Vaucluse Holdings Limited v Fruehauf Pacific Limited

IN THE COURT OF APPEAL OF NEW ZEALAND

CA237/99

BETWEEN	VAUCLUSE HOLDINGS LIMITED
First Appellant

AND	FRUEHAUF PACIFIC LIMITED
Second Appellant

AND	NEW ZEALAND GUARDIAN TRUST LIMITED
Respondent

Hearing:	12 April 2000
Coram:	Blanchard J McGechan J Young J
Appearances:	M A Gilbert for Appellants J O Upton QC for Respondent
Judgment:	20 April 2000

JUDGMENT OF THE COURT DELIVERED BY BLANCHARD J

This is an appeal against summary judgment entered in favour of the respondent, against the appellants Vaucluse Holdings Ltd (“Vaucluse”) and Fruehauf Pacific Ltd (“Fruehauf”) in respect of their respective liabilities as guarantors of the obligations of Mr B N Lindsay by virtue of deeds of guarantee and indemnity dated, in the case of Fruehauf, 2 December 1994 and, in the case of Vaucluse, 5 July 1995.
Gary Innes Domett was the owner of 60% of the shares of Fruehauf which is a heavy road trailer manufacturing company based in Feilding. Mr Lindsay held the other 40%. Mr Domett had been the managing director of Fruehauf until 1988 and had since been a non-executive director and also acted as a consultant. He and Mr Lindsay had fallen out. Both were interested in selling. In mid 1993 the firm of Milloy Reid Wong & Co Ltd (“Milloy Reid”) had been approached for assistance in selling their shares in Fruehauf but by the middle of 1994 no progress had been made.
Shortly before the events with which this judgment is concerned Mr Domett transferred his shares to a family trust of which New Zealand Guardian Trust Ltd (“NZGT”) was appointed the trustee. The trust was known as the Innes Trust. Mr Mahoney, Wellington Regional Manager of NZGT, then replaced Mr Domett as a director of Fruehauf.
In June 1994 Mr Lindsay suggested to Mr Milloy that his firm should acquire 80% of the shares in Fruehauf on the basis that Mr Lindsay was able to acquire Mr Domett’s 60% interest. Mr Domett says he knew nothing of this development.
On 26 August 1994 NZGT entered into an agreement to sell the 60% shareholding to Mr Lindsay along with Mr Domett’s shareholder advances to Fruehauf of $518,000. The total consideration was $2,470,000 ($3.25 per share). The agreement was conditional upon due diligence and an audit report as at 31 August 1994 by Ernst & Young. Prior to that time the accounts had not been subject to audit.
As contemplated by the agreement, Ernst & Young supplied Mr Milloy’s firm and the parties with audited financial statements in September 1994. They showed that the net earnings after tax were lower than, but reasonably consistent with, earlier years’ unaudited earnings. But the figures were significantly lower than had been forecast by Messrs Domett and Lindsay. There was also revealed a cash payment to Messrs Domett and Lindsay of which Mr Milloy’s firm had not previously been made aware.
In the light of this information Mr Milloy was not willing to proceed with the agreement of 26 August. Negotiations and an exchange of correspondence ensued and it was agreed on 7 November 1994 that the share price would be decreased to $3.10 per share.
On 2 December 1994, accordingly, several agreements were entered into. In the first of them NZGT sold its 60% shareholding to Mr Lindsay together with Mr Domett’s shareholder advances. The total price was $2,378,000 including those advances. In the second agreement Mr Lindsay sold to Vaucluse, a company associated with Milloy Reid, 80% of the shares in Fruehauf together with all shareholder advances made by himself and Mr Domett. The total price payable by Vaucluse to Mr Lindsay was $3,272,000.
The third agreement was a term loan contract under which Mr Lindsay borrowed from NZGT the sum of $1,378,000. Fruehauf was a party to this agreement as a covenantor. It also executed a fourth document, a deed of guarantee and indemnity to NZGT in respect of Mr Lindsay’s indebtedness, and this obligation was secured by a deed of debenture over the assets of Fruehauf. Both the guarantee and indemnity and the debenture charge were provided for in the first agreement, namely that under which NZGT sold shares to Mr Lindsay.
There was a provision in the share sale agreement between Mr Lindsay and Vaucluse which required Vaucluse to assume Mr Lindsay’s liability for payments to NZGT and to give a guarantee to NZGT of the performance by Mr Lindsay of his obligations under the loan agreement. An approach was made to NZGT by Vaucluse but execution of a guarantee document by Vaucluse was delayed for several reasons, the principal of which appears to have been the need to re-register Fruehauf under the Companies Act 1993. The deed of guarantee and indemnity by Vaucluse was finally executed on 5 July 1995, the parties being Vaucluse as guarantor, Mr Lindsay as borrower and NZGT as lender.
In the meantime on 23 December 1994 Ernst & Young advised Vaucluse that the net asset position of Fruehauf was worse than had been understood on 2 December. The Milloy Reid interests took the view that this gave rise to breaches of warranty by Mr Lindsay under his agreement with Vaucluse. A settlement was reached between Vaucluse and Mr Lindsay on 8 March 1995.
In October 1995 Ernst & Young supplied further information showing that the net profit for the twelve month period ended 31 August 1994 had been a great deal less than had previously been thought (as disclosed on 23 December 1994), with consequent further reduction in the shareholders’ equity as at that date. Mr Milloy says that, as a result of the failure of Ernst & Young to report the correct figures, all the parties had acted on a mistaken basis in entering into the various agreements, which he says are all inter-related.
Vaucluse proceeded to sue Ernst & Young for negligence but that claim was settled in December 1998 with a payment by Ernst & Young to Vaucluse of $1.35 million. Vaucluse also sued Mr Lindsay and obtained judgment against him for $904,414.56. That amount has not been paid.
In the meantime the term loan agreement had obligated Mr Lindsay to make 10 six monthly instalments of $171,548 commencing on 30 May 1995. Those payments were duly made by Vaucluse on behalf of Mr Lindsay until the instalment of 30 May 1998 fell due. At the request of Vaucluse, made on behalf of Mr Lindsay, NZGT agreed to defer that payment until 30 November 1998. A further request from Vaucluse for another deferral of that instalment and deferral of the next instalment due on 30 November was refused. Interest payments were however met by Vaucluse on behalf of Mr Lindsay up to 30 November 1998, since which time no interest has been paid.
The present proceeding, and the summary judgment application, was for the outstanding principal sum under the loan agreement of $620,699.69 together with interest thereon at 12% p.a.
Vaucluse and Fruehauf raised an affirmative defence. They said that the agreements were all inter-connected and that they, Mr Lindsay and NZGT, in their respective decisions to enter into the agreements were, in terms of the Contractual Mistakes Act 1977, all influenced by the same mistake as to the financial position and profitability of Fruehauf, namely the mistake induced by the incorrect reporting by Ernst & Young in September 1994. This mistake was said to have resulted in a substantially unequal exchange of values between NZGT and the defendants. They sought relief under the Contractual Mistakes Act in the form of an order cancelling the loan agreement, the two deeds of guarantee and indemnity and the debenture over Fruehauf’s assets.
In his reserved judgment delivered on 16 September 1999 in the High Court at Wellington Master Thomson noted affidavit evidence on behalf of NZGT that its manager, Mr Mahoney, was surprised on being told for the first time on 9 February 1999 by Mr Milloy that there was a possibility of Vaucluse bringing an action for misrepresentation against Mr Domett and also being told that Vaucluse would not be making any further payments in reduction of the loan to Mr Lindsay and that Fruehauf could not, and would not, make those payments.
Master Thomson referred to the evidence of Mr Domett that his last contact with Mr Lindsay was at the end of May 1994 and with Ernst & Young on 23 June 1994, apart from a telephone call from them on 4 November 1994. He had seen Mr Milloy on 7 July 1994 and wrote to him on 11 July and 11 October. Mr Domett left all negotiations to his solicitor, Mr Howie. As far as Mr Domett was concerned, Mr Milloy was acting on behalf of Mr Lindsay. He had personally made no representations about the financial position of Fruehauf. Mr Domett said in his affidavit that he knew the business inside out and had a price in mind. He was not influenced in any way by the financial statements prepared by Ernst & Young. He was totally unaware of the arrangements between Mr Lindsay and Mr Milloy. Mr Howie confirmed that Mr Domett was not involved in the negotiations which ultimately led to the agreements of 2 December 1994. According to Mr Howie, Mr Domett had a figure in his mind at which he would sell and it was slightly revised downwards as a result of the negotiation process. However Mr Howie said that the price of $3.10 per share was not based on advice received from Ernst & Young but on Mr Howie’s discussions with Mr Domett. It was the sale price his client was prepared to accept. Mr Howie was totally unaware until after the event that Mr Lindsay had entered into a “side deal” with the Milloy interests under which there was an on-sale of shares.
The Master thought that there was considerable force in the submission of Mr Upton QC that the defence and counterclaim amounted to a “try-on”, being raised for the first time some five years after the shares were sold. He said this, firstly, because Mr Lindsay had not made an affidavit saying that he was under any mistake as alleged by Mr Milloy when he agreed to buy Mr Domett’s shares in December 1994. Secondly, the Master said, the parties were agreed that the terms for the sale of the Domett shares were those in the “amended August agreement” i.e, that signed on 2 December 1994, which contained a provision as follows:
18.      Entire Agreement
18.1     This Agreement constitutes the entire Agreement between the parties with respect to the subject matter hereof. It supersedes and extinguishes all prior agreements and understandings between the parties with respect to the matters covered hereby and all representations or warrantees as previously given.
18.1     This Agreement may not be amended, modified or supplemented except by an agreement executed by the parties or by parties duly authorised in writing on behalf of the parties.
The Master thought it highly significant that Mr Lindsay and NZGT had contracted on an entirely different basis from that entered into by Mr Lindsay and Vaucluse. In the latter agreement Mr Lindsay had warranted as to the truth of the settlement balance sheet. The August agreement between NZGT and Mr Lindsay was not entered into in reliance “on the truth of Fruehauf’s balance sheet.” Mr Lindsay was to carry out due diligence,
Thirdly, the Master said, there was no reference in the contract between Mr Lindsay and NZGT to the contract between Mr Lindsay and Vaucluse. The Master said that there was no suggestion by Mr Milloy that Mr Mahoney and Mr Domett knew of it. It could be readily inferred that Mr Milloy and Mr Lindsay did not wish the terms of their agreement to be disclosed to the Domett interests. There was a confidentiality provision.
Fourthly, Master Thomson referred to a letter of 19 October 1994 from Mr Milloy to Mr Domett making a revised offer indicating that at that time Messrs Milloy and Lindsay did not consider the shares to be worth $3.10. They were making an amended offer of $2.47 per share on the basis of the lower level of forecast and sustainable earnings following Ernst & Young’s audit and due diligence. It was clear to the Master, however, that if Mr Domett was not going to get his price or somewhere near it, then he was simply not prepared to sell his shares. When Mr Lindsay had withdrawn his August “offer”, Mr Domett’s solicitor sought confirmation that the deal was at an end.
Fifthly, Mr Mahoney had said that there was no inter-relation between the two agreements. Sixthly, there had been a price adjustment made between Mr Lindsay and Vaucluse in March 1995 which was prior to the commitment of Vaucluse to the guarantee on 5 July 1995. This had occurred despite the fact that immediately after the December 1994 agreements were signed Ernst & Young had confessed to substantial errors in their September 1994 report. Nevertheless, Vaucluse went ahead. The fact that the accountants were to further confess in October 1995 that the position of Fruehauf was even worse did not, the Master thought, alter that position. He was satisfied that there was no merit in the purported defence.
Mr Gilbert submitted that the essence of the appellants’ case is that all parties were influenced when entering into the transactions by a common mistake about the financial position and profitability of Fruehauf (s6(1)(a)(ii) of the Contractual Mistakes Act 1977). They were all unaware that the financial statements grossly overstated shareholders’ funds and profits and that there had been negligence on the part of Ernst & Young. They had all as a consequence made a crucial mistake in agreeing to the price and thus to the amount of the loan to Mr Lindsay which was the means of satisfying part of the price and which was the subject of the two guarantees and of the security over the assets of Fruehauf. Fruehauf’s net profit for the period ended 31 August 1994 was $205,331, not $682,247 as reported by the auditors before the agreements were signed unconditionally in December 1994. The shareholders’ equity was $704,608, not $1,186,524. As a result of this error there was a substantially unequal exchange of values.
Counsel said that it is arguable for the appellants on the material now before the Court that, despite what Mr Domett and Mr Howie have said in their affidavits, they, and through them NZGT, were influenced by the audited accounts in the decision made to reduce the price from $2,470,000 to $2,378,000.
Dealing with the reasons given by the Master, Mr Gilbert said that although Mr Lindsay has not made an affidavit, he has raised the issue of mistake in a notice of opposition; the entire agreement clause does not bar an action for mistake; and it is arguable that the respondent did have knowledge of the Lindsay/Vaucluse transaction. It was submitted that the assertions by Messrs Domett and Howie of ignorance in that respect, like their assertions of not being influenced by the accounts, need to be tested by cross-examination. It was said that the negotiations were conducted on an assumed basis that the accounts fairly reflected the true position of Fruehauf and that could not have been irrelevant to Mr Domett’s thinking. Although some further errors on the part of Ernst & Young had come to light before July 1995, that was just “the tip of the iceberg”.
Mr Upton QC submitted in response that the evidence on the question of whether Mr Domett was influenced by the accounts was all to the effect that he was not, and that the Master’s conclusions were supportable. Mr Domett had a price in his mind. He was familiar with Fruehauf’s position and he paid no attention to the accounts provided by Ernst & Young during the negotiations which took place after the conditional agreement lapsed. Counsel said that the Domett interests knew in a general sort of way in 1994 that the Milloy interests might purchase some of the shares held by Mr Lindsay but had no knowledge at all of the terms of the actual agreement between Mr Lindsay and Vaucluse, which was “nothing to do with them”. There was no common mistake and no series of inter-related agreements.
We have come to the conclusion that on the current state of the evidence there remains a doubt over two crucial issues of fact. The first is whether the Domett interests, using that term to include NZGT and the solicitor, Mr Howie, who conducted the negotiations on behalf of Mr Domett and NZGT between September and November 1994, had such knowledge of what was occurring between Mr Lindsay and the Milloy interests that, in view of the provision in the Lindsay/Vaucluse contract for the latter to assume Mr Lindsay’s liability to NZGT and execute a guarantee, all the transactions should be regarded as inter-related. There is a letter to which counsel drew our attention in which Mr Milloy, writing on 11 October 1994 to both Mr Domett and Mr Lindsay, made a complaint about their having misled his company concerning the financial position of Fruehauf, which he said made the due diligence a futile exercise. The fact that he chose to write to both of these gentlemen rather suggested that he did not see himself as merely a representative of Mr Lindsay. As a recipient of the letter Mr Domett may have understood this. In making his complaint, Mr Milloy referred to the fact that Milloy Reid “were to join Mr Lindsay as a shareholder in FPL [Fruehauf]”.
Replying to this letter on 17 October 1994, Mr Howie noted that Milloy Reid had “since May of this year been acting for Mr B N Lindsay (and latterly for yourselves) in endeavouring to arrange finance to purchase the other shares”.
Clearly then it is arguable that Mr Howie knew that the Milloy interests were intending to become a purchaser from Mr Lindsay. Mr Howie’s claim that he was “totally unaware” of the “side deal” with the Milloy interests may be questioned, although it is possible that all he meant in his affidavit was that he had no knowledge of the terms of any such deal.
The second matter of factual contention is whether the Domett interests were influenced when agreeing to the lower price by the information provided by Ernst & Young. Again, the same correspondence suggests that to be a possibility, notwithstanding the strong denials. Mr Milloy’s letter of 11 October referred to the Ernst & Young audit. In the reply Mr Howie stated that the valuation of Fruehauf “has been based on a price/earnings ratio which applied to profits”. Later he referred to Milloy Reid’s continuing contact with Ernst & Young and to an approach by the Domett interests to another accountant, Mr Donald, for a second opinion on the originally agreed price ($3.25 per share). Mr Lindsay at that time had made, through Milloy Reid, a revised offer of $2.47. Mr Howie said that Mr Donald thought that $3.25 was not unrealistic as “on an earnings basis” this amounted to a PE of about three on “profits before taxation”, whereas the Milloy/Lindsay adjusted offer (and that description can also be noted) represented a PE of two and was regarded as not realistic. The references to the earnings basis and the profits before taxation must have been to the figures disclosed by the Ernst & Young audit.
In a letter again written to both Messrs Domett and Lindsay on 19 October 1994, Mr Milloy mentioned the audit several times. At one point he commented that the $2.47 per share maintained the same PE multiple “but it is applied to a lower level of earnings as a result of Ernst & Young’s audit and due diligence”.
Although when agreeing to $3.10 per share in a short letter to Mr Lindsay on 7 November 1994 Mr Howie did not mention the financial statements or Ernst & Young, there is, as the evidence now stands, room for the view that, contrary to their assertions, the Domett interests may have been affected in their thinking by what the auditors had reported. The lower results could have been a factor influencing their agreement to take a lower price. This is a matter which cannot be resolved as the evidence stands at present. Therefore if relief under the Contractual Mistakes Act could be available to the appellants in this situation, they must be taken to have an arguable defence.

There may in the end be difficulties for the appellants in relying upon s6 of the Contractual Mistakes Act but we would not be prepared to say, in advance of trial, that such will necessarily preclude a successful defence to NZGT’s claim. It was not entirely clear to us exactly how the appellants sought to bring themselves within the section so that the Court has power to grant relief under s7. It seemed that counsel’s preferred approach was to claim through Mr Lindsay on the basis that, to the extent he is not liable to NZGT, then the guarantee liability of Vaucluse and Fruehauf correspondingly is reduced. That involves looking at Mr Lindsay’s ability to obtain relief in respect of his contract with NZGT whereby he bought the Innes Trust’s shares, and in respect of the loan contract which satisfied part of the price. It appears to be open to argument that, when he signed the contracts in December 1994, Mr Lindsay was labouring under a mistake induced by the negligence of the auditors, and that NZGT and the other parties to those contracts were similarly influenced. Arguably, it is not implicit that Mr Lindsay agreed to accept the risk that a report from a third party was negligently prepared. The appellants’ pleading and their notice of opposition to summary judgment lacks something in specificity but is, we think, sufficient to raise this issue.
The alternative approach is to consider whether s6 applies directly to the contracts of guarantee and the supporting debenture. This may be more problematic because there may be a complicating factor in relation to Vaucluse (but not Fruehauf). Either at the time the December agreements were entered into or shortly afterwards (the evidence differs – compare Mr Milloy who says that in the normal course the guarantee would have been executed on 2 December 1994, with Mr Mahoney who uses the expression “subsequently” without indicating any clear reference date), the Milloy interests approached NZGT offering the guarantee by Vaucluse. They were obliged to do this by virtue of their arrangements with Mr Lindsay but, as we understand the position, NZGT itself had no right to insist upon receiving such an additional guarantee (i.e. additional to that given, arguably as a result of the common mistake, by Fruehauf). There may therefore be an issue about whether NZGT was influenced by the Ernst & Young report in becoming a party to the (volunteered) guarantee even if it had been so influenced when earlier entering into the sale contract with Mr Lindsay and the accompanying documents. It is also unclear at exactly what point Vaucluse became legally committed to giving NZGT the guarantee, though the better view on the material before the Court would perhaps be that it was not committed to do so until the guarantee was actually executed in July 1995. If that is so, then the state of Vaucluse’s knowledge about the financial position of Fruehauf had by that time altered to some extent because of the further information received from Ernst & Young during the intervening period. But if the correct position is, on the other hand, that Vaucluse became committed to NZGT when it first offered its guarantee and had that offer accepted, there is still a problem to be overcome because it can be suggested that s6(2)(b) of the Contractual Mistakes Act precludes a grant of relief:
(2) For the purposes of an application for relief under s7 of this Act in respect of any contract, -
…(b) the decision of a party to that contract to enter into it is not made under the influence of a mistake if, before he enters into it and at a time when he can elect not to enter into it, he becomes aware of the mistake but elects to enter into the contract notwithstanding the mistake.
After further disclosures from Ernst & Young on 23 December 1994 Vaucluse may have been in a position to cancel its contract with Mr Lindsay, but, instead, on 8 March 1995 it entered into a settlement with Mr Lindsay and was then obliged to proceed to give the guarantee. When this possibility was put to Mr Gilbert he argued that the crucial time under s6(2)(b) is when the decision is made to enter into the contract (which was December 1994) when the allegedly common mistake was still influencing Vaucluse. He further argued that the subsection does not apply unless the party in question “becomes aware of the mistake”, in the sense not just of being aware that there has been some kind of mistake but of knowing the whole extent of it, which Vaucluse did not until 23 October 1995 (well after execution of the deed of guarantee). If so, Vaucluse’s decision to enter into the guarantee remained in July 1995 influenced by the alleged common mistake. It is undesirable that, without having had full argument on this question, which arose only in the course of exchanges between the bench and Mr Gilbert, we should express a view on it, particularly as it may not require to be answered in the case, depending upon the way in which the appellants choose to advance their argument at trial.
It is enough for us to conclude, as we do, that in relation to the Contractual Mistakes Act the appellants have a tenable defence.
A further issue relates to letters written by Mr Milloy in 1998 to NZGT which, on the face of it, could amount to an affirmation of the loan contract and guarantee in whole or in part. But, again, the evidence relating to them is sketchy and Mr Upton did not appear to place a great deal of weight upon them in seeking to uphold the Master’s decision.
We have reached the view that it cannot be said that the appellants have no defence.
The appeal is therefore allowed and the summary judgment set aside. The appellants are to have costs on the appeal of $3,000 together with their reasonable disbursements, including travel and accommodation costs of counsel, as fixed by the Registrar.

Solicitors

Chapman Tripp Sheffield Young, Auckland for Appellants

Bell Gully Buddle Weir, Wellington for Respondent

[2000] NZCA 286

20 April 2000