New South Wales Supreme Court CITATION : Parker v Muir Family Investments Adoption of Referee's Report [2002] NSWSC 240 CURRENT JURISDICTION: Equity Division FILE NUMBER(S) : SC 3293 of 2000 HEARING DATE(S) : 19, 20 March 2002 JUDGMENT DATE : 28 March 2002 Morgan Ross Parker (First Plaintiff) SSOR Pty Ltd (Second Plaintiff) Muir Family Investments Pty Ltd (First Defendant) Thomas Robert Holden Muir (Second Defendant) PARTIES : Atalya Pty Limited (Third Defendant) Carl Oscar Peterson (Fourth Defendant) Piaster Pty Limited (as Trustee for the Bensan Discretionary Trust) (Fifth Defendant) Jonathan Alfred Grey Trollip (Sixth Defendant) Meridian International Capital Ltd (Seventh Defendant) Kingston Factors Pty Limited (Eighth Defendant) JUDGMENT OF : Windeyer J at 1 COUNSEL : R. McDougall QC with him Mr R V Gray (Plaintiffs) S G Finch SC with him Mr S Burley (Defendants) SOLICITORS : Frank G Kalyk (Plaintiffs) Kemp Strang (Defendants) CATCHWORDS : PRACTICE - Adoption of Referee's Report - determination of assets and liabilities of a partnership at 30 June 2000 - Supreme Court Rules 1970 Pt72 LEGISLATION CITED : Supreme Court Rules Pt 72 Chloride Batteries Australia Limited v Glendale Chemical Products Pty Limited (1988) 17 NSWLR 60 CASES CITED : Foxman Holdings Pty Limited v NMBE Pty Limited (1995) NSWLR 615 and Super Pty Limited v SJD Formwork (Australia) Pty Ltd (1992) 29 NSWLR 549 DECISION : See paragraph 26 - 11 - IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION WINDEYER J THURSDAY 28 MARCH 2002 3293/00 MORGAN ROSS PARKER & ANOR V MUIR FAMILY INVESTMENTS PTY LTD & ORS JUDGMENT Outline 1 This judgment concerns a motion for adoption of a report of a referee pursuant to a reference under Part 72 of the Supreme Court Rules. The referee was to determine the assets and liabilities of a partnership as at 30 June 2000 and the interest of the second plaintiff (SSOR) in those assets as at that date. Proceedings to date 2 The partnership in question was the Meridian International Capital Partnership. The partners at date of dissolution, namely 30 June 2000, were the second plaintiff and the first, third and fifth defendants. Those four corporate parties are corporate vehicles conducted by the plaintiff and the second, fourth and sixth defendants respectively. The partnership affairs were conducted through Meridian International Capital Limited as nominee for the partnership. 3 On the commencement of the original hearing before me it was always intended that the question of value be subject to a reference although the actual order was not made until the fourth day of the trial. On that day I made an order pursuant to Pt 31 r2 that questions as to value as at 30 June 2000 of the interest of SSOR in the partnership be referred to a referee and that reference not proceed until after the court had given judgment on all other issues in dispute. On 7 August 2001 I delivered judgment. On 20 September I made an order referring the valuation question to Mr Ian Armstrong as referee. Apart from costs orders I made no other orders because I had determined in my judgment that an order should be made for payment by the defendant partners to SSOR of the amount of the plaintiff's interest and that would depend upon the result of the reference and report. Some fresh application has been foreshadowed in this matter and it is not necessary to deal with this aspect at the moment. 4 I will not repeat any of the matters set out in my judgment of 9 August which can be read with this one so far as is necessary. Proceedings on Report 5 The principal report of the referee is dated 19 November 2001. After correspondence with the parties a supplementary report was issued on 29 November 2001 and a further supplementary report on 11 December 2001. In the end the referee valued the net assets of the partnership as between $15.86 million and $15.69 million and the value of the interest of SSOR being 20.8% of that between $3.3 million and $3.26 million. The variation related to differing discount rates allowed. No arguments were addressed to me on the high or low figure. The higher discount rate leads to a lower figure which I am prepared to accept. 6 The plaintiffs move for adoption of the report. There were of course some findings in it unfavourable to the plaintiffs such as the determination that no value was to be attributed to goodwill. Nevertheless the parties accept that the present motion falls to be determined within the principles set out in Super Pty Limited v SJP Formwork (Aust) Pty Ltd (1992) 29 NSWLR 549; Foxman Holdings Pty Limited v NMBE Pty Limited (1995) 38 NSWLR 615 and Chloride Batteries Australia Limited v Glendale Chemical Products Pty Limited (1988) 17 NSWLR 60, which it is not necessary to recite. The defendants, however, contend the report is flawed because the referee failed to give sufficient attention to certain fundamental matters in the particular business leaving to error in certain calculations; because clear errors were made in particular matters; and because other errors revealed that insufficient care and attention was given to the whole matter by the referee. The result, according to the defendants, is that the court should reject the report and as I understood it if it did so then the court should proceed to determine the value itself on the evidence before the referee. That, however, was a suggestion only by which the defendants are no way bound. 7 There is no dispute about the figures ascribed to the partnership assets and liabilities other than the values of future cash flows for management and advisory fees and from restructuring fees. I can therefore come directly to those figures relevant to present value of future cash flows and deal with the defendants' contentions on those matters. Before doing, however, I should set out what senior counsel for the defendant described as overarching arguments as to claimed faults in the report which he said gave rise to a necessity to reject it. Overarching defects 8 The defendants submit that the referee failed to give proper or sufficient attention to: (a) The requirement to obtain approval of the lease parties to assignment of the leasing contracts; (b) The right of the investor to terminate the manager if control of the composition of the board of the manager existing at the date of relevant equity participation agreement materially changed; (c) The lack of non-compete conditions in the partnership agreement. It is the defendants' claim that these failures led the referee into wrong decisions which require his report to be rejected. It is also argued that – as is clearly a case – it could not be assumed that the defendant companies would be the purchasers of the partnership business but that the referee proceeded on the basis that would be the case. I should say I do no think that is correct. 9 It is of course necessary, when dealing with these submissions, to consider them in relation to those parts of the report to which they are said to be relevant and I will do this in turn. Future earnings under existing contract 10 Under the leveraged leasing agreement documents arranged by the Meridian Partnership there were, at the date of dissolution, entitlements to substantial fees to be paid in the future by way of deferred arranger's fees, management fees or administration fees for those contracts. The referee was required to determine the value of these contractual entitlements at dissolution. The relevant agreements all gave the right to the equity participants to object to assignment and the right to terminate which I have set out in paragraphs (a) and (b) of paragraph 8 above. It was necessary to determine the present value of the future cash flows under the contracts. Those cash flows were rights, not possibilities, under the existing contracts, but of course subject to the risk of being brought to an end on assignment without consent or upon change of management control. 11 The experts on each side, namely Mr Lonergan for the plaintiffs and Mr Robertson for the defendants, agreed upon a discount rate of 6.17% to bring about the present value of the future earnings. This was referred to as a risk free discount. They agreed on a further discount of 2.5% for additional risks, those risks stated by the referee to be credit risks of lessees and the risk of replacement of manager. The referee considered that there was a low credit risk. There is no basis on which he could not have come to that view. He considered the risk of Meridian being replaced as manager to be minimal. That conclusion was open to him. The defendants claim that he did not consider or give sufficient weight to the risks that the equity partners would not consent to assignment or to the absence of what was called a non-compete clause in the partnership agreement. As to the first objection, it is not correct. The referee stated that he believed the current partners would only sell the future income stream to a party or parties acceptable to the equity partners and otherwise would manage the contracts themselves. That was a conclusion open to him. The duty of the partners to each other was to obtain the best price for the assets. That would obviously be obtained by selling to a party acceptable to the lessors. The referee did not accept the opinion of Mr Robertson that income to be received after three years should be disregarded. He did not accept the opinion of Mr Robertson as to very large discounts to be applied in years 1, 2 and 3 beyond increasing the higher discount rate – thus bringing about a lower valuation figure – to 9.5%. That conclusion was open to him. The court is not to re-determine it. 12 The ability of the former partners to set up in competition is relevant to and was relevant to the valuation of goodwill which, in any event, was valued at nil. The parties, having sold the business, would not then be able to attempt to gain for themselves, the contract income streams which they had sold. Their ability to enter into competition with any purchaser of the partnership business is acknowledged but is quite separate from this consideration. Failure to have regard to prior comparable transaction 13 This attack is without foundation. My earlier judgment explained why. The earlier sale by Messrs. Lewis and Peterson to the other three partners proceeded on the basis of no payment for goodwill and little payment for future cash flows. It was not comparable and is quite irrelevant. The second paragraph of the report dealing with this subject may be an inaccurate or shorthand way of expressing what I decided, but that does not give any reason to set aside the report which, on this subject was clearly correct. Failure to bring to bear tax implications in valuation of future cash flows 14 This attack like the previous one has nothing to do with overarching arguments, but stands on its own as a reason for rejection or partial rejection on one application of the report. The attack seems to be contrary to the argument that the defendants have foreshadowed they may seek to raise, but on the basis of the orders which would result from my judgment, the attack has substance. The question to be decided is the price a purchaser would pay for the future income stream. It can be assumed the purchaser would be a company liable to thirty percent tax on income. The vendors would not pay tax on a sum received for sale of their partnership interest which would be received by them on capital account. It is clear no purchaser would pay 100 cents for the ability to received 70 cents after tax. SSOR claims entitlement to an order that the defendants pay to it the value of its share. On the argument of counsel for SSOR it would receive 100 cents for something the net worth of which to a purchaser is 70 cents. Discussion of capital gains tax is irrelevant to this. This conclusion is also relevant to the argument on anticipated earnings from restructuring fees. The position would obviously be different if SSOR were to receive its share of future income on distribution of its interest. But the matter did not proceed on that basis. The report requires variation on this subject. 15 Although the argument was presented somewhat differently I consider the proper way to adjust this matter is to take the figure determined for the discounted value of future income from contractual entitlements and restructuring possibilities, to deduct from that the administration expenses involved in collection of that income and to reduce their net figure by thirty percent to make the necessary deductions for taxation. The parties can address further argument as to this if that methodology is not considered correct, having regard to my decision on the necessary allowance for tax. Restructuring opportunities 16 The fact that the chance of obtaining future earnings from restructuring was treated as a separate item and not as a component of goodwill goes some way to explaining why no value was ascribed to goodwill. 17 The experts agreed on a figure before discount – with the exception of the possibility of a fee for the restructure of the Mackay sugar lease - of $2,988,000. The figures accepted were close to those actually earned but rather than a check that is probably irrelevant. 18 The defendants make a number of attacks on the referee's conclusion on restructuring fees. The first relates to the amount allowed prior to discount for what was called the Mackay sugar lease. Mr Lonergan included a figure of $598,000 for this. Mr Robertson on instructions from the defendants included $100,000. In fact the restructure did not proceed but that cannot bear on the opportunity value at 30 June 2000. The referee was entitled to accept Mr Lonergan on this. The passage on page 5 of the report may not be quite correct as expressed but the conclusion was open to the referee. 19 There was some challenge to the decision of the referee to apply ten percent discount to the total fees for uncertainty rather than the twenty percent advocated by Mr Robertson, albeit on a slightly different basis. This was a matter to be decided by the referee. He was entitled to decide as he did. He was entitled not to accept the evidence of Mr Worrall. 20 It seems logical that my conclusion as to thirty percent allowance for tax for future earnings should also apply to earnings from opportunities for restructurings on the basis under which these were brought into account. This was not properly addressed, but it is obviously reasonable, particularly as the fees were likely to be earned within a very short time if earned at all. There is no reason to think the referee did not give attention to the overarching matters in coming to his decision on discount for uncertainty. He was entitled to take into account restrictions on partners going out on their own from taking to themselves the value of work in progress on a restructuring deal. Kingston Factors 21 Some cash flows went to this company which is a wholly owned subsidiary of Meridian. This arrangement was for tax purposes so as to ensure the financing agreement was a lease not a hire purchase arrangement. Kingston took a risk of the lessors exercising rights under put options if the lessee company did not purchase the leased asset at the end of the lease. The referee considered the risk negligible. He was entitled to come to this view. To reconsider this would be to have a second hearing on the same facts and submissions. Administrative expenses in collecting cash flows 22 I will not recite the referee's decision on this. He was entitled to reject the evidence of Mr Dean in a general way and he was also entitled not to accept the evidence of Mr Humphries - whether as to in house cost or out sourced cost. But what the referee did in his first report was to allow a figure of $900,000 for these expenses. He did not accept the evidence which went to attempting to calculate actual costs, all of which was theoretical in any event. He went back to percentages put forward by the experts. Mr Lonergan had estimated expenses at six percent of revenue and Mr Robertson at 13.3 percent. The referee found for a figure of 7.5 percent. But then, having considered written submissions the referee, by supplementary support, having understood that he had determined the matter on an incorrect basis, determined on a percentage of 18 percent for future discounted cash flows, the previous percentages having been based on net revenue. During the hearing before me I had some doubts about this, but on consideration I think it is a determination open to the referee. Some leases required more management than others, some extended for longer periods than others, the work towards the end of the leases when there were a few left might have been less. It is not possible to say that the decision was flawed. It provided a figure of $2.1 million over the period of the leases. Administrative costs of restructuring 23 The referee treated these fees on a different basis. Certainly it seems he made an error in his original report. In his final report he allowed $100,000, stating that he considered most of these fees would have been realised during the first twelve months after dissolution, which was correct, and that a significant part of the work necessary to earn such fees would have been done by 30 June 2000. It was put that he was incorrect in this and that he must have ignored the evidence in a document which is called Exhibit CP4 to an affidavit of Mr Peterson sworn on 22 August 2000. As I understand that material was before the referee. It is not possible to say that he ignored it and I do not know whether or not he was referred to it. On any basis I cannot say that his conclusion was wrong or not open to him. Percentage interest of Mr Parker 24 It is claimed that Mr Bauer is entitled to four percent of the net profits of the partnership so that the interest of Mr Parker was in fact 20.8 percent of 96 percent of the partnership. I am unable to understand how any interest that Mr Bauer had would apply after dissolution and in any event it was never said to apply to any interest in capital assets but rather an entitlement to some share of income. Neither expert referred to this, although there is some reference to the matter at page 27 of the transcript before the referee. Neither side was in a position to direct me to any evidence which would take this matter further or make the position certain. It was for the defendants to do this, although as I pointed out, the plaintiff ought to assist. As the matter stands before me I can see no basis on which the report should be modified in regard to this matter. If there is some evidence which I have overlooked which would somehow show that Mr Bauer was entitled to four percent of the partnership assets after dissolution, which seems rather unlikely, then I would be prepared to allow the parties to address me further on this matter. Final matter 25 It is accepted that in his final report the referee omitted to add a figure of $100,000 to what is described as the lower figure for administration costs on restructuring. That can now be attended to. In addition the figure for surplus cash in Kingston Factors is now ascertained to have been $160,000 and the report will need to be adjusted for that. Finally it will need to be adjusted having regard to my decision on the tax treatment for future cash flows for management and advisory fees and restructuring and for restructuring fees. I see no basis to determine the matter other than to accept the referee's low figure rather than the referee's high figure, he not having given me any reason to do otherwise and I propose to do that. 26 The parties can now prepare final calculations based on these orders and bring in draft minutes of order to give effect to my decision on the report. ********** Last Modified: 05/07/2002 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. 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