Supreme Court New South Wales Medium Neutral Citation: Lifehealthcare Distribution Pty Limited -v- Stewart Allen Nicholas [2011] NSWSC 661 Hearing dates: 2, 3, 4, 5, 9, 10, 11, 12, 16 & 17 May 2011 Decision date: 29 June 2011 Jurisdiction: Equity Division - Commercial List Before: Hammerschlag J Decision: Plaintiff's claim dismissed with costs. Defendants' cross-claim dismissed with costs Catchwords: CONTRACT - sale of shares agreement containing warranties that financial information provided was true and not misleading in any material respect - plaintiff sues for damages for breach of warranties - whether plaintiff has established breach and whether it has established damages; TRADE PRACTICES - Fair Trading Act 1987 (NSW) - ss 41, 42(1) and 68(1) - plaintiff makes alternative claim for damages on the basis that in providing information and in not providing certain other information defendants engaged in conduct that was misleading or deceptive or likely to mislead or deceive - whether plaintiff has established that defendants had engaged in such conduct and whether it has established that it suffered loss by the conduct complained of Legislation Cited: Fair Trading Act 1987 (NSW) Cases Cited: Luna Park (NSW) Ltd v Tramways Advertising Pty Ltd (1938) 61 CLR 286 Watts v Rake (1960) 108 CLR 158 Wenham v Ella (1972) 127 CLR 454 HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd (2004) 217 CLR 640 EW Blanch Pty Ltd & Anor v Cooper & Anor [2005] NSWCA 217 Campbell v Backoffice Investments Pty Ltd (2009) 238 CLR 304 I & L Securities Pty Ltd v HTW Valuers (Brisbane) Pty Ltd (2002) 210 CLR 109 Sellars v Adelaide Petroleum NL (1994) 179 CLR 332 The Commonwealth v Amann Aviation Pty Ltd (1991) 174 CLR 64 Malec v JC Hutton Pty Ltd (1990) 169 CLR 638 JLW (Vic) Pty Ltd v Tsiloglou [1994] 1 VR 237 Troulis v Vamvoukakis [1998] NSWCA 237 Hampton Court Ltd v Crooks (1957) 97 CLR 367 Jones v Dunkel (1959) 101 CLR 298 Kizbeau Pty Ltd v W G & B Pty Ltd (1995) 184 CLR 281 Kenny & Good Pty Ltd v MGICA (1992) Ltd (1999) 199 CLR 413 Chappel v Hart (1998) 195 CLR 232 Rosenberg v Percival (2001) 205 CLR 434 Ellis v Wallsend District Hospital (1989) 17 NSWLR 553 Category: Principal judgment Parties: Lifehealthcare Distribution Pty Limited - Plaintiff/First Cross-Defendant Paul Mirabelle - Second Cross-Defendant Geoffrey Thompson - Third Cross-Defendant Daren McKennay - Fourth Cross-Defendant Stewart Allen Nicholas - Defendant - First Defendant/First Cross-Claimant Patricia Lynette Nicholas - Second Defendant/Second Cross-Claimant Representation: Counsel: M.J. Darke with J.B. Spinak - Plaintiff/First, Second, Third and Fourth Cross-Defendants N.A. Cotman SC with G.P. McNally SC - First and Second Defendants/First and Second Cross-Claimants Solicitors: McLachlan Thorpe Partners - Plaintiff/First, Second, Third and Fourth Cross-Defendants Hunt & Hunt - First and Second Defendants/First and Second Cross-Claimants File Number(s): 2009/298678 Judgment INTRODUCTION 1His Honour: On 1 February 2006, after negotiations spanning some months and extensive due diligence, the plaintiff (Buyer) bought the defendants' (Sellers) shares in Admed Pty Ltd ("Admed") for consideration totalling $12,600,000. 2Their written Share Purchase Agreement ("the Agreement") provided for an Initial Purchase Price of $10,080,000 and the issue to each of the defendants of a redeemable preference share in MMT Healthcare Pty Ltd ("MMT") (the plaintiff's holding company), redeemable (at the election of the holder) at a price of $1,260,000. 3Under the Agreement the defendants warranted to the plaintiff that: ...the information given to the Buyer or its advisers by a Seller about each Group Company including the information in the Schedules and in the Disclosure Letter: (a) is true and is not misleading in any material respect whether by omission, failure to particularise or otherwise; ("warranty (a)") and (b) comprises all information which would be material to a buyer for value of the Sale Shares. ("warranty (b)") 4Section 42(1) of the Fair Trading Act 1987 (NSW) ("the Act") (which is in Pt 5) provides: A person shall not, in trade or commerce, engage in conduct that is misleading or deceptive or is likely to mislead or deceive. 5Section 68(1) of the Act provides: A person who suffers loss or damage by conduct of another person that is in contravention of a provision of Part...5... may recover the amount of the loss or damage from the other person or from any person involved in the contravention, in a court of competent jurisdiction. 6The plaintiff sues for damages alleging that the defendants breached the warranties and engaged in misleading and deceptive conduct in contravention of s 42 of the Act by: a overstating Admed's profit before tax ("PBT") as at 30 November 2005; b providing the plaintiff with a misleading profit forecast for the financial year ended 30 June 2006 ("FY06"); and c not providing the plaintiff with adequate information about the loss which Admed made in December 2005. 7On or about 12 December 2006, the defendants elected to redeem 75 per cent of the preference shares (for $1.89M cash) and to convert the remainder ($630,000) into shares in MMT. They allege that they were misled into taking the shares in MMT rather than cash and thereby suffered loss. They counterclaim for damages under s 68 of the Act. THE PROCEEDINGS 8The hearing occupied ten days over the period 2 to 17 May 2011. Mr M J Darke and J Spinak of counsel appeared for the plaintiff. Mr N Cotman SC and Mr G McNally SC appeared for the defendants. 9Seventeen volumes of documentary material (including a significant amount of accounting material) were tendered. The Court was taken to numerous documents (although most of them were in only seven of the volumes). 10There was affidavit evidence from five lay witnesses for the plaintiff, as well as evidence from an expert forensic accountant who provided four reports. Three affidavits were read by the defendants. All witnesses were cross-examined, some at length. 11There were numerous factual disputes (some of which are peripheral to say the least) including whether and where particular meetings were held, what was said at those meetings and what was said in telephone conversations. Much cross-examination was directed to these disputes. However, in the end the plaintiff (correctly in my view) did not challenge the credit of the defendants, whom, I should say, impressed me as witnesses who were entirely truthful. 12Although the defendants challenged the evidence of the plaintiff's witnesses, they did not do so on the basis (also correctly in my view) that their evidence was not honestly given. There are respects in which I have not accepted the evidence of the plaintiff's witnesses. 13I have endeavoured to refer to only so much of the affidavit and oral evidence and documentary material as is necessary to facilitate a proper understanding of the issues, and the reasons for my conclusions. THE PARTIES 14The plaintiff (previously called Healthcare Distribution Pty Ltd) was incorporated on 6 December 2005 by Messrs Paul Mirabelle, Daren McKennay and Geoff Thompson. They had all previously worked for MIA Group, a listed company with radiology businesses. They had left following the merger of that group with another radiology service network. 15Paul Mirabelle, Daren McKennay and Geoff Thompson are each highly experienced in commercial matters. Paul Mirabelle has a law degree and an MBA. Prior to 2005, he had occupied senior executive positions in both Canada and Australia. Geoff Thompson is a chartered accountant. Before joining MIA he was employed by AMP as Head of Group Risk Management and later as Chief Financial Officer of GIO. He is highly skilled in the analysis of financial information. Daren McKennay has a Bachelor of Business and an MBA. Before joining MIA he was Chief Executive Officer of various hospitals. 16They incorporated the plaintiff as a vehicle for the acquisition and consolidation (sometimes termed aggregation) of businesses in the healthcare industry, particularly in the medical devices and equipment sector. Their goal was to purchase "cornerstone" businesses with strong foundations and strong potential for growth, to which other smaller businesses could be attached (or "bolted on"). Their ultimate objective was to create a business on a national scale and later to float it on the stock exchange. 17In about 1987, the defendants, Mr Stewart Allen Nicholas and Mrs Patricia Lynnette (Lyn) Nicholas (together "the Nicholases") acquired Admed. Each acquired one of the two shares on issue. Admed was in the business of providing hospital and aged care medical equipment to the nursing home and hospital sector and to veterans funded by the Commonwealth Department of Veteran's Affairs ("DVA"). Before that, Stewart Nicholas had been a motor car sales person and Lyn Nicholas had been a bank teller. 18When they acquired Admed it operated only in New South Wales, from premises at Ingleburn. In about 1992, Admed moved into Queensland. It did this through a wholly owned subsidiary, Abbetta Medical Wholesalers Pty Ltd ("Abbetta"). Unless the context otherwise indicates, where I refer to Admed this should be taken to include Abbetta. 19In about 2003, Admed moved into Victoria by which time it had ten branches and seventy-five employees. In August 2004, Admed was successful in tendering for a contract to supply equipment to the DVA. 20The Nicholases' daughter, Belinda Fowler, started working for Admed in about 1991 as Office Junior. She later became Purchasing Manager, then Sales Manager and in 1999 became General Manager. 21Over some 18 years the Nicholases built the business into a substantial enterprise. 22At all material times Mr Joe Barilla, of the accounting firm Widdup and Barilla, was Admed's external accountant. Joe Barilla passed away on 2 April 2009. NEGOTIATIONS LEADING TO THE FIRST TERM SHEET 23Paul Mirabelle, Daren McKennay and Geoff Thompson identified Admed as a target and made contact with the Nicholases in about September 2005. 24They identified Crescent Capital Partners ("Crescent"), the manager of an investment fund, as a potential investor in, and source of equity for, the proposed enterprise. Mr Michael Alscher is a principal of Crescent. Crescent reached an arrangement with them to invest in the proposed enterprise via a corporate entity (which transpired to be the plaintiff). 25Paul Mirabelle and Geoff Thompson met with the Nicholases on 14 September 2005. They made a presentation to the Nicholases about their vision and the advantages of being part of a network. Paul Mirabelle asked about the DVA contract and its profitability. According to Lyn Nicholas, Geoff Thompson said they would require Admed's budget for FY06. She says that she responded by saying that Admed did not produce a budget but that they did set measurable objectives in relation to revenue growth. She says that Geoff Thompson asked her for their "best guestimate [sic] - nothing formal". She says that later in the conversation Stewart Nicholas said that if he were to consider selling the business it would not be based on any forward outcomes because he was not going to be held accountable for things outside his control. He also said that if they wanted to base their offer upon 2006 outcomes, he would be expecting a higher price. 26At the time, the Nicholases were apparently not looking to sell the business but were prepared to think about it. They were concerned about sharing confidential information. 27On 15 September 2005, Geoff Thompson wrote to the Nicholases asking for a balance sheet of Admed as at 30 June 2005, actual revenues, gross margin and PBT for FY04 and FY05 and budgeted revenues, gross margin and PBT for FY06. He attached a confidentiality agreement for the Nicholases' review. Mrs Nicholas says that she called Geoff Thompson and repeated that they did not have a budget. He responded by asking her to give an estimate along the lines of what she thought revenue, profit and gross margin would be that year, to give them a guide. 28On 20 September 2005, Lyn Nicholas, responding to a request from Geoff Thompson, provided by way of an email of that date ("the 20 September email") a "Budget" for FY06 in the following form: Budget 2006 Revenue - $18,400,00 [sic] Profit - $2,200,00 [sic] Margin - 38% 29Paul Mirabelle and Geoff Thompson say that they met the Nicholases on 7 October 2005. The Nicholases say there was no meeting at that time. They say that they were away after the October long weekend. 30On 16 October 2005, Michael Alscher of Crescent gave Paul Mirabelle a letter of offer by Crescent to invest in the proposed enterprise (which it styled "HealthCo"). 31The letter provided amongst others that Paul Mirabelle, Daren McKennay and Geoff Thompson would receive performance shares in the investment vehicle if it acquired businesses at a multiple of less than 5.75 times their audited FY06 earnings before interest and tax ("EBIT"), that they would receive incentive shares based on the internal rate of return which Crescent had earned on its investment when it ultimately exited from it and that each would receive management fees. Paul Mirabelle would be Group Chief Executive Officer (at $340,000 p.a.), Daren McKennay would be Group Chief Operating Officer (at $280,000 p.a.) and Geoff Thompson would be Group Chief Financial Officer (at $280,000 p.a.). 32On 20 October 2005, Paul Mirabelle and Geoff Thompson met with the Nicholases. The Nicholases indicated that they were interested in selling their business. 33Paul Mirabelle's version of the meeting is as follows: Stewart Nicholas said he wanted 5 times profit, plus the value of stock and debtors, and that he figured that the business was worth $7.5M, plus stock and debtors; Paul Mirabelle said that they normally acquired working capital as part of a business so that it was already included in the multiple they would pay, that the typical range paid for a private business was 4 to 5 times earnings but one would not normally pay extra for working capital on top of that or, if one did, the multiple would be much less than 5 times; Stewart Nicholas said he did not care how the business was valued, that was the price they wanted, they had about $3M in stock and about $1.5M in payments due after accounts payable were accounted for; Paul Mirabelle responded that this meant a price of $11 to $12M based on $1.5M profit for the last year, which was well outside what people pay for a private business and that 5 times profit, plus working capital, would equate to a multiple of 8 and that he would not get support for that; Stewart Nicholas said that their last year profit was $1.5M, but that this did not reflect their investment over the last 12 months to win the DVA contract from which they were starting to see real benefit which would continue that year; Lyn Nicholas said that they were budgeting for $2.2M in profit for FY06; Paul Mirabelle asked how they were going to get there, given their last year's profit was $1.5M; Stewart Nicholas said DVA work was ramping up and they had expanded the number of branches; Paul Mirabelle said that if this was the case, there may be a basis for them to meet the Nicholases' price expectation and at the same time get support for the transaction, provided they could satisfy themselves in the course of due diligence that the business would actually deliver $2.2M in EBIT and he suggested the preparation of a term sheet setting out their offer; Lyn Nicholas said that they had been approached by someone else who was interested in buying the business (which was in fact an organisation called Loftus Capital). 34Lyn Nicholas says that at this meeting there was a discussion about the financials she had provided Geoff Thompson. Her version of the meeting is as follows: Paul Mirabelle said they were impressed with the financials and asked how they had come up with the $2.2M budget; her response was that she expected an increase in earnings on the previous year but that this was an estimate based on her discussion with Geoff Thompson, that she had not had to estimate one before, so she looked to Stewart Nicholas and Belinda Fowler for feedback and they concluded that based on the extra sales from the DVA, the implementation of their rental and textiles divisions over the next few months and the fact that they were looking like securing a contract for ward beds in New South Wales, they made the assumption that profits could reach $2.2M; she said that the revenue figure was "as per our company [sic] measurable objective growth of 10%"; Paul Mirabelle asked whether she thought they were going to make the profit, to which she responded that Geoff Thompson had asked for a "best guestimate", that they did not do budgets and perceived growth to be an increase in revenue, not profit; Paul Mirabelle responded saying that he was just curious as to how they arrived at the figures given that she had said that they did not have a budget and that based on what they had seen, they had come up with a possible scenario; Paul Mirabelle gave a detailed presentation of how the proposed network would be formed; Paul Mirabelle handed to them a sheet outlining the possible returns upon investing in the network upon float; after some further discussion Stewart Nicholas said they would expect a multiple of 5 plus net working capital reflected then, not months ago. 35Stewart Nicholas gave evidence of a meeting in about mid October 2005 in which Paul Mirabelle asked what they were expecting (as a price) for the business, to which he responded that he was expecting 5 to 6 times profit, plus stock, debtors, cash and assets. He says Paul Mirabelle said that that was not how you buy a business - assets just come with the company. He says he replied that that sounded ridiculous to him, that he thought they would have to put a value on it, that not all companies were the same and that they did not owe money on their assets. 36On 24 October 2005, Paul Mirabelle, Daren McKennay and Geoff Thompson met Michael Alscher and Nathaniel Thomson, Crescent's Investment Manager responsible for considering and implementing acquisitions. Before the meeting, Paul Mirabelle and Geoff Thompson discussed the drafting of a briefing document for Crescent and the putting of a proposal to the Nicholases in a term sheet. Paul Mirabelle says they discussed amongst themselves the need to reflect that Admed had a forecast 2006 EBIT of $2.2M and that they needed to be comfortable that the information provided by Admed to date was accurate and that what they found out in due diligence supported it. 37At the meeting, Crescent was presented with a briefing document, entitled "Agenda", summarising the Admed opportunity, along with some other acquisition targets they were investigating. The Agenda described Admed's business and its prospects. It referred to the fact that Admed had won the DVA contract in New South Wales. It described key weaknesses and threats to Admed's business, key opportunities identified by Admed, and broader opportunities identified by the plaintiff. It described the current status of discussions with the Nicholases. Its contents included the following: Overview * ... * Budget for 2006 - $18.4m and they are spot on so far in the year EBIT of $2.2m Valuation * The owners have strongly indicated that they would only accept an offer of 5X FYO5 EBIT plus net working capital and are not interested in an earn-out - FY05 EBIT $1.5m x 5 $7.5m - Net working capital $5.2m - Total $12.7m * At 30 June 2005 the company had net working capital of $5.2m which appears unusually high (compared to $2.1m for Company 2 and $1.6m for Company 4) * Based on the limited information available, and subject to due diligence assessment, it may be possible to release up to $2m of working capital (see model), which may be factored into the valuation considerations Bottom line * Asset is not cheap but appears to be a very good cornerstone in the rehab segment - worth acquiring * Stuart [sic] and Lyn are very traditional operators- very tight management, deep industry knowledge, no particular interest in stepping back for the foreseeable future * Both display old-fashioned business values- pride in the business, honesty, integrity 38Paul Mirabelle says that there was a discussion about the possibility that the price being asked for by the Nicholases could be met, on the basis of the forecast 2006 profit of $2.2M, and that Michael Alscher said that if the purchase price was to be around $12.7M then they would all have to be satisfied through the due diligence process that Admed was tracking to the forecasted EBIT for 2006. Paul Mirabelle says that, based upon the discussions that he had with the Nicholases at the meeting on 20 October 2005, he understood that the price required by the Nicholases for their business was $12.7M. However, based on a profit of $1.5M in FY05 and $5.2M in net working capital, this would have required a multiple of approximately 8.5, which was well outside what he considered to be a normal multiple. Accordingly, he says he did not believe that it would be possible to meet this price unless the business could be valued on a different basis, namely, by taking into account projected profit for FY06. If the projected profit of $2.2M was achieved, then a price of $12.7M meant a multiple of close to 5.7 which, although high, was acceptable given their arrangements with Crescent. 39His view was that Admed was a relatively large medical distribution business with revenues approaching $20M and forecast EBIT of $2.2M, and that there were very few companies he had identified as possible target acquisitions that had EBIT which was greater than $1.5M. In addition, with a forecast EBIT of $2.2M for FY06, Admed presented as a business that was growing very strongly relative to its FY05 performance of what he understood to be $1.5M EBIT. Lastly, Admed's size, growth prospects and position in the rehabilitation equipment market offered strategic value as he felt it would represent a good initial cornerstone business to build from. He says that the result of these considerations was that he was willing to recommend an acquisition multiple higher than a more typical multiple of 4 to 4.5, in order to justify the purchase price of $12.7M required by the Nicholases. 40On 27 October 2005 Paul Mirabelle handed the Nicholases a letter of offer to purchase Admed ("the firm term sheet"). He says he did this at the local RSL Club. Lyn Nicholas says that Daren McKennay was also at the meeting and that he was introduced as the person who would be overseeing the due diligence. 41The first term sheet included the following provisions: 2. Purchase Consideration As per our discussions we wish to make you a formal offer to purchase Admed for an amount determined by adding two components: i The amount determined by multiplying the normalised FY05 earnings before interest and tax (EBIT) of Admed (amount to be confirmed) by five (5) ; plus ii The amount equal to the net working capital in Admed at the time of completion of this transaction (amount also to be confirmed but for the sake of clarity to include cash, plus receivables, plus the book value of inventory less creditors, and provisions). This purchase consideration is to purchase 100% of the outstanding shares, options and any other equity capital instruments of Admed and includes the capital of all related entities necessary to acquire all the business assets associated with Admed. The purchase consideration will be comprised of three components: i. 80% of the agreed purchase consideration in cash, paid immediately at the completion of the purchase process; ii. The balance paid on 30 June 2006; iii. An option for you which expires on 30 June 2006. You may elect to reinvest up to the full amount of the balance in MMT Healthcare shares on the same terms and conditions as all syndicate investors (i.e. Crescent, MMT and other syndicate investors) have already invested. In exchange for that option, but only if exercised the net working capital component defined above will be defined to be net working capital less $900,000. We have structured your right to invest in MMT Healthcare in such a way so that you have the opportunity to review the financial parameters and contractual terms in a considered way over a period of time to determine whether this option is in line with your expectations. With respect to the option, we would ask that you notify us as to your election at least seven days prior to 30 June 2006. We will be working with you prior to that date to provide you with a considered view as to MMT Healthcare's performance and future strategy and prospects. 42Based on the PBT in the 2005 accounts and the net working capital in the November compilation reports (referred to below), the formula yields a purchase price of more than $13.5M. 43Paul Mirabelle says that he took the Nicholases through the first term sheet paragraph by paragraph; that he explained that Crescent was assisting in providing equity funding; that Crescent's Investment Committee would have to approve the price; that he told them that they generally applied a multiple of 3 to 5 to EBIT and that the average multiple that they would apply would be approximately 4, depending on the underlying earnings of the business and its size for a business as a going concern; that he said that typically there was no extra payment for working capital as the working capital was acquired as part of the business; that he told them they (the purchaser) would normalise the accounts through the due diligence process to make adjustments for any non-arm's length arrangements that they might have in their business; that they would adjust their evaluation of the earnings so that they had an accurate picture of what the business would look like after they bought it and that their primary purpose was to form a view on how profitable the business would be after they bought it, assuming they paid normal market based salaries for the Nicholases ongoing employment with the company, market based rental for any leases, etc. 44Paul Mirabelle says he said: As we discussed before, we may be able to meet what you're looking for in terms of an overall price and get support from Crescent for the deal by applying a multiple at the top of the range to EBIT. However, we need to be satisfied the business is tracking to the budget number of $2.2 million EBIT which you've shared with us. We will confirm that in our due diligence. That's the basis for this term sheet and what I'd like to do now is to walk you through it. 45With respect to the reference to para 2i in the term sheet, he says he said: We would typically express this as a multiple of the FY06 earnings but I understand that you want to sell the business outright without an earn-out and so I have set this out as a multiple of FY05. 46Paul Mirabelle says that he was not willing to proceed with the term sheet unless he was confident that the business would achieve its budgeted expectation of $2.2M EBIT for FY06. 47He says that following this discussion, they had a brief discussion about the due diligence process and what work it would entail. He says he explained that they would undertake three types of due diligence. Firstly, they would arrange accounting due diligence looking at previous year's numbers. This would be done by an outside accounting firm, PricewaterhouseCoopers (PWC). Secondly, they would perform operational due diligence looking at Admed's current year performance and would talk to customers and suppliers. Lastly, they would do legal due diligence such as reviewing lease arrangements and major contracts. This would be done by their lawyers. 48The Nicholases say that the meeting took place at their home. Lyn Nicholas says that Daren McKennay was present and was introduced as the person primarily running the due diligence. She denies that anybody on the plaintiff's side said that they needed to be "satisfied that the business is tracking to the budget number of $2.2M EBIT which you've shared with us. We will need to confirm that in our due diligence". She denies that Paul Mirabelle discussed a multiple and she denies that he said the words, "The most important thing during due diligence is that we will need to confirm that the business is tracking to the level of performance as set out in your budget". She denies that Paul Mirabelle held out that he was relying on a budgetary expectation of $2.2M EBIT for FY06 when he handed over the first term sheet. Stewart Nicholas supports Lyn Nicholas' version. 49The Nicholases say that Paul Mirabelle told them that, at the end of the process, PWC would know more about their business than they did. 50The Nicholases signed the first term sheet later that same week and returned a copy to Paul Mirabelle. THE DUE DILIGENCE PROCESS AND NEGOTIATIONS LEADING TO THE SECOND TERM SHEET 51Daren McKennay was in charge of supervising the due diligence process on behalf of the plaintiff. 52The accounting due diligence carried out by PWC was under the overall supervision of a partner of that firm, Mr Andrew Sneddon, and managed on a day-to-day basis by an accountant, Ms Jo Rhoden. 53On 4 November 2005, on a Crescent letterhead, the plaintiff sent a memorandum to the Nicholases attaching a list of information "typically required during the due diligence period". It included a request for forecast 2006 performance with commentary. 54On or about 4 November 2005, at Daren McKennay's request during the due diligence, Lyn Nicholas provided Paul Mirabelle with a bundle of information including a document headed "Admed Pty Ltd Summary Financials (as provided by Admed on 20/9/05)" which contained the same "Budget" which she had provided in the 20 September 2005 email. 55Paul Mirabelle says he instructed PWC to focus on the accounts to 30 June 2005 and to review management accounts, which included reports to the end of September 2005 which were then already available. 56On or about 17 November 2005, Paul Mirabelle and Geoff Thompson arrived at Admed's premises with Michael Alscher and Nathaniel Thomson. Representatives of PWC were also present. Stewart Nicholas took everybody on a walk through of the Ingleburn premises. 57The PWC due diligence team arrived at Admed's Ingleburn premises on about 20 November 2005 and, according to Lyn Nicholas, was still there on 22 December 2005 when she left on annual leave. There is evidence that satisfies me that they were there until the Agreement was signed on 1 February 2006. 58To prevent Admed's staff from becoming unsettled, Lyn Nicholas told them that PWC were conducting an audit. 59Daren McKennay says that through the due diligence process, he found it particularly difficult to obtain required information from Admed. He says, for example, he was unable to obtain from Lyn Nicholas any documentation relating to reconciliation of the debtors of the business with the general ledger and financial accounts and that Admed appeared to rely upon its external accountant, Joe Barilla, for most of its financial information. Where Lyn Nicholas provided him with information, she normally did so verbally - mainly over the telephone and sometimes in person. 60Daren McKennay says he recalls saying to Lyn Nicholas over the telephone on a number of occasions words to the effect: Because you are unable to provide me with the information that is necessary and because you repeatedly ask me to take your word for it, I must make it clear to you that MMT Healthcare is going to be relying heavily upon your warranties in the Share Purchase Agreement. 61Lyn Nicholas denies that a discussion to this effect ever occurred. 62On or about 28 November 2005 Daren McKennay and Lyn Nicholas had a telephone conversation in which, according to Daren McKennay, the following was said: DAREN MCKENNAY: You have provided me with a lot of general information about Admed's revenue, but I need to understand Admed on a granular level. I really need to satisfy MMT Healthcare and Crescent, that Admed is tracking to $2.2 million. I need to feel comfortable with whether the business is going to hit its budget for this the year [sic]. Would you please provide me with a sales analysis broken down into branches? LYN NICHOLAS: Daren, this really is very invasive, but I will see what I can get for you. 63On the same day Lyn Nicholas emailed Daren McKennay in the following terms: Hi Daren Sorry , but I was not able to talk - my P .A. was standing by as we ar e trying to catch up on the MASS tender. Stewart & I bot h feel that this sort of information, is the sort of thing that we would expect to be provided after settlement & I really don't understand the relevance -other than you needing to know as much as you can about the company- this makes me a little uncomfortable. Regards Lyn 64Attached to this email was a document entitled "July-September Budget Analysis" containing a table broken down into branches of two sets of figures, one in a column entitled "1 st Quarter Budget", and the other in a column entitled "Actual". Lyn Nicholas says that the budget figures were based on targets given to sales persons and were obtained by her from Con Dimitriou, Admed's financial controller. (MASS is the Medical Aids Subsidy Scheme in Queensland). 65Shortly thereafter Daren McKennay replied as follows: Thanks Lyn I appreciate you pullin g this information together for me. It is important we understand the YTD performance of the business at the level that has the most relevance to the way the business actually operates. To gain confidence in the forecast for FY06 we need to have a good understanding of how the business is tracking in the key regions. This information together with the discussion we had last week gives us a solid basis to understand how the business is travelling against FY06 budget. We are not meaning to make you feel uncomfortable and I would be happy to discuss this with you further if it helps relieve some uncertainty. Please be reassured , this is normal information that is asked for at this stage of the Due Diligence process and we only ask for it in a genuine attempt t o better understand the business. Kind Regards Daren McKennay 66The due diligence exercise carried out by PWC was extensive. According to Lyn Nicholas, they were given access to all records and all staff members; staff were directed to assist PWC and Joe Barilla was instructed to fully cooperate with PWC. She says that she became uneasy with the process and was taken aback by the extent and level of questioning, but always responded promptly and thoroughly. 67On or about 30 November 2005, Jo Rhoden told Lyn Nicholas that she had reviewed revenue figures supplied by Joe Barilla and they did not correspond with the reports generated by Admed's computer system. She said that the debtors balance was out. Lyn Nicholas told her to speak to Joe Barilla about it. She says she did not hear further from Jo Rhoden on the subject. 68On 1 December 2005, Jo Rhoden provided Paul Mirabelle with a draft due diligence report. The report included a profit and loss account to 30 June 2005 adjusted to reflect a number of matters including what was described as a "$304k write off to expenses relating to debtors balances which appears over-stated compared to the sub-ledger". Paul Mirabelle says that he then spoke to Jo Rhoden who said that Lyn Nicholas was adamant that the figure in the sub-ledger was correct and that the receivables would be collected. Jo Rhoden said that unless they did a full audit, which would take a great deal more time and was beyond the scope of due diligence, this could not really be verified. 69Paul Mirabelle says that the effect of the overstatement was to depress net profit for FY05 by $300,000 from the "represented profit EBIT amount of $1.5M to around $1.2M", which he viewed as a significant matter in terms of the sale. This would mean that the multiple component of the purchase price in the first term sheet would decrease by $1.5M. He says that he immediately discussed his conversation with Jo Rhoden with Geoff Thompson and Daren McKennay. 70Paul Mirabelle says that on 7 December 2005, after receipt of the draft PWC report, he went alone to Admed's Ingleburn premises where he met with the Nicholases. In his affidavit evidence he recounts a discussion in which he says he canvassed with them the discrepancy of $300,000 and told them that the amount of the purchase price represented by the discrepancy was $1.5M. He says that he said that there were a number of possible solutions to the problem, one of which was to defer the payment that related to the discrepancy until an audit was done and that if the $300,000 was there, to make a subsequent payment, which would allow the transaction to complete. He says that he proposed as an alternative that they could simply split the difference and move forward then with some clarity. He says that Stewart Nicholas said they were not interested in any deferred payment and that Lyn Nicholas said that the receivables were there. He says that Lyn Nicholas said further that she did not know why this was such a big deal because they had a very strong month in November and did $1.1M in profit to the end of November. 71Paul Mirabelle says he asked what the basis was for the November 2005 result and that Stewart Nicholas said they had very strong DVA sales, which were at a higher gross margin than the rest of their business and that Lyn Nicholas said that this is what they had been saying all along, namely that the business was going very well and she was not sure why they should sell it at all. Paul Mirabelle said he asked to see the November 2005 accounts and was told they had not been completed because of a stocktake and the files still had to be sent to Joe Barilla to be completed. He says that Lyn Nicholas said that she was getting nervous because if the transaction did not go ahead they had shared confidential information about their business. 72Paul Mirabelle says that the meeting concluded without any resolution on the $300,000 discrepancy. He says that at this stage he was concerned that the deal might be slipping away because the Nicholases were not responsive to a compromise solution and understood that they (particularly Lyn) were becoming increasingly frustrated with the due diligence process. 73The Nicholases deny that there was any meeting with Paul Mirabelle at Admed's premises before 12 December 2005. Lyn Nicholas denies that Paul Mirabelle ever made the statements he asserts in her presence. She says that the next meeting was held at their home on or around 12 December 2005, which was the first occasion upon which Paul Mirabelle discussed the debtors discrepancy with them. She says she remembers this clearly because Paul Mirabelle argued that they should accept a reduced asking price for the business. Stewart Nicholas has no recollection of the meeting recounted by Paul Mirabelle. He says that the first time he was made aware of the debtors discrepancy was when Paul Mirabelle visited their home on the evening of 12 December 2005. 74A further meeting took place between Paul Mirabelle and the Nicholases on 12 or 13 December 2005. The Nicholases say it was on 12 December 2005, Paul Mirabelle says it was on 13 December 2005. 75By all accounts the meeting was lengthy and somewhat turbulent. Lyn Nicholas says that Paul Mirabelle produced a document (which had apparently been produced by PWC) adjusting Admed's profit to 30 June 2005 to take account of a reduction in debtors of $304,499. Paul Mirabelle's affidavit evidence is that he showed them a revised term sheet marked up with differences from the first term sheet. However, his oral evidence was that the document he took was not marked up. There is some dispute about precisely what was said at the meeting. The debtors discrepancy was discussed. Paul Mirabelle proposed a revised term sheet reflecting a fixed purchase consideration of $12,200,000. 76According to Paul Mirabelle he said that this amount reflected the value of the goodwill and the net assets of the business. According to Lyn Nicholas, he said the due diligence results had affected the multiple for FY05 and that the discrepancy, using the multiple of 5, reduced the purchase price by $1.5M. Lyn Nicholas says she asked to see PWC's due diligence report to that point and that Paul Mirabelle declined on the basis that it belonged to Crescent. At this point she says she became emotional and took the position that she would not be signing anything until she had discussed it further with her husband. She says that Paul Mirabelle said he wanted to conclude the transaction that night. She says Paul Mirabelle said that if they withdrew, Crescent would be holding them liable for one half of the cost of the due diligence. She says that after further discussion, Paul Mirabelle said he needed to close the deal that night and would stay until they reached agreement because he had a meeting with the board the following day. In the end result, Lyn Nicholas was not prepared to sign that night. She says that when Paul Mirabelle left he said to Stewart Nicholas that he would have his mobile phone with him all night and wanted a call that night with a decision, no matter how late it was. 77There is some dispute about the course of events immediately thereafter. 78Paul Mirabelle says that he called back the following day. He recounts a number of conversations he says he had with Stewart Nicholas. In one, he says he put the figure of $12.6M and confirmed that the risk with respect to receivables was something the purchaser would bear and would not impact on the purchase price. He says that he said that given the way the business was tracking, they were prepared to bear that risk. 79According to Lyn Nicholas, later that night, after further discussions between themselves and a friend, the Nicholases phoned Paul Mirabelle and put a figure of $12.6M. Stewart Nicholas says that a conversation to the following effect took place: STEWART NICHOLAS: Lyn and I have discussed it, we are not at all happy, with the way that the negotiations have been handled but you are right, we cannot take a lot more of this, we will accept $12.6M, not one cent less and if you don't see the value then just walk away, we will not discuss it further. PAUL MIRABELLE: I believe on you reaching $2.2m profit this financial year, I can sell this to the board . STEWART NICHOLAS: What are you talking about, the negotiations between us have always been based on historic figures and you have just negotiated our price down, based on these historic figures. I have never agreed to forecasts, so make sure your offer reflects this . PAUL MIRABELLE: No problem. I will meet with the board in the morning and phone you, I am confident that I can sell them on this price and we can sign off tomorrow. 80Lyn Nicholas says that on the following day (13 December 2005) she telephoned Paul Mirabelle and discussed a number of things in the term sheet. She also telephoned their solicitor, Paul Farrugia. 81Stewart Nicholas says that the following day (13 December 2005) he and Lyn Nicholas executed a second term sheet (with handwritten amendments) and he faxed it to Paul Mirabelle. He says he also faxed it on 14 December 2005 when Paul Mirabelle was out of the office. 82Paul Mirabelle says that after a discussion with Stewart Nicholas on 14 December 2005 he asked Stewart Nicholas to make changes by hand, sign it and send it back to him, which Stewart Nicholas did that afternoon. 83The amended term sheet as signed ("the second term sheet") included the following terms: Offer to Purchase Admed Hospital Supplies ("Admed") Firstly, we would like to thank you again for the time you have spent with us to date - we appreciate that the process of the last few weeks has been demanding for everyone involved. Notwithstanding all of that hard work we have enjoyed building a relationship with you and are excited about working closely with you in the development and growth of the group. To that end and having conducted the due diligence work, we are in a position to clarify our offer to purchase the company. This offer replaces the term sheet dated 27 October 2005 and seeks to provide you with certainty on the purchase consideration. Further to our discussions, this letter outlines an offer by MMT Healthcare Pty. Ltd. ("MMT Healthcare") with respect to the purchase of 100% of the equity in Admed. In consideration for 100% of the equity in Admed, the shareholders of Admed will receive a combination of cash and an option to acquire equity in MMT Healthcare. This purchase will be funded by our funding partner, Crescent Capital Partners Management Pty Ltd ("CCPM" or "Crescent"), more specifically by Crescent Capital Partners II, LP one of the private equity funds managed by CCPM. This offer is made based on discussions with you and the historical financial accounts made available to MMT by Admed. ... 2. Purchase Consideration As per our discussions we wish to make you a formal offer to purchase Admed for $12,600,000. This purchase consideration is to purchase 100% of the outstanding shares, options and any other equity capital instruments of Admed and includes all the net assets of the business (including but not limited to cash, receivables, inventory and fixed assets) and the capital of all related entities necessary to acquire all the business assets associated with Admed. This purchase consideration is inclusive of any outstanding obligations the company has to you with respect to long service and annual leave entitlements. The purchase consideration will be comprised of three components: i. Initial payment - 80% of the agreed purchase consideration in cash ($10.08m), paid immediately at the completion of the purchase process; ii. Second payment - The balance ($2.52m) paid on 30 June 2006 ("second payment) iii. An option, which expires on 30 June 2006. You may elect to roll over the second cash payment into $1.62m worth of MMT Healthcare shares on the same terms and conditions as all syndicate investors (i.e. Crescent, MMT and other syndicate investors) have already invested. We have structured your right to invest in MMT Healthcare in such a way so that you have the opportunity to review the financial parameters and contractual terms in a considered way over a period of time to determine whether this option is in line with your expectations. As you are aware there are number of accounting issues that could not be fully reconciled during the course of the due diligence process, the most significant being the quantum of outstanding debtors in the business. In accepting this offer you acknowledge the debtors balance requires careful assessment to reconcile the outstanding differences and we will look to your knowledge and assistance in seeing this work through to completion. Having said that, and for the sake of clarity, the purchase consideration set out above is in no way contingent on there being a satisfactory resolution of the outstanding debtors issue or indeed any of the other accounting reconciliations identified in the course of due diligence. It is our intention that; an audit be completed for the company in line with ASIC requirements; this will be completed during the first six months of calendar year 2006 new financial and management information systems will be introduced over the same time period to help facilitate growth in the company new accounting resources will be employed to lead these efforts. The cost of both of these initiatives and the new accounting resource will be at the cost of the company and will not impact on the purchase consideration set out above. ... 4. Ongoing Involvement of Stewart Nicholas and Lyn Nicholas and other Family Members We respect the business you have created and we are excited about your ongoing commitment to the business and our shared plans for it. We do not see a change in roles currently performed other than for Lyn who will shift more of her time to tenders and other contract negotiations. Stewart will continue to lead the business in his capacity as Managing Director while Belinda will continue as General Manger. Total remuneration packages for the key family members are as follows: Stewart Nicholas - $180,000 Lyn Nicholas - $104,000 ... These packages can be modified in composition to best meet the requirements of the individual. 5. Conditions Precedent MMT Healthcare's decision to proceed with the purchase outlined in this offer is dependant upon the following conditions precedent: i) The business is bought on an 'as is' basis with no further shareholder draws except for executive salaries over the due diligence and completion period; ii) The net working capital position (including cash) does not materially change and the net cash position as at 13 December 2005 does not change in any material way from this date to the date of completion without the approval of MMT with the exception to normal company trading; iii) Agreement from Admed's agency principals to transfer the agency agreements to MMT Healthcare; iv) That the appropriate legal documentation is negotiated and executed; v) That agreed employment contracts including non-compete agreements are negotiated with all key employees including Stewart, Lyn and [sic]; vi) Approval by CCPM's Investment Committee; vii) The vendors will provide normal representations and warranties; viii) The financial information, as presented, is correct and provides a true and fair view of the underlying business; ix) That the business has been operated in the ordinary course since 30 June 2005 and there have been no related party payments (including dividends, share buybacks and capital reductions) except for normal salaries and those declared in the 2005 accounts; x) Any shareholder loans (if any) in the accounts are to be cancelled upon completion of this proposed purchase; The purchase consideration will be funded via a combination of equity capital and debt. We are open to structuring the purchase consideration in a way that best suits your needs. In the absence of any alternative suggested structure the full purchase consideration (inclusive of the 2 nd payment) will be reflected in the value of the shares (and any other equity instruments) to be purchased. ... 8. Costs All expenses incurred by MMT Healthcare during the due diligence process will be borne by MMT Healthcare. In the event that MMT Healthcare wishes to proceed on the terms described in this term sheet and Admed does not wish to proceed then the actual costs associated with conducting the due diligence will be shared 50:50 by Crescent and Admed, up to a maximum cost to Admed of $35,000. In the event that MMT Healthcare has not issued the appropriate and final legal documentation encompassing the investment by MMT Healthcare 22 December 2005 [sic] this term sheet being signed then no costs will be payable by Admed. If you are in agreement with the process and the purchase consideration outlined, could you please sign below your acceptance. THE HEALTHCO INVESTMENT MEMORANDUM 84The period between 15 to 23 December 2005 involved intense activity by the plaintiff, the plaintiff's solicitors, PWC, Crescent and the Bank of Scotland (which provided part of the finance). 85In mid-December an investment presentation ("HealthCo Investment Memorandum"), prepared principally by Michael Alscher and Nathanial Thomson, was placed before the Crescent Investment Committee. The document runs to well over 100 pages. It is a comprehensive assessment by Crescent of the proposed investment. 86Apart from Admed, the companies immediately targeted for acquisition by the plaintiff were Taylor Bryant, which distributed high-end medical devices and equipment to orthopaedics and neurosurgeons; CNS, a niche business focusing on neurological and audiological diagnostics and monitoring; and TiMax, a distributor of surgical products. 87The HealthCo Investment Memorandum contained analyses of the prospects of these various businesses. It incorporated sophisticated computer modelling of the future of Admed's business. 88It made the following recommendation to Crescent's Investment Committee: Our recommendation is that Crescent Capital Partners II, LP makes an investment of $5.0m ($3.5m expected to be drawn down immediately) into HealthCo to fund the acquisition of medical device companies, subject to the first two transactions being Admed and Taylor Bryant and subject to the receipt of an acceptable due diligence report on Taylor Bryant. Any additional acquisitions which require further funding over and above the initial $5.0m will require additional investment committee approval. In addition CCPM seeks permission, if necessary, to use bridging finance prior to receiving call proceeds . Please note, it is proposed that Admed and Taylor Bryant are the only two acquisitions that are described as essential to the initial investment. Due diligence with PWC is ongoing in regards to TiMax and CNS and the situation may evolve where 1, 2 or neither of the bolt on transactions take place following final due diligence and other bolt ons are made in their place e.g. CWS (or all three are made). Accordingly we would like to retain some flexibility in regards to the initial bolt on acquisitions to the larger entities (Admed and Taylor Bryant). 89It contained a summary of interviews that had been held with Admed customers. It reflected that Admed was a good organisation with high service standards, good product range and competitive pricing. It stated that the DVA appeared to be happy with the service Admed was providing and that Admed was winning more work than expected, due to its service standards. 90It incorporated term sheets for the various proposed acquisitions. In respect of the Admed term sheet it stated: Admed $12.6m purchase price which after deducting $1.4m for cash and $2.0m of excess working capital reflects a true EV of $9.2m which equates to 7.7 x '05 actual EBIT and 4.4 x '06F EBIT (as confirmed by PWC). Excluding the decrease in working capital the purchase price reflects 5.3 x EBIT '06F. 91Based on the computer modelling, it included the following Profit and Loss Balance Sheet Review of Admed (emphasis added): Profit and Loss and Balance Sheet Review Admed Profit and Loss Forecast >>>>>>>>>>>>>>> Estimate Forecast Forecast Profit and loss 2004 2005 Sep-06 2006E 2007F 2008F Total revenue (inc other revenue) $'000 11,054 15,907 4,124 17,543 18,516 19,856 COGS $'000 7,021 10,138 2,384 10,315 10,869 11,648 Gross margin (in other income) $'000 4,033 5,769 1,740 7,228 7,647 8,208 % 36% 36% 42% 41% 41% 41% Staff costs $'000 2,279 3,015 741 3,284 3,674 3,920 Rent $'000 347 391 105 421 442 464 Freight and cartage $'000 114 148 50 192 196 210 Motor vehicle $'000 298 399 102 440 473 508 Overhead $'000 549 618 187 755 786 838 Total SGA costs $'000 3,587 4,570 1,186 5,093 5,571 5,941 EBITDA $'000 446 1,199 554 2,135 2,076 2,267 % 4% 8% 13% 12% 11% 11% Depreciation and amortisation $'000 13 41 4 22 32 38 EBIT $'000 434 1,158 550 2,114 2,044 2,229 % 4% 7% 13% 12% 11% 11% 92On 11 January 2006, the plaintiff entered into an agreement to purchase Taylor Bryant. THE DUE DILIGENCE REPORT 93On about 15 December 2005, PWC provided Crescent with a written due diligence report ("the Due Diligence Report"). This too is a comprehensive document. 94Under a heading "Key Findings", PWC reported, amongst others, as follows: Background and Overview + Overall, the Admed acquisition, although plagued by poor accounting and management systems, appears to be a good footprint for the proposed amalgamation of aged care and hospital supplies by Crescent and MMT. The DVA contract in particular has considerable upside potential, most notably by taking more market share from Paraquad which also supplies under this contract. + The Admed business buys and sells a variety of hospital supplies and goods into the aged care sector. Revenues largely split between one major contract with the DVA and many other smaller customers. + The business systems were not sophisticated and sufficient data for informed management decision making was not available, however, the business appears to be profitable and satisfactorily run. There is very clear opportunity to run the business more efficiently through implementation of effective systems, in particular for the management of stock and reporting by revenue stream. In addition, implementation of good warehousing and work-flow processes should allow the business to ramp up in terms of capacity. + Potential opportunity for growth is also noted by expanding geographically, targeting the hospital secutor in addition to the nursing homes already serviced by Admed, and growing the equipment rental business. Maintenance and review of financial results in each of these areas would be needed in order to facilitate appropriate decision making. + There are a number of risks in acquiring the business such as the accuracy of the information reported and the cost of implementing reliable management systems which would enable the new management team to run the business effectively going forward. + Due to the poor quality of the data and the systems utilised, it is difficult to quantity the full extent of exposures until a full statutory audit as at 30 June 2005 is completed. It is important that the Sale and Purchase Agreement protects Crescent and MMT from any exposure that may appear following proper reconciliation of the accounting systems. Background + It has been difficult to obtain and identify the correct data, establish valid underlying source data and trace how it makes its way to the financial statements. This is largely due to the use of a mixture of manual and computer based systems to both manage the business and account for it. + There is also significant complexity around the treatment of the different types of stock and its accounting into the four different ledgers of DVA, NSW, Qld and Vic. + The Micronet system was implemented around the June year end of 2004 and a full implementation does not appear to have taken place. Full details of the system issues identified are detailed in the following pages. Risks + The lack of robust reconciled financial systems, and existence of significant differences between the Micronet and manual systems means there is a significant risk that the reported numbers are incorrect. Without full reconciliations on each of the major balances between the financial statements and the underlying sub-ledgers (debtors, cash and creditors), it is not possible to quantify the level of potential exposure. PwC therefore recommends that final pricing and settlement be dependent upon the results of a full statutory audit of the June 2005 year end. System Issues + Admed accounts for its operations using a mixture of manual and computerised systems. The computer package used is Micronet. A summary of the systems utilised is diagrammatically represented below. + PwC has noted variances between Joe Barilla's numbers and the underlying sub-ledgers for Debtors. The variance appears to be increasing since June 2004 and at June 2005 amounted to $304k. + PwC has reviewed the underlying Micronet debtors sub-ledgers balance including aging. This ledger is used to drive the business and manage debtors and therefore the balance from this ledger is the only value which is supported by line by line debtor values. + The purchase ledger was never fully implemented and Admed never review or run any creditors figures from the sub ledger. PwC review of the manual creditors ledgers to underlying supplier statements indicated that this balance appears to be supported. + The Micronet General ledger has still to be completely implemented and numbers generated from this are not reviewed or reconciled. The balances contain errors and uninvestigated differences. These largely appeared to be due to poor system implementation. However as no meaningful reconciliations are prepared, there is significant exposure in regard to the accuracy of the financial information. + The overall impression is that the system has been implemented piecemeal and incompletely. Management do not trust or understand the complexity of the system and so have continued to run their manual systems in parallel. PwC notes however that the manual and computer based systems are not reconciled and this creates an exposure for the business. 95In a section entitled "Historical Balance Sheet" and under the heading "Receivables", PWC reported, amongst others, as follows: Ledger differences + PwC noted a difference between the balance per aged debtors listing and the Financial statements of $44k, $304k and $315k for the periods ended June 04, June 05 and September 05 respectively as can be seen in the table below. Lyn Nicholas has advised that the system has not functioned accurately from its inception. She stated that the correct balance comes from Joe Barilla who maintains his own high level debtors balance. This is done by taking the monthly sales figure received from Lyn Nicholas every month and reducing it for payments identified as debtors in the bank statements. 96In the same section and under the heading "Liabilities", PWC reported, amongst others, as follows: Trade Creditors + A creditors ledger is maintained on the Micronet system, however Lyn Nicholas has informed us that the ledger does not balance correctly and this ledger is not utilised to run the business. When the system was set up, adjustments were put into the system to make the ledger balance. The system has not been corrected since deployment because the support staff work out of Canada. No Creditor aging analysis was obtained. + A separate manual creditors ledger is maintained for Sydney, DVA, Victoria and Queensland. Small variances arise between the aggregated ledgers and the financial statements. This is due to Joe Barilla making adjustments to the ledger on a monthly basis when he receives the monthly summary reports from Lyn Nicholas. PwC agreed the manual creditors summary to the financial statements and tested to supplier statement reconciliations which are performed regularly by Admed. Any small variances were explained and were not material. 97Under the heading "Accounting Policies" the Due Diligence Report reported: The special purchase financial reports prepared by Joe Barilla include details of accounting policies adopted by Admed. PwC noted some contradictions between policies reportedly adopted and the findings from the due diligence work conducted. In particular we note: + The reports state that they are prepared on an accruals basis and based on historic costs. + PwC notes that the business accounts on a cash basis and does not account for accruals and prepayments. Additionally, stock is revalued and not reported on a historic cost basis. + The report states that the liability method of tax effect accounting is adopted by the company whereby income tax expense shown in the profit and loss accounts is based on the operating profit before tax adjusted for any permanent differences. Timing differences are brought to account in the balance sheet. + PwC notes that no deferred tax assets or future income tax benefits are accounted for in the financial statements. + The report states that inventories are valued at the lower of cost and net realisable value. Costs are assigned on a FIFO basis. + PwC notes that, based on discussions with management, cost is based on the average cost of the last 5 invoices for the product and stock is revalued at year end. + The report states that property, plant and equipment are included at cost. Tax depreciation rates are used for depreciation of the assets. + PwC notes that, whilst this is true for the fixed assets which are disclosed, a significant amount of capitalised expenditure has been expensed immediately to the P&L. PwC notes that going forward a review of appropriate accounting policies, in particular stock valuation, should be undertaken and applied correctly to the business. 98The Micronet system (about which much more is said below) is a computerised general ledger system with sub-ledgers for sales, debtors, purchases and creditors. 99Paul Mirabelle, Daren McKennay and Geoff Thompson were provided with the Due Diligence Report. 100Notwithstanding PWC's adverse comments with respect to the accuracy of Admed's accounting records, Paul Mirabelle gave affidavit evidence that he believed the Nicholases had a thorough knowledge of Admed's business and that accordingly the basic financial information they provided, such as revenue, costs of goods sold and gross margin, was likely to be accurate and reliable, that he also believed that they would not fail to disclose material information about Admed's performance and that to the extent that there were risks as to these matters, he believed they could be accommodated by obtaining appropriate warranties from the Nicholases in the final agreement for the acquisition of Admed. THE NOVEMBER COMPILATION REPORTS 101On a monthly basis, Admed produced Special Purpose Financial Reports comprising of a Balance Sheet, Trading Account and Profit and Loss Statement. These reports may be properly described as management accounts. The parties referred to them as "compilation reports" and I will do the same. 102Compilation reports for Admed and Abbetta as at 30 September 2005 were produced on 26 October 2005. Compilation reports as at 31 October 2005 were produced some time late in November 2005. By 20 January 2006 these had been given to the plaintiff. 103Each compilation report includes notations to the following effect: Our procedures do not include verification and validation procedures. No audit or review has been performed and accordingly no assurance is expressed. No person should rely on the Special Purpose Financial Report without each having an audit or review conducted. 104On 20 January 2006, Paul Mirabelle sent an email to Stewart Nicholas in which he said, amongst others, We need the latest (December) monthly accounts for the bank- Geoff tells me that you suggested we get them from Joe Barillo [sic] but he has not been in the office. Can Lyn or someone else in Joe's office provide us with these please. 105He says that at this time he wrongly assumed that the November compilation reports had been provided and were being looked at by Geoff Thompson. He says that by referring to the bank he wanted to imply that he had no discretion in asking for these accounts, given that he perceived Lyn Nicholas to be "jittery about the transaction" and "reacting poorly to requests for information". He says he expected December sales to be reasonably good, although Admed would not be that busy in the week after Christmas, and that his expectation of the December accounts was a profit in the order of $100,000 to $150,000. 106On 24 January 2006, Lyn Nicholas emailed Geoff Thompson in the following terms: Hi Geoff I called earlier & left a message on your mobile - in case you didn't receive it. I wanted to let you know that I spoke with Joe late this afternoon, he has prepared the November accounts & will forward a copy to you via fax tomorrow - mid morning. In relation to December, we do not have all the relevant info ready to do these at the moment (the usual hold up is the reconciliation of the creditors) we should have these figures for Joe by mid next week & as soon as I can produce the relevant information he needs, they will be sent to you. Kindest regards 107On 25 January 2006, Joe Barilla faxed to Lyn Nicholas compilation reports for both Admed and Abbetta for the period to 30 November 2005. 108I will refer to these as the November compilation reports. 109Geoff Thompson requested Lyn Nicholas to fax them to the plaintiff's solicitors, which she did. She also sent an email to Paul Mirabelle which included the following: Stewart faxed these accounts to George at approx 11am this morning & Geoff acknowledged receipt of same. Perhaps these results, which are very pleasing will help you to understand our emotional response to the drawn out settlement, as well as the fact that we are currently $100,000 up in January on last year with a number of days left to invoice which is very encouraging given that we were not so fortunate in December. 110The trading account for Admed in the November compilation report is as follows: ADMED PTY LIMITED ACN 002 142 896 TRADING ACCOUNT FOR THE PERIOD ENDING 30 TH NOVEMBER 2005 NOV NOV JUNE 2005 2004 2005 $ $ $ $ TRADING ACCOUNT Sales 5734973 1208898 1282525 13166961 LESS COST OF SALES Opening Stock 2721153 2770282 2448401 2295776 Purchases 3282001 515352 830839 8679108 6003154 3285634 3279240 10974884 Closing Stock 2894453 2894453 2655372 2721153 3108701 391181 623868 8253731 TOTAL TRADING PROFIT 2626272 817717 658657 4913230 111Its profit and loss account shows total income of $2,661,401 made up as follows: NOV NOV NOV 2004 2005 2006 $ $ $ $ INCOME Gross Profit Trading 2626272 817717 658657 4913230 Commissions 19470 - - 21058 Refund Payroll Tax - - - 32076 Insurance Recoveries - - - 22263 Interest Received - Bank 15659.88 3603 1140 20550 TOTAL INCOME 2661402 821320 659797 5009177 112The account goes on to show total expenses of $ 1,843,607, yielding an operating profit before income tax of $817,794. 113Abbetta's November compilation report reflects an operating profit before income tax of $242,645 derived from a total income of $524,596, of which $521,565 is gross profit from trading, less total expenses of $281,951. 114The November compilation reports disclose a combined operating for the period to November 2005 of $1,060,440 before income tax. DECEMBER 2005 115Admed made a trading loss for the month of December 2005. There is a dispute as to the extent of it. 116Paul Mirabelle says that he understood from Lyn Nicholas' email of 25 January 2006, that December 2005 revenue was not as strong as expected but that they were making up for it in January and that the disappointment in December was in the order of $100,000. He says that the next day he had a telephone conversation with Stewart Nicholas to the following effect: PAUL MIRABELLE: We got the November accounts yesterday. Thanks for sending these through. I noticed that Lyn mentioned in her email that December was not so great? STEWART NICHOLAS: Sales weren't as strong as what we might have expected but we are making up for it in January. January is normally quiet but we are having a good month. That's not unusual, sometimes you have a slow month but then you have a good month in the following month. 117He says he was satisfied with this explanation. 118Stewart Nicholas' response is that he made Paul Mirabelle very much aware that December sales were down considerably. He says he clearly remembers a number of heated discussions in December 2005 and said words to the following effect: Your presence and the due diligence has had a major adverse affect on the business. 119He says that Paul Mirabelle seemed to shrug this off whenever he brought up the subject. He says that Geoff Thompson was also aware of the sales figures - as was PWC. 120He says that on 13 December 2005, prior to signing the second term sheet, he had a conversation with Paul Mirabelle to the following effect: STEWART NICHOLAS: Get out of our hair, let us get on with running the business. We are having a shocker of a December because of all you, not letting us get on with our jobs. PAUL MIRABELLE: The worst is behind us. You'll have the money soon. You can get on your boat and relax over Christmas with all this behind you. 121He also says that some time after Lyn Nicholas' email of 25 January 2006 he had a discussion, either by telephone or face to face, to the following effect: STEWART NICHOLAS: I have made it abundantly clear to you throughout the month of December that we were going to have a shocker... You will need to stop talking sometime and start to listen to what I tell you. PAUL MIRABELLE: Well that's one thing you don't have to guess what you are thinking. 122Geoff Thompson was seeking information, including sales information, on a daily basis in, and past, December 2006. His evidence was that he could not recall to what extent he had knowledge that sales were down in December 2006 but that the result was substantially different to his expectation. THE AGREEMENT 123The Agreement was entered into on 1 February 2006 and the plaintiff took over ownership of Admed. I have already referred to the relevant warranties contained in the Agreement. It contains the following further provisions. 124Clause 9.2 provides as follows: 9.2 Buyer's investigation The Buyer's rights are not adversely affected by an investigation made by or on behalf of the Buyer about a Group Company, whether before or after the date of this agreement except where the matter the subject of the Warranty claim has been disclosed by the Sellers in the Disclosure Letter or otherwise in writing by the Sellers' Solicitor in relation to a specific Warranty. 125Clause 9.3 provides as follows: 9.3 Indemnity Subject to the limitations in clause 9.4, the Sellers indemnify the Buyer against any claim, loss, liability, cost or expense which the Buyer pays or is liable for arising directly or indirectly from a Warranty being false or misleading when made under this agreement. 126Clause 15.11 provides as follows: 15.11 Entire agreement (a) This agreement supersedes all previous agreements about its subject matter and embodies the entire agreement between the parties. (b) The Buyer acknowledges that no representations or warranties in connection with the sale of the Shares have been made by the Seller or anyone on behalf of the Seller other than the Warranties. (c) Any statement, representation, term, warranty, condition, promise or undertaking made, given or agreed to in any prior negotiation, arrangement, understanding or agreement, has no effect except to the extent expressly set out or incorporated by reference in this Agreement. 127The Agreement contains, as a schedule, Admed's and Abbetta's Financial Statements for FY05. THE DECEMBER COMPILATION REPORTS AND LATER EVENTS 128On about 8 February 2006, compilation reports for Admed and Abbetta as at 31 December 2005 were produced. According to these reports for the year to date (six months), Admed had sales of $6,506,905 and Abbetta had sales of $1,219,384 making a combined $7,726,289. Admed's cost of sales were $3,720,328 and Abbetta's cost of sales were $754,972, making a combined $4,475,300. This results in a gross margin of $3,250,989 or 42.1 per cent on sales. 129The combined sales revenue for the month of December 2005 was $896,656 (with cost of sales of $793,504) compared to combined sales revenue of $1,305,913 for December 2004, a drop of $409,257. Admed's gross margin for the month was 20.77 per cent. Abbetta's cost of sales exceeded sales, resulting in a gross margin of negative 45.8 per cent, making a combined gross margin of 11.5 per cent. 130On the December compilation reports for the month, Admed and Abbetta made a combined trading loss of $459,722. Their combined trading profit for the financial year to date was $600,718. 131According to Lyn Nicholas, when the plaintiff took over, her role changed at the request of Paul Mirabelle. An internal accountant was appointed to take over her role controlling and managing financial and accounting matters. 132Paul Mirabelle says that he had numerous discussions with Stewart Nicholas starting in the third week of February 2006 about his concern with the dramatic downturn in performance. He says that although year end performance indicated an initial result in the order of $1.5M EBIT, Stewart Nicholas commented that they would make up for it in the 2007 financial year and a budget was prepared which forecast a result of $2.2M consistent with what was expected in 2006. 133In about February 2006, Paul Mirabelle requested Gordon Ford, MMT's financial controller, to review Admed's financial results. Gordon Ford produced a report ("the Ford Report") which included suggested adjustments to Admed's figures for the seven months to 31 January 2006. His report contained a break-even analysis which included the following statement: Reasonably assuming a fixed costs structure of $420K per month and a gross margin of 42%, the breakeven revenue level is $1,000K per month. 134According to the Ford Report, the cost of sales for the period 1 July 2005 to 31 January 2006 was $5,816,015. 135On the adjusted figures in the Ford Report, Admed made a trading profit, before depreciation, of $904,568 for those seven months. Annualised on a straight line basis this results in a profit of $1,550,688 for FY06. 136Admed's accounts were audited (as part of the group) in September 2006 by Ernst & Young. The plaintiff, however, did not produce signed audited accounts in the proceedings. An unsigned version of financial accounts for Admed and Abbetta on a consolidated basis for FY06 was produced and there was evidence that the audited version was not different. According to the consolidated income statement in those accounts, Admed performed as follows in FY06: Revenue Sale of goods 16,097,688 Cost of sales 9,074,201 Gross profit 7,023,487 Other revenue 42,885 Employee benefits expenses 3,783,404 Marketing expenses 41,291 Occupancy expenses 508,498 Administrative expenses 1,049,310 Finance costs 38,386 Distribution expenses 177,085 Depreciation & amortisation expense 195,642 Profit before tax from operating activities 1,272,756 Income tax expense 384,206 Profit after tax from operations 888,550 137On 3 December 2007, the plaintiff (through solicitors then acting for it) wrote to the Nicholases detailing claims against them. Amongst others the letter asserted that Admed had made a loss of approximately $459,722 for December 2005, which loss resulted primarily from sales of only $896,656 as compared to sales of $1,376,292 in November 2005 and a gross margin of 12 per cent as compared to a gross margin of 66 per cent in November 2005. 138In response to this assertion, the Nicholases through their then solicitors, by letter dated 19 December 2007, said: Our clients had, at meetings held before 13 December 2005, informed your client's directors that they anticipated poor results for December 2005 due to the disruption caused by the audit process, the several meetings with your client's directors and the usual Christmas closure. The alleged difference in the gross margin between November and December 2005 was probably due to the purchases of November being paid for in December, giving a distorted impression of the cost of goods in both November and December 2005. At any rate, our clients do not understand your claim of a loss in December 2005 of $459,722 when their copy of the 2006 monthly accounts indicate an EBIT loss of only $60,129. 139After taking over Admed, the plaintiff created a hospital and rehabilitation division integrating four businesses (including Admed and Abbetta) involving five further companies. Until about March 2008, Lifehealthcare Pty Ltd (ABN 62 116 839 368) was the parent company of the plaintiff. Through a corporate restructuring in about March 2008, another entity with the same name but ACN 130 225 599 ("Lifehealthcare no. 2") became the plaintiff's parent. The accounts of Admed and Abbetta were consolidated fully into the accounts of Lifehealthcare no. 2 for the financial years ending 30 June 2008 and 30 June 2009 and for part of the year ending 30 June 2010. Daren McKennay gave affidavit evidence of transactions in 2009 and 2010 which had the effect of the disposition of the hospital and rehab divisions. 140Michael Alscher gave the following evidence: Q. Then, what happened, how did this all ultimately wash up? A. To be honest, it was a bit of a mess. We had a really strong bid in the national hearing business, which was a hearing audiology business, which was another division we bought. Then, what we found is, we put a number of these smaller companies together. What ended up happening was, the hospital and rehabilitation part of the business underperformed, the medical device business did a good job, and the hearing business was actually doing very, very. Well we ended, because what was going on was, basically, all of the cash was being stolen out of the hearing business to prop up some of these poorer performing businesses. About eighteen months, two years in, we demerged the businesses, separated out the hearing business completely separately from the medical device and hospital rehabilitation businesses, and that business continued to perform and grow. We went about restructuring the remaining businesses that were in that piece, and we ended up closing down or selling off all the hospital rehabilitation part of the business, and some of the other acquisitions that we did, and focusing on purely the high-end medical device side, which is what Daren McKennay runs today, and just focusing very much on growing organically the underlying business. THE NOVEMBER COMPILATION REPORTS CLAIM 141The plaintiff says that the combined PBT was $663,085 (approximately) and not $1,060,440, as stated in the November compilation reports. It claims that this was a breach of warranty (a) because the Nicholases gave it information which was not true and was misleading in a material respect, in that the November compilation reports overstated the year to date PBT by approximately $397,356. 142Alternatively, it says that by the November compilation reports the Nicholases represented that Admed's PBT was as stated, which representation was, because of the overstatement, misleading or deceptive or likely to mislead or deceive in contravention of s 42 of the Act. It says that but for this misrepresentation it would not have entered into the Agreement. 143The plaintiff puts that the overstatement of PBT was the consequence of an understatement of cost of sales in the trading account in Admed's November compilation report, which was carried over to its profit and loss account. 144Its submissions do not challenge the opening and closing stock figures. It puts, rather, that the figure for purchases is significantly understated. It says that the only credible explanation for this is that the cost of sales made in November 2005 was brought to account in the December 2005 compilation reports. In other words, it says that the November compilation reports did not include all the cost of sales expenses which were incurred to generate sales in the period they cover. 145For breach of warranty the plaintiff claims as its loss, the amount representing the difference between the true worth of the shares it received and the value they would have had, had the warranty been true, that is, had the year to date profit in the November compilation reports been accurate. 146It puts that the consideration paid under the Agreement is the price actually negotiated in an open and unrestricted market between a knowledgeable, willing, but not anxious buyer and a knowledgeable, willing, but not anxious seller at arm's length and therefore reflects the value the shares would have had had the warranties been true. 147It puts that the true worth of the shares is the value of the underlying business. It contends that this should be assessed by determining the present value of the projected future earnings of the business. 148For the alleged misleading and deceptive conduct it claims as its loss, the difference between the consideration it paid and the true value of the shares it received. This amount is less than the breach of warranty claim because part of the consideration paid to the Nicholases was by way of the issue to them of redeemable preference shares in MMT, which issue (in the absence of redemption) cost the plaintiff nothing. The money consideration actually paid by the plaintiff is $11.97M made up of $10.08M paid on 1 February 2006, and $1.89M paid in December 2006 in respect of the partial redemption of the redeemable preference shares. 149The Nicholases deny any breach of warranty (a) and deny that their conduct was misleading or deceptive. 150They say that it has not been established that the November compilation reports overstated the year to date PBT. Indeed, they say that those reports are correct. 151They say that, even if the November compilation reports overstated the year to date PBT, those reports formed part of a much wider body of information which they gave the plaintiff (either directly or by making it available through the due diligence process) and that, seen in the context of the wider information, the November compilation reports were not misleading. 152With respect to the misleading and deceptive conduct claim, they put that if (contrary to their primary contention) there was an overstatement of PBT, the plaintiff suffered no loss because it would have proceeded with the purchase anyway. 153They take issue with the plaintiff's approach to quantification. They say that if the plaintiff had established an understatement, its damages would be limited to that amount or, alternatively, that the method used to determine true value should be the same one used by the plaintiff in reaching the price. 154To establish breach of warranty the plaintiff must establish on the balance of probabilities that the information given to it was not true and was misleading in a material respect. 155The plaintiff cannot recover substantial as opposed to nominal damages for breach of warranty unless it proves both the fact and the amount of damage it suffered; Luna Park (NSW) Ltd v Tramways Advertising Pty Ltd (1938) 61 CLR 286; Watts v Rake (1960) 108 CLR 158 at 159. 156Generally, the measure of damages for breach of warranty is the amount representing the difference between the price paid for the shares and their true value at the time. See Wenham v Ella (1972) 127 CLR 454; HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd (2004) 217 CLR 640 at [35]; EW Blanch Pty Ltd & Anor v Cooper & Anor [2005] NSWCA 217 at [118]. 157However, in Campbell v Backoffice Investments Pty Ltd (2009) 238 CLR 304 at [164] the Court made the observation that if the price paid by the plaintiff was fixed by a method later used to assess the "true" value it is not self-evident that damages for breach of warranty should in that case be assessed as the difference between the price paid and the value of what was bought. 158To establish breach of s 42 of the Act, the plaintiff must show on the balance of probabilities that the conduct complained of induced error or was capable of inducing error. 159To recover damages it must show that it suffered loss which was caused by the conduct complained of. This is to be determined by approaching the matter in a common sense and practical way. 160The measure of damages on this count is the amount representing the difference between the position the plaintiff is in and the position it would have been in had the misleading conduct not occurred. See I & L Securities Pty Ltd v HTW Valuers (Brisbane) Pty Ltd (2002) 210 CLR 109. 161The core issue for determination of liability and quantum in both the breach of warranty claim and the misleading conduct claim is thus whether the plaintiff has established on the balance of probabilities that the November compilation reports reflect an overstatement of PBT and, if so, the extent of it. 162I will deal with this issue first. 163At the outset it is necessary to refer to the principles which govern determination of whether the plaintiff has proved its damage. 164Mere difficulty in establishing damages does not relieve a court from responsibility of estimating them as best it can. For example, the assessment of damages for a loss which depends on future chances or possibility of benefit may be fraught with difficulty and attended by uncertainty but this does not relieve a court from the responsibility of attempting to assess them as best it can. Where there has been an actual loss of some sort the common law does not permit difficulties in estimating the loss in monetary terms to defeat an award of damages. A lost commercial advantage or opportunity is a compensable loss, even where there is a less than 50 per cent likelihood that the commercial advantage will be realised. Damages for breach of contract are to be assessed by reference to the probabilities or possibilities of what would have happened: Sellars v Adelaide Petroleum NL (1994) 179 CLR 332 at 349; The Commonwealth v Amann Aviation Pty Ltd (1991) 174 CLR 64 at 125; Malec v JC Hutton Pty Ltd (1990) 169 CLR 638 at 643. 165Those kind of cases where loss suffered cannot be proved with precision are to be distinguished from those where it can. In JLW (Vic) Pty Ltd v Tsiloglou [1994] 1 VR 237 at 241 and following, Brooking J discussed the two types of cases. As his Honour remarked, where precise evidence is obtainable, the court naturally expects to have it; where it is not, the court must do the best it can. Whether a tribunal of fact is at liberty to award substantial damages depends on the nature of the loss in the particular case and the evidence led in it. There is no rigid dividing line between cases in which guesswork is permissible in assessing damages and cases in which it is not. The borderline between guesswork and rational assessment is itself indistinct, as is the line between evidence that is precise and evidence that is not. 166In Troulis v Vamvoukakis [1998] NSWCA 237, Gleeson CJ said As Deane J observed in The Commonwealth v Amann Aviation Pty Ltd (1991) 174 CLR 64 at 118-119, the limitations of the curial process, or the nature of the subject matter in question, often mean that the task of assessing damages involves a pragmatic exercise of a kind traditionally left to the good sense of a jury. Where, however, what is involved is the valuation of the goodwill of a business, and the plaintiff fails to adduce either reliable evidence of the trading results of the business, or evidence as to how one goes about valuing such a business, then there is an absence of the raw material to which good sense may be applied. Justice does not dictate that, in such a case, a figure should be plucked out of the air. 167The plaintiff's case is that the November compilation reports understate the PBT to 30 November 2005 because, on the accruals method of accounting, they understate the cost of sales to that date by an amount of $397,356 (although the plaintiff pleads this to be an approximate amount). Whereas the PBT was shown as $1,060,441, it says only $663,085 was earned. Its valuation evidence proceeds on the establishment of a figure for the understatement. 168The critical figure of the overstatement ought to be one capable of precise assessment by reference to Admed's and Abbetta's books and records. It involves four components: sales, opening stock, purchases and closing stock, which components yield the total trading profit which is carried over to the profit and loss account. There is no dispute between the parties as to the sales figure. There is also apparently no dispute between them as to the opening and closing stock figures. The plaintiff's essential case is that the closing stock figure was too high because it reflected the value of inventory for which payment had not yet been made. 169Determination of the understatement involves assessing how much of the value of the stock on hand at 30 November 2005 was yet to be paid for. One would expect, at a minimum, production and identification of records of payment, corresponding to unpaid invoices at that date. Either way, the claimed overstatement (if there was one) is undoubtedly capable of being the subject of precise evidence. 170This is a case where the Court would naturally expect to have that evidence, in particular from the plaintiff which had control of Admed and Abbetta for a number of years and where, under its stewardship, their accounts were audited. The failure on its part to produce that evidence must be evaluated in the light of its power to have done so: Hampton Court Ltd v Crooks (1957) 97 CLR 367 at 371. 171The plaintiff, however, did not approach the matter by reference to unpaid invoices related to stock on hand as forming part of the cost of sales calculation or by reference to evidence of payments for it. 172Mr Potter gave evidence that the financial records and information regarding the accounting processes and controls available to him did not enable him to form an opinion on the truth and correctness of the compilation reports without performing a full reconstruction of the transactions of Admed throughout the period under review. He said, further, that the information available to him was limited and that ordinarily a complete reconstruction of the financial accounts would be required to accurately assess the extent to which the cost of sales have been underestimated, but that such an exercise was outside the scope of his report. In his Supplementary Report in Reply, he says that he relied on the Micronet system's reported cost of sales to estimate the understatement in cost of sales in the compilation reports for the period July to November 2005 "in the absence of any other comprehensive data being available". He did say, further, that in his opinion, and based on his experience, a full reconstruction would be impractical and not possible with any degree of precision . However, he did not explain why this was so, particularly, in relation to the ascertainment of stock on hand for which payment was due as at 30 November 2005. 173Mr Potter calculated the cost of sales for the period July to November 2005, as recorded on the Micronet system, and compared it to the cost of sales in the compilation reports for the same period. He calculated the accumulated difference between the two sources to be $397,356, the Micronet figure being higher to this extent. He concludes that the reason for the difference is that the compilation reports do not fully reflect the cost of sales. 174He identified some individual sale transactions in those reports on which no cost of sale is recognised and expresses a concern that it is possible that the cost of sales based on those reports may be further underestimated. 175Additionally, Mr Potter carried out a comparative analysis of Admed's gross margins. His opinion is that Admed's gross margin for November 2005 (of 67.6 per cent) and Abbetta's gross margin (of 55.35 per cent) - combined 66 per cent - was implausibly high. His opinion is that their gross margins for December 2005 (Admed 20.77 per cent and Abbetta 45.8 per cent) - combined 11.5 per cent - was implausibly low. He calculated the cost of sales ratio for the five months to 30 November 2005 to be 54 per cent which in his opinion was inconsistent with FY03 (38 per cent), FY04 (36 per cent) and FY05 (37 per cent and 39.5 per cent if one adopts Micronet as accurate). He opines that the reported cost of sales ratio for the five months ended 30 November 2005 was 54 per cent and that this is not consistent with the prior year reported results or his analysis of the sales and margins disclosed in the sales reports extracted from Micronet. His view is that the true and correct ratio was in the order of 60 per cent. 176In addition to relying on Mr Potter's opinion, the plaintiff puts that the 19 December 2007 letter from the Nicholases then solicitors contains an admission that the November compilation reports overstated PBT. 177The fundamental thesis underlying Mr Potter's opinion is that the high gross margin in or to November 2005 is explained by there having being purchases of stock in November 2005, not accounted for in that month but brought to account later. It entails the corresponding thesis that Admed paid for the stock later than November 2005 (most probably in December 2005). 178The Nicholases proffer an alternative explanation. They say that the stock figures and high gross margin for November 2005 are principally explained by the fact that there were, over the previous five months, taken into stock, at value, goods which had been returned free to Admed. This occurred most frequently where equipment (for example, a bed sold for the use of a retired veteran who passes away) was no longer needed and was returned to Admed for no consideration ("free stock"). Free stock was then available to be used again, usually as rental stock. 179They say that there is no necessary correlation between the Micronet cost of goods sold and cost of sales in the compilation reports. They say that Mr Potter's assumption that there is absent from the November compilation reports an accrued obligation to pay for stock reflected in them, is unsubstantiated. They say that Admed did not use Micronet stock reports to calculate cost of goods sold. 180Lyn Nicholas gave evidence of difficulties with the Micronet system, in particular in relation to its unreliability as a source of determining cost of sales. She identified a number of problems. Firstly, the system did not price and record non-standard items. A separate code "NINV" was set up to record these non-standard items but the prices of these items were not automatically recorded in the system. These were recorded manually and not automatically taken up in the creditors ledger for the month. The problem was compounded when the prices for non-standard items changed, and this was often overlooked. Secondly, when specialised items were ordered, suppliers at times did not know the prices and the goods were recorded as having no cost. This would be rectified later. Thirdly, where prices on invoices were incorrect, items would be recorded as having no cost until the price issue was resolved and the correct price recorded manually. Fourthly, Micronet would record the full cost of an item being rented although it had previously been paid for. Fifthly, Admed's invoices would include a cost for freight, for example in the Sydney metropolitan area freight was charged at $10 for a small item and at $25 for a large item. In the case of a nursing home installation, freight might be substantially more. Micronet incorrectly included this freight as a cost of sale although it involved no specific outlay by Admed, delivery simply being part of Admed's general overheads because it had its own transport fleet. 181Micronet included a stock ledger which was relied on as providing an accurate record of inventory from time to time but, as is self-evident, the particular shortcomings in the system would either cause the cost of that inventory to be overstated, or understated as the case may be. 182In his Second Supplementary Report in Reply, Mr Potter undertook a search of the November 2005 Micronet system sales report to identify invoices in relation to "Hire". He identified 67 invoices of which 3 incorrectly reflected cost of sale. His view was that the amounts involved were immaterial in the context of the total monthly sales and cost of sales. This examination was limited to only one month. Immaterial amount or not, the analysis demonstrates the unreliability of Micronet, in this instance entailing the overstatement by Micronet of the cost of sales. 183Mr Potter also identified "in the data available" to him three transactions using the NINV code having a total value of $382.50. His evidence was that the extent and effect the NINV code would have on his analysis and his report is unclear. This further demonstrates the unreliability of Micronet. 184There can be little doubt that Micronet is an unreliable source with respect to cost of sales. PWC identified its shortcomings generally in its due diligence report under the sub-headings Risks and System Issues extracted earlier. No one from PWC was called. 185Mr Ford's figure as at 31 January 2006, presumably derived from primary records of Admed, is $5,186,015 (as opposed to Mr Potter's $5,360,001), a not insignificant but unexplained variation of $173,986. 186The evidence reveals that the stock figures as at November 2005 were fixed after a physical take of closing stock by PWC during the course of the due diligence. 187PWC's work resulted in a closing stock adjustment increasing the value of stock on hand (excluding rental stock) then recorded in Admed's records as the figure of $3,158,491, to $3,511,742. This increase of $353,251 roughly approximates to the $397,356 shortfall assessed by Mr Potter. The actual combined closing stock figure in the November compilation reports is $3,513,981. The difference of $2,239 between the PWC figure and that in the November compilation reports was unexplained. 188To the extent that it related to free stock, the upwards stock adjustment would not have a corresponding increase in the cost of sales to acquire it. The evidence established that free stock was included, but not how much. 189The stock revaluation provides a plausible alternative explanation for the elevation of the closing stock figure (or at least a part of it) without any corresponding cost of sales. It also provides a plausible alternative explanation for at least some of the elevated gross profit percentage for November 2005. 190To compound the difficulties, in his Second Supplementary Report in Reply, Mr Potter observed a discrepancy between the stock figures in the November compilation reports and a figure shown in PWC's due diligence report which, according to him, indicated a possible overstatement of stock, which could explain a significant portion of the difference he identified between Micronet's cost of sales and that in the compilation reports. This possible explanation would be inconsistent with the plaintiff's primary thesis. I refer to it only because it underlines the difficulty in the way of finding a particular understatement in the absence of primary records. But the plaintiff did not challenge the opening or closing stock figures in those reports. 191No primary records were identified by the plaintiff as reflecting bought but unpaid for stock on hand as at November 2005 or the payment for it in December 2005 (or later) in accordance with Mr Potter's thesis. Admed's Bank Statements were in evidence but no payments of that character were identified. 192Lyn Nicholas' evidence was that December 2005 was a particularly bad trading month. This provides the possible explanation or partial explanation for the depressed gross margin figures for that month. 193Mr Potter's comparative analysis of percentage gross margins earned for different periods is consistent with his general thesis, but it is not inconsistent with the Nicholases' position, and it provides no foundation for the fixing of a specific amount. 194The letter dated 19 December 2007 from the Nicholases' solicitors, relied on as an admission, is of very limited weight. It refers to the alleged difference in gross margin between November 2005 and December 2005 and admits no more than the probability that this was due to purchases in November 2005 being paid for in December 2005. It also directly puts in issue the alleged December 2006 loss. Even if the letter is construed as an admission, it provides no assistance in the task of determining on the probabilities, with sufficient precision, the amount of any overstatement. 195In Jones v Dunkel (1959) 101 CLR 298 at 305 Dixon CJ said: But the law ... does not authorise a court to choose between guesses, where the possibilities are not unlimited, on the ground that one guess seems more likely than another or the others. The facts proved must form a reasonable basis for a definite conclusion affirmatively drawn of the truth of which the tribunal of fact may reasonably be satisfied. 196I am not persuaded on the balance of probabilities that there was an overstatement, let alone a material one. Even if I were to have formed the view that an overstatement had been proved, fixing an amount would thrust the Court into the realm of impermissible guesswork. Justice does not dictate that a figure be plucked out of the air. There is no starting point for the plaintiff's valuation contentions. 197The facts proved do not form a reasonable basis for a definite conclusion as to the existence and amount of the overstatement affirmatively drawn of the truth of which I am reasonably satisfied. 198The result is that this claim fails. 199The claim for misleading and deceptive conduct fails for the additional reason that I am not persuaded that even if the PBT to 30 November 2005 was $663,085, and the plaintiff had known it, it would not have proceeded anyway. 200What the plaintiff would have done is to be assessed as at 1 February 2006, bearing in mind that the December 2005 accounts were not available until after that date. 201Neither party suggested that the transaction would have proceeded at a lower price. Accordingly, if the plaintiff had not paid the Nicholases' price it would have foregone the acquisition. 202The plaintiff has, throughout, contended that the overstatement was brought about by a failure to account for cost of sales in November 2005 which would have had a corresponding effect thereafter, predominantly in December 2005. This attitude and conduct reflects its state of mind. It follows that a November 2005 overstatement would have been counterbalanced by a belief that December 2005 would show an understatement. 203Moreover, the plaintiff would undoubtedly have taken into account such information as it had with respect to January 2006's performance. In her email of 25 January 2006, enclosing the November 2005 compilation reports, Lyn Nicholas referred to the fact that they were currently $100,000 up in January 2006 on last year with a number of days left to invoice. Paul Mirabelle accepts that the January 2006 performance was above the historical January position, although his concession was qualified with the words "as came out in March". 204In my view, these considerations are sufficient in themselves to displace the plaintiff's contention that the November 2005 overstatement would have deflected it from purchasing. 205There are, however, other objective factors inimical to the suggestion that the figures in the November compilation reports were causative of the plaintiff entering into the transaction, being the nature of the plaintiff's own investigations, the problems with Admed's accounts which were drawn to its attention (including that the accounts were not prepared on a full accruals basis), the significance of the transaction to the plaintiff's general strategy, the personal stake of Paul Mirabelle, Daren McKennay and Geoff Thompson in the transaction, the warranties which it took and particular provisions of the Agreement. These are dealt with in the context of the Budget Claim, to which they are also pertinent. Added to these considerations are the facts that: a contrary to Admed's and Abbetta's accounts as at 30 June 2005, which were expressly incorporated into the Agreement, no other compilation reports were incorporated into the Agreement even though they existed before it was entered into. This is consistent with what Stewart Nicholas says he conveyed to Paul Mirabelle on 12 or 13 December 2005 that the negotiations had always been based on historic figures and he had never agreed to any forecast; and b the November compilation reports contain the disclaimers referred to earlier. 206As at 20 January 2006 Paul Mirabelle had not looked at the November compilation reports though he had understood that they had been provided and were being looked at by Geoff Thompson. 207Given these conclusions, it is not necessary to consider whether the claimed overstatement (if it had been established) would nevertheless not have been misleading because of other information given to the plaintiff at the time. Additional information which threw doubt on the compilation reports would only reinforce my conclusion that the plaintiff would have proceeded anyway. 208Absent a finding (or the availability of one) that an overstatement has been established, it is neither feasible nor appropriate to proceed to consider the question of quantum. There are, however, a number of observations pertinent to the approach taken by the plaintiff which are warranted in the circumstances. 209Mr Potter was instructed to value the issued shares of Admed as at 1 February 2006. He did this by using the conventional Discounted Cash Flow (DCF) method to derive the present value of expected future returns of the business, on three possible scenarios relating to the continuation of the DVA contract. 210For each scenario, he took the revenue and expenses for July to November 2005, adjusting only for the cost of sales in the Micronet reports, and then annualised those figures to estimate Admed's net profit to 30 June 2006. He adjusted Admed's estimated net profit to 30 June 2006 for an increase in salaries and wages of $270,000 (covering an appropriately qualified financial manager and increasing owner and other management salaries to market level) and applied growth assumptions to project Admed's revenues and expenses for each year until 30 June 2012. Mr Potter converted these projected revenues and expenses to cash flows by making assumptions, based on Admed's historical performance, about inventory holdings and the time taken to receive payment from debtors and to pay creditors and then discounted those cash flows to a net present value, starting with the risk free rate and adjusting upwards for specific risks. To derive a total value, he added a terminal value, assuming particular revenue and expenses growth. 211The plaintiff puts that this was the true value of the shares it acquired on 1 February 2006. 212The first observation is that, as has been earlier mentioned, it was observed by the High Court in Campbell v Backoffice Investments that this is not self-evidently the correct approach where, as the plaintiff would have it, it gauged the purchase price on the basis of a multiple. 213Secondly, rather than using actual figures for 2006 (and thereafter), Mr Potter annualised the figures to November 2005 (and then made a forward estimation). He gave evidence to the following effect: Q. And is there some reason why you have used an extrapolation rather than the actual? A. My instructions were to base my valuation on information available as at the 1st of February 2006. Q. And so your opinion as expressed in these documents takes a snapshot of how things stood as at 1 February 2006 and does not take into account the actual events that unfolded after that date? A. The first part is correct, I do base it on information at 1 February 2006, but I did have regard to subsequent information to see if my estimates were wildly inaccurate. 214There is an obvious shortcoming with this approach. The Court should (if not must) take into account relevant events that occurred after the purchase of the business in determining its value as at the date of its purchase, particularly where the plaintiff had control of it for more than three years after buying it; see Kizbeau Pty Ltd v W G & B Pty Ltd (1995) 184 CLR 281 at 294. 215The shortcoming is exposed by the fact that Mr Potter's straight-line extrapolation of figures to November 2005 to reach a full year figure differs from the actual figures to June 2006. The absence of major inaccuracy does not provide a solid foundation for a finding. 216Thirdly, the evidence placed before the Court did not extend to permitting an understanding of how Admed and Abbetta performed after 2007 or what consideration was attributed to them when they were effectively disposed of, or to measure the benefits the plaintiff obtained by using the cash which the acquisition provided and which enabled it partly to pay for Taylor Bryant. THE BUDGET CLAIM 217There was a somewhat heated difference of opinion as to whether the forecast provided by Lyn Nicholas on 20 September 2005 and restated in the Summary Financials document given on about 4 November 2005 is properly to be described as a budget. I do not think anything turns on how it is described. I will for convenience refer to it as the 2006 Budget. 218The plaintiff claims that the Nicholases breached warranty 4(a) by giving it the 2006 Budget, which it says was information that Admed was likely to achieve a PBT of $2.2M in 2006 and that the Nicholases had reasonable grounds for believing that Admed would do so. 219It claims that this information was not true and was misleading in a material respect because as at 1 February 2006 (and earlier) Admed was not likely to achieve the forecasted profit and that the Nicholases did not have reasonable grounds for believing that it would. 220In the alternative, it contends that the Nicholases represented that Admed was likely to achieve a PBT of $2.2M in 2006 and that they had reasonable grounds for believing that it would. 221Sections 41(1) and (2) of the Act provide that: (1) For the purposes of this Part, where a person makes a representation with respect to any future matter (including the doing of, or the refusing to do, any act) and the person does not have reasonable grounds for making the representation, the representation shall be taken to be misleading. (2) The onus of establishing that a person had reasonable grounds for making a representation referred to in subsection (1) is on the person. 222The plaintiff says that under s 41(2) of the Act the Nicholases have the onus of establishing that they had such reasonable grounds, which onus they have not discharged. Inherent in this submission is the proposition that the representation was with respect to a future matter within the meaning of s 41(1) of the Act. 223For the breach of warranty, the plaintiff claims that its loss is the difference between the true worth of the shares it received and the value they would have if Admed had been a company with a likely PBT of $2.2M for FY06. 224For the alleged misleading conduct, it claims that its loss is the difference between the price it paid and the true worth of the shares it received on the basis that it says that but for these representations it would not have entered into the Agreement. 225The Nicholases dispute that the 2006 Budget was information as to the likelihood of Admed achieving the forecast profit. They say they had reasonable grounds for believing that it would. 226They deny that the 2006 Budget was a representation as to a future matter. They say it was a representation as to their present state of mind, namely, that they genuinely considered that Admed could meet it. 227The Nicholases dispute the plaintiff's contention that as at 1 February 2006 (and earlier) Admed was not likely to achieve the 2006 Budget. 228They say that the actual performance of Admed in FY06 was significantly and adversely affected by things which the plaintiff as the new owners did, but for which Admed would not have fallen materially short of the 2006 Budget. 229The Nicholases say that in any event there were reasonable grounds for the 2006 Budget. 230They also dispute the plaintiff's assertion that but for being given the 2006 Budget it would not have proceeded with the purchase. 231At the outset I should say that I do not consider that the 2006 Budget was information that Admed was likely to achieve the forecast PBT or that the Nicholases had reasonable grounds for believing that it would . 232In my view, the 2006 Budget reflected no more than the Nicholases' genuine expectation of how they expected Admed and Abbetta might perform in 2006. 233In my view they were not conveying information that they had reasonable grounds for believing that Admed would achieve the 2006 Budget. 234The provision of the 2006 Budget did not bring with it more than the implication of a genuinely held belief that it was a realistic one. It brought no implication, let alone a necessary one, that they had reasonable grounds for the forecast. It is not suggested that they did not genuinely believe the 2006 Budget was realistic. 235If the 2006 Budget was a representation as to a future matter, it was no more than a representation of the existence of a genuine expectation as to how Admed and Abbetta might perform. 236For these reasons, this claim fails at the first hurdle. 237It fails for the additional reasons that: a the plaintiff has not established that as at 1 February 2006 (and earlier), Admed was unlikely to meet the 2006 Budget; and b the Nicholases had reasonable grounds for believing that Admed would achieve the 2006 Budget. 238I also consider that had it not been given the 2006 Budget, the plaintiff would nevertheless have proceeded with the purchase. 239I will deal with each of these matters in turn. As at 20 September 2005, 4 December 2005 and 1 February 2006, was Admed unlikely to meet the 2006 Budget? 240According to the financial statements for FY06, Admed returned a PBT of $1,272,756. 241The assessment of the likelihood, in fact, of Admed meeting the 2006 Budget requires an assessment of its actual performance to 30 June 2006, having regard to any decisions taken by the plaintiff with respect to Admed's mode of business which affected its performance both in respect of revenue and in respect of expenses. 242It may be observed that Admed's Management Accounts at that date - prepared under the stewardship of the plaintiff, and seen by Daren McKennay at the relevant time - show a PBT of $1,712,772. 243I will, however, adopt as the starting point the figures in the FY06 financial statements. Revenue 244In 2005, and as at the date of the Agreement, the Nicholases had plans to implement a new rental division and a new textile division. 245According to the Nicholases and Belinda Fowler, a decision had been taken in 2005 to start the textile division which would sell sheets, blankets, pillow cases, towels, curtains and other textile items to be used in hospitals and nursing homes. Belinda Fowler's intention was that the division would be up and running by January 2006 and that set-up costs would be minimal, given that there was already a distribution system in place. Admed already had its own delivery trucks and sales representatives. All that was needed was a manager for the division and stock. Stewart Nicholas' evidence was that stock could be purchased from Asia which could be sold at a 30 per cent mark-up and that he considered that sales of $130,000 a month were feasible. 246Also in mid-2005, Belinda Fowler was taking steps to set up a rental division. Her view was that expansion into the business of renting white goods and basic mobility products which Admed was accumulating in-store was a natural progression for the business and could be implemented with minimal overheads. In September 2005, Admed advertised for the rental division manager. This division did not progress beyond advertising for the manager. 247Belinda Fowler says that she had a meeting with Paul Mirabelle, Daren McKennay and Geoff Thompson some time in 2005, during which she told them of Admed's current and future plans, including the proposed rental and textile divisions. With respect to the textile division, she says she told them that she had been in talks with Robert Turch who was in the linen industry. She says Paul Mirabelle said words to the effect: We're currently in talks with a number of other companies within the health care market - each one with their own focus and established market. I might just get you to hold off on any new divisions at the moment - because we might end up duplicating services. 248Stewart Nicholas says (and Paul Mirabelle denies), that Paul Mirabelle "put a stop" to the plans to form a rental and textile division. 249Paul Mirabelle says that in around February 2006 Belinda Fowler referred to having earlier mentioned the idea of introducing a textile business and mentioned Robert Turch's name. He says that he made direct contact with Robert Turch and obtained a business plan from him. He says that he and Belinda Fowler met with Robert Turch in late March 2006 and that he then spoke to her and Stewart Nicholas expressing doubt as to whether Robert Turch was the right person, that fixed costs would be involved and that there were only three months left in that financial year. He says that Stewart Nicholas suggested they needed to keep looking around and that he agreed. 250There is a significant issue between the parties as to whether a textile division could have feasibly been set up to contribute to FY06 profit, given especially that set-up costs would have been involved. Whilst I accept that the Nicholases and Belinda Fowler genuinely believed that the division was a good prospect and that it could have been up and running in early 2006, the evidence does not satisfy me that it could have made a material difference to Admed's profit for FY06. 251The situation is different with respect to the rental division. Not much exertion was needed because Admed had stock and the necessary distribution system. 252Lyn Nicholas' evidence is that at a meeting on 20 October 2005, Paul Mirabelle said: PAUL MIRABELLE: In relation to the rental division that you are proposing, because we are in discussions with a number of other businesses who have established rental divisions that we can replicate, I want you to hold off. STEWART NICHOLAS: I'm not real happy about that because Belinda and I have spent a lot of money and effort to set it up. 253Paul Mirabelle's affidavit evidence was that he discussed the rental business with Stewart Nicholas at some point in December 2005 and expressed a view that the rental division was a good idea. He says he told Stewart Nicholas that if he thought it would be profitable he should go for it. 254His oral evidence was to the following effect: The rental business was continuing to be grown, as I understood it. But to be fair, I was not running the business on a day-to-day business [sic], Mr Nicholas was, and the general manager was his daughter, Belinda Nicholas. So, all these initiatives fell within their purview as managing director of the company. But the ownership structure changed 255I prefer the evidence of the Nicholases and Belinda Fowler. It provides a logical and rational explanation for why the rental division did not, in the face of their optimism and the ease with which it could have been implemented, go ahead, either before or after the change in ownership. Correspondingly, the absence of action does not sit easily with Paul Mirabelle's avowed optimism. 256Stewart Nicholas' evidence was that the rental market was lucrative. By late 2005, Admed already had a rental contract with the Wentworth Area Health Service and also rented some equipment to the DVA. By mid-2005, the DVA was renting air mattresses, patient lifters and beds and Stewart Nicholas was planning to expand the business to cover chairs, wheelchairs, walkers, crutches, shower chairs and other items. He was also considering providing bariatric packages (equipment constructed to assist people suffering from obesity, such as lifters and extra strength beds). He gave evidence of enquiries from hospitals about renting these packages, because of the expensive nature of this equipment. 257By October 2005, Admed had available for hire 90 reconditioned walkers which were boxed and ready to go, 40 - 50 height adjustable seating, 20 electric lifters, 8 - 10 electric lift chairs and 10 - 12 beds, plus other equipment. He estimated an ability to generate $50,000 per month from this business, which would represent almost 100 per cent profit, given the equipment was already owned and paid for. The cost of the rental manager would have to be borne. 258Admed also had the prospect of obtaining a contract with the NSW Health Authorities for the supply of ward beds. It had lodged a tender with the NSW Department of Health in 2004 and Stewart Nicholas had been attempting for years to obtain a contract to supply ward beds. In 2005, the Department requested a re-tender and Admed lodged one on 2 November 2005. That tender was conditionally accepted on 18 April 2006. The tender required certain items to be rectified. It is possible that beds could have been sold to the Department, so as to contribute to FY06 profit, but the window for this to occur was limited, given the approaching end of the financial year. In the circumstances, I do not consider that there was sufficient prospect of receiving revenue from this source to warrant it being taken into account in assessing the likelihood of Admed meeting the 2006 Budget. 259I am satisfied that the extensive due diligence, including the PWC stock-take, would have had a negative impact on revenue. 260Lyn Nicholas' evidence was that of the 38 working days in November and December 2005, herself and other employees were occupied for 19 days attending to due diligence related matters. She was also unable to close off the November month until all the stock was accounted for and PWC signed off on the stock count. This did not occur until eight days into December 2005, during which time no goods were invoiced and no stock was delivered. The Queensland and Victorian branches were closed down for two days (and the regional offices for almost as long) and customer enquiries were not addressed for a number of days. Expenses 261The evidence establishes that after the plaintiff assumed stewardship of Admed on 1 February 2006, it brought about changes to Admed's expense structure, which had a negative effect on Admed's performance, although it is not possible to precisely quantify the extent of the effect. 262For FY05, Admed and Abbetta earned combined revenue from sales $16,144,515 compared to $16,097,688 for FY06, an immaterial difference. Yet, a employee benefits increased from $3,158,264 in FY05 to $3,783,404 in FY06 (a difference of $625,140); and b administrative expenses increased from $771,107 in FY05 to $1,049,310 in FY06 (a difference $278,203). 263In addition, in FY06 Admed paid marketing expenses of $41,291, finance costs of $38,386, recruitment fees of $23,762 and $10,000 for a business consultant (or "sales guru"), none of which type of expense had been incurred in FY05. Admed incurred increased travel costs in the period March to June 2006 in the order of $18,000. Under the plaintiff, Admed also employed an in-house accountant for which it paid $33,333. 264Also, in FY05 Admed had earned interest from cash on hand. There is no issue that once Admed took control, it utilised cash on hand, including for the payment for the acquisition of Taylor Bryant. No interest was earned after 1 February 2006. 265Under the plaintiff's stewardship annual expenses for FY06 (although the plaintiff was only in control for five months) increased by $887,926 over the 2005 figures - an increase of 18 per cent, on any view, a material increase. 266According to Paul Mirabelle, some of the increase is to be attributed to an attempt to boost flagging sales. The Nicholases' response, which I find convincing, is that the new owner's own acts contributed to the flagging sales. In this context the plaintiff put that Stewart Nicholas stayed on as Managing Director at a substantial salary and that he remained in control. I prefer Stewart Nicholas' evidence that he occupied the position in name only and that the new owner was dictating the direction of the business. 267The plaintiff made the observation that, according to the December 2005 compilation reports, expenses were $2,692,986, which, if annualised, would have resulted in yearly expenses of $5,385,971 as opposed to the expenses of $5,793,616 actually incurred, a somewhat smaller variance than that between FY05 and FY06. 268However, Gordon Ford's break-even analysis considered a reasonable fixed cost structure to be $420,000 per month (or $5,040,000 per year). According to the financial statements for FY05, combined yearly expenses were $4,565,253, equating to $380,437 per month. 269Admed and Abbetta made a gross profit of $7,023,487 for FY06. Assuming expenses according to Gordon Ford's assumption, they would have made a PBT of $1,983,000, without including bank interest received and other income of $42,885. Adding this additional income would result in a PBT of $2,025,885, less than a 10 per cent shortfall from the forecast $2.2M in the 2006 Budget and an immaterial difference in accounting terms. 270The plaintiff also observed that PWC adjusted Admed's FY05 EBIT downwards to $1,158,142 but this adjustment was heavily disputed and no one from PWC was called. 271Michael Alscher gave the evidence that in aggregating four or five businesses with Admed the plaintiff "bought businesses with poor management to start with and we ended up compounding that business with the management that we put in place and ended up deciding that we wanted to exit that whole area". 272I am satisfied that the plaintiff's management of Admed's business adversely affected Admed's financial performance to a not insignificant degree. Conclusion 273Whilst it is not possible to gauge with any degree of accuracy the level of FY06 a revenue that would have been earned from the rental business; b revenue which was foregone as a result of the due diligence operation; and c expenses attributable to steps taken by the plaintiff; all of these factors clearly negatively impacted on Admed's FY06 performance and all play a part in my conclusion that the plaintiff has not established that Admed was unlikely to achieve the 2006 Budget. 274This finding is sufficient to warrant the further finding that the Nicholases had reasonable grounds for believing that Admed was likely to achieve the 2006 Budget. 275However, even if Admed were to be regarded as not having been likely to meet the 2006 Budget, the Nicholases had further reasonable grounds for believing that it was. Reasonable grounds 276Even though I have concluded that neither the textile division nor the ward bed contract should be regarded as factors going to the actual likelihood of the 2006 Budget being met, the Nicholases were undoubtedly entitled to take them into account in forming their view as to Admed's prospects. 277But they had the following further grounds. 278They had valid reason to consider that there would be increased income from the DVA contract. Crescent's own assessment was that it appeared that Admed was winning more work than expected due to its service standards and that its share of the revenues being earned from supplying equipment to the DVA was growing. 279Admed had in excess of $1M of cash on hand which was available for expansion. Would the plaintiff have proceeded? 280The plaintiff puts that the relevant question in determining whether it suffered loss is whether it would have entered into the Agreement had it known what Admed's likely FY06 PBT really was. 281I do not accept this submission. The relevant question is whether the conduct complained of (providing the 2006 Budget) was a cause of the plaintiff entering into the Agreement, that is, whether it materially contributed to that occurrence; see Kenny & Good Pty Ltd v MGICA (1992) Ltd (1999) 199 CLR 413. 282I do not consider that the 2006 Budget was such a cause. In my view, the 2006 Budget played no meaningful role in the plaintiff's decision to proceed and the plaintiff would have proceeded whether it had received it or not. 283Lyn Nicholas' evidence was that at the 14 September 2005 meeting she was asked for a best "guestimate" and that she had a conversation with Geoff Thompson on 15 September 2005 in which he asked for an estimate to give them a guide. Her evidence of the 20 October 2005 meeting is that she repeated that she had been asked for a best guesstimate and that Paul Mirabelle said he was curious as to how they had arrived at the figures, given that she had said she did not have a budget. 284Daren McKennay's evidence was that he told Lyn Nicholas that the plaintiff and Crescent needed to be satisfied that Admed was tracking to $2.2M and asked for a sales analysis broken down into branches. She provided figures broken down into branches which she said were based on targets provided by Admed's financial controller. Daren McKennay replied to the effect that year to date performance had the most relevance and to gain confidence in the forecast for FY06 they needed to have a good understanding of how the business was tracking in key regions and that the information that was being sought in a genuine attempt to better understand the business. 285It may be accepted that in its consideration of the purchase price it was prepared to pay, the plaintiff took into account what it considered was a realistic, achievable, PBT for FY06 to which it applied a multiple or range of multiples. The same may be accepted with respect to Crescent's decision to invest. 286It may also be accepted that the plaintiff regarded $2.2M as the achievable figure (although it is to be observed that the Crescent modelling predicted an EBIT of $2.114M - somewhat less - on revenue of $17.543M - somewhat less than the $18.4M in the 2006 Budget). 287However, I do not accept that the 2006 Budget played any role, or at least any causative role, in the plaintiff's decision to enter into the Agreement on 1 February 2006 or in Crescent's decision to invest. 288At the outset, it should be observed that the Nicholases deny Paul Mirabelle's evidence as to the 27 October 2005 meeting (undoubtedly given to emphasise the importance he says he placed in the 2006 Budget), in particular, his evidence of saying that "they needed to be satisfied that the business was tracking to the budget number of $2.2M EBIT which you've shared with us" and that "the most important thing during due diligence is that we will need to confirm that the business is tracking to the level of performance as set out in your budget". I am not persuaded that the conversation as recounted by Paul Mirabelle occurred because there was no challenge to the Nicholases' credit and they made a positive impression upon me anyway (this is consistent with the plaintiff's own observations in the agenda document that the Nicholases displayed old fashioned business values - "pride in the business, honesty, integrity"). Similar considerations apply where other conversations alleged by the plaintiff are disputed by the Nicholases. 289For the reasons which follow, in my view, the plaintiff's avowed reliance on the 2006 Budget is significantly exaggerated. 290I do not find that the evidence as to what the plaintiff would have done was not given genuinely. However, this evidence is in substance no different to the hypothetical type of evidence described by McHugh J in relation to medical issue cases in Chappel v Hart (1998) 195 CLR 232, at [32] in footnote (64) as follows: Human nature being what it is, most plaintiffs will genuinely believe that, if he or she had been given an option that would or might have avoided the injury, the option would have been taken. In determining the reliability of the plaintiff's evidence in jurisdictions where the subjective test operates, therefore, demeanour can play little part in accepting the plaintiff's evidence. It may be a ground for rejecting the plaintiff's evidence. But given that most plaintiffs will genuinely believe that they would have taken another option, if presented to them, the reliability of their evidence can only be determined by reference to objective factors, particularly the attitude and conduct of the plaintiff at or about the time when the breach of duty occurred. 291Resort to the objective factors and to the attitude and conduct of Paul Mirabelle, Daren McKennay and Geoff Thompson displaces the contention that the plaintiff would not have proceeded. Their present conviction is undoubtedly coloured by hindsight in the light of a business deal later found to be unsatisfactory; see Rosenberg v Percival (2001) 205 CLR 434 ; Ellis v Wallsend District Hospital (1989) 17 NSWLR 553. 292For a start, Paul Mirabelle, Daren McKennay and Geoff Thompson are highly qualified and very experienced commercial operators. 293The 2006 Budget is simplistic to say the least. Its form is consistent with it being the so-called "best guestimate" which Lyn Nicholas says was the term used to describe it. There is no evidence that Admed had ever produced such a thing in the past. 294The 2006 Budget is to be contrasted with the sophisticated and comprehensive modelling and in-depth analysis carried out by Crescent, the significant investigations which the plaintiff carried out in its own right and the comprehensive due diligence carried out on its behalf by PWC. The plaintiff's due diligence included interviews with Admed's most significant customer, the DVA. 295The idea that a three-line budget was a cause of the plaintiff entering into a significant transaction, such as the Agreement, rather than its own judgment that Admed was a good prospect, based on the in-depth processes which it implemented, is fanciful. 296Even if the conversation recounted by Paul Mirabelle (and denied by the Nicholases) on 27 October 2005 occurred, Paul Mirabelle said that the plaintiff would confirm $2.2M EBIT in its due diligence. As Daren McKennay sought to reassure Lyn Nicholas on 28 November 2005, the material was sought to enable the plaintiff to better understand the business. The plaintiff's operatives reached that understanding from in-depth due diligence and their own analysis, not from Lyn Nicholas' three line budget. 297The second term sheet records that, having conducted the due diligence, the plaintiff was "in a position to clarify our offer to purchase the company". 298In the face of the Due Diligence Report having made it abundantly clear that the records of Admed were unreliable, I consider Paul Mirabelle's evidence that he nevertheless placed reliance on the 2006 Budget to be unconvincing and I do not accept it. 299Admed was a cornerstone acquisition in a larger enterprise which they would not likely have abandoned. It had a unique position in the marketplace and was to be the first of the network businesses the plaintiff was looking to aggregate and the plaintiff was aware of a possible alternative purchaser. The recommendation put to and accepted by the Crescent Investment Committee described the Admed and Taylor Bryant acquisitions as essential to the initial investment. 300The plaintiff had a positive view of the Nicholases (reflected amongst others in the 24 October 2005 agenda), who they regarded as having deep industry knowledge and whose services they had been able to secure for a period after the acquisition. 301The evidence of the parties' dealings immediately prior to the signing of the second term sheet reveals keenness, almost to the level of anxiety, on the part of Paul Mirabelle to conclude the deal. There can be little doubt that he applied pressure on the Nicholases including by the prospect of them being liable for one half of the cost of the due diligence. 302Paul Mirabelle had succeeded, against the odds, in persuading the Nicholases to take a significant reduction in the purchase price. As the second term sheet records, the purchase consideration was in no way contingent on there being a satisfactory resolution of the outstanding debtors issue or indeed any of the other accounting reconciliations identified in the course of due diligence. It also may be observed that on a purchase price of $14M, or $13.5M, which would have resulted under the first term sheet on the June 2005 and November 2005 figures, respectively, the multiple (on a projected EBIT of $2.2M) would have been 6.36 or 6.13, respectively, which is significantly more than the multiple of 4 to 5 which Paul Mirabelle described as typical, according to his evidence of the 20 October 2005 meeting. 303Admed had cash which the plaintiff intended to use, and did use, partly to finance the acquisition of Taylor Bryant which it had committed to purchase on 11 January 2006. Paragraph 5 ii) of the second term sheet made it a condition precedent that the net cash position of $1,445,099 as at 13 December 2005 did not change in any material way to the date of completion without the plaintiff's consent except for normal trading activities. The agenda document presented to the meeting on 24 October 2005 foreshadowed the possibility of releasing up to $2M of working capital. The plaintiff was unlikely to forego this benefit. 304Each of Paul Mirabelle, Daren McKennay and Geoff Thompson had a personal stake in the venture, by way of incentive shares and executive appointments and substantial salaries. The plaintiff was unlikely to forego these prospects. 305By cl 15.11 the plaintiff, a sophisticated entity, covenanted that any statement, representation, term, warranty, condition, promise or undertaking made, given or agreed to in any prior negotiation, arrangement, understanding or agreement, had no effect except to the extent expressly set out or incorporated by reference in the Agreement. 306Daren McKennay's evidence (albeit disputed by Lyn Nicholas) was that he informed her that the plaintiff would be relying heavily on the warranties because Lyn Nicholas was unable to provide him with necessary information. This further undermines the suggestion that the 2006 Budget played any meaningful role in the plaintiff's decision. 307I find that the 2006 Budget did not play any meaningful role in causing the plaintiff to enter into the Agreement. 308The plaintiff made a somewhat perfunctory submission that it was assisted by cl 9.2, which provides that its rights are not adversely affected by the due diligence process carried out by it. The submission is unsustainable. There is no right in the plaintiff which is adversely affected by the due diligence process. The due diligence process is a fact which contributes to the conclusion that the plaintiff has no relevant right to begin with. THE DECEMBER LOSS CLAIM 309The plaintiff claims that the Nicholases breached warranty 4(b) because the information which they gave the plaintiff did not comprise all information which would be material for a buyer to know, in that the information given did not include disclosure that Admed had made a trading loss of approximately $459,000 (or in any event a material loss) in December 2005. 310It claims as damage the amount representing the difference between the true worth of the shares it received and the value those shares would have if Admed had not been a company which made a material loss for that month. An assessment on this basis requires a finding as to the amount of Admed's December 2005 loss. 311Firstly, the evidence satisfies me that well before it entered into the Agreement, the plaintiff knew December 2006 was going to involve a loss. Leaving aside the evidence of Stewart Nicholas (which I accept) of the conversations he had with Paul Mirabelle about December 2006's performance, well before it entered into the Agreement, the plaintiff was given access to all of Admed's sales information, including that for December 2006. According to Lyn Nicholas, whose evidence I accept, PWC were on the premises through January and had access to all documents. 312Secondly, the plaintiff adduced inconsistent evidence as to the extent of the December loss. The December compilation reports show a loss of $459,000. Management accounts produced by the plaintiff show a loss of $60,123 on an EBIT basis and $45,173 when depreciation and amortisation are included. According to Mr Potter, Micronet discloses a loss of $204,024 (perhaps this confirms its unreliability). The Court is unpersuaded on the probabilities that any of these figures or any other figure was the December loss. 313In these circumstances the plaintiff has fallen well short of establishing that the defendants failed, in breach of warranty 4(b) to provide all information which was material for the plaintiff to know. 314It has also failed to establish the extent of the December loss. THE INDEMNITY CLAIM 315The plaintiff claims that it is entitled to be paid its legal costs of prosecuting these proceedings under the indemnity contained in cl 9.3 of the Agreement. 316It follows from what is said above that this claim fails. THE CROSS-CLAIM 317The Nicholases bring their cross-claim against the plaintiff as well as Paul Mirabelle, Daren McKennay and Geoff Thompson saying that they were misled by them into not taking cash for that part of the Preference Shares that they agreed to convert into shares in MMT. 318The Redeemable Preference Shares terms are contained in Attachment D to the Agreement. It is not necessary to set them out. They provide for the Redeemable Preference Shareholders to give notice of redemption no later than 60 days after they receive the audited accounts of MMT for FY06 and to redeem or to convert into Class A shares according to a specified formula. The redemption price is $1,260,000. In the absence of the Nicholases giving notice of redemption, they are deemed to have elected to convert their Preference Shares into Class A Shares in MMT. 319Prior to the Nicholases making their election, the shares were apparently divided, enabling them to redeem 75 per cent and to convert the remainder to Class A Shares in MMT. 320On 21 November 2006, Geoff Thompson provided the Nicholases with a summary of the 2006 Profit & Loss Statement for MMT (by then known as Lifehealthcare Pty Ltd), its budget for 2007 and its Balance Sheet as at 30 June 2006. 321On around 4 December 2006, Lyn Nicholas notified Paul Mirabelle that she and Stewart Nicholas had received advice from their financial adviser, Paul Lyon, to redeem 75 per cent of their Preference Shares and convert the remainder to Class A Shares in MMT. 322Later in December 2006, the plaintiff paid $1,890,000 (i.e. 75 per cent of $2.52M) to the Nicholases in relation to the redemption of their Preference Shares, and MMT issued 202,500 shares to each of the Nicholases (405,000 in total). 323Had the Nicholases redeemed rather than converted the remaining 25 per cent of their Preference Shares they would have received an extra $630,000. 324Following a demerger of MMT, they continued to hold 405,000 shares in that company (renamed NHC Group Pty Ltd) and also received 405,000 shares in a new company named Lifehealthcare Pty Ltd. 325The Nicholases continued to hold their 405,000 shares in NHC Group until they sold them in November 2009 for $554,040. Had they held them until December 2010, they could have sold them for $1,041,862. 326Their 405,000 shares in Lifehealthcare have been consolidated to 405 shares, which they still hold. 327This claim can be briefly disposed of. 328Firstly, I am not satisfied on the evidence that the conduct of the plaintiff was causative of the Nicholases' decision to redeem some of the Redeemable Preference Shares. Their evidence was that they relied on external legal advice. 329Under cross-examination Lyn Nicholas gave the following evidence: Q. And you also had a financial planning advisor, Mr Paul Lyon? A. No, not until later. Mr Mirabelle introduced us to Mr Lyon. Q You first engage him not long after signing the 13 December term sheet? A. Yes. Q. He gave you advice about whether to convert all or some of your redeemable preference shares into cash? A. Yes. Q. And you followed his advice on that matter? A. Yes, I did. 330Under cross-examination Stewart Nicholas gave the following evidence: Q. The 2006 accounts for MMT Health Care were provided to you, if you recall, in about November of 2006, do you remember that? A. Mm. Q. And I think I wrongly said to you before that this presentation at page 1688 was provided to you in June of 2008. I meant 2006? A. Yes, I can see that. Q. Yes. Now, what I was asking you is whether you considered that this information was deficient because it didn't include the actual financial results for MMT Health Care for 2006 which you didn't actual receive until November of 2006? A. Yes I would have, I wouldn't have thought they would have the 06 at that time. Q. No. A. But they possibly would have had, like, the accounts up to May to show us? Q. You wouldn't want to make any decision about whether or not to redeem your redeemable preference shares until you had seen the actual results of MMT Health Care for 2006, is that right? A. I don't know. I can't tell you, I'm sorry. I've never had shares in anything before. Q. So you were heavily dependant on the advice that you got from Mr Lyon in relation to redeemable preference shares? A. Yes we were, yes. Q. And you provided the information that you received to him, and he gave you advice and you acted on it, is that what happened? A. Yes. 331Secondly, the plaintiff failed to adduce any admissible evidence which would permit the Court to ascribe a value to the shares which they still hold. CONCLUSION 332The plaintiff's claim is dismissed with costs. 333The Nicholases' cross-claim is dismissed with costs. 334The exhibits are to be returned. ********** 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. Decision last updated: 29 June 2011