New South Wales Supreme Court CITATION : KSSLZ v Childs [2006] NSWSC 180 HEARING DATE(S) : 20, 21 March 2006 JUDGMENT DATE : 30 March 2006 JURISDICTION : Equity Division Commercial List JUDGMENT OF : Associate Justice Macready at 1 CATCHWORDS : Contract. Agreement for sale of a series of childcare centres at prices calculated by use of a formula. Whether condition precedent to the particular childcare centre has been fulfilled. Question of construction of agreement. Held condition fulfilled. PARTIES : KSSLZ No 2 Pty Limited & 5 Ors v Childs Family Kindergartens Limited FILE NUMBER(S) : SC 50125 of 2005 COUNSEL : Mr A Bell SC & D. McLure for plaintiffs Mr N Francey for defendant SOLICITORS : Henry Davis York for plaintiffs Elliot Tuthill for defendant - 1 - IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION COMMERCIAL LIST Associate Justice Macready Thursday 30 March 2006 50125/2005 KSSLZ # 2 PTY LIMITED & 5 ORS v CHILDS FAMILY KINDERGARTENS LIMITED JUDGMENT 1 His Honour: This matter concerns a dispute between the parties in respect of the sale of a childcare centre. The sale was pursuant to an agreement between the parties executed on 8 October 2004. 2 The six plaintiffs are companies which are part of a group known as Acre Woods Childcare Group. That group has as its business the establishment and development of childcare centres with a view to the on-sale of those centres. The defendant is a public listed company which owns and operates childcare centres. 3 There were originally discussions between the principals of the relevant companies between December 2003 and July 2004. An offer to sell various childcare centres was made on 12 July 2004. The offer related to the sale of ten childcare centres which were operating with an arrangement that in due course the next ten childcare centres when they developed would be purchased on the same terms. 4 This led to the execution on 8 October 2004 of a series of documents. In respect of the existing childcare centres there were ten options to purchase granted which in due course were exercised and completed. On the same day an agreement to purchase was reached in respect of the childcare centres that were still being developed by the Acre Woods Childcare Group. That agreement related to the purchase of the further ten childcare centres. The centres were in different stages of development and the structure of the arrangement was that as each childcare centre achieved a 70% occupancy rate then the parties were obliged to proceed, subject to various conditions, with the execution of a contract for the sale of business and in due course completion of the sale of that childcare centre. 5 The first of this second group of childcare centres that the defendant was to purchase under the agreement was situated at Lane Cove. On 20 April 2005 notice was given in accordance with the terms of the agreement that the 70% occupancy had been reached. There followed considerable correspondence and discussion with regard to the matter and on 3 August 2005, in accordance with the agreement of October 2004, the first plaintiff, which is the owner of the Lane Cove childcare centre, executed the contract for the sale and forwarded it to the defendant. Under the terms of the agreement there was an obligation to exchange within 30 days after notification of the occupancy having been achieved. The defendant declined to sign the contract for sale and these proceeding have been brought in which the first plaintiff seeks damages in respect of the failure to complete. There are also claims by the first plaintiff and the other plaintiffs who are various vendors under the agreement of October 2004 for declarations as to the defendant's liability to complete the contracts. Deed of Agreement dated 8 October 2004 6 The six plaintiffs are parties to this contract as they are the owners of several of the childcare centres which were the subject of the parties' agreement. Clause 3.1 of the sale agreement provided for the various vendors to sell the businesses referred to in Schedule 1 to the defendant upon the terms contained in the agreement and in particular Schedule 2 to the agreement. Schedule 2 to the agreement provided a trigger on any childcare centre reaching a 70% occupancy of the total number of licensed places. Once that was achieved the defendant was to be advised within 30 days. Thereafter contracts for the sale of the businesses with a 10% cash deposit were to be exchanged within 30 days after the notification and completion was to be effected no later than 60 days after exchange of contract subject to various conditions. 7 Clause 3.2 of the agreement provided for the purchase price. It was in these terms: "3.2 The Purchase Price of each of the Businesses will be set at a multiple of 6 times EBITDA of that Business in accordance with the formula contained in Schedule 3." 8 EBITDA is defined as meaning earnings before interest, tax, depreciation and amortisation. Schedule 3 was the relevant container of the purchase formula. As it is of some importance in the matter the formula is as follows: "1. The businesses will be valued as per the computer generated "Financial Model ("FM") 29.9.04", a copy of which is attached, at six times the EBITDA of each business (indicated in the attached model as the Projected Annual Net Profit). 2. The projected "EBITDA" will be based on full year profit based on the total number of licensed places and calculated according to the financial model. 3. The Financial Model for any centre requires the following essential variables to be entered to arrive at the Projected Annual Net Profit*. These variables are explained in the instructions page of the "Financial Model (FM) 29.9.04". These variables are: (a) Name of the Centre. (b) Age group licensed for (c) Total number of licensed places (d) Number of licensed places per age group (e) Daily Fees of licensed children per age group charged at time of exchange of contracts (exclusive of GST) (f) Total rent payable per annum (exclusive of GST) *This Financial Model is based upon the total number of licensed places and the total number of children per age group and is not based upon any actual occupancy, at the time that the 70% occupancy level is reached or at time of exchange of contracts. The income is based on the centre operating for 50 weeks of the year. The Projected Annual Net Profit is before interest, tax, depreciation and amortisation (EBITDA)" 9 An important clause in the contract contained a condition as to the profitability of the business to be sold. Clause 3.3 is in the following terms: "MINIMUM EBITDA 3.3 All the Businesses must have a minimum EBITDA of $200,000.00. If any of the ten businesses referred to in Schedule 1 hereto does not reach a minimum EBITDA of $200,000, then the relevant nominated Vendor referred to in Schedule 1 or AW will retain such business, and AW will use its best endeavours to secure an alternate business which will have a minimum EBITDA of $200,000." 10 Plainly the contemplation of the clause is that all businesses must achieve a certain profitability. We are here concerned with the first of those contemplated and accordingly, it is only the first business to be sold which is relevant to the present matter. It is important to note for the purposes of the defendant's argument that within clause 3.3 there is no reference to schedule 3 to the agreement. This is in contrast, of course, to clause 3.2. However, there was an admission in the contentions which was in the following form: "7. For the purposes of clauses 3.2 and 3.3 of the Deed of Agreement, the Earnings before Interest and Tax and Depreciation and Amortisation (EBITDA) of the Plaintiffs' businesses are to be calculated in accordance with the purchase formula set out Schedule 3 to the Deed of Agreement." 11 I have earlier set out the purchase formula in schedule 3. Paragraph 1 refers to a copy of the model being attached in order to determine the projected annual net profit. The pages of the financial model in their uncompleted form were attached to the contract and there was also attached an example of a test run for a particular hypothetical centre. That test run was based upon there being 90 places and a spread of revenues over the three licensed age groups for children. The financial model was to be completed using an Excel spreadsheet, a copy of which was tendered before me. Of note is that the last comment in schedule 3 that the model is based upon the total number of licensed places - was repeated again in the accompanying explanatory written model. The written model which was attached constituted the instructions for using the Excel spreadsheet programme. Seventy percent occupancy 12 The first question which arises is whether or not the 70% occupancy was achieved. Evidence was given before of the numbers attending per week in the relevant period. This information was taken from sign-in sheets signed by parents when the children were left at the childcare centre. The evidence, which was not cross-examined upon, clearly demonstrates that 70% occupancy was achieved. Conditions precedent 13 There are a number of conditions precedent to the fulfilment of the agreement and the evidence establishes that the relevant conditions of clauses 3.10 and 3.14 have been fulfilled. The debate between the parties is whether the provisions of clause 3.3 have been complied with in order to permit the sale to proceed rather than have a substituted sale. The dispute between the parties revolves around the completion of the formula. There are, as indicated above, a number of variables depending upon the childcare centre concerned. A true variable is, of course, the daily fee charged at the time of exchange of contracts. Another true variable is the rent payable in respect of the childcare centre. The matter which is at the heart of the dispute is, of course, what is described as a variable but which is expressed as being the total number of licensed places for the relevant childcare centre. It will be recalled that in the parts of the model I have quoted there is a statement that the financial model is based upon the total number of available licensed places rather than any actual occupancy. 14 In these circumstances the plaintiffs say that the appropriate variable to be included in the financial model is 39 which the evidence discloses is the licensed number of places. Using this number and the other variables which are not in dispute between the parties the financial model produces a projected annual net profit of $308,277. That is the EBITDA. Pursuant to clause 3.2 this makes the purchase price of $1,849,662. The defendant says that as a matter of construction, applying the formula, one should not use the total number of licensed places but the number of actual places at the time the 70% occupancy level is reached. In the present case this number is 27 and the use of the formula with this number provides for a projected annual net profit of $158,860. In these circumstances the defendant submits that clause 3.3 is not satisfied and that, accordingly, it is for the first plaintiff to retain such business and that the defendant is not obliged to purchase that particular business. 15 Clause 3.3 must be construed in the light of the admission contained in paragraph 7 of the plaintiffs' contentions. One is thus contemplating a process of determining the EBITDA for the purposes of clause 3.3 using the formula in schedule 3 to the agreement. No question arises of EBITDA being determined based upon actual calculations using historical accounting information in respect of the childcare centre. 16 The defendant submits that on its proper construction clause 3.3 requires the formula in schedule 3 to be completed by showing the variable for the number of licensed beds as being that amount which reflects the occupancy at the time of the contract. In advancing this argument the defendant points to the fact that the agreement by its very nature is to do with the development of various childcare centres from a start-up position to a position where they have achieved some measure of profitability and occupation. The relevant occupation trigger is 70% and there is a natural inference it was submitted that this would be the touchstone for determining the profitability. No doubt many a childcare centre could achieve the 70% occupancy at very reduced charges to parents. That would not demonstrate profitability such that the parties should be compelled to proceed with the sale of the business. 17 I will later refer to the fact that the evidence before me demonstrated that the value of the childcare centre at Lane Cove calculated on actual performance in accordance with ordinary valuation principles provides a value at the relevant time of $950,000 which is substantially less than the purchase price determined by means of the formula. The defendant points to this and emphases that they have paid a substantial premium for the businesses. No doubt this was done for the defendant's own good business reasons but it is referred to in order to show the need for there to be a profitable business which it is acquiring. 18 The defendant also contended that the use of the formula according to the plaintiffs' calculations led to an illegal result in the sense that contrary to Regulation 53(2) of the Children's Services Regulation 2004 two members of primary contact staff were not available to be present when children were being provided with services. However, the evidence shows more than two staff present. Having regard to the fact that there was no cross-examination on this issue to suggest that these staff were not appropriate for the role, I am not satisfied on the balance of probabilities that there would be any breach of the regulation. 19 The plaintiffs submit that this is not the proper construction of clause 3.3. That clause requires the use of schedule 3 for determining EBITDA, and on their submission the schedule is plain on the subject, relevantly: (a) note 2 provides that "the projected EBITDA will be based on full-year profit based on the total number of licensed places and calculated according to the financial model"; (c) note 3 exhaustively lists the six variables to be entered into the model. Variable (c) is "total number of licensed places"; (d) the footnote to note 3 states that "this financial model is based upon the total number of licensed places and the total number of children per age group and is not based upon any actual occupancy, at the time that the 70% occupancy level is reached or at time of exchange of contracts…". 20 The plaintiffs also point to the fact that the financial model has many similar pointers. Relevantly: (a) the six variables are again exhaustively listed. Variable (c) is "total number of licensed places"; (b) the footnote to the list of variable states that "once the variables described above have been entered the financial model is complete and has all the required detail in order to calculate the Projected Annual Net Profit"; (c) the footnote set out at paragraph 8 above appears again. 21 The plaintiffs submit that there is nothing inconsistent with the parties agreeing that part of the formula shall be the total number of licensed places. In their submission there is still room for the operation of clause 3.3 because there are other variables such as the age groups, fees charged and the rent for the premises all of which effect whether or not at 100% occupancy the childcare centre achieves the requisite profitability as measured by an EBITDA of $200,000. The presupposition of the parties appears to have been that in due course each childcare centre would operate at full capacity or near full capacity. 22 Apart from the matters I have mentioned the defendant did not point to any other circumstance to support their construction even if there was some ambiguity in the words which were used. In my view the words used in the model are plain and straightforward and there is no ambiguity. In these circumstances I accept the construction put forward by the plaintiffs. The first plaintiff's claim for relief 23 The first plaintiff did not submit that on the evidence in this case damages were an inadequate remedy and, accordingly, it elects to claim damages rather than specific performance. 24 The damages claimed are the difference between the sale price for the Lane Cove childcare centre calculated in accordance with the deed and the ordinary market value. I have already found that the sale price calculated in accordance with the deed of 4 August 2005 was $1,849,662. 25 There is evidence from Mr Barry Coad, a valuer, that as at 25 January 2006 the value was $950,000. He also gave evidence that the value in the period from 20 May 2005 to that date would have been lower. The first plaintiff does not, however, claim damages for that difference. The first plaintiff is entitled to damages in the sum of $899,662 with interest. 26 There are the other five plaintiffs who are relevant vendors under the one agreement made between all six plaintiffs and the defendant. There are potentially another nine contracts for the sale of childcare centres which may eventuate out of that agreement. The other plaintiffs as well as the first plaintiff also seek declarations in respect of the agreement. None of the other five plaintiffs are seeking damages as they have not yet reached the stage of a childcare centre being sold. 27 In Young, Declaratory Orders (2nd ed) the learned author indicates at pages 9 – 10 that there are six factors that must be present before there can be a declaratory order, namely: 1. a controversy between the parties; 2. the proceedings must involve a "right" which is recognised in law; 3. the proceedings must be brought by a person who has a proper or tangible interest in obtaining the order; 4. the controversy must be subject to the court's jurisdiction both within the court's own charter and also within the jurisdiction so far as private international law rules are concerned; 5. the defendant must be a person having a proper or tangible interest in opposing the plaintiff's claim; 6. the issue must be ripe. It must not be merely an academic interest, hypothetical or one whose resolution would be of no practical utility. 28 All these factors are present in this case and it is appropriate that there be declarations to resolve the matters in issue in respect of this contract of 8 October 2004. Declarations 1 and 2 in the summons are consented to and can be made. Declaration 2(A) can be made with the insertion after the second word of the words "for the purposes of clause 3.2 and 3.3 of the contract between the parties dated 8 October 2004". 29 In respect of the declarations in paragraphs 3, 4 and 5 of the summons I have already found these facts which are relevant and essential for the purposes of the first plaintiff's claim for damages and, accordingly, there is no need for separate declarations. 30 The parties can bring in short minutes to reflect these reasons. ********** 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.