FEDERAL COURT OF AUSTRALIA

Harding Investments Pty Ltd v PMP Shareholding Pty Ltd (No 3)

[2011] FCA 1370

THE COURT ORDERS THAT:

1.    The parties bring in orders to give effect to these reasons for decision by 4:00pm on 5 December 2011.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

INTRODUCTION

1    On 27 May 2011, declarations and orders were made: see Harding Investments Pty Ltd v PMP Shareholding Pty Ltd (No 2) [2011] FCA 567. In general terms, the Second Respondent, Donald Stewart Gordon (Gordon), the Third Respondent, Jashtra Holdings Pty Ltd (ACN 118 130 233) (Jashtra Holdings) and the Fourth Respondent, Paul Robert Dick (Dick) were found to have breached a Business Succession Agreement executed on 27 February 2006 by terminating the Second Applicant, Steven John Harding (Harding), as a director and employee of Lotic Pty Ltd (ACN 116 609 851) (Lotic). In addition, the First Respondent, PMP Shareholdings Pty Ltd (ACN 118 155 856) (PMP Shareholdings) and Jashtra Holdings were found to have contravened s 232 of the Corporations Act 2001 (Cth) (the Corporations Act). PMP Shareholdings and Jashtra Holdings were ordered to purchase the shares in Lotic held by the First Applicant, Harding Investments Pty Ltd (ACN 118 130 402) (Harding Investments).

2    In advance of the initial substantive hearing, both parties provided valuations of Lotic. There was a large variance between them. In addition, the parties’ submissions did not address the question of the date on which the shares should be valued. On 27 May 2011, a procedure in relation to the purchase of shares was put in place which included the following steps:

1.    by 4:00pm on 10 June 2011, the parties were to file and serve an outline of submissions, of no more than five pages, identifying the date for fixing the value of the shares in Lotic held by Harding Investments that should be struck and the reasons for choosing that date;

2.    an independent registered company auditor (the Independent Person) nominated by the President (for time being) of the Institute of Chartered Accountants (the Institute) was to inspect the books of Lotic which, in his or her opinion, may yield information pertaining to the formation of an opinion as to the value of Lotic and the value of Harding Investments’ shares in it;

3.    if, in the opinion of the Independent Person, it was necessary to do so for the purpose of the valuation, the Independent Person was appointed to restate the accounts for any period;

4.    the Independent Person was appointed by the parties to proceed to value Lotic and the shares in it;

5.    each party was entitled to provide a submission of not more than 10 pages to the Independent Person on or before 30 June 2011; and

6.    the Independent Person was to provide the valuation (the Valuation Report) by no later than 14 July 2011.

(the 27 May Orders).

3    The parties complied with paragraph 2(1) above. The Applicants submitted that the appropriate date for the valuation of Lotic’s shares was the date of the Court’s order, 27 May 2011. The Respondents submitted that the appropriate date was 15 January 2010 because the oppression commenced in January 2010. Alternatively, the Respondents submitted, that the appropriate date was no later than 13 July 2010 (the date of Harding’s removal), 30 September 2010 (the date initially proposed by the Applicants) or 8 November 2010 (the commencement of the administration of Lotic).

4    Then things went awry. In relation to paragraph 2(2) above, the appointment of the Independent Person, on 30 May 2011 the Applicants’ solicitors sent a letter to the Institute requesting that it appoint an Independent Company Auditor. No response was received. On 14 June 2011, the Applicants’ solicitors sent a further letter to the Institute which was responded to on 15 June 2011. Further communications with the Institute ensued and a cheque was sent to the Institute in payment of the Institute’s nomination fee. The Institute required the parties to sign a Deed of Release. The Applicants signed the Deed and requested that a List of Nomination be provided to the parties without delay. The Respondents were unwilling to sign the Deed of Release. The Institute would not provide the List of Nomination in the absence of the Deed of Release signed by both parties. Thus, no Independent Person was nominated and the 27 May Orders were not complied with. The parties came before the Court on 21 July 2011. The time for compliance with the 27 May Orders was extended. Shortly after that hearing, the Respondents signed the Deed of Release and the Institute nominated an Independent Person. The Institute nominated Mr Nick Burne FCA, an Audit Partner of BDO Audit (NSW-VIC) Pty Ltd, to be assisted by Mr Phillip Rundle FCA, a Director in the Forensic Services Division of BDO Corporate Finance (NSW-VIC) Pty Ltd (BDO Forensic Services). Mr Rundle then took extended leave and he nominated Mr Michael Smith, a Chartered Accountant and Director of BDO Forensic Services (Mr Smith), to take over his role of assisting Mr Burne.

5    On 4 August 2011, the parties complied with paragraph 2(5) above and provided submissions to the Independent Person. The Valuation Report was prepared by Mr Smith as the Independent Person and provided to the parties on 18 October 2011.

6    Both parties made submissions to this Court in response to the Valuation Report.

VALUATION OF LOTIC

7    As was stated in Harding Investments (No 2) at [55]:

… The Corporations Act does not identify the basis upon which the price for shares is to be fixed if an order for compulsory purchase is made. As the High Court said in Campbell v Backoffice at [178].

Although s 233(1)(d) gives the court power to make an order for the purchase of shares by a member, the Corporations Act is silent about the terms on which such a sale may be ordered. In particular, the Corporations Act does not identify the basis upon which the price for the shares is to be fixed if an order for compulsory purchase is made. Under earlier forms of the oppression provisions of companies legislation, orders were made for the compulsory sale of shares by one member to another at prices to be fixed according to various criteria. In some cases [footnote omitted] the price has been fixed at the value the shares would have had at the commencement of the proceedings but for the effect of the oppressive conduct. In other cases [footnote omitted] a date other than the date of commencement of the proceedings has been fixed. Again, there is no reason to give the present oppression provisions some narrower construction. In particular, the power given to the court by s 233(1)(d) should not be hedged about by implied limitations [footnote omitted]. …

8    It is to those questions that I now turn.

(a)    Date of valuation

9    Consistent with paragraph 3 above, before Mr Smith the Applicants submitted that the appropriate date for the valuation of Lotic’s shares was the date of the Court’s order, 27 May 2011. The Respondents submitted that the appropriate date was 15 January 2010 on the basis that the Applicants should be taken to be seeking an order for compulsory acquisition of Harding Investments’ shares from the date they were denied influence and management opportunity over the company. Alternatively, the Respondents submitted, the appropriate date was no later than 13 July 2010 (the date of Harding’s removal), 30 September 2010 (the date purportedly proposed by the Applicants) or 8 November 2010 (the commencement of the administration, when all directors were effectively excluded from management).

10    The Respondents’ overarching submission was that the Court ought not fix any date later than 30 September 2010 because:

1.    the report of Mr Lipson (an expert retained by the Applicants) furnished to the Respondents on 25 October 2010 in draft form and unchanged at the time of submission in final form on 4 March 2011, nominated 30 September 2010 as the date for fixing the value of the shares;

2.    at the substantive hearing on 2 March 2011, Counsel for the Applicants confirmed that the Applicants sought a valuation of the shares as at 30 September 2010;

3.    in reliance on the Applicants’ adoption of the 30 September 2010 date, the Respondents did not lead, but could have led, evidence from creditors that their approval of the Deed of Company Arrangement proposal submitted by the Respondents (the DOCA) was on the grounds that they were in favour of Lotic moving forward under the exclusive stewardship of Gordon and Dick as opposed to a board including Harding which was a composition that had proved no longer workable; and

4.    the Applicants must be bound by their case to prevent severe prejudice to the Respondents.

11    For the purposes of the Valuation Report, the valuation date of 30 June 2011 was selected by Mr Smith for the following reasons:

1.    the Court order for the Respondents to purchase the shares in Lotic held by Harding Investments was dated 27 May 2011;

2.     the share value should be at the closest possible date to the order to purchase date (that is, 27 May 2011);

3.    Lotic’s financial year is 30 June. Accordingly, a full year financial performance of Lotic can be utilised in determining value; and

4.    30 June 2011 is the closest possible date for which reasonable accurate financial information is available.

The Applicants submitted at this hearing that as no material distinction arises between 27 May 2011 and 30 June 2011, the date selected by Mr Smith of 30 June 2011 was appropriate.

12    The question of what date should be used to value Lotic’s shares is a matter for the Court. It is the responsibility of the Court to fix a price for the shares that represents a fair value in all the circumstances of the case: Dynasty Pty Ltd v Coombs (1995) 59 FCR 122 at 143. In Dynasty, the Court stated at 143-145 that:

… It was the responsibility of the learned trial judge to fix a price for the shares that represented a fair value in all the circumstances of the case. [The trial judge] approached that task by referring to the remarks of Lord Denning in Scottish Co-operative Wholesale Society v Meyer at 369. The relevant passage from his Honour’s reasons for judgment reads as follows:

To arrive at a fair value to be paid now by valuing the shareholding at some date in the past and by adding to that value an allowance for the fact that the shareholder has been kept out of the enjoyment of that value in the meantime, to borrow the words of Lord Denning, is to give to the oppressed shareholder ‘what is in effect money compensation for the injury done to [the shareholder]: but I see no objection to this. The section gives a large discretion to the Court and it is well exercised in making an oppressor make compensation to those who have suffered at his hands’.

The appellants complained that Lord Denning alone had addressed this notion of compensation; they said that the correct approach was that of Lord Keith of Avonholm who had said (at 364):

Lord Sorn [in the court below] has, in my opinion, approached this matter on a correct principle, by considering what would have been the value of the shares at the commencement of the proceedings had it not been for the effect of the oppressive conduct of which complaint was made.

While Lord Denning speaks of “a fair value to be paid now” and Lord Keith makes reference to the value of the shares at the commencement of the proceedings, Lord Denning essentially is describing a methodology by which the value of the shares might be assessed. The date at which shares are to be valued in oppression cases varies having regard to all relevant circumstances. The remarks of Nourse J in Re London School of Electronics Ltd [1986] Ch 211 at 224 are apposite:

If there were such a thing as a general rule, I myself would think that the date of the order or the actual valuation would be more appropriate than the date of the presentation of the petition or the unfair prejudice. Prima facie an interest in a going concern ought to be valued at the date on which it is ordered to be purchased. But whatever the general rule might be it seems very probable that the overriding requirement that the valuation should be fair on the facts of the particular case would, by exceptions, reduce it to no rule at all. That that is so is already suggested by such authorities as there are on this question. In Scottish Co-operative Wholesale Society Ltd v Meyer the shares were ordered to be purchased at the value which they would have had at the date of the petition if there had been no oppression. In Re Jermyn Street Turkish Baths Ltd [1970] 1 WLR 1042; [1971] 3 All ER 184 the order of Pennycuick J discloses that the assets, undertaking and goodwill of the company were to be valued on an inquiry as at the date of the master’s certificate. In Re A Company (No 002567 of 1982) [1983] 1 WLR 927; [1983] 2 All ER 854 Vinelott J held that the shares of a petitioner who had unreasonably rejected previous fair offers to purchase them ought to be valued at the date of the valuation and not at the date when he had been excluded from participation in the affairs of the company. However, Vinelott J said that he could conceive of many cases where, in an application under s 75, fairness would require that the valuation should relate back to an earlier date such as, in that case, the exclusion of the petitioner: see Re A Company at 937D-E; 862-863. That observation was approved by Mervyn Davies J in Re OC (Transport) Services Ltd [1984] BCLC 251 at 258, where he held that the facts required the valuation to be made at a date earlier than the date of the petition, in fact at the date when the unfair prejudice had occurred. Finally, in Re Bird Precision Bellows Ltd [1984] Ch 419 the valuation was made as at the date of a consent order that the shares should be purchased at such price as the court should thereafter determine. That case is not of any real assistance on this point, because the date was no doubt implicit in the terms of the consent order.

(Emphasis added.)

13    I see no reason to depart from the date selected by Mr Smith. Mr Smith listed the factors that influenced the date he selected. His task was to value the shares of a going concern, a going concern that Harding was “kept out of the enjoyment of”. The date selected by Mr Smith was “fair” and consistent with the authorities referred to above.

14    Before turning to the other questions, a number of matters should be noted about the way in which the parties conducted this hearing. At the commencement of it, Counsel for each party was asked to identify the evidence to be relied upon at the hearing. Other than the Valuation Report and reference to the earlier findings in Harding Investments (No 2), no additional evidence was sought to be adduced or relied upon. Counsel for the Respondents initially sought to tender a valuation report from another valuer, Mr Blashki, but ultimately withdrew the tender. That forensic choice made by Counsel meant that in the absence of other facts and matters, the Court was left with the Valuation Report to assist it in making a determination as to value in the context of the earlier reasons for decision. Put another way, there was no other valuation of the shares in Lotic at any other date in evidence.

15    Moreover, the Respondents’ forensic decision meant that the submission that they were prejudiced by the date selected by Mr Smith (and that the Applicants should not be permitted to rely upon the later date) must be rejected. As best as I could understand it, the Respondents’ complaint was that if they had known a later date was to be selected, they may have made different forensic decisions about the management and conduct of the first hearing including offers of settlement. The Respondents’ submission must be rejected because the Respondents (and the Applicants) were entitled to provide evidence and submissions to both Ms Smith and this Court on the question of the appropriate date and, if there was a case to be made, the prejudice the Respondents would suffer as a result of a later date being selected. The Respondents’ submissions (written and oral) to the Court asserted prejudice but did not adduce any evidence to support that assertion. Their submissions on this aspect are rejected.

(b)    Methodology

16    As noted above, for the purposes of the substantive hearing, both parties provided valuations of Lotic. There was a large variance between them – the Applicants’ valuer valued Lotic at $1.903 million as at 30 June 2010 and $4.42 to $5 million as at 30 September 2010, whereas the Respondents’ valuer valued Lotic at nil as at 30 June 2010 and 30 September 2010. According to the Valuation Report, that variance arose for a range of reasons including different valuation methods being applied, different beliefs in the future performance of the business and various opinions on accounting methods and adjustments to determine the future maintainable earnings.

17    The Valuation Report opined (at [8.7]) that the usual approach to the valuation of a business is by reference to the capitalisation of future maintainable earnings method. That is correct. As was stated by the High Court in Abrahams v Federal Commissioner of Taxation (1944) 70 CLR 23 at 42:

The final assessment of the value of the shares must be made principally on the basis of the income yield … but where, owing to exceptional circumstances, the valuation on this basis presents “enormous difficulties” it is legitimate … to rely more than usual on the assets value …

(Citations omitted.)

18    In respect of Lotic, Mr Smith adopted that methodology. Mr Smith:

1.    assessed the value of Lotic by separately valuing the business with reference to the capitalisation of future maintainable earnings method and the assets and liabilities that were surplus to the requirements of the business. (It is important to note that the first is a reference to capitalisation of future maintainable earnings method);

2.    valued the business with reference to earnings before interest and tax (EBIT);

3.    in seeking to establish future maintainable earnings for adoption under the capitalisation of future maintainable earnings method, had regard to past years’ operating performance, making appropriate adjustments for items of income and expenditure unlikely to reoccur, items of income and expenditure which, having not occurred in the past, may be likely to occur in the future and adjustments for all transactions to reflect their arm’s length value. Mr Smith also had regard to forecast financial information which he was provided with;

4.    determined a reasonable capitalisation rate to the assessed future maintainable earnings and, in doing so, considered factors including general economic conditions, industry related conditions and business related risks;

5.    valued Applied Water Technologies Pty Ltd, 95% of which is owned by Lotic, separately, adopting an asset-based approach under a going concern basis; and

6.    analysed the reconstructed balance sheets as at 30 June 2011 to ascertain the reasonable level of net assets for the Lotic’s business based on expected levels of growth.

19    The Applicants agreed that the capitalisation of future maintainable earnings method was an appropriate methodology. The Respondents did not dispute that the methodology was an appropriate methodology. In the absence of any “unfairness”, there is no reason to depart from the methodology decided upon by the valuer. As Hargrave J stated in Candoora No. 19 Pty Ltd v Freixenet Australasia Pty Ltd [2008] VSC 367 at [46]:

There are a number of cases where the courts have considered the proper approach to the determination of the “fair value” of shares in a company which conducts a business. The relevant principle arising from the cases is that the valuer must give separate consideration to the word “fair”. This involves the valuer considering the circumstances of the particular case and, where those circumstances reveal one or more factors which may affect the fairness of a valuation arising from a particular valuation method, determining whether that method should be modified or abandoned in favour of another method (or combination of methods) which is more likely to result in a fair valuation. There are a broad range of factors which have been identified in the cases as informing the criterion of fairness in the circumstances of those cases. Of course, each case must depend on its own facts. However, the cases do provide guidance as to the kinds of factors which may inform fairness in any case. The fact that a particular factor is of relevance to the criterion of fairness in one case does not mean that it will be relevant in all cases. This is especially so where the terms of the applicable legislation or contract require certain matters to be disregarded in the valuation process.

(Emphasis added.)

20    Before turning to consider the areas of dispute about the capitalisation of future maintainable earnings method, it is appropriate to record, as was the fact, that Mr Smith also opined at [8.7] that “where there is another method that is generally accepted by an industry, as an industry rule of thumb, this may be used as a comparison to the value assessed by reference to the capitalisation of future maintainable earnings method” (emphasis added).

(c)    Independent Person’s Conclusions as to Value

21    Mr Smith found, by application of the capitalisation of future maintainable earnings method, the value of Lotic’s business as at 30 June 2011 was between $1.755 million and $2.145 million, the mid point of which is $1.95 million

22    In accordance with [20] above, Mr Smith undertook a cross-check by valuing the net tangible assets. The going concern value of the net tangible assets of Lotic as at 30 June 2011 was valued by Mr Smith at approximately $1.317 million. Thus, he assessed the value of intangible assets at between $438,000 and $828,000: at [9.26].

23    Mr Smith then moved to determine the price that an arm’s length purchaser would pay for the shares in Lotic, as distinct from the value of the Lotic’s business. As Counsel for the Applicants explained, Mr Smith distinguished the business value of Lotic, represented by its future maintainable earnings, from the share value of Lotic, which would be affected by Lotic’s assets and liabilities. Because there were substantial non-business liabilities associated with Lotic which would affect the arm’s length price a third party purchaser would pay for Lotic’s shares, Mr Smith effectively conducted the “bargaining process” that would ordinarily occur between a vendor and a purchaser seeking to negotiate an arm’s length price.

24    Mr Smith opined that:

Taken [sic] into account the net non-business liabilities of $1.022 million, including the net present value of the obligation under DOCA of approximately $1.784 million (refer to Appendix 3), a 100% equity value of Lotic is between $467,000 and $857,000, with the mid-point value of $662,000. Accordingly the value of the Applicants’ shares in Lotic, i.e. 33.33% will be between $156,000 and $286,000 million [sic], with the mid-point of $221,000.

(d)    Applicants’ submissions

25    The Applicants endorsed the Valuation Report subject to two adjustments. First, the Applicants submitted that while the Valuation Report properly determined the amount an arm’s length third party purchaser would pay for shares in Lotic, that amount was not the appropriate price for the majority, that is Jashtra Holdings and PMP Shareholdings, to pay for Harding Investments’ shares. Rather, the price to be determined was that to be paid as compensation to Harding Investments for its shares being sold in consequence of the majority’s oppressive conduct. In support of that proposition, the Applicants referred to Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 at 369 which, in relation to s 210 of the Companies Act 1948 (UK), stated that section “gives a large discretion to the court, and it is well exercised in making an oppressor make compensation to those who have suffered at his hands”. That, the Applicants submitted, aptly describes s 233 of the Corporations Act.

26    The Full Court in Dynasty at 145 said of that case:

… It is not surprising then that the order which was the subject of the unsuccessful appeal required the shares be purchased at the value which they would have had at the date of the petition if there had been no oppression.

(Emphasis added.)

Hence, the Applicants submitted, in determining the price for its shareholding in Lotic, the result should not be (a) that the majority benefits from its oppressive conduct or (b) that Harding Investments suffers from vicissitudes it could not, by that conduct, participate in ameliorating.

27    How did this affect the valuation? The Applicants submitted that Mr Smith calculated Lotic’s net non-business liabilities in determining Lotic’s enterprise value and therefore share value with the result that those liabilities significantly reduced (and improperly reduced) the value of the shares. The liabilities were for the Deed of Company Arrangement ($1,784,113), hire purchase costs for motor vehicles ($147,774 and $431,426) and a loan owing to Gordon’s family trust ($13,106). Mr Smith found those liabilities not to be relevant to the requirements of Lotic’s business; that is, they were liabilities not referable to the activities of Lotic’s shareholders.

28    The Applicants submitted that, by its oppressive conduct, the majority excluded Harding Investments from participating in those activities identified in the preceding paragraph. In particular, Lotic was placed into administration and Harding’s motor vehicle was repossessed from him after these proceedings were commenced. It follows, the Applicants submitted, that those liabilities should not be taken into account in determining the price the majority should pay for Harding Investments’ shares because otherwise they would benefit from their oppressive conduct.

29    Secondly, the Applicants submitted that, in determining value, Mr Smith gave a weighting of 67% to the forecast of EBIT for the 2012 financial year with the result that the price would be reduced by the forecast vicissitudes for that year. The Applicants submitted that by the majority’s oppressive conduct, Harding Investments did not and could not participate in ameliorating those vicissitudes. Therefore, the Applicants submitted, determination of value ought not include weighting towards the 2012 financial year forecast. Rather, the forecast of EBIT for the 2011 financial year, as calculated and adjusted in the Valuation Report, should be used to represent the future maintainable earnings to which the appropriate capitalisation rate is to be applied. That amount is $1.037 million.

30    Finally, the Applicants made a submission about the appropriate capitalisation rate. That issue will be addressed below.

(e)    Respondents’ submissions

31    At the hearing, the Respondents primarily relied upon their written submissions. Indeed, Counsel for the Respondents informed the Court that he would adopt a “simple approach”, rather than a line by line critique of the Valuation Report. In particular, Counsel for the Respondents submitted that in the exercise of the Court’s discretion, the Court should select the lowest price possible. Consistent with adopting the earliest possible date for the valuation (a course that I have rejected for the reasons outlined earlier), the Respondents contended that the Applicants should not (as a matter of fairness) be awarded any part of the increased value of Lotic after January 2010 because that increased value was entirely the result of the actions of the Respondents after Mr Harding had been excluded from the affairs of Lotic. In support of that last contention, the Respondents referred to two significant contracts signed in August 2010 and an injection of capital by one of the Respondents, Mr Gordon.

32    The Respondents’ written submissions also disputed the data Mr Smith used in the capitalisation of future maintainable earnings method. Specifically, they submitted that Mr Smith relied only on an “abnormal year”, being the 2011 financial year, and an incomplete year, being the 2012 financial year, whilst ignoring the historical performance of Lotic in the 2008 to 2010 financial years. The Respondents referred to Mopeke Pty Ltd v Airport Fine Foods Pty Ltd (2007) 61 ACSR 395 at [98] in which the Court accepted a valuation that utilised figures from the three years leading up to the valuation date.

33    The Respondents further submitted that given the nature of Lotic’s business, the uncertainties about its future maintainable earnings and the case of Mopeke, a more appropriate and accurate assessment of the future maintainable earnings is determined by reference to an average of the adjusted EBIT over a number of years using the historically accurate data from the last financial years from 2008 to 2011. Using that data, the average of the adjusted EBIT was $182,839 as opposed to the future maintainable earnings of $780,000 determined by Mr Smith using a 33% and 67% weight on the 2011 financial year and the forecast 2012 financial year performance respectively. In the event that the forecast 2012 financial year was to be included, then the future maintainable earnings on the Respondents calculation was $276,363. The Respondents then submitted that utilising the historical EBITs (that is, from 2008-2010 financial year), the value of Lotic’s business was negative $833,000 and, in the event that the 2012 financial year forecast was to be included, the value of Lotic’s business was negative $598,000.

(f)    Summary of respective positions

34    The differences between the parties’ positions with respect to future maintainable earnings, by reference to the Valuation Report, are best summarised in the following table:

A careful reader will notice that the capitalisation rate the Court has included for the Applicants is 2.7 and not 2.75. Although the Applicants submitted that this Court should adopt the highest rate, their submissions used a rate of 2.7. It is that rate which is included in the table. At the hearing, the Applicants submitted that the reference to 2.7 was an error and the Court should adopt the higher rate.

(g)    Analysis

35    As noted earlier, there is no dispute about the methodology adopted. The disputes may be divided into the following topics or integers which affect the ultimate value: (i) the capitalisation rate; (ii) the use of data for the 2008-2010 financial years; (iii) the use of data for the 2012 financial year; and (iv) the adjustments to the future maintainable earnings calculations made by Mr Smith.

(i)    Capitalisation Rate

36    The Applicants submitted that it was open to the Court, in its discretion, to have regard to prior valuations provided to Mr Smith by the parties which adopted significantly higher capitalisation rates – from 3.5 to 5.24. In these circumstances, the Applicants submitted, the Court should accept the highest of Mr Smith’s capitalisation rates in lieu of the middle rate. I do not agree. The valuations were not in evidence. Indeed, it was because of the limited utility of the previous valuations (see [2] and [14] above) that the Court ordered an Independent Person to value the shares in Lotic. It is therefore inappropriate for the Applicants to cherry-pick one favourable aspect of the previous valuations in circumstances where those valuations have been largely superseded by the Valuation Report. The Respondents did not dispute the capitalisation rate selected by Mr Smith. In the circumstances, the Court adopts the capitalisation rate of 2.5 selected by Mr Smith.

(ii)    2008-2010 Financial Years

37    The Respondents submitted that in calculating the capitalised value of Lotic’s future maintainable earnings as at 30 June 2011, Mr Smith should have used an average of adjusted EBIT over a number of years.

38    That issue was addressed by Mr Smith in the Valuation Report as follows:

Assessment Future Maintainable Earnings

9.9    After assessing the amount of adjusted EBIT for each financial year under review, it is necessary to ascertain the most appropriate assessment of future maintainable earnings. Future maintainable earnings can be determined with reference to an average of adjusted EBIT over a number of years (either a real average or a weighted average), particularly where there is no evident trend or with reference to adjusted EBIT for an individual financial year where there is an obvious trend.

9.10    Based on my review of earnings over a number of years and my understanding of Lotic Business, in particular the decline in performance of the business in 2009 and 2010 during the [global financial crisis] and as a result of the internal dispute between the shareholders. In assessing the future maintainable earnings and in the absence of forecast long term cash flows, I have assessed the future maintainable earnings with reference to FY11 and forecast FY12.

9.11    Given the significant improvement in results in FY11 which may not be sustainable, I have given greater weight to the forecast FY12. I have considered 33% and 67% weight on FY11 and forecast FY12 performance respectively which result in the future maintainable earnings of approximately $780,000.

39    There are a number of matters that should be noted. First, as the passage reveals, Mr Smith took into account a number of factors including the global financial crisis and the internal dispute. The Respondents did not suggest that there were any factors which Mr Smith failed to take into account. That is not surprising. Both sides were given the opportunity (which they took) of providing material and submissions to Mr Smith. Instead, the Respondents’ complaint is that Mr Smith failed to give some factors the correct weighting and / or discount. What the Respondents invited the Court to do was not to reject Mr Smith’s advice but simply to choose the lowest price because he failed to give some factors the correct weighting and / or discount. Again, in the absence of evidence and other material which would justify such a course to be adopted, it must be rejected. A contrary conclusion is not supported by Mopeke, to which the Respondents referred. That case involved no point of legal (or, indeed, valuation) principle but a different expert valuing a different company on different facts.

(iii)    2012 Financial Year

40    Both parties submitted that the forecast for the EBIT for the 2012 income year should not have been taken into account in assessing future maintainable earnings. I disagree. As the Valuation Report states at [8.11]:

In seeking to establish future maintainable earnings for adoption under the capitalisation of future maintainable earnings method, it is usual to have regard to past years’ operating performance, making appropriate adjustments for items of income and expenditure unlikely to reoccur, items of income and expenditure which, having not occurred in the past, may be likely to occur in the future, and adjustments for all transactions to reflect their arm’s length value. Where forecasts have been prepared, it is also usual to have regard to the forecast financial information. I have been provided with the forecast cash flows for 10 months ending 30 April 2012. Based on this forecast and discussion with [Lotic’s finance manager] I have constructed the forecast of Lotic’s financial performance for FY12 which have been reviewed by [Lotic’s finance manager] and have considered it in assessing Lotic’s future maintainable earnings.

41    That is a legitimate approach and there is no reason to depart from it: see for example, Pratt SP, Reilly RF, Schweihs RP, Valuing a Business: The Analysis and Appraisal of Closely Held Companies (4th ed, McGraw-Hill, 2000) p 212.

42    For those reasons, I accept that the capitalised value of Lotic’s future maintainable earnings as at 30 June 2011 is $1.95 million the mid point identified by Mr Smith: see [21] above.

(iv)    Further Exercise

43    As noted above, Mr Smith undertook a further exercise of valuing the net tangible assets. The going concern value of the net tangible assets of Lotic as at 30 June 2011 was valued by Mr Smith at approximately $1.317 million. Thus, he assessed the value of intangible assets at between $438,000 and $828,000: at [9.26]. However, Mr Smith did not stop there: see [22]-[24] above. He went on to adjust the capitalised value of Lotic’s future maintainable earnings to account for Lotic’s surplus assets and non-business liabilities.

44    Mr Smith’s exercise was premised on the proposition that the value of Lotic was represented by the value of its main business (assessed by the capitalisation of the future maintainable earnings) and the value of the net assets and liabilities that were surplus to the business or non-business: see [18(1)] above. Mr Smith opined that those assets and liabilities which were surplus to the business or non-business would be accounted for in the value of the Lotic shares to an arm’s length purchaser.

45    There were a number of complaints about this exercise. The Applicants submitted that there should be no adjustment for net non-business liabilities. The Respondents agreed with Mr Smith, but for different reasons. The Respondents submitted that if an earlier date was chosen, the inclusion of the items would fall away. Next, the Respondents submitted that the Applicants should not benefit from the improvement in Lotic’s performance since Mr Harding was excluded: see [31] above. These submissions have already been rejected: see [9]-[13] above. Indeed, the second aspect (that the Applicants should not benefit from the improvement in Lotic’s performance since Mr Harding was excluded) strikes at the heart of the compulsory order for purchase.

46    The Court must fix a price for the shares that is a fair value in all the circumstances of the case. The only matters referred to by the Respondents, in this context, were the two contracts and the capital injection referred to earlier: see [31] above. The Respondents did not refer the Court to any evidence to support the contention that these matters were totally unrelated to Mr Harding or, at the very least, should result in a lower value. Indeed, the Valuation Report did not record any capital injection and the evidence at the substantive hearing was that, at the very least, the initial dealings in relation to the two contracts involved Mr Harding. For example, Mr Harding’s evidence at the initial trial was that he was the one who identified a project giving rise to one of the major contracts in the first place.

47    The issue which remains is whether the adjustments identified by Mr Smith should be excluded from the value ascribed to the business using the capitalisation of future maintainable earnings methodology. The assets and liabilities were listed in the last column of Appendix 3 to the Valuation Report. The evidence about the nature and identity of those items is limited to the description in that Appendix. No other evidence was led by any party in relation to these items. Having regard to the nature of the assets and liabilities identified, I do not accept that it is appropriate to deduct from the value of the business (assessed by using the capitalisation of future maintainable earnings methodology) the net present value of the obligations under the DOCA. It is not a non-business liability. It reflects, as recorded in the Respondents’ written submissions, the reorganisation of the existing liabilities of Lotic simply because of this dispute. Indeed, Mr Smith addressed this issue himself when seeking to explain the variation in working capital as at 30 June 2010 and 30 June 2011: see [9.24] of the Valuation Report.

48    What then is the position in relation to the other listed items? As noted, the evidence before the Court about these items as at 30 June 2011 was limited to the Valuation Report: see [9.24]. It was common ground that the car recorded by Mr Smith as having been provided to Mr Harding was removed from Mr Harding’s possession many months ago. Given the limited evidence and the nature of the items, I do not consider that it is fair in the circumstances to deduct the net value of these items from the value attributed to the business using the capitalisation of future maintainable earnings methodology.

(h)    Conclusions and Orders

49    For those reasons, I consider that the fair value of Lotic and Harding Investments’ shares in Lotic may be summarised as follows:

50    As will be apparent, I have selected the lowest capitalisation rate. The selection of that rate reflects (and takes into account) the Respondents’ submissions about the uncertainties which exist in relation to Lotic including, but not limited to, the global financial crisis, the state of the industry and the business specific risks.

51    I will direct the parties to bring in orders to give effect to these reasons for decision by 4.00pm on 5 December 2011.

Associate:

Dated:    30 November 2011