PAGE v McKENSEY SUPREME COURT OF NEW SOUTH WALES COURT OF APPEAL PRIESTLEY, HANDLEY and SHELLER JJA 17 February 1995, 28 February 1995 [1995] NSWCA 351 PARTNERSHIP: — valuation of goodwill The appellant and the respondents were partners in a firm of chartered accountants, Forsythes. On 27 May 1993, Windeyer J had, by consent, declared that the partnership was dissolved on 30 June 1992 and that the assets of the partnership at that date included but were not limited to goodwill and the value of the shares in the two companies, which were defendants but were not joined as parties to the appeal. A number of questions were referred to a referee for enquiry and report pursuant to Pt72 of the Supreme Court Rules. When the reference proved abortive and the report not such that it could be adopted, his Honour agreed to determine the only question referred which had not been agreed on; namely the question of goodwill. His Honour accepted Mr Rodgers' (the respondents' valuer) evidence that the value of the name without covenants was $150,000 and treated that as the value of the goodwill. The appellant sought to have his Honour's determination of the value of the goodwill set aside and substituted in an amount of $2,523,126. As Windeyer J's judgment was interlocutory, the appeal required leave of the Court. Leave was not opposed by the respondent and was granted. The success of the appeal depended on the Court accepting that Windeyer J had erred in wholly rejecting Mr Hawkey's (the appellant's valuer) evidence of the value of the goodwill. Mr Hawkey's valuation of the accounting part of the business was assessed on the basis of the sale of a going concern with full covenants including restraint covenants. His Honour considered that Mr Hawkey's valuation was not made in accordance with well established principles; Trego v Hunt [1986] AC 7; David v Matthews [1899] 1 Ch 378; Hookham v Pottage (1872) LR 8 Ch App 91. On appeal the Court did not consider that there were any grounds to interfere with his Honour's conclusions. His Honour correctly stated the method of valuation to be used, reviewed the evidence, rejected a valuation which had proceeded by a wrong method, and, on the basis of the evidence that he accepted, himself valued the goodwill. Mr Hawkey's evidence did not support any different value of the goodwill. Priestley JA I agree with Sheller JA. This appeal raised questions about findings made by Windeyer J, the answers to which depended on a thorough review of the proceedings at trial and the effect of the evidence there given. These matters were well argued in written and oral submissions before this court which led me to conclude, for the reasons summarised by Sheller JA, that there was no acceptable basis for interfering with Windeyer J's decision. I agree with the orders proposed by Sheller JA. Handley JA I agree with Sheller JA. Sheller Jaintroduction This is an appeal from a decision given by Windeyer J on 17 December 1993 in proceedings commenced in the Equity Division by the appellant, Geoffrey Francis Page, seeking relief related to the affairs of a firm of chartered accountants known as Forsythes in which the appellant and the 2 UNREPORTED JUDGMENTS respondents were the partners. On 27 May 1993 Windeyer J had, by consent, declared that the partnership was dissolved on 30 June 1992, and that the assets of the partnership at that date included but were not limited to goodwill and the value of the shares in two companies, which were defendants but have not been joined as parties to the appeal, Forsythes Computer Services Pty Ltd and Forsythes Computer Systems Pty Ltd. His Honour referred the following questions to a referee for inquiry and report pursuant to Pt72 of the Supreme Court Rules: "a. the amount of the plaintiff's loan account with the partnership as at 30 June 1992 and this date; b. an enquiry as to the net assets of the partnership and their value and of the respective interests of the partners therein as at 30 June 1992; c. an enquiry as to the amount for which the plaintiff is liable to account pursuant to my first judgment; d. the sum properly payable to or by the plaintiff in consequence of the said enquiries." The reference proved abortive and the report not such that it could be adopted. His Honour agreed to determine the questions referred himself. Apparently agreement was reached on most of the matters listed so that there remained for determination what his Honour described as "the question of goodwill". VALUATION OF GOODWILL No partnership agreement existed and no receiver was appointed on dissolution. After dissolution the respondents continued to use the name Forsythes and his Honour found "to all intents and purposes continued the partnership business". The appellant set up business on his own account taking with him clients whose gross annual billings for the year ended 30 June 1992 came to around $192,000 although valuation calculations were based on a figure of about $200,000. As at 30 June 1992 Forsythes had the following five divisions: "A. Newcastle accounting practice B. Cessnock accounting practice C. Personnel business D. Financial planning business E. Computer advisory and sales business." The relevant evidence about goodwill was given by a former partner, Mr McKensey, and two valuers, Mr Rodgers for the respondents and Mr Hawkey for the appellant. Both valuers, at least superficially, approached the valuation of the accounting part of the business by capitalising gross maintainable billings or earnings. His Honour did not accept the substance of Mr Rodgers' valuation because it was based on a market rate of only 30 cents in the dollar of maintainable turnover. Neither party seeks now to rely upon that part of Mr Rodgers' valuation. However Mr Rodgers also said he would value "the practice without covenants at zero, excepting that I would attach some value to the name Forsythes". By "practice" he meant "goodwill". He went on to say: "T value the goodwill attaching to the right to use the name Forsythes at $150,000 based on an estimate of costs and loss of profits over one year to change the practice name from the existing name Forsythes to some other form". Windeyer J found that Mr Hawkey's valuation of the goodwill of the accounting part of the business was not made in accordance with well established principles stated by his Honour as follows: URJ PAGE v McKENSEY (Sheller Jaintroduction) 3 "On a dissolution of partnership the value of assets must be determined at the date of dissolution having regard to the terms of any agreement among the partners. Here there were no such terms. It follows that goodwill must be valued on the basis that it could be purchased by an outsider or one or more of the former partners. Any outside purchaser of goodwill would take into consideration the facts that: a. the former partners would be free to practise in the immediate vicinity; b. the former partners would be free to deal with any former clients, and free to make their new circumstances known, but not free to solicit former clients of the dissolved partnership. c. the former partners would be free to take over any existing files of the dissolved partnership if the clients so wished and fees for work to the date of dissolution were paid to the old firm. d. the former partners would not be free to use the name of the former partnership or a name so close to it that it would be likely to be confusing or to mislead people to think it was a continuation of the old partnership. These principles are I think established as to canvassing by Trego v Hunt [1896] AC 7 and as to the other matters by David v Matthews [1899] Ch 378 and as to advertising recommencement of business by Hookham v Pottage (1872) LR 8 Ch App 91. Former partners purchasing goodwill would do so with knowledge of these matters and their likely effect on outside buyers. Thus while the value of goodwill is a question of fact in all cases it is a question to be determined within and in accordance with the principles I have set out. Differences in partnership history, size, areas of work and other matters will of course influence the value of goodwill." This statement is unexceptionable. Mr Hawkey valued the goodwill of the accounting part of the business on the basis of the sale of a going concern with full covenants including restraint covenants. When asked what would be the position if all that remained to be sold was the name, Mr Hawkey said its value would depend on the circumstances and he could not generalise. Nor did his Honour accept Mr Hawkey's valuation of the other divisions of the business because these were also done on the basis of a sale with covenants. The appellant argued that those divisions were stand alone businesses, not dependent upon the accountancy firm partners' introductions. Windeyer J said that, even if this were so, it did not follow that, if the respondents were at liberty to set up in opposition in the immediate vicinity, those businesses would not suffer or that it could possibly be correct to use the same multiplier or that the same percentage return would be applicable. "So that while the basis for Mr Rodgers lumping all the businesses together on the basis of some statement of Mr Hewitt may not have been justified there is no basis for accepting the flawed basis of Mr Hawkey's figures based as they were on full covenants and 'stand alone' businesses which was not correct." His Honour accepted Mr Rodgers' evidence that the value of the name without covenants was $150,000 and treated that as the value of the goodwill. On this basis and the various matters that had been agreed by the parties his Honour made declarations and orders. He said that in due course he would hear argument as to what further directions were needed to conclude the action. APPEAL The appellant sought to have his Honour's determination of the value of goodwill set aside and substitute a valuation assessed on the basis of Mr Hawkey's evidence in an amount of $2,523,126. The respondents did not cross 4 UNREPORTED JUDGMENTS appeal or file a notice of contention. Windeyer J's judgment was interlocutory so that the appeal did not lie without the leave of the Court. Leave was not opposed. The case is one appropriate for leave which should be granted. The appellant did not challenge the correctness of Windeyer J's statement of the method by which goodwill should be valued. However he submitted that in the particular circumstances of this case the valuation of the goodwill of the partnership should have taken account of the fact that the five remaining partners had continued to carry on the business and had the benefit of the goodwill unaffected by any discount to take account of the absence of covenants. Alternatively the appellant submitted that Mr Hawkey's evidence supported a valuation of approximately $2 million without covenants. We were asked to reassess the value of goodwill. The success of the appeal depended upon the appellant's persuading the Court that Windeyer J erred in wholly rejecting Mr Hawkey's evidence of the value of the goodwill. In making his valuation Mr Hawkey assumed that the practice would be sold as a going concern and that the vendors of the practice would give "normal undertakings". He said: "Tf I had been advised that there were no covenants and I was asked and I was further advised that there would be no covenants because the important part of the covenant is between the vendor and the purchaser, and that the practice was to be sold without covenants, and covenants would not have been given, then my approach would have been different. Q. You would have written quite a different valuation, would you? A. I would have to have made different investigations." Mr Hawkey was asked to assume the sale of Forsythes by the six partners on terms that each of them could walk out from the firm and open up in practice next door but without using the same name and without liberty to solicit the customers of the firm. He said that that assumption obviously would dramatically affect the goodwill of the practice. In re-examination Mr Hawkey was asked to make further assumptions and express his opinion upon them. In argument the text of his evidence was closely examined. Mr Hawkey said that he was aware that there were no restraint of trade covenants in respect of the partners who intended to leave the partnership or if the partnership was dissolved. He was asked to take account of the appellant's leaving the firm taking with him clients whose fees were in the order of $190,000 to $200,000. He gave the following evidence: "Q. Would those factors have been relevant to your valuation of the good will of the partnership as a whole, that is, the six of the partners including Mr Page as at the date of dissolution on the 30 June 1992? A. Yes. Q. And some of those factors I think you have said in your evidence in cross examination you did not take into account such as the lack of restraint of trade covenants. In the light of those factors I have put and the assumptions I put to you in what way would your valuation of the goodwill of the partnership as a whole be altered if those factors and assumptions be in fact the facts? A. I will take into account the expected diminution in future billings and I would arrive at a different figure for future maintainable billings probably reduced by the full amount of the clients that had left with Mr Page." Later in re-examination Mr Hawkey gave the following evidence: "Q. In the light of factors on the assumption I asked you to make would either of those figures have altered? A. What I did for Newcastle was to take the last two years billings and average them to arrive at an estimate of future maintainable URJ PAGE v McKENSEY (Sheller Jaintroduction) 5 billings which I estimated to be $2,775,528 then and capitalise those billings by that factor of 0.75. If I had known that Mr Page was to take say $200,000 worth of fees, I would have reduced probably the resultant figure by the $200,000 so I would have a figure of 2.575. Q. Multiplied by.75? A. Multiplied by.75 which would reduce the value accordingly. Q. Would your valuation in any other way alter on the factors and assumptions I put to you apart from an arithmetical way resulting from the alteration to the valuation of the Newcastle goodwill? A. Well, you were silent on Mr Page's attitude towards the rest of his clients. Q. I am sorry? A. You did not ask me to make any assumptions about Mr Page's attitude towards the balance of his clients. Q. The balance of his clients being whom? A. Those that are still in the practice, if he has any. He does not have any? Q. Yes? A. No, it would not." The appellant relied upon the re-examination and, in particular, those parts I have quoted, to submit that it was open on Mr Hawkey's evidence to value the goodwill at an amount in the order of $2 million and that his Honour in assessing the value of goodwill ignored this evidence. The respondents were given leave further to cross examine Mr Hawkey. The following is part of that cross examination: "Q. You were asked to make several assumptions by Mr Sullivan prior to the luncheon adjournment? A. Hmm. Q. He asked you to make a set of assumptions about Mr Page and the fact that he was taking away his clients' worth, 5 per cent or something of the overall firm's billing? A. Right. Q. And that he would be taking 100 per cent of his own clients with him but you were also asked to assume none of the partners were giving any covenant not to complete? A. To him? Q. No, to the buyer. A. To the buyer coming in? Q. Who was going to pay your valuation. A. I was not asked that question one way of the other. HIS HONOUR: Q. In Mr Sullivan's questions, the three assumptions, that was not one. RAYMENT: My note was that the second assumption was that there was no restraint of trade from the persons on dissolution. HIS HONOUR: Only Mr Page was free. RAYMENT: Q. Did you assume that the other persons were bound by a covenant? A I was not asked. Q. Did you assume they were bound by a covenant? A. I am getting lost, in what circumstances? Q. The question you answered before the morning tea adjournment? A. I was asked how I would change my valuation if Mr Page went out of the practice with his clients. Q. No, you were not. A. On three assumptions. Q. Would you please answer my question, did you assume the other partners were bound or not? A. I was not asked to assume that. Q. When you wrote your original valuation I think you told us you did it on a going concern basis? A. Correct. Q. You didn't have in mind the kind of situation that might arise on dissolution of a partnership on the basis that outgoing partners were free to compete? A. No. 6 UNREPORTED JUDGMENTS Q. And the only change you have made to the situation for the purposes of answering Mr Sullivan's question before the adjournment, was to assume in doing the valuation that a part of the firm's income would no longer be receipts which a purchaser would require [sic? acquire]? A. That is correct. Q. But you still give evidence do you, about a going concern valuation for the remainder of the firm's income? A. Yes" This cross examination was also closely examined in argument. The appellant submitted that, properly understood, the cross examination did not undermine the contention that the amount at which Mr Hawkey valued goodwill was not, in his opinion, affected or not substantially affected by the absence of covenants. This submission depended upon emphasis being placed on particular words in the answers given by Mr Hawkey. We were asked to treat the answer "I was not asked to assume that" as implying that the witness was drawing a distinction between being asked whether he was aware and being asked whether he assumed that the partners were not bound by covenants in restraint of trade. Windeyer J, who heard the evidence, said that he must reject all the evidence of Mr Hawkey as to the value (of goodwill) as the valuation he made was not the required one. Obviously this Court cannot interfere with that conclusion on the basis that the transcript might, on one view, be interpreted differently. For my part I am quite satisfied that to the extent to which in re-examination Mr Hawkey seemed to assent to the proposition that his valuation would not be affected by the absence of covenants he was proceeding upon a misapprehension as to the assumptions put to him. A reading of the re-examination demonstrates confusion about the assumptions. In the original cross examination Mr Hawkey was definite when he said that the absence of covenants would dramatically affect the goodwill of the practice. In re-examination, if there was any retraction from this opinion, it was upon the basis of a misunderstanding. In my opinion the appellant has failed to show any ground for interfering with his Honour's conclusion that Mr Hawkey's evidence about the valuation of the goodwill should be rejected. It follows from this, as his Honour held, that the only evidence which could be accepted and which his Honour did accept was that of Mr Rodgers valuing the name of Forsythes at $150,000. This conclusion means that the appeal must be dismissed. In deference to the appellant's argument I refer to matters raised in his written submissions. The appellant drew comfort from his Honour's statement during the course of the hearing that he saw himself as acting in the capacity of a Master conducting an enquiry by request. The Court was bound to inquire into the matter and do its best to determine the value of the goodwill. The appellant relied upon passages in the cross examination of Mr Hawkey in which he said the value of the goodwill even without covenants would not be nil and referred to various statements of account showing the value placed on the goodwill of the partnership by the partners. According to the appellant, all this led to a finding, which his Honour ought to have made, that the value of goodwill without covenants was that stated by Mr Hawkey with covenants discounted marginally "so as to reflect any diminution in the value of the goodwill by reference to the possibility that the appellant might take from the successor practice some further business in excess of that agreed to be taken by him of about $200,000 for which credit has already been given." The appellant said that this valuation was supported by other factors including the intention of the members of the practice that the respondents should continue to conduct the business without the appellant. Various propositions were put by reference to the extremes between all partners of a firm to be sold declining to give covenants and all partners but one URJ PAGE v McKENSEY (Sheller Jaintroduction) 7 in a firm with many members agreeing to give covenants. It was submitted that it would be an extraordinary consequence if the respondents could appropriate to themselves the benefit of valuable goodwill and then assert that it was, in the hands of outside purchasers, of no value. It was pointed out that in summarising Mr Hawkey's evidence Windeyer J extracted figures for the Newcastle practice from Mr Hawkey's first report and appeared to overlook his second report dated 4 March 1993 which supplemented and updated his first report. This variety of submissions does not detract from the fundamental proposition that his Honour correctly stated the method of valuation to be used, reviewed the evidence, rejected a valuation, which had proceeded by a wrong method, and, on the basis of the evidence that he accepted, himself valued the goodwill. His Honour could only act on the evidence before him. He could not speculate about how the valuers might, if asked, have valued the goodwill on the basis of different assumptions. The appellant has not demonstrated error. Finally the appellant argued that his Honour should not have rejected Mr Hawkey's evidence about the goodwill of the other three divisions of the business. His Honour again rejected Mr Hawkey's valuation which was based on a sale with covenants and said it mattered not for this purpose whether the businesses were stand alone. The appellant suggested that the businesses should have been treated as stand alone. The respondents directed attention to what was described as an agreed balance sheet as at 30 June 1992 which showed shares in the two defendant companies which were part of the other three divisions, as assets of the partnership. Accordingly it was said that the partners had no interest in the goodwill of those companies. However this may be, no ground was shown for interfering with his Honour's conclusion that Mr Hawkey's valuation of the goodwill of the other three businesses was flawed in the same way as his valuation of the goodwill of the accounting part of the business. The overall valuation for the goodwill of the five parts of the business, whatever their precise inter-relationship, was found to be $150,000. This conclusion cannot, in my opinion, be disturbed. CONCLUSION I would propose the following orders: 1. The appellant be granted leave to appeal from the decision of Windeyer J of 17 December 1993; 2. The appeal dismissed with costs. 1. The appellant granted leave to appeal from the decision of Windeyer J of 17 December 1993; 2. The appeal dismissed with costs. COUNSEL: Appellant: RG Forster SC/RE Montgomery Respondents: BW Rayment QC/AM Gruzman SOLICITORS: Appellant: Wood Roberts, Mayfield Respondents: Bowen-Thomas and Hewitt