] Mr Gray became concerned about the overpayment of rent. He was also concerned about the surrender of the lease of the Turner Street building and the proposed relocation, which he thought was to his financial detriment. The parties discussed issues through to July 2004 when Mr Gray decided to leave the partnership. He gave notice of his intention to withdraw from the partnership on
16 July 2004. The partnership was dissolved on 30 September 2004. The existing partners of Short & Co., not including Mr Gray, Messrs Short, Burcher and MacDonald, continued to practise in the central business district of Auckland. Mr Gray continued to practise under a new practice name in Takanini and Warkworth, using the same premises as before.
[12] On 21 December 2007, Short & Co. served a demand on Mr Gray for payment of the $44,600 loan, together with interest at 22 per cent compounding of
$3,822,742.32. On 14 April 2008, the three remaining partners of Short & Co. issued proceedings against Mr Gray claiming the amount of $44,600 and the interest claimed in the demand, also claiming in relation to the dissolution that Mr Gray had received assets of a total value of not less than $333,008 rather than his entitlement of $34,995, and had failed to pay the excess of $298,013 to his former partners.
Alternatively, an account of the amount due to each of the five members of the dissolved partnership in respect of capital was sought.
[13] An amended statement of claim was filed on 12 August 2008, which is the statement of claim presently before the court. The sum of interest is reduced. It is no longer claimed at 22 per cent compounding. The claim is for interest of
22 per cent being $196,240. The claim in respect of the amount Mr Gray had received in excess to his entitlement was reduced to $253,412. The alternative plea for an account in respect of certain specific items was retained.
[14] Mr Gray has filed a counterclaim. In that counterclaim he asserts that the charging of above market rental to the firm by Messrs Short, Burcher and MacDonald in their capacity as owners of the Turner Street property, constituted a breach of the duty to observe the utmost fairness and good faith towards Mr Gray, and a breach of duties of a fiduciary nature. The sum of $144,313 is claimed, on the basis that this sum constitutes the reduction of the defendant’s income as a consequence of the overpayment. There was a second cause of action in the counterclaim but no ruling is now sought on it.
The issues
[15] The issues for determination have been refined during the trial. The dissolution of the partnership has always been accepted by the partners, and they have resolved a large number of matters between them. There were, when the trial began, six issues. These were:
a) In relation to the loan, has it been called up, and what is the appropriate interest rate?
b) What allowance, if any, should be made for goodwill?
c) What allowance, if any, should be made for work in progress?
d) What adjustments should be made in respect of holiday pay?
e) Was the defendant entitled to be reimbursed for $15,000 for the fit-out costs of the Warkworth office?
f) The defendant’s counterclaim for damages for breach of duty because of the payment of over-market rental on the Turner Street premises.
[16] The third issue, work in progress, was the subject of contention throughout the hearing. However, in closing submissions it became apparent that the issue of whether there was work in progress may be able to be resolved by a more careful taking of account. In the end Mr Stewart QC for Mr Gray sensibly accepted that an adjournment of the issue in relation to work in progress could be the best way forward, so that a further account could be taken. After this decision the proceeding will be adjourned, and if necessary that issue will be heard later.
[17] The adjustments that should be made in respect of holiday pay were resolved during the course of the trial, when further details were made available. Thus, the payment that the plaintiffs were seeking in this regard was not pursued. Further, Mr Gray’s claim to $15,000 for fit-out costs for the Warkworth office was abandoned.
[18] The deferment of the work in progress issue and the resolution of the other two issues leaves three issues to be determined: the loan, the goodwill, and the counterclaim. In essence, the plaintiffs are seeking judgment in respect of the loan and interest and the goodwill, and the defendant is seeking judgment on the counterclaim. It is necessary, therefore, to deal with these three issues.
The loan
[19] Mr Dugdale for Short & Co. submits that the loan of $44,600 is payable, and that interest has been running from the date of the advance of 1 July 1987 at
22 per cent per annum. The total interest claimed is $196,240 to 30 June 2007, and for further interest to be calculated to the date of judgment.
[20] Mr Stewart accepts that the advance was made and that it has not been repaid. However, he submits that no proper demand has ever been made for the loan and that it has still not been called up. He submits that the plaintiffs are mistaken in relying on the agreement as providing for interest of 22 per cent per annum, and that in fact there is no interest payable on the loan.
Clause 11
[21] Clause 11 in the agreement, relied upon by Mr Dugdale to support the interest claimed at 22 per cent per annum, reads as follows:
11.JOHN GRAY may at his option terminate the Agreement herein by notice in writing that he desires to repurchase the sale asset and repay the loan and any monies paid to Pritchard Gray & Ellis and/or Lyon Lucas & Co to purchase assets or otherwise howsoever in which event the parties shall enter into an Agreement for Sale and Purchase on all such usual and reasonable terms and conditions applicable to such Agreements but providing for a purchase price of an amount nominated by the Purchasers including goodwill but not less than the purchase price hereunder and the amount of monies loaned or advanced or paid to Pritchard Gray & Ellis and/or Lyon Lucas & Co. or otherwise howsoever together with interest at the greater of 22% or [the] Short & Co. current bank overdraft rate payable from the 1st of July 1987 together with an allowance for improvements and all payments of a capital expenditure made by Short & Co. in and about preserving and improving John Gray’s practice but without any provision for restraint of trade.
Clause 12 is also relevant. It provides:
12.AT any time before the expiry of Two (2) years from the 1st of July 1987 Short & Co. may offer and John Gray may accept a partnership with Short & Co. in which event John Gray and Short & Co. shall enter into a Deed of Partnership regulating their practice on terms and conditions agreeable to John Gray and Short & Co.
[22] Mr Dugdale submits that it was the clear intention of the parties that if ownership of the Takanini assets were to revert to Mr Gray, as occurred following the dissolution in 2004, he was to pay the monies loaned, together with interest at the
22 per cent rate. Mr Stewart argues that this clause never applied, as it envisaged a termination of the agreement and Mr Gray taking back his assets within the two year period prior to him becoming a partner. Instead, Mr Stewart submits, Mr Gray became a partner, so the clause ceased to have any effect.
[23] I accept Mr Stewart’s submission. The clause on its face contemplates action being taken by Mr Gray during his period as a consultant, should he choose not to become a partner. This is indicated by the immediate juxtaposition to it of clause 12, which recorded that at any time before the expiry of two years Short & Co. may offer and John Gray may accept a partnership with Short & Co. I see clause 11 as being intended to apply in the event of an early termination by Mr Gray at his instigation. But there was no termination in that period. Mr Gray had become a partner on 1 April 1989, which meant that clause 11 ceased to have effect from that date, and sixteen years later the partnership was dissolved. The 1987 agreement itself has never been terminated and clause 11 does not apply. Indeed, the specific procedure set out in clause 11 for its application, namely a termination of the agreement by John Gray by notice in writing, with a statement that he desires to repurchase the sale asset and repay the loan and the monies paid to Pritchard Gray & Ellis and/or Lyon Lucas & Co. to purchase the assets, was never instigated. Nor was any agreement for sale and purchase as envisaged by clause 11 ever entered into. When the dissolution occurred 16 years after the agreement was signed, Mr Gray did not “terminate the agreement” in the way envisaged by clause 11. Clause 11 had long since ceased to have effect.
[24] Therefore, it is necessary to put clause 11 to one side in considering whether there has been demand and the interest to be paid. I turn to other relevant provisions relating to interest on the loan.
[25] The governing document is the Deed of Covenant, which specifically applies to the loan of $34,100 and further advances. It provides at clause 1 that Mr Gray will pay to the Short & Co. partners the principal sum “upon three months’ written notice of demand”. It is also provided at clause 2 that:
The borrower will pay to the lender interest as agreed from time to time between the parties on each interest date (commencing with that which follows the interest commencement date) …
Clause 3 provides for the provision of penalty interest, without setting out how penalty interest is to be calculated.
[26] I will first deal with whether there has been written notice of demand, and, if so, when.
Notice of demand
[27] It is not suggested by the Short & Co. partners that any notice of demand was given prior to the dissolution of partnership. Mr Dugdale placed some reliance upon an unsigned dissolution of partnership document prepared by Mr Short and sent on
30 July 2004 after Mr Gray had given notice of dissolution, but before actual dissolution. This document provided at paragraph 6:
Advance to John $44,600 repayable by 30 September 2004.
[28] This reference to the advance being repayable appears to be one of a number of proposals being put forward in the document by Mr Short on 30 July 2004 in relation to the dissolution. There are a number of controversial issues referred to in the document, and there is no suggestion that they were agreed to by Mr Gray. In particular, there is no suggestion that Mr Gray agreed to the proposal that the advance was repayable by 30 September 2004. The gap between the date on which the dissolution of partnership document was sent, which appears to be between
30 July 2004, and 30 September 2004 is two months and not three months. It was not, therefore, a written notice of demand in terms of the Deed of Covenant at all, but, rather, a proposal for Mr Gray to consider. He did not agree to it. So it does not give three months' notice, as well as not being a notice of demand.
[29] No steps were taken in respect of the loan thereafter for three years after 30
July 2004. The next document that could be a written notice of demand is a notice of demand sent by the Short & Co. partners to Mr Gray on 21 December 2007. The notice demands repayment of the debt together with interest at 22 per cent compounding of $3,822,742.32, the money to be paid within three months of receipt of the notice.
[30] Mr Stewart argues that this cannot be a valid notice of demand because of the grossly overstated sum claimed for interest. He relies on the decision of Australian
Guarantee Corporation (NZ) Ltd v Slade.[1] There the Court of Appeal accepted the proposition in relation to a notice under s 92 of the Property Law Act 1952 that a notice might be ineffective because inferentially the excess “may be so large or so wrongful as to justify an inference that the mortgagee would refuse to accept what was properly due”.[2] The Court of Appeal relied on the Privy Council decision in
Campbell v Commercial Banking Co. of Sydney.[3] The Court held a notice to not be a
valid demand because of this overstatement of the debt.
[1] Australian Guarantee Corporation (NZ) Ltd v Slade CA256/91 24 August 1992.
[2] At p 19.
[3] Campbell v Commercial Banking Co. of Sydney (1879) 40 LT 137
[31] In my view, there is a clear distinction between a demand made under s 92(1) of the Property Law Act 1952, and a demand such as the demand before me for a simple loan. In the case of a s 92 notice, the default will have already occurred and the issue is what the mortgagor should do to remedy the default. The notice under s 92(1) makes the power of sale exercisable. It is necessary for a mortgagor to know exactly what is required to remedy the default.
[32] There is also a distinction between a s 289 (Companies Act 1993) notice which does not show an undisputable core amount of debt, and a notice of demand calling up a loan that was undeniably made such as this. Here the purpose of the notice of demand is, first, to actually call up the loan and make it payable. It also secondly advises of, and demands, the interest that is owing. The intention is unmistakable. The lender is demanding repayment of principal. I do not consider it to be a reasonable inference to be drawn from the notice that the principal would not be accepted unless all the interest was paid. Indeed, under the heading “background” in the notice of demand, it is stated that the loan is repayable on three months’ notice, and that the vendor requires “repayment of the debt and interest”. This wording is echoed in the “Demand” part of the notice. It is not implicit that the principal can only be repaid with the interest.
[33] There can be a valid demand for money owed, despite an inflated claim for interest or other additional payments. This conclusion is supported by the Court of Appeal decision in United Homes (1998) Ltd v Workman,[4] where it was observed
[4] United Homes (1998) Ltd v Workman [2001] 3 NZLR 447.
that a statutory demand is not to be set aside by reason only of a material erroneous description of a debt unless the court considers “substantial injustice would be caused if it were not set aside”. It was observed: [5]
The Courts have come to recognise that statutory demands can be allowed to stand in reduced figures representing items not open to dispute.
[5] At [46].
[34] The notice of demand here quite clearly sought repayment of the original amount advanced. There was and is no dispute that it is owing. I am satisfied that there was a valid notice of demand given on 21 December 2007, and interest therefore was payable three months from that date, from 21 March 2008.
Interest rate following demand
[35] The next issue to be determined is the interest rate. There was no interest agreed from time to time. What interest, if any, should be paid? Mr Dugdale relies on s 87(2) of the Judicature Act 1908. That section provides:
87 Power of Courts to award interest on debts and damages
…
(2)In any proceedings in the High Court, the Court of Appeal, or the Supreme Court for the recovery of any debt upon which interest is payable as of right, and in respect of which the rate of interest is not agreed upon, prescribed, or ascertained under any agreement, enactment, or rule of law or otherwise, there shall be included in the sum for which judgment is given interest at such rate, not exceeding the prescribed rate, as the Court thinks fit for the period between the date as from which the interest became payable and the date of the judgment.
[emphasis added]
He says that interest was payable as of right under clause 2 of the Deed of Covenant, which provided for the borrower to pay interest “… as agreed from time to time between the parties on each interest date …”.
[36] Mr Stewart argues that interest is not payable as of right under clause 2, as it has to be agreed between the parties, and if not agreed the only remedy for the lender is to call the loan up. I accept that submission. This is not one of those loans where
there is a statement that the borrower is obliged to pay interest from the outset. This is confirmed by the disclosure document which shows the cost of credit as “nil” and has no entry beside “finance rate”. There is in fact no obligation under this clause to pay any interest at all until it is agreed. It was not agreed here. Section 87(2) is not applicable, as until rent is agreed, rent is not payable to Short & Co “as of right”. If they sought interest, but could not agree on an interest rate with Mr Gray, they would have to call up the loan or accept a situation where no interest was payable.
[37] Even if this interpretation of s 87(2) is wrong, and the power given by that section could be applied over the entire period of the loan, I would not in my discretion consider it appropriate to order any interest until a demand had been made. It is my interpretation of the evidence that the Short & Co. partners were content to not force the issue of interest for the bulk of that period, because of their satisfactory partnership relationship with Mr Gray.
[38] However, s 87(1) applies from the period when the loan was due. Under that section the court has the discretion to order interest, as it thinks fit, on the whole or any part of the debt from when the cause of action arose to the date of judgment. The cause of action for repayment of the loan arose on 21 March 2008, three months after the expiry of the demand. It is perfectly fair for interest to be payable from then, and I will direct that interest should be paid from then at the Judicature Act 1908 rate applying for any given month. For the avoidance of doubt, I note that the rate changed on 1 July 2008, and the applicable rate will therefore vary to correspond to the change, on that date.
Goodwill
[39] The Short & Co. partners called a senior and experienced Auckland chartered accountant, Bruce Sheppard, to support their claim for goodwill. It was Mr Sheppard’s evidence that Mr Gray has achieved an advantage in terms of goodwill of $136,537 for which he should reimburse the Short & Co. partners. He reached this figure by adopting a model, which he described as “capitalisation of super profits”. This entailed assessing the sustainable profits on economic salaries, and deducting from the enterprise value the net assets required to run the enterprise
(ignoring interest bearing debt). He was then able to arrive at what he described as “the difference”. He stated that, if positive, that difference represented goodwill, and if negative, represented the discount to tangible assets the purchaser would require to complete the purchase. His view was that the firm should be valued on a multiple of three, and he produced charts to justify his calculation.
[40] Mr Dugdale relying on this evidence submitted that the goodwill was part of the net assets of the Short & Co. partnership, and the defendant received a rateable proportion of the overall goodwill in excess of his 25 per cent entitlement. He argued that on Mr Sheppard’s figures Mr Gray received goodwill of $395,741 whereas his entitlement was $259,200. That difference was the $136,541, which was what Mr Gray owed his partners. He relied in particular on the Court of Appeal
decision of Davidson v Wayman,[6] for the proposition that the market value of the
goodwill or a share thereof can be hypothetical, and calculated on the assumption that there is a market.
[6] Davidson v Wayman [1984] 2 NZLR 115.
[41] Mr Gray called two accountants, Mr Dennis Lane and Mr John Hagen, who are also senior and experienced accountants. They both asserted that there was no extra goodwill at all taken by Mr Gray on dissolution, and that in fact there was no goodwill at all in the partnership that had a market value or was a saleable commodity. The individual partners had personal goodwill, but that was not an asset of the partnership. The key to their argument that there was no goodwill in any of the three offices was that without a restraint of trade, any of the partners could have set up shop down the road from the old practice, and without soliciting kept their clients. This meant that no-one would pay anything on the open market for goodwill, because the business would follow the former partner and not stay with the firm. Following dissolution there was nothing to buy.
[42] When Mr Gray joined Short & Co. in 1987 as a salaried consultant, he had been practising in South Auckland since 1969. He had a significant client base and connections in the area. He sold his practice to the Short & Co. partners for $1. When on 1 April 1989 he joined the partnership as an equity partner, there was no partnership agreement and no restraint of trade provision signed. This was
consistent with the position of the other partners. There was an amount of $40,000 shown as goodwill in the accounts of the firm when Mr Gray joined. There was no explanation for why this was historically shown in the books. When Mr Carnachan left, his one-quarter share of that goodwill was deducted so that the goodwill reduced by $8,000 to $32,000. There appears to have been no goodwill adjustment to take into account either Mr Gray joining the partnership or, when at a later stage, Mr Jones joined the partnership. Thus, in terms of what actually happened between the partners in Short & Co. from 1987, there is nothing to indicate that a value was attached to the goodwill of Mr Gray’s practice.
[43] It is necessary to consider the nature of goodwill. Lord Lindley defined it as follows in RC I’Anson Banks Lindley and Banks on Partnership:[7]
[7] 18th ed, Sweet & Maxwell, at para 10-189.
The term goodwill can hardly be said to have any precise signification. It is generally used to denote the benefit arising from connection and reputation; and its value is what can be got for the chance of being able to keep that connection and improve it. Upon the sale of an established business its goodwill may have a marketable value, whether the business is that of a professional man or of any other person. But it is plain that goodwill has no meaning except in connection with a continuing business; it may have no value except in connection with a particular house, and may be so inseparably connected with it as to pass with it under a will or deed without being specially mentioned. In such a case the goodwill increases the value of the house; but the value of the goodwill of any business to a purchaser depends, in some cases entirely, and in all very much, on the absence of competition on the part of those by whom the business has been previously carried on.
[footnotes omitted]
Scrutton LJ discussed the component parts of goodwill in his classic statement in
Whiteman Smith Motor Co. v Chaplin:[8]
[8] Whiteman Smith Motor Co. v Chaplin [1934] 2 KB 35, 42.
A division of the elements of goodwill was referred to during the argument and appears in Mr Merlin’s book as ‘cat, rat and dog’ basis. The cat prefers the old home though the person who has kept the house leaves. The cat represents that part of the customers who continue to go to the old shop, though the old shopkeeper has gone; the probability of their custom may be regarded as an additional value given to the premises by the tenant’s trading. The dog represents that part of the customers who follow the person rather than the place; these the tenant may take away with him if he does not go too far. There remains a class of customer who may neither follow the place nor
the person, but drift away elsewhere. They are neither a benefit to the landlord nor the tenant, and have been called ‘the rat’ for no particular reason except to keep the epigram in the animal kingdom …
[44] As the two quotes indicate, there must be clients who are ready to follow the place or the name, who present an available body of business, for it to follow that a purchaser will pay for that place or name. Those clients may stay available after dissolution because of the nature of the business, or because of a restraint of trade on those who might otherwise take the business. But an essential element is that non- transportable return business that constitutes marketable value. For the purposes of this exercise I consider that goodwill is best regarded as the difference between what a third party would pay for the Short & Co. practice or a part of that practice in an open market purchase, over and above what such a purchaser would paid for the tangible assets.
[45] Mr Sheppard analysed the firm’s turnover and overheads for the period commencing 1991 through to 2004 to establish the earnings before interest and tax of the respective offices. This showed that the city’s office turnover with its three partners was $703,000, the Takanini ‘earnings before interest and tax’ (“EBIT”)
$194,206, and the Warkworth EBIT $216,165, with a single partner, Mr Gray, running them. This meant that the EBIT for Takanini and Warkworth were worth more than a quarter of the combined EBIT. Loosely the figures were a total turnover of $1.1 million, with $400,000 under Mr Gray’s control for 2004. It is this basic fact that Mr Gray was taking a greater amount of EBIT with him when he left that led Mr Sheppard to conclude that he was taking goodwill and that it should be valued. He made the point that to a certain extent, even if the notional salaries of the partners were increased or reduced, the net result remained unchanged. He assessed the economic salaries of the partners at $140,000 per partner.
[46] Mr Sheppard said that only if the notional salaries per partner exceeded
$250,000 would the super profits that were the basis for his calculation of goodwill, disappear. Mr Sheppard was not prepared to accept that there was no guarantee that the client base would move with Mr Gray. He pointed out that the deeds would still be with the Short & Co. partners and, therefore, physical possession of core documents would be at the existing premises. However, he did concede that if
Mr Gray stayed in the areas and continued in business where the firm had been trading, that no third party would pay money for goodwill in the Short & Co. businesses in Takanini and Warkworth. However, following that concession he observed that there was what he would describe as a fiduciary duty to behave decently and in good faith between partners. He stated that his brief was to work out the value of the economic transfer between the parties, accepting that fiduciary relationship. He stated:
The assumption that I made is that when people choose to do business with each other in a partnership that they are agreeing with each other, whether in writing or not, to commercially exploit an opportunity for mutual advantage of all, on the basis that they will share the rewards of that equally, and that the rewards comprise the income and value growth of that which they created … Against that backdrop I assume that there has been an asset created that is jointly owned by all of them that is now being petitioned or purloined by one or other partners, one or more of the partners.
[47] Mr Hagen and Mr Lane considered that the reasonable salary would be closer to $200,000 per annum for a partner in Mr Gray’s position. Mr Lane noted that his practice was in family law which was an extremely personal type of practice. In both Mr Hagen and Mr Lane’s views the absence of a restraint of trade provision eliminated goodwill. Mr Hagen observed that Mr Sheppard was not in fact calculating goodwill, but, rather, carrying out an arithmetical exercise in numbers, which had no relation to the marketplace.
[48] Mr Gray personally specialised in family law. He had productive legal executives doing conveyancing work. Having heard the evidence of all three accountants I am left with no doubt that because of the absence of a restraint of trade on Mr Gray’s practice, no third party would have paid goodwill for that practice without certainty that Mr Gray would not be practising in the relevant areas when the partnership dissolved. Indeed, I doubt whether any third party would have paid any goodwill for any aspect of the business of Short & Co., because of the absence of restraints of trade. To adapt Scrutton LJ’s epigram, a restraint of trade clause could have turned Mr Gray’s clients from dogs into cats, but without such a clause they would follow him.
[49] I consider that to be fatal to the Short & Co. partners’ claim that Mr Gray owes them for goodwill. No sensible person would have paid money for what would just be a name and a location. With or without solicitation all the existing clients were likely to follow Mr Gray to wherever he was in the area, leaving a purchaser with the task of building up a new practice.
[50] That is not to deny the arithmetical soundness of Mr Sheppard’s calculation. It is undoubtedly the case that Mr Gray’s turnover as a percentage of the total was a greater turnover than that of his partners, and that, therefore, he is likely to have taken that turnover with him and enjoyed after dissolution, therefore, a greater percentage of the business of the firm than his remaining three partners. However, given Mr Sheppard’s comments about moral duty it is necessary to make these observations. The fact that Mr Gray took that greater turnover with him did not, in my view, create any legal or indeed moral obligation on his part to reimburse his partners so that they got something for the loss of the personal goodwill attaching to him. That goodwill had developed principally as a consequence of Mr Gray’s own efforts in his practice, which had produced a greater turnover than that of his partners. His partners had had the benefit of that greater turnover when they were together. They paid nothing for that benefit, and there was nothing wrong in Mr Gray taking it with him. Further, the absence of a restraint of trade clause meant that the partnership arrangement contemplated him taking that goodwill with him when he left. It had been his personal goodwill at the start and was his at the end. Indeed, clause 11 of the 1987 agreement in referring to what Mr Gray would pay back in the event of early termination noted that there was no restraint of trade, and made no provision for payment of goodwill (although as I have noted, this dealt with the pre- partnership situation).
[51] I also record that I prefer Mr Hagen’s evidence that a person who was in the same position as Mr Gray in terms of work experience and ability would expect a salary of $200,000 per annum and not $140,000 per annum. I also accept Mr Hagen’s evidence that he knows of numerous examples in accounting firms where partners who are going to continue practising, walk away with their own client base without payment, and was not satisfied that Mr Sheppard was able to give
analogous examples of professional persons in Mr Gray’s legal and factual position paying goodwill.
[52] I do not consider that the decision of Davidson v Wayman assists Mr Dugdale. That decision undoubtedly recognises the existence of goodwill in accountancy practices, but it was made clear by Cooke J that for goodwill to be payable it had to have an actual market value. He stated:[9]
[9] At 119.
But it was a figure, certainly material to sharing under s 47, but totally irrelevant in the actual ascertainment of the goodwill to be shared, unless [the arbitrator] found either that the aggregate happened to coincide with actual market value or that there was an agreement that a partner giving notice of dissolution was to be paid out on the basis of the credit.
It was held that the arbitrator fell into an error of law using book value as the foundation of his award for goodwill instead of determining its market value.[10] I do not consider the short consideration of the issue by Somers J to be inconsistent with that of Cooke J. In the High Court decision following that successful appeal of Wayman v Davidson,[11] also relied on by Mr Dugdale, it was noted[12] by Ellis J that there was evidence that a market existed which would buy if the business were offered for sale. Reference was made to the fact that despite the absence of a restraint of trade clause, there was value in a “block of fees”. That may well be accurate in relation to an accountancy practice. However, in this case there was no evidence of any such value to any part of the practice of Short & Co. There was no transferable “block of fees”.
[10] At 120.
[11] Wayman v Davidson (1986) 1 NZBLC 102,328.
[12] At 102,334.
[53] I conclude, therefore, that no allowance should be made for a payment of goodwill by Mr Gray to the Short & Co. partners. The goodwill he took with him was personal goodwill. It had no saleable value because of the absence of a restraint of trade clause, and was not an asset of any value to the partnership.
Breach of fiduciary duty
The amount of the overpayment of rent
[54] In the initial years of Mr Gray’s partnership with Short & Co. the rent on
18 Turner Street was below market rent. However, by 1 April 1991 the rent being paid was in excess of market rental, and it continued to be in excess of market rental during the years that followed. The plaintiffs called as a valuer, Mr Brian Turner, and the defendants, Mr Reid Quinlan. In the end it was not necessary for either of them to give detailed evidence, as they had discussions during the trial and ultimately filed a joint memorandum where they stated, with two qualifications, that the contract rents exceeded the rent payable under a notional market based lease by a theoretical total of $242,920 for the 15½ year period from 1 April 1989 to
30 September 2004.
[55] There were two areas in which agreement was not reached which if the Short
& Co partners are right reduces that excess, and the valuers gave short evidence on these. The first was as to the value, if any, to be attributed to extra carparks that were not part of the lease but which were made available to Short & Co. The second was whether an adjustment was necessary for a management fee which was not in fact charged by the landlords, but would have been if they were landlords in a true market situation. I heard evidence on these two specific points, which I will deal with first.
[56] Short & Co. had the use of four carparks to the rear of the property situated at
16 Turner Street for a period, in addition to the carparks provided under the lease. The position in relation to the carparks was clarified by further evidence from Mr Short. In fact the four carparks were made available by a neighbouring landlord as a consequence of an arrangement with Messrs Short, Burcher and MacDonald (“the Short & Co. landlords”) from 1996. The nature of the benefit was not defined with precision, but the evidence was sufficient to satisfy me that the four additional carparks made available by the Short & Co. landlords, were obtained for consideration by them, and were of real benefit to the Short & Co. partnership as a
whole. They were therefore a benefit of the lease, and properly seen as part of the benefits offered by the Short & Co landlords.
[57] I, therefore, consider it appropriate to take into account in assessing the market rental an allowance for the provision of those four carparks from 1996. I do not, however, accept that there should be any allowance for other additional carparks that were made available by the neighbour, as it appears that they were made available simply as a consequence of goodwill between neighbours, and would have been available to the Short & Co. partnership without any need for the Short & Co. landlords to have provided any consideration as landlords. That being so, the excess of market rental reduces to $176,360.
[58] The second preliminary question is whether there should be an allowance for management fees. Mr Turner considered that an independent landlord would have charged a management fee for the considerable amount of work involved in managing the premises, such as garden maintenance, carpark maintenance, and general maintenance. Mr Quinlan, on the other hand, while accepting that management fees were charged by landlords, said that it was by no means the invariable practise and, indeed, in his view it would have been “a little bit unusual” for a management fee to be charged.
[59] The lease gave the landlord the power to make such a deduction for a management fee, and I accept prefer the view of Mr Turner on market practice. I conclude that an independent landlord would more likely than not have charged a management fee in a true market situation. Therefore, a deduction for a management fee that might otherwise have been charged will be made. This means that following adjustments for carparks and management fees, the amount of overcharging for the period of the relevant partnership was $141,648. The amount at issue is for overcharged rent is, therefore, one-quarter of that, being $35,412.
The nature of the fiduciary duty
[60] In assessing whether there has been a breach of fiduciary duty it is first necessary to set out the facts relating to the lease.
[61] When Mr Gray joined the partnership he was aware that the Turner Street property was owned by the Short & Co. partners. The Short & Co. partnership generally was paying rental. He does not suggest he was unaware that the landlord partners would have made a profit on the rental in the sense that the amount they received would exceed the outgoings. Indeed, it is clear from his evidence that he expected them to be achieving a market rental, which would have meant that the Short & Co. landlords made a profit before interest and tax.
[62] The rental for the initial few years was under-market, but from 1 April 1991 it was over-market as stated by the agreed memorandum as to rental of the valuers, modified by the two matters already discussed. There were two yearly reviews. The rental was increased and fixed at $75,000 per annum as at 1 April 1991 and appears to have stayed at that level through to 1 September 2002 when it was increased again. At all times the rental was accurately shown for Turner Street in the quarterly and annual accounts, which Mr Gray presumably saw and accepted. Mr Short in his unchallenged evidence on the point described the rental charged to have been, in his opinion through the relevant period, “generous but nevertheless fair”. Mr Short was not challenged on his evidence that “... the rent while being realistic was nevertheless set at the upper rather than lower end of the market rent.”
[63] The Short & Co. Partners obtained no valuations through the 1990s. It was not put to Mr Short or suggested in submissions that the Short & Co. partners in any way misled Mr Gray about whether the rent being paid was at market, or indeed that the Short & Co landlords were aware that rent was being charged in excess the parameters of market rent, as explained by Mr Short. Mr Burcher did make a comment at the partnership meeting in April 2004 that they had “creamed rent out of Turner Street for many years”. That statement was not put to Mr Short and indicates no more than, as Mr Short acknowledges, the partners regarded the rent they received as generous. I bear in mind that there are no absolutes in the area of fair market rental. The initial significant disagreement between the reputable valuers employed by each side as to the correct level of market agreement indicates the fluid nature of market rental parameters. There is room for rental to be generous or modest within market levels.
[64] It is necessary to assess the allegation of breach of fiduciary duty against this background. In equity partners owe to each other a duty of the utmost good faith. It was stated by Vice Chancellor Bacon in Helmore v Smith:[13]
[13] Helmore v Smith (1886) 35 Ch.D 436, 444.
If fiduciary relation means anything I cannot conceive a stronger case of fiduciary relation than that which exists between partners. Their mutual confidence is the lifeblood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust each other that the business goes on.
The general obligation is reflected in the terms of the Partnership Act 1908 in ss 32 and 33, where it is stated that partnerships are to account for private profits and not to compete with the firm. In particular, s 32 provides:
32 Partners to account for private profits
(1) Every partner must account to the firm for any benefit derived by him without the consent of the other partners from any transaction concerning the partnership, or from any use by him of the partnership property, name, or business connection.
(2)This section applies also to transactions undertaken after a partnership has been dissolved by the death of a partner, and before the affairs thereof have been completely wound up, either by any surviving partner or by the representatives of the deceased partner.
[emphasis added]
[65] Mr Stewart relied on the observation of Blanchard J who also gave reasons for Tipping and Gault JJ in Stevens v Premium Real Estate Limited,[14] that an informed consent is one which is given in the knowledge that there is a conflict of interest between the parties. Blanchard J stated that the burden of proof of adequate disclosure is on the breaching party, and that the innocent party “… would need to have been told enough to appreciate that a real conflict of some kind existed”.[15]
[14] Stevens v Premium Real Estate Limited [2009] NZSC 15; [2009] 2 NZLR 584.
[15] At [72].
Mr Stewart also relied on the decision of Potter J in Rusher v Owen.[16] That case
[16] Rusher v Owen HC Auckland AP 17-SW99 9 June 1999.
concerned a company director who had purchased the company’s premises and charged the company a rental in excess of market. He was found liable to compensate the company for the amount charged in excess of market rental. Potter J observed that the fact that rental was paid without complaint was not an answer to
the breach of fiduciary duty. The company and the other directors did not have information before them which indicated that the rental was over-market, and only found out at a later point when the situation was fully investigated.
[66] While the duty to account for profit can be avoided by consent, it is undoubtedly essential that a partner makes full disclosure of his interest to his co- partners before that consent is effective. Thus in Dunne v English,[17] the claimant knew that the defendant had some interest in the purchase beyond his share of a known profit of £10,000, but he did not know what that interest was and the real position was concealed from him. It was held following a long line of authority that
[17] Dunne v English (1874) 18 Eq. 524.
the defendant, being the claimant’s partner and expressly entrusted with the conduct of the sale, was bound to make full disclosure of the true facts. Having failed to do so he could not exclude the claimant from his due share of the profits realised on the sale. Thus, I accept that nothing less than full disclosure is required for any consent to be effective.
[67] In considering breach of fiduciary duty it is, however, necessary to bear in mind the words of Fletcher Maulton LJ in Re Coomber: Coomber v Coomber,[18] where he observed that:
[18] Re Coomber: Coomber v Coomber [1911] 1 Ch.D 723, at 739.
There is no class of case in which one ought more carefully to bear in mind the facts of the case … than cases which relate to fiduciary and confidential relations and the action of the court with regard to them.
As Deane J stated in Chan v Zacharia:[19]
[19] Chan v Zacharia (1984) 154 CLR 178, at 204.
Many of the statements of general principle requiring a fiduciary to account for a personal benefit or gain are framed in absolute terms – ‘inflexible’,
‘inexorably’, ‘however honest and well-intentioned’, ‘universal application’
– which sound somewhat strangely in the ears of the student of equity and which are to be explained by judicial acceptance of the inability of the
courts, ‘in much the greater number of cases’, to ascertain the precise effect
which the existence of a conflict with personal interest has had upon the performance of fiduciary duty: see per Lord Eldon, Ex parte James; per
Rich, Dixon and Evatt JJ, Furs Ltd v Tomkies. The principle is not however
completely unqualified. The liability to account as a constructive trustee will not arise where the person under the fiduciary duty has been duly authorised, either by the instrument or agreement creating the fiduciary duty
or by the circumstances of his appointment or by the informed and effective assent of the person to whom the obligation is owed, to act in the manner in which he has acted.
[68] A partner who has a disclosed interest in assets used by the partnership, separate from that of the firm, is not estopped by that relationship from exercising all the rights and powers arising from that other interest. In Brenner v Rose,[20] a partnership had been trading in partnership and leased premises. One of the partners acquired the leasehold reversion. The partner landlord’s right to possession and recovery of rent was held to be not “whittled away” by the mere fact that he was one of the partners. Brightman J stated:[21]
[20] Brenner v Rose [1973] 1 WLR 443.
[21] At p 447.
I do not see that the defendant’s fiduciary capacity as a member of a partnership which includes the benefit and burden of the under-lease raises any sort of equity which should be allowed to prevent him from exercising the rights as landlord which he would have had if he were a stranger to the partnership.
[69] In Geltch v McDonald,[22] the plaintiff and defendants had been partners, owning a hotel business. The defendant partners acquired the property during the course of the partnership to the knowledge of the plaintiff. After a disagreement, the defendant partners served a notice purporting to terminate the lease to the partnership. Brereton J found that the contractual provisions contained in the lease circumscribed the scope of the fiduciary obligation, and that the partner lessors’ fiduciary obligations did not require them to subordinate their interests to those of
[22] Geltch v McDonald [citation].
the partnership.[23] The fact that the effect of terminating the lease was that certain
[23] At [51].
benefits in the partnership would revert to the freehold, for the benefit of the landlord lessors, did not prevent the landlord lessors from preferring their own separate interests to those of the partnership (although it was relevant to that conclusion that the contractual provisions required the partners as lessee to obtain and maintain the benefits for the benefit of the lessors).
[70] These decisions indicate that while there is a need for there to be clearly understood rules in relation to fiduciary relationships, flexibility is demanded particularly where experienced and mature commercial persons in a fiduciary
relationship accept, as they have here, that some of the fiduciaries may profit from the relationship. There is a danger in an overly rigid approach. As Deane J observed in the Australian High Court decision Chan v Zacharia:[24]
[24] At 204.
One cannot but be conscious of the danger that the over-enthusiastic and unnecessary statement of broad general principles of equity in terms of inflexibility may destroy the vigour which it is intended to promote in that it will exclude the ordinary interplay of the doctrines of equity and the adjustment of general principles to particular facts and changing circumstances and convert equity into an instrument of hardship and injustice in individual cases.
[71] Here the position was that there was full disclosure of the nature of the Short
& Co. landlords’ interest and that they would be making a profit, at the outset. They were the landlord and leasing the premises to the firm for a profit. There was no duty on the Short & Co. partners to appraise themselves on a continuous basis thereafter of the true market value and ensure that there was disclosure if anything more than the market value was charged. There is no principle that where a partner with the consent of the others provides a service for a profit to the partnership, that the exact extent of the profit-maker’s profit must be continuously disclosed. This would be unreasonable and impracticable, particularly in the area of a professional law partnership. The position may have been different if the Short & Co. partners knew that the rent was in excess of market rent and did not disclose this to Mr Gray, or were privy to some information, such as a valuation, indicating that they were profiting over and above the market rent, which they did not disclose. However, there is no evidence of this. It does not seem that the Short & Co landlords knew what the market rental was. Nor was there any duty on the Short & Co. partners to ensure, without more, that the rental was a market rent.
[72] The position can be distinguished from that in Rusher v Owen, where the other directors did not appear to have been commercially aware. Mr Gray can hardly be regarded as a vulnerable person, given that he was a practising solicitor successfully running a significant practice, and that his wife had a share in the ownership of the Takanini property for a period. There is nothing in the circumstances of the firm paying the rental, accepting that it was somewhat above
market, that offends the conscience. If the Short & Co. partners had failed to reveal to Mr Gray relevant information about the rental they may well have been in breach of fiduciary duty. If they had known that the rental was distinctly over-market they may have had a duty to pass on that information. But in the actual circumstances, there was no breach of fiduciary duty by the second plaintiffs to Mr Gray.
Result
[73] Short & Co. succeed (although not to the extent claimed) on their claim for the repayment of the advance of $44,600, and are entitled to interest at the maximum rate permitted by the Judicature Act 1908 that applied for any given month throughout the period from 21 March 2008. This will include a change to coincide with the interest rate on 1 July 2008. They fail in their claim for goodwill. For the reasons given, I conclude that there was no breach of fiduciary duty by them to Mr Gray. Therefore, the counterclaim does not succeed.
[74] This is an interim judgment. Work in progress is still an issue. I refrain from entering judgment for any sum at this point, and the parties have leave to apply for further orders.
Costs
[75] Costs are reserved. Both parties have achieved a measure of success, particularly when the compromises achieved during the course of the hearing are taken into account. It may be that the appropriate result is for costs to lie where they fall. If the parties wish to pursue costs they should agree a timetable and file submissions.
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Asher J
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