New South Wales Supreme Court CITATION : Drinkwater v Caddyrack Pty Ltd [2001] NSWSC 255 CURRENT JURISDICTION: Equity Division FILE NUMBER(S) : SC 3970/96 HEARING DATE(S) : 16/03/01 JUDGMENT DATE : 10 April 2001 PARTIES : Peter Westgarth Drinkwater, John Francis Drinkwater and Lustray Pty Ltd (Plaintiffs/Respondents) Terrance Kyrwood, Geoffrey Kyrwood, Gedrot Pty Ltd and Gavros Pty Ltd (Defendants/Appellants) JUDGMENT OF : Young J LOWER COURT Supreme Court (Master) JURISDICTION : LOWER COURT 3970/96 FILE NUMBER(S) : LOWER COURT Master McLaughlin JUDICIAL OFFICER : COUNSEL : M Ashhurst (Plaintiffs/Respondents) M Painter (Defendants/Appellants) SOLICITORS : Hansens (Plaintiffs/Respondents) Wood Roberts (Defendants/Appellants) CATCHWORDS : PROCEDURE [115]- Masters- Appeal- Valuation judgment- When appeal allowed. VALUATION [25]-Shares- Capitalization of maintainable profits- When appropriate method. VALUATION [36]- Appeal- Valuation by Master- When appeal against valuation by Master should succeed. Ahmedi v Ahmedi (1991) 23 NSWLR 288 Commssioner of Succession Duties (SA) v Executor Trustee & Agency Co of South Australia (1947) 74 CLR 358 Do Carmo v Ford Excavations Pty Ltd [1981] 1 NSWLR 409 Drinkwater v Caddyrack Pty Ltd [1999] NSWSC 17 Dynasty Pty Ltd v Coombs (1995) 59 FCR 122 Golosky v Golosky (NSWCA 5.10.93) House v The King (1936) 55 CLR 499 CASES CITED : Kent & Martin v Federal Commissioner of Taxation (22.10.1945) Kyrwood v Drinkwater [2000] NSWCA 126 Ledesma v Nobule Pty Ltd (Master McLaughlin 11.12.97) Morrison v Judd (NSWCA 10.10.95) Narayanan Chettiar v Kaliappa Chettiar [1946] AC 116 Re Golden Bread Pty Ltd [1977] Qd R 44 Sapir v Sapir (No 2) (1989) 13 Fam LR 362 Wilsher v Essex Area Health Authority [1988] AC 1074 DECISION : Appeal dismissed with costs. THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION YOUNG J TUESDAY 10 APRIL 2001 3970/96 - DRINKWATER v CADDYRACK PTY LTD JUDGMENT 1 HIS HONOUR: This is an appeal from Master McLaughlin who, in a reserved judgment delivered on 26 August 1999, valued the shares of the first defendant as of 25 September 1997, at $41,495 per share. 2 The reason why that question was before the Master is a judgment I gave in 1997, formalised in orders made on 28 November 1997 in proceedings under what is now s 233 of the Corporations Law. 3 That decision was taken on appeal to the Court of Appeal. The Court heard argument on 1 February 2000 and reserved its decision. On 25 August 2000, the appeal was dismissed. It is reported sub nom Kyrwood v Drinkwater [2000] NSWCA 126. The Court of Appeal's decision was a split decision, Powell and Meagher JJA forming the majority, Fitzgerald JA dissenting. An application for special leave to appeal to the High Court has been filed and the best prognosis at present is that that application will be heard in June 2001. 4 No stay was granted of my orders of 1997. One of those orders was that the 5th and 6th defendants purchase the shares which the second plaintiff holds in the first defendant at a valuation to be agreed or assessed in accordance with the orders. The parties could not agree and order 6 came into play, that is, "Order that the Master hold an enquiry and thereafter certify the value of the shares." 5 The learned Master heard evidence on 12 March and 12 April 1999. It would seem that no application was made to postpone the valuation hearing pending the Court of Appeal's decision, though that circumstance may be in part explained by the Master's interlocutory decision noted as [1999] ACL 325 NSW 243, given in this matter on 1 February 1999 (Drinkwater v Caddyrack Pty Ltd [1999] NSWSC 17). However, when the present matter was called on before me, Ms Painter, counsel for the appellants, applied to adjourn the hearing of this appeal until the result of the special leave application was known. This was opposed by Mr Ashhurst of counsel for the respondents. I refused that application for the reasons I gave on 16 March 2001 and the hearing then proceeded. 6 Neither party had bespoken a transcript of the evidence before the Master. It was common ground that the principal evidence before the Master was the valuation report of Garth W Griffiths, a registered valuer with Wilsons Business Brokers Pty Ltd bearing date 10 March 1998, evidence of a chartered accountant, Mr C Hewitt, both tendered for the plaintiffs, and evidence from Mr S Pritchard, a certified public accountant, tendered by the defendants. The appeal proceeded on this evidence, plus the facts referred to in the learned Master's judgment, and I was also referred to the written submissions made by counsel to the learned Master which were in the court file. 7 The grounds of appeal, as enunciated by Ms Painter (which did not entirely match those in the notice of appeal as filed), were basically as follows: (1) The learned Master erred in principle in preferring one valuer over the other; (2) The learned Master did not make his own determination of the value of the shares; (3) The learned Master should not have adopted as a method of valuation the method of capitalization of future maintainable profits; (4) If the learned Master did use the right method of valuation, he misapplied it; (5) The learned Master made assumptions not supported by the evidence, viz: (a) that the corporation would continue to produce its major product with the consent of the licensor of the intellectual property even in the absence of a licence agreement; (b) that the right to manufacture that product was more or less assured; (c) that that right would produce income; (d) that many thousands of units would be produced by the company; (e) that the real profit of the company could only be ascertained from the trading results of a number of entities; (f) that $100,000 was needed to service trade debtors and stock levels; (g) that the appropriate multiplier if the capitalization of future profits was applied, was 2.5; (h) that the combined value of the group of entities was $3 million; (i) that Caddyrack Pty Ltd and Caddyrack International Pty Ltd had assets of a combined value of $1,839,000. 8 The basal facts of the matter can be simply stated. Caddyrack Pty Ltd was formed to exploit a special golf club holder. It was essentially a partnership of the Drinkwaters and the Kyrwoods. In 1995 it assigned its patents in that holder to an associated company based in the Isle of Guernsey. However, it and associated companies, continued to sell the product. The "partners" in the enterprise then argued, as a result of which the oppression suit was commenced and heard before me and I virtually ordered that one side buy the other out. 9 Mr Griffiths took the fact of the existence of the various companies into account and he analysed the accounts and determined that the value of the business was $1,839,000. His report says he did that by "taking the combined pre-tax nett profit of $795,748.00 and deducting from it a proportionate cost of servicing stock and debtors of $60,000.00 and then capitalizing the balance of $735,748.00 at 40% i.e. a P.E. ration of 2.5." Mr Hewitt adjusted those figures downwards to $1,659,794 and as there were 40 ordinary issued shares in the first defendant, divided that sum by 40 to obtain a value of $41,495 per share. 10 Mr Pritchard said that in his opinion, the shares had no commercial value. He noted that there were two generally accepted methods of valuing shares in a company such as Caddyrack Pty Ltd, namely, capitalization of future maintainable profits and nett tangible assets per share at current value. He opined that it was neither appropriate nor possible to value the shares on the basis of future maintainable profits. He then noted that there was a deficiency of shareholder funds, and that the shares accordingly had no value. 11 It would appear that all the valuers were comprehensively cross examined before the learned Master, but as I say, I have no transcript of any of that evidence. 12 The learned Master adopted the Griffiths/Hewitt approach. However, he did not do so uncritically. He said that there were a number of reasons for that preference, which in summary were: (1) On the basis of experience and qualifications alone, Mr Griffiths should be preferred to Mr Pritchard; (2) He was unconvinced that one could not apply the future maintainable profits method of valuation where there was an asserted, but not substantiated history of losses; (3) My 1997 judgment proceeded on the assumption that the shares did have significant value and this was reinforced by the great ardour which the protagonists in the proceedings competed with each other; (4) Mr Pritchard appeared to indicate a basic misunderstanding of the concept of goodwill; (5) Mr Pritchard's valuation appeared to fly in the face of reality and common sense. 13 The Master made it clear that he seriously took into consideration the objections made in the present appellants' written submissions and in Mr Pritchard's evidence to the Griffiths/Hewitt approach. He considered what the Full Federal Court had said in Dynasty Pty Ltd v Coombs (1995) 59 FCR 122 at 143-4 and his own previous decision in Ledesma v Nobule Pty Ltd - 11 December 1997, unreported. 14 An appeal from a Master to a Judge lies under Part 60(10) of the Supreme Court Rules 1970. Generally speaking, an appeal from a Master to a Judge is in the same plight as an appeal from a Judge to the Court of Appeal. 15 The Court of Appeal has on many occasions said that appellate courts must "show restraint in disturbing the evaluative determinations of primary decision makers" (Golosky v Golosky - NSWCA 5 October 1993, unreported, per Kirby P). It is against the policy of the Supreme Court Act "that one member of the Supreme Court (a single Judge) should simply substitute his or her opinion on a discretionary decision concerning a matter of practice for that earlier determined by another member of the Supreme Court (a Master)" (Morrison v Judd - NSWCA 10 October 1995, unreported, the quotation from the judgment of Kirby P with whom Meagher and Powell JJA agreed). 16 In Do Carmo v Ford Excavations Pty Ltd [1981] 1 NSWLR 409, 420, Cross J said that an appeal from a Master to a Judge involves applying the principle in House v The King (1936) 55 CLR 499, 505, that the appellant must show that the Court below has acted on a wrong principle such as allowing extraneous or irrelevant matters to guide or affect him or her or has mistaken the facts or has failed to take into account some material consideration and it is insufficient that had the Judge been in the position of the Master he or she would have taken a different course. 17 Of course the learned Master's decision in the present case was not a discretionary one. The Master's task was, as I said in Sapir v Sapir (No 2) (1989) 13 Fam LR 362, 364, for him to find as a fact the value the shares in question, aided by expert evidence of value. 18 However, as indicated in Wilsher v Essex Area Health Authority [1988] AC 1074, 1091 and Ahmedi v Ahmedi (1991) 23 NSWLR 288, 299-300, the resolution of conflicting expert evidence is to be regarded as no less important as the resolution of any other conflict of primary fact. 19 In Re Golden Bread Pty Ltd [1977] Qd R 44, 50, D M Campbell J said that in this sort of case "An appeal cannot succeed unless the basis of the valuation is successfully challenged, or the valuation is shown to be entirely erroneous." See also Narayanan Chettiar v Kaliappa Chettiar [1946] AC 116 and Commissioner of Succession Duties (SA) v Executor Trustee & Agency Co of South Australia (1947) 74 CLR 358, 367. 20 In this background, I turn to the instant dispute. 21 The primary question for the Master was whether the Griffiths/Hewitt approach or the Pritchard approach was correct. 22 Mr Pritchard's view was that it was neither appropriate nor possible to value the shares on the basis of nett maintainable profits and therefore one applied the asset backing value. Of course, here, as the Master said, Mr Pritchard completely ignored intangible assets, but that is another matter. 23 In my view the learned Master correctly rejected the Pritchard view. 24 Mr Pritchard reinforced his view by reference to Mr W Lonergan's book "The Valuation of Businesses, Shares and Other Equity". The quotation was from the 2nd 1994 edition at page 20. In the 3rd (1998) edition the passage is on page 30 viz: "While the capitalisation of FMP is the most commonly used valuation method, there are some situations where it is not appropriate. This method should not be adopted where there is: · a history of losses · rapidly declining profits in an industry with poor profits · profitable trading but severe liquidity problems · a single year's profit in a high risk market." Mr Pritchard said that at least three of those bullet points were present in the instant case. 25 It must be remembered that whilst Mr Lonergan is a respected valuer, and his book is on the shelves of most leading law libraries, and indeed, I own a copy myself, his work is really more in the sense of a trade handbook than it is a legal textbook and is almost expert evidence rather than a commentary on the law. 26 In any event, passages such as the one I have extracted have not set out a cast iron rule. The learned author in fact uses the words "should not" and the gravamen of the passage is that there are dangers in using this methodology in certain circumstances. However, there may be equal dangers in using other methods and a tribunal which has to make a finding of fact cannot shirk from making that finding merely because there are difficulties in applying different methods. It makes adjustments and it does the best it can on what it has. 27 There are indeed, instances in the reports where the future maintainable profits methods have been used in rather bizarre circumstances. The best illustration is the decision of Williams J in the High Court of Australia Kent & Martin v Federal Commissioner of Taxation - 22 October 1945, unreported, but the text of the judgment is fully set out in Volume 3 of the Australian Property Law Journal at pp 65 and following. It is surprising that now this decision is available generally and is perhaps the leading decision on valuation of shares in difficult circumstances, it was not referred to the learned Master. 28 In Kent's case, the question was as to the value of shares for Federal estate duty in respect of the estate of a person who died on 3 January 1941. The value of the shares had been seriously affected both by the war and also by additional taxes which had been levied because of the war. It was thus very awkward for the Court to ascertain what were the future maintainable profits. At 73 and following, Williams J analyses all the useful cases on the subject and by excluding certain years and making certain adjustments, obtains a figure from which he can make the appropriate capitalization to get a valuation. 29 The exercise which Williams J performed was even more complex than the exercise that had to be performed in the instant case. 30 Furthermore, the learned Master took the view that on the facts the difficulties in using the future maintainable profits method of valuation, that were argued by Mr Pritchard and the now appellants' submissions, were exaggerated. The learned Master pointed out from Mr Griffiths' evidence that if one removed the extraordinary expenditure of $1.2 million from the 1996 accounts, that year would have shown a profit rather than a loss and that it was possible to employ the usual method of valuation of future maintainable earnings or profits. 31 I cannot see any error in principle in the learned Master proceeding in that way. The selection of the method was a step in making his finding of fact. The selection of method was a matter of principle, but the learned Master not only adopted the ordinary method of valuing shares, other than for a company which has completely ceased trading, but also took into consideration the reasons why he should or should not adopt that method and then decided it was appropriate to apply the method. 32 The learned Master was reinforced in his view by his finding that the Pritchard method was unreal and that he had completely disregarded the value of any intangible assets. 33 Accordingly, the learned Master made the decision that the appropriate method was the future maintainable earnings or profit method; he heard cross examination of Mr Griffiths and Mr Hewitt; he took into account the various objections both to that method and to the evidence, and he decided that it provided the appropriate guide. He then made his assessment. 34 Mr Ashhurst says that this is enough to dispose of the appeal. A fortiori he submits in a case where the Court does not have the transcript of any cross examination. He points out that this must follow from the test in Re Golden Bread Pty Ltd (supra) noted earlier. 35 I would agree with that submission. 36 Ms Painter said that the fact that the learned Master decided completely in favour of one valuer's opinion in itself showed that the Master had failed to carry out his task and that task was to make his own decision on the facts as to what was the value of the shares. She put that the decision shows that what the learned Master did was merely choose between two competing expert opinions. 37 Certainly, in many cases the fact that the tribunal of fact has completely endorsed one expert's opinion and completely discounted the other, may lead the appellate court to the inference that the court below has not performed its task. It is quite clear that it was a matter for the Master to make his own determination as a matter of fact of the value of the shares and not merely endorse that of an expert. As I said in Sapir v Sapir (No 2) cited earlier, the value of the expert valuers was merely to assist the Court in making its determination and was not to be a substitute for its determination. 38 However, Mr Ashhurst met this submission by saying that whilst in many cases the appellate court might draw that inference, it could not do so in the present case in the light of the learned Master's judgment. That judgment showed that there were two expert opinions based on two different methods. The learned Master found one method completely flawed. He thought that the other method was the appropriate method in any event. There was only one set of facts and figures with respect to the appropriate method, that furnished by his clients, and the learned Master virtually had no option once he had seen that it passed the test of cross examination, to follow that method and accept the figures. 39 Again, in my view that is the correct way to approach the matter. 40 Ms Painter said that there were a whole lot of other assumptions in the Griffiths' valuation which were not proved. However, this submission runs into a number of problems. First, there is just not the evidence before me to show whether they were or were not proved, as I do not have a transcript. Secondly, the assumptions were fully put on the table and an opportunity was given to challenge them, or for there to be evidence in reply, and there was none, or at least none that I know about. Thirdly, the exercise that the Master had to perform was to value the shares. It may be that he had inadequate material before him; it may be that he had to make assumptions; it may be that he chose to make the same assumptions as Mr Griffiths made, but his task was to make a finding of fact and he performed that task without apparent error. 41 The present case was an awkward valuation exercise. It might have been possible to be over-legalistic and put more emphasis on the fact that there was no actual licence agreement from the Guernsey company to Caddyrack Pty Ltd and to make various other adjustments. However, all these matters were considered by the learned Master; he came to his decision on a question of fact without, in my view, making any error of principle or falling into the other sorts of errors illustrated in the judgment of the High Court in House v The King (supra). 42 Accordingly, in my view, the appeal must be dismissed with costs. The exhibits, being the valuations, should remain with the papers. ****************** Last Modified: 04/10/2001 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated.