FEDERAL COURT OF AUSTRALIA

P.E. Kafka Pty Ltd (ACN 000 075 758) v The Hermitage Motel Pty Ltd (ACN 113 674 990) [2009] FCAFC 94

TRADE PRACTICES – reliance upon misleading representation – whether misleading representation must be sole cause of loss and damage – method of assessment of damage

Fair Trading Act 1987 (NSW) s 42

Federal Court of Australia Act 1976 (Cth) s 51A

Trade Practices Act 1974 (Cth)ss 52 and 82   

APIR Systems Ltd v Donald Financial Enterprises Pty Ltd [2009] FCAFC 45 cited

Elsinora Global Ltd v Deputy Commissioner of Taxation (2006) 155 FCR 413 cited

Gates v City Mutual Life Assurance Society Ltd (1986) 160 CLR 1 cited

Golden West Refining Corp Ltd v Daly Laboratories Pty Ltd (1995) ATPR 41-378 cited

Hermitage Motel Pty Ltd v P.E. Kafka Pty Ltd [2008] FCA 442 affirmed

Hermitage Motel Pty Ltd v P E Kafka Pty Ltd [2008] FCA 483 affirmed

HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd (2004) 217 CLR 640 followed

I & L Securities Pty Ltd v HTW Valuers (Brisbane) Pty Ltd (2002) 210 CLR 109 followed

Lactos Fresh Pty Ltd v Finishing Services Pty Ltd (No 2) [2006] FCA 748 cited

Marks v GIO Australia Holdings Pty Ltd (1998) 196 CLR 494 cited

Potts v Miller (1940) 64 CLR 282 followed

P.E. KAFKA PTY LTD (ACN 000 075 758), SOVEREIGN INNS PTY LTD (ACN 001 226 937), WARWICK DOWLING NOTT, MEGAN JANE NOTT, TONI GILCHRIST, DILWYNIA ESTATE PTY LTD (ACN 000 262 537)and MONICA GARDINER v THE HERMITAGE MOTEL PTY LTD (ACN 113 674 990)

NSD 596 of 2008

RYAN, GORDON and FOSTER JJ

13 AUGUST 2009

SYDNEY

THE COURT ORDERS THAT:

1.                  The Appeal be dismissed.

2.                  The Appellants pay the Respondent’s costs of the Appeal.

Note:    Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using eSearch on the Court’s website.

REASONS FOR JUDGMENT

THE COURT:

INTRODUCTION

1                     The Sovereign Inn at Muswellbrook in New South Wales was put up for sale in February 2005.  The occupation rate, revenue and net profit figures disclosed by the vendor companies (P E Kafka Pty Ltd and Sovereign Inns Pty Ltd), the directors of the vendor companies (Warwick Dowling Nott and Megan Jane Nott), the manager of the Inn (Toni Gilchrist) and the vendors’ accounting company and accountant (Dilwynia Estate Pty Ltd and Monica Gardiner) were false.  Hermitage Motel Pty Ltd (“the purchaser”) purchased the Sovereign Inn for $2,050,000.  Contracts were exchanged on 18 May 2005.  Settlement took place on 6 June 2005.  The trial judge found, that by reason of the false figures, the purchaser was induced to purchase the Inn.  The Court assessed the main component of damages as the difference between the purchase price ($2,050,000) and the value of the Inn at the time of contract ($1,600,000).  There were some additional heads of consequential damage which are not the subject of appeal.  They may be put to one side.

2                     The appellants contend that the orders of the trial judge should be set aside or varied.  Their principal ground of complaint is that the purchaser did not suffer any loss and therefore should not be entitled to any compensation.  The other grounds of appeal concerning the question of reliance and interest were not abandoned but were not developed in oral argument.  It is necessary first to deal with the issue of reliance.

RELIANCE – APPEAL GROUNDS 1 AND 5

3                     The trial judge approached the question of reliance on the basis that:

 “[i]t [was] accepted that … [the purchaser] was induced to purchase the Sovereign Inn Muswellbrook Motel at Muswellbrook in New South Wales by misleading misrepresentations as to occupation rate, revenue and net profit for which the [named respondents] are responsible. … After taking over the motel, the true records of the trading of the motel for a period prior to purchase were discovered.  There was a large gap between representation and reality.  A comparison is as follows:

4                     His Honour then went on to deal with the evidence of Mr Draper, the principal of the purchaser, and his discussions on 16 March 2005 with Toni Gilchrist, the relieving manager at the Inn.  His Honour found that Ms Gilchrist had confirmed the figures in an advertising brochure and accepted that Mr Draper believed her.  Moreover, the trial judge found that Mr Draper’s version of his dealings with Ms Gilchrist on 16 March 2005 had been corroborated in significant respects by a Mr Brislee.  Mr Brislee was a licensed business agent retained by the vendors to the sell the Inn.

Ground of Appeal 1

5                     In their Further Amended Notice of Appeal, the appellants contended that the “correct finding” would have been that the purchaser did not rely upon the “misrepresentations per se” when entering into the contract to purchase the Inn:  the first ground of appeal.  Exactly what was meant by relying on the “misrepresentations per se” was not explained.  As noted earlier, the trial judge proceeded on the basis that it was accepted that the purchaser had been induced to purchase the Inn by the misrepresentations alleged.  In other words, his Honour accepted or assumed reliance by the purchaser on the representations which he found to have been made.  Although the appellants contended that the trial judge should not have proceeded on this basis, no argument was advanced in amplification of that contention.  The appellants simply denied that such a concession had been made without explaining why his Honour erred in accepting or assuming reliance.  The respondents submitted that his Honour was entitled to proceed on that basis because, during oral submissions at trial, Counsel for the appellants had stated that the “relevant…question for the court is what loss was suffered, nothing else, in our submission.”  This was not refuted.  It is therefore unsurprising that his Honour’s reasons proceeded from the premise that reliance was not in issue and turned to the question of damage: see APIR Systems Ltd v Donald Financial Enterprises Pty Ltd [2009] FCAFC 45 at [56].

6                     Moreover, the assertion that there was no reliance on the “misrepresentations per se” appears to stem from the misconception that, under the Trade Practices Act 1974 (Cth) (“the Act”), the misleading conduct must be the sole cause of the loss and damage.  It need not be.  It is sufficient if the contravening conduct was a cause of the loss and damage:  see I & L Securities Pty Ltd v HTW Valuers (Brisbane) Pty Ltd (2002) 210 CLR 109 at [33] (per Gleeson CJ), [57] (per Gaudron, Gummow and Hayne JJ) and [216] (per Callinan J) and the authorities cited. 

7                     Mr Draper, the principal of the purchaser, considered the misleading figures in the advertising brochure.  Mr Draper believed the figures in the brochure to be accurate.  He also was told by Ms Gilchrist that the figures in the brochure were accurate and he believed her and he believed the accountant’s certification of the accuracy of the figures.  On the basis of the figures in the advertising brochure, Mr Draper decided to proceed with the contract.  The appellants’ liability under the Act is not diminished by reason of the purchaser having made its own enquiries, the purchaser having obtained a due diligence report from a firm of accountants or by the disclaimers in the advertising brochure, the valuation report and the contract of sale.  None of those matters denied the fact that the misleading figures were, at the very least, a cause of the purchaser’s loss and damage.  The first ground of appeal fails.  No appellable error was identified. 

Ground of Appeal 5

8                     The fifth ground of appeal is related to the first.  The complaint is that the trial judge erred in concluding that the evidence of Mr Draper about his dealings with Ms Gilchrist was corroborated in significant respects by Mr Brislee and, as a result, the trial judge should not have concluded that, in breach of s 42 of the Fair Trading Act 1987 (NSW) (“the FTA”), Ms Gilchrist had misrepresented to Mr Draper that the occupancy rate for the Inn was 45%.  This ground of appeal also fails. 

9                     The case pleaded against Ms Gilchrist must be borne steadily in mind.  It was that Ms Gilchrist had misrepresented to Mr Draper that the occupancy rate for the Inn was 45%.  No other representations were pleaded.  Much of the parties’ submissions on appeal were directed at other matters allegedly discussed between Mr Draper and Ms Gilchrist.  They may be put to one side.

10                  In relation to the pleaded case, Mr Draper’s evidence was that Ms Gilchrist had confirmed that the occupancy rate for the Inn shown in the brochure for 2004 was accurate.  Ms Gilchrist’s evidence in chief was that, when Mr Draper asked her about the figures, Mr Brislee had said that questions about figures should be directed to him or Mr and Mrs Nott and that, when Mr Draper specifically asked her about the figures in the brochure, she replied saying that she did not know.  During cross examination, Ms Gilchrist accepted that when she met Mr and Mrs Draper, she had been working at the Inn for about five years and was aware of the occupancy rate from being on reception. 

11                  Mr Brislee’s evidence was that on 16 March 2005 he and Mr and Mrs Draper inspected the Inn accompanied by Ms Gilchrist.  During that inspection, Mr Brislee recalled Ms Gilchrist telling Mr Draper that the Inn had been trading “really well” and Mr Draper reporting to him that Ms Gilchrist had said that the Inn was running in line with the figures.  The occupancy figure represented in the advertising brochure was 45%.

12                  As this summary of the evidence discloses, there is no basis for contending that the trial judge erred in concluding that Mr Draper’s evidence of his dealings with Ms Gilchrist was corroborated in significant respects by Mr Brislee.  The only relevant issue concerned the occupancy level and Mr Brislee’s evidence corroborated Mr Draper’s evidence in that respect.  The appellants have failed to demonstrate any appellable error.  This ground of appeal fails.

VALUATION – APPEAL GROUNDS 2, 3 AND 4

13                  These grounds of appeal concern the method of calculating the purchaser’s loss and damage. 

14                  At trial the appellants advanced various arguments about the methodology to be adopted.  These arguments were not pursued on appeal.  The rules to be applied in assessing the loss or damage to be awarded under s 82 of the Act (or its equivalent provision in the FTA) were not in dispute:  see HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd (2004) 217 CLR 640 at [35] (judgment of the Court) and Potts v Miller (1940) 64 CLR 282 at 289-290 (per Starke J) and at 297-300 (per Dixon J) especially at 298. 

15                  If a person is induced by misrepresentation to buy an article, the purchaser is entitled only to recover the difference between the value as represented and the real value at the time the article was bought:  HTW Valuers (Central Qld) 217 CLR 640 at [35] and Potts v Miller 64 CLR 282 at 298.  If the article subsequently becomes destroyed or damaged while in the possession of the purchaser, the damage recoverable does not change.  The purchaser cannot add to the claim for damage any deterioration in value of the article brought about by some supervening cause.  Consistent with that “rule”, if the subsequent deterioration in the article is attributable to a defect inherent in the article itself, then that inherent defect is reflected in the real value of the item at the time of acquisition:  HTW Valuers (Central Qld) 217 CLR 640 at [40] and Potts v Miller 64 CLR 282 at 298. 

16                  However, those “rules” are not inflexible, universal or rigid:  HTW Valuers (Central Qld) 217 CLR 640 at [35].  First, the loss is the difference between the price paid and the “real value”, not the market value:  HTW Valuers (Central Qld) 217 CLR 640 at [36] and [37] and the authorities cited.  Secondly, in the assessment of compensation in some circumstances, subsequent events may be taken into account for no other reason than that it is the duty of an arbitrator or tribunal in determining compensation to have regard to facts instead of conjecture:  HTW Valuers (Central Qld) 217 CLR 640 at [39] and the authorities cited.  In other words, if an event about which a guess or estimate would otherwise have to be made has in fact occurred, the arbitrator or tribunal should not guess or estimate but should set out the established fact.

17                  Of course, the burden lies on the claimant to prove that the article acquired was, at the time of purchase, of less value than the amount paid:  Potts v Miller 64 CLR 282 at 299.  If a claimant cannot discharge that burden, the action fails. 

18                  Against that background it is necessary to turn to consider the approach of the trial judge and the relevant grounds of appeal. 

19                  The trial judge assessed the question of compensation at the time of contract.  On appeal, there was no dispute that this was the correct approach.  The evidence led at trial in fact related to the date of completion but there was no suggestion that the value of the Inn had changed between the date of contract and date of completion. 

20                  Next, the trial judge accepted that the purchaser’s loss was to be calculated by deducting the true value of the Inn from the purchase price paid ($2,050,000).  It was common ground that the true value of the Inn was to be assessed by capitalisation of the annual net return of the Inn and that the formula to be applied (Hermitage Motel Pty Ltd v P.E. Kafka Pty Ltd [2008] FCA 442 at [7]) was:

100 ÷ capitalisation rate × net return = value

21                  Two valuers were called.  The appellants called Mr John Drewitt Smith.  The purchaser called Mr Ron Roberts.  They disagreed about each integer – the capitalisation rate and the annual net return.  Much of the appellants’ argument on appeal proceeded from the premise that the trial judge should have, but had not, chosen between the competing views expressed by the experts.  That is not right.  The fundamental question for the trial judge was what loss or damage had been suffered by conduct of another person which contravened one of the identified provisions of the Act: Marks v GIO Australia Holdings Pty Ltd (1998) 196 CLR 494 at [38] (per McHugh, Hayne and Callinan JJ).  In other words, the trial judge was required to determine “the appropriate measure of damages recoverable by a plaintiff who suffers loss or damage by conduct done in contravention of [the Act]”: Gates v City Mutual Life Assurance Society Ltd (1986) 160 CLR 1 at 11 (per Mason, Wilson and Dawson JJ).  That question was to be answered having regard to the expert evidence adduced but not necessarily merely by choosing one or other of the views expressed.

Capitalisation rate

22                  The trial judge described the capitalisation rate as the “rate of return from a business that a purchaser seeks to achieve from the capital outlaid on the purchase of a business”:  Hermitage Motel Pty Ltd v P.E. Kafka Pty Ltd [2008] FCA 442 at [15].  As the trial judge recorded (at [16]), the capitalisation rate of the purchase price in fact paid by the purchaser on the basis of represented figures was known – it was 15%.  Mr Roberts adopted the same capitalisation rate – 15%.

23                  Mr Drewitt Smith adopted a capitalisation rate of 12.75% on the basis that the most directly comparable sales supported a capitalisation rate of between 12.25% and 12.5% but then selected a higher rate to reflect the fact that the Inn was then underperforming and the time required by an alternative operator to improve occupancy and overall profitability:  see Hermitage Motel Pty Ltd v P.E. Kafka Pty Ltd [2008] FCA 442 at [18].

24                  The trial judge selected a capitalisation rate of 12.5% on the basis that if the actual results had been known by an informed purchaser, that purchaser would have recognised the possibility of correcting the downturn by better management and would therefore have been prepared to accept a lower capitalisation rate.  As the trial judge noted (Hermitage Motel Pty Ltd v P.E. Kafka Pty Ltd [2008] FCA 442 at [20]), adopting a lower capitalisation rate would result in an informed purchaser being willing to pay more for the Inn.

25                  As will be apparent, the capitalisation rate selected by the trial judge was more favourable to the appellants than that advanced by their own expert.  None of the appellants’ written or oral submissions sought to challenge the capitalisation rate selected by the trial judge.  No appellable error has been identified.

Annual net return

26                  The last integer is the annual net return.  In a straightforward acquisition of a business with a trading history, ascertaining the annual net return is usually a mechanical accounting exercise in identifying the trading results and calculating the annual net return.  The two valuers and the judge adopted different approaches.

27                  Mr Drewitt Smith had the actual trading figures for the years ended 30 June 2002 and 30 June 2003.  He was not provided with, and therefore did not rely upon, the actual trading figures for the period from 1 July 2004 until completion.  His approach was to reconstruct the trading figures for the period from 1 July 2004 until completion by taking the actual trading figures for the years ended 30 June 2002 and 30 June 2003 and adjusting those results upwards by 8.5%.  He arrived at an estimated annual net profit before tax of $261,841:  see Hermitage Motel Pty Ltd v P.E. Kafka Pty Ltd [2008] FCA 442 at [9].  Mr Drewitt Smith sought to justify his approach on the basis that a fire had occurred in the restaurant of the Inn on 26 May 2003.  As a result of the fire, Mr Drewitt Smith assumed, the restaurant had been closed until 28 October 2003 which had seriously affected patronage and revenue. 

28                  On the other hand, to calculate the net annual return, Mr Roberts selected the 50 week period from November 2003 to October 2004 for which the primary records maintained by the vendors were available.  That 50 week period included summer and winter seasons and holiday periods.  Mr Roberts arrived at an annual net return of $159,023.

29                  Unsurprisingly, the trial judge rejected both approaches.  His Honour took the actual results for the period from 1 July 2003 to May 2005 as reflecting the actual and sustainable results.  As the chart at [3] above records, the net profit since 2003 had declined.  His Honour determined that “speculation” about whether there was some credible explanation for the decline from earlier periods did not permit the actual profit figures to be adjusted.  Rather, his Honour concluded, that was an issue to be assessed in the selection of the appropriate capitalisation rate:  see [24] above.  His Honour’s calculation of the annual net return involved taking the actual net profit figure for the 2004/2005 financial year ($196,088) as the maintainable annual profit and rounding it up to $200,000.  The resulting value of the Inn was $1,600,000.

30                  The appellants criticised the approach of the trial judge.  They contended that the trial judge should have adopted as preferable the method of valuation used by Mr Drewitt Smith.  The appellants contended that it was not open to the trial judge to accept Mr Roberts’ approach as it was contrary to “Professional Practice” as recorded in International Valuation Guidance Notes published by the Australian Property Institute and the Property Institute of New Zealand.  We reject the appellants’ contentions.

31                  As noted earlier, the question on appeal is whether the trial judge erred in arriving at an annual net return of $200,000.  For the appellants to succeed, they had to demonstrate that the trial judge had erred in selecting an annual net return of $200,000 and, in fact, should have selected a higher annual net return.  There was no basis for selecting a higher annual net return. 

32                  The actual net profit figures for the 2002 ($268,683), 2003 ($267,736) and 2004 ($172,927) financial years showed a decline in annual net profit.  His Honour’s approach in selecting $200,000 as the annual net return at the time of purchase by the purchaser was both reasonable and, in our view, appropriate.  It was a figure consistent with the evidence of the value of the Inn at the time of sale. 

33                  The actual net profit figures for the 2005 and 2006 financial years were $196,088 and $196,357 respectively.  As those figures indicate, there was some improvement in net profit for the period after the sale but those figures reflect the intervening actions of the new management (see the principles outlined at [14] to [17] above) and, in any event, were not greater than $200,000.  The conclusions explained at [21] to [33] above demonstrate that grounds of appeal two to four must fail.

INTEREST – APPEAL GROUND 6

34                  This ground of appeal fails from the outset.  The appellants advanced no written or oral submissions in support of this ground of appeal despite the respondent directly addressing it in both its written and oral submissions.  However, putting to one side the appellants’ failure to pursue this ground of appeal and assuming, in their favour, that it was not abandoned, we can identify no appellable error. 

35                  The amended ground of appeal stated that “his Honour erred in allowing interest from the date of the adjournment of the proceedings in November 2006 to the date of the orders”.  The proceeding was originally fixed for trial on 27 November 2006.  On the Friday before the proceeding was to commence, the appellants foreshadowed that they would be raising a new argument during the hearing.  The respondent sought an adjournment.  His Honour granted it.  According to his Honour, through no fault of the respondent, the matter did not come on for hearing for some months.  In his written reasons, his Honour determined that the costs of the adjournment be costs in the application and those costs then followed the substantive judgment.  When judgment was delivered on 4 April 2008 (noting that final orders were not made until 9 April 2008 as his Honour heard from the parties regarding the form of those orders), his Honour indicated that interest on the judgment should “run for the full period” – in other words in assessing damages, the assessment included interest until the date of judgment and not merely until the date when the hearing was first adjourned – 27 November 2006. 

36                  The power to award interest in a Federal Court proceeding is conferred by s 51A of the Federal Court of Australia Act 1976 (Cth) (“the FCA”).  Section 51A of the FCA relevantly provides that the Court shall upon application, unless good cause is shown to the contrary, order interest upon the sum for which judgment is given for “the whole or any part of the period between the date when the cause of action arose and the date as of which judgment is entered”.  In short, there exists a discretion to award interest for only part of the period over which a proceeding is pursued: see Golden West Refining Corp Ltd v Daly Laboratories Pty Ltd (1995) ATPR 41-378; Elsinora Global Ltd v Deputy Commissioner of Taxation (2006) 155 FCR 413 at [63].  The discretion is broad: see Lactos Fresh Pty Ltd v Finishing Services Pty Ltd (No 2) [2006] FCA 748 at [114]-[116].

37                  For this ground of appeal to succeed it would need to be demonstrated that his Honour failed to properly exercise the discretion conferred by s 51A of the FCA.  We can identify no such failure.  As explained by his Honour in Hermitage Motel Pty Ltd v P E Kafka Pty Ltd [2008] FCA 483 at [3] to [5], the need for the adjournment was justified given the actions of the appellants, any ensuing delay was no fault of the respondent and therefore an award of interest should run for the whole period.  There is nothing to suggest that the exercise of the discretion miscarried: see also APIR Systems Ltd v Donald Financial Enterprises Pty Ltd [2009] FCAFC 45 at [75]-[77].  This ground of appeal fails.

ORDERS

38                  For these reasons, we would dismiss the appeal and order the appellants to pay the respondent’s costs of the appeal.  

Associate:

Dated:         13 August 2009