Administrative Decisions Tribunal New South Wales Medium Neutral Citation: Torchia v Swanton (No. 2) [2011] NSWADT 185 Hearing dates: 5 and 6 May 2011 Decision date: 02 August 2011 Jurisdiction: Retail Leases Division Before: D Patten, Deputy President T Tyler, Advisor Decision: 1. I order the respondents to pay the sum of $92,650 to the applicants. 2. No order as to costs. Catchwords: Damages - loss of opportunity - quantification - business valuation Legislation Cited: Retail Leases Act 1994 Cases Cited: Biotechnology Australia Pty Ltd v Pace (1988) 15 NSWLR 130 United Group Rail Services Ltd v Rail Corporation NSW 74 NSWLR 618 Category: Principal judgment Parties: Eugene Torchia and Lesley Astill-Torchia (Applicants) Alastair Swanton and Beverley Swanton (Respondents) Representation: Counsel Mr M McCall (Respondents) Mr S Spring (Agent - Applicants) Stephen Tester and Associates (Respondents) File Number(s): 105054 REasons for decision 1RETAIL LEASES DIVISION (D PATTEN (DEPUTY PRESIDENT), T TYLER (NON-JUDICIAL MEMBER / ADVISOR)): On 5 October last, I gave a decision in this matter on the issue of the respondents' liability to the applicants. My conclusions were summarised in these two paragraphs: I also find, as indicated earlier, that the lack of good faith exhibited by the respondents was unconscionable within section 62B of the Act and that as such conduct was in connection with a retail shop lease the applicants are entitled to damages under section 62B(8). It is unnecessary to consider whether they may alternatively be entitled to damages under section 72. In light of my findings and the basis upon which the case was argued it will be necessary for there to be a further hearing as to damages. Provisionally my view is that damages should be quantified as indicated by Allsop P (in United Group Rail Services Ltd v Rail Corporation NSW (2009) 74 NSWLR 618) on the basis that the applicants lost the opportunity to have their request for a renewed lease discussed in good faith and with fair consideration. The Tribunal will be obliged to assess the applicants' prospects of success in negotiating a fresh lease having regard to those criteria. 2It is unnecessary to repeat at length what was published on 5 October but there will be references to particular aspects during the course of these reasons which deal with the issue of damages. Upon that subject the Tribunal heard evidence on 5 and 6 May. Such evidence comprised a further affidavit of Mr Torchia sworn 3 May 2011 and three affidavits of Mr Garry Hughes both of whom were cross-examined, an affidavit of the second respondent, Dr A W Swanton, and an affidavit of Mr Warwick Dolman. Both Dr Swanton and Mr Dolman were also cross-examined. It is noteworthy that Dr Swanton did not give evidence on the liability issue, it being then stated that his wife conducted all business transactions on their joint behalf. 3Dr Swanton's affidavit deposed to matters which I regard as relevant in assessing the value of the chance lost by the applicants. It included these paragraphs: 3. My wife and I have often lived apart for several years, however we remain close. We have occasions when we live in the same house and we still provide some mutual practical and emotional support to each other. We have never been divorced nor undertaken any sort of Family Law property settlement. Our financial affairs remain intertwined. 4. While I have always been equally involved in making decisions about major matters concerning the property, for example, whether we will sell it or not, my wife has had the major role in managing the Lennox Head property until the last few months. 5. In more recent times, I have been taking a greater role in matters concerning the property as a result of my wife's deteriorating health. Proposed sale of property 6. While Passwoods (predecessors to the applicants in their business) were still the tenants of the property, my wife and I started discussing the sale of the property. We knew that all leases and option periods would be up during 2010 and that it might be a more attractive proposition to a potential buyer if the property was not encumbered with leases. It was for this reason that we would not agree to give Passwoods another lease beyond the option they were entitled to which expired on 3 May 2010. 7. In about late July 2008, my wife and I had some more discussions about selling the Lennox Head property and determined to have a real estate agent list the property. 8. We decided to list the property with Byron Bay Property Sales. ... 9. About a year passed with no success in selling the property, and accordingly my wife and I agreed to try another real estate agent. ... 4Documents annexed to the affidavit indicate that the property was to be offered for sale subject to existing leases. 5In April 2010 the property (which comprised three shops including the subject premises) was taken off the market, no buyers having been found in the meantime. In June 2010 however Mrs Swanton, over a period of some weeks, negotiated with a Mr Greg Morris for him to take a lease of the premises by then vacated by the applicants. Mrs Swanton offered a lease for 3 years with an option for renewal for 3 years but ultimately Mr Morris withdrew from the negotiations. In or about July 2010 negotiations were entered into between Mrs Swanton and a Mr Sleep who was also interested in taking a lease of the premises. Negotiations went as far as an offer by Mrs Swanton to lease the subject premises for a term of 3 years with an option for a further 3 years at an annual rental of $19,200 plus outgoings. These negotiations also ultimately broke down. 6In the previous decision I set out at page 13 the reasons advanced by Mrs Swanton in her affidavit of 4 June 2010 for refusing to renew the applicants' lease. Despite what was said in paragraphs 81.2 and 81.3 of the affidavit, Dr Swanton's testimony makes it clear that by 6 April 2010, before the applicants vacated, the property was taken off the market and within a few weeks the respondents were negotiating with a prospective lessee. 7Mr Torchia in his affidavit of 3 May 2011 deposed to the fact that he and his wife, at the time the respondents were negotiating with Mr Morris and Mr Sleep, were themselves ready, willing and able to enter into a fresh lease on the terms which the respondents were offering. I accept that evidence. 8The obligation of the respondents, which as I have found was breached, arose out of para 8 of the Heads of Agreement signed on 8 May 2008 following a mediation. The para read: 8. Each party expresses their intention to restore and maintain cordial relations and in this context to discuss in good faith and with fair consideration any request for a new lease. 9As I indicated in the earlier reasons the respondents pre empted their obligation "to discuss in good faith etc" by instructing their solicitors to write the letter dated 26 November 2009. They presumably also instructed their solicitors not to reply to the letter of 17 December 2009 written by a solicitor then acting for the applicants. 10Mr McCall, counsel for the respondents, submitted that by 26 November 2009 the applicants no longer regarded themselves bound by para 8 of the Heads of Agreement. That submission is I think no longer available to the respondents in view of the findings made in the liability decision. But in any event I do not think it is correct. There is in my opinion no doubt that at all relevant times the applicants were extremely anxious to renew their lease of the premises. It is inconceivable to me that they would have decided to turn their backs on the very significant and solemn obligation undertaken by the respondents in para 8 of the Heads of Agreement. As a consequence I draw no inference adverse to the applicants from the fact that their solicitor did not mention the Heads of Agreement in his letter of 17 December 2009. 11It was also submitted by Mr McCall, as I understand it, that the animosity generated by the applicants' application to this Tribunal on 4 June 2009 provided a sufficient reason for the respondents wanting to have nothing more to do with them. Although in the earlier reasons I categorised the proceedings commenced on 4 June 2009 as misguided, I did not seek to imply that the applicants had no genuine grievance. The situation was I think probably to the contrary consistently with my finding that Mrs Swanton was a difficult and unreasonable lessor who sought to frustrate the applicants' legitimate business interests. In that circumstance I do not accept that the respondents were entitled to rely on the June 2009 proceedings as a factor which would diminish the likelihood of discussions in good faith and with fair consideration being consummated in the grant of a fresh lease. 12In my opinion the obligation undertaken by virtue of para 8 of the Heads of Agreement predicated that both parties would negotiate reasonably and rationally. Reasonableness would suggest that a lease be offered to the existing tenants who had for 3 years conducted a business in the premises unless there was a rational reason for not doing so. Mr McCall submitted that the situation should be considered as at 26 November 2009 when the applicants were informed that the lessor did not propose to offer a renewal or extension of the lease. At that time the premises were listed for sale. 13However nothing in my previous decision suggested that damages should be looked at as at the end of 2009 or early 2010. In my opinion the request for a new lease as contemplated by para 8 of the Heads of Agreement was constituted by Mr Flugge's letter of 17 December 2009. That letter in my view enlivened the obligation imposed upon the respondents by para 8. I see no reason why that obligation should not be regarded as continuing at least up to the commencement of these proceedings by which time the property had been taken off the market and the respondents were only a few weeks away from negotiating with other prospective tenants. 14As a consequence I am of the view that an intention to sell the property was not a valid or rational reason for refusing to enter into negotiations. Nor in my opinion was the asserted ill health of Mrs Swanton such a reason as she was apparently capable of negotiating with other people and if necessary could have dealt with the applicants through her solicitors or an agent. 15The absence in my view of any compelling reason why negotiations conducted in good faith and with fair consideration would not have led to the grant of a new lease is a factor to be taken into account in determining the value of the opportunity lost to the applicants. Of course as Mr McCall pointed out this question has to be considered in relation to the obligations of the applicants as well as those of the respondents. Mr Torchia conceded to Mr McCall that he had no legal obligation to enter into a lease even if one on reasonable terms had been offered to him by the respondents. However consistently with my findings in the earlier reasons I am satisfied that the applicants were at all times more than anxious to renew the lease and as a consequence any discount attributable to the possibility that the applicants would not accept a lease offered on, reasonable, even generous terms to the respondents, is so slight as to be virtually non existent. 16Nonetheless Mr McCall submitted that in the hypothetical situation created by the Heads of Agreement the prospect of a further lease being granted by the respondents to the applicants was very low. He referred to factors I have already dealt with, namely Mrs Swanton's ill health, the respondents' wish to sell the property and the misconceived proceedings commenced in June 2009. 17He also submitted correctly in my view that the respondents were not obliged to ignore their own interests. He referred to the decision followed by me in the earlier reasons United Group Rail Services Ltd v Rail Corporation NSW 74 NSWLR 618 and in particular to statements made in paras 70, 71, 76 and 77. At issue in Rail Corporation was a dispute resolution clause requiring the parties through senior representatives to meet and undertake "genuine and good faith negotiations". The content of such obligation seems to me to be encapsulated by Allsop P (with whom the other members of the Court agreed) at paras 76 and 77 (references to authority omitted): 76 In Hooper Bailie and Elizabeth Bay Developments, Giles J saw as crucial to his view that an obligation to negotiate in good faith was uncertain the "necessary tension between negotiation, in which a party is free to, and may be expected to, have regard to self-interest rather than the interests of the other party, and the maintenance of good faith": see Hooper Bailie at 209 and Elizabeth Bay Developments at 716. This was similar to the consideration that influenced Lord Ackner in Walford v Miles. I do not agree that the posited contradistinction exists, at least in a clause such as the present. First, the obligation to undertake genuine and good faith negotiations does not require any step to advance the interests of the other party. The process is the self-interested one of negotiation. Secondly, there is, however, a constraint on the negotiation, though this constraint is not one to advance the interest of the other party. Rather, it is a (voluntarily assumed) requirement to take self-interested steps in negotiation by reference to the genuine and honest conception of the pre-existing bargain, including the rights and obligations therefrom and of the facts said to comprise the controversy. Within that constraint of those genuinely and honestly held beliefs as to the bargain, the required behaviour is genuine and good faith negotiations with a view to settlement or compromise. 77 In Laing v O'Rourke , Hammerschlag J followed Handley JA in Coal Cliff and Giles J in Elizabeth Bay Developments on the basis that they exhibited the correct legal approach. With respect, I disagree. Hammerschlag J said at [50]: "It is not the tension between negotiation and good faith that is the lynch pin in the argument, it is the absence of an objective yardstick by which to measure the good faith or otherwise of a negotiating party's stance. An appropriate (and indeed often effective) negotiating strategy may be a refusal to negotiate." I disagree that there is no yardstick. The yardstick is honest and genuine negotiation, within the framework of fidelity to the bargain and the posited controversy. If, by "refusal to negotiate", his Honour meant not undertaking negotiations, it is to be recognised that the parties, here, have agreed that they will "meet and undertake genuine and good faith negotiations". How a party does that, and whether it has done it, will be a question of fact. It is not necessarily helpful to point to hypotheses outside a real factual example. Once one appreciates that the content of such a clause, in the framework of existing legal obligations, includes fidelity to the existing bargain, including the clause itself, the constraint that a party has taken on by the voluntary and willing entry into the contract is that it is free to pursue its own interests in negotiation, but by reference the honest and genuine appreciation of the rights and entitlements arising out of the relationship and touching the controversy. 18Although negotiations conducted between the parties may have foundered for reasons which are not now obvious, on the face of it, it seems to me that it was in the best interests of the respondents to grant a fresh lease to the applicants and that if they had negotiated in good faith and with due consideration a lease would probably have been granted. In saying this I leave aside any personal animosity of Mrs Swanton towards Mr and Mrs Torchia the furtherance of which, objectively viewed, would not have been in the respondents' best interests. Moreover there is no evidence that there was any animosity between Dr Swanton and either Mr or Mrs Torchia. It was certainly not revealed in his affidavit or in his oral evidence. 19Obviously the prospect of a successful outcome to the negotiations expressed as a percentage cannot be calculated with mathematical precision but in my opinion bearing in mind the yardstick of "good faith and due consideration" and bearing in mind my objective assessment of the interests of the respondents I think the percentage should be determined at considerably more than 50%. I regard 70% as an appropriate figure. 20In reaching the above conclusion I have not ignored Mr McCabe's submission that damages are to be assessed on the basis that the respondents would have performed the contract in the way most favourable to themselves. ( Biotechnology Australia Pty Ltd v Pace (1988) 15 NSWLR 130 at 156D). Assuming that the principle applied to this case, for the reasons already given in my opinion if the respondents had negotiated in good faith and with fair consideration it would not have been in their best interests to refuse to enter into a lease. The contrary position is more likely. 21As to the value of what the applicants lost, the commencing point is that both experts, Mr Hughes called in the applicants' case and Mr Dolman in the respondents' case, agreed that when the lease expired on 2 May 2010 the business in the absence of a fresh lease for a significant term had virtually nil value. 22The evidence of Mr Torchia was to the effect that when he and his wife took over the business at the end of May 2007 it was in a run down state. This evidence which I accept is borne out by evidence as to the profitability of the business before it was acquired by the applicants. A statement annexed to Mr Torchia's affidavit of 2 May 2011 shows that for the year ended 30 June 2004 sales amounted to $283,195 and gross profit was $144,209. For the year ended 30 June 2005 sales had fallen to $235,636 with a gross profit of $127,786 and for the year ended 30 June 2006 while sales had remained reasonably steady at $235,010, gross profit had fallen to $115,265. 23The applicants immediately spent a further sum of approximately $17,000 on plant and equipment with the result that in all they spent nearly $50,000 on plant and equipment and about $11,000 on goodwill and legal costs. 24Ignoring the initial period of the applicants' operation of the business to 30 June 2007, their accounts show that for the 12 months to 30 June 2008 they had sales of $121,715 with a gross profit of $41,475, for the year ended 30 June 2009 sales of $205,496 with a gross profit of $110,345, and for the period from 1 July 2009 to 30 April 2010 when the applicants ceased trading immediately before the expiration of the lease, sales were $240,626 and gross profit $154,087. 25I am satisfied that during the first year of full operation of the business by the applicants, that is the year ended 30 June 2008, they were considerably hampered by the activities of the respondents referred to in the earlier reasons. The next 2 years I think accurately reflect the rising potential of the business under the stewardship of the applicants. Nonetheless there was disagreement between the two experts as to how such trading improvement should be reflected in its value. 26Mr Hughes holds a Bachelor of Business with distinction from the Southern Cross University and has been a partner in Wappetts' Chartered Accountants in Lismore and Ballina since 1999. He has some personal knowledge of the subject business. 27He assumed that he was asked to value the business sold as a going concern with a 5 year lease on the open market. In his report he listed the techniques available for making such a valuation and concluded that the most appropriate is "the capitalisation of future maintainable earnings". It may be said at once that Mr Dolman agreed with this and it therefore in my view requires no further consideration. According to Mr Hughes the method requires "the determination of the future maintainable earnings of the business, assessment of an appropriate capitalisation rate and valuation of any assets surplus to the core business". 28For the purpose of determining the profit earned by the business in each of the years it was owned by the applicants, Mr Hughes wrote back into the accounts interest on loans and financing, legal expenses and motor vehicle expenses but deducted remuneration for each of the applicants viz $34,150 each for the years ended 30 June 2008 and 30 June 2009 and $28,458 each for the shorter period to 30 April 2010. 29These deductions and additions resulted in a loss of $26,816 for the year ended 30 June 2009 and a profit of $43,619 for the year ended 30 June 2010. The quantum of the deductions for remuneration of the two applicants constituted the main point of disagreement between Mr Hughes and Mr Dolman. The base used by Mr Hughes for each applicant was the Retail Services Employees (State) Award. 30Mr Hughes commented: Future Maintainable Income The business appears to have established a pattern of revenue growth, which is assumed should continue into the immediate future. Allowing for the uncertainty of forward markets and trading conditions we consider that based on the partnership's current position a reasonable estimate of future maintainable earnings would be in the range of $50,000 to $60,000 per annum, after allowing for reasonable remuneration. Based on these figures, I will utilise a future maintainable earnings figure of $55,000. 31Upon the above basis and applying a capitalisation rate of between 2.5 and 3.5 (a matter about which Mr Dolman did not take issue) Mr Hughes valued the business as at April 2010 as within the range $137,500 to $192,500. 32Mr Dolman agreed with Mr Hughes that the business, apart from proceeds of sale of plant and equipment, had a nil value when required to close at the end of April 2010. 33He dealt with the writing back into the accounts of reasonable remuneration for the applicants in these terms: The major flaw in the report of Mr Hughes is the level of reasonable remuneration for the partners in the business. He has used the award wages of retail employees to determine market remuneration instead of the salaries appropriate for the duties of the partners including management and administration of the business, cooking, ordering supplies, customer service and all of the other duties involving owners of a business which would not be performed by an employee paid at a basic award rate. The other major flaw in Mr Hughes report is that the award is for a 38 hour working week where Mr Torchia actually worked on average 60 hours weekly and Mrs Torchia 30 hours weekly (according to their affidavits), a total of 90 hours weekly not 76. 34Mr Dolman also took issue with Mr Hughes' assessment of $55,000 as a reasonable estimate of future maintainable earnings. He contended that $55,000 represented the profit of $43,619 to 30 April 2010, annualised to 30 June 2010 a circumstance which overlooked "seasonal factors" namely that the period to 30 April 2010 included the summer months where trade was likely to be busier. It was therefore so he contended an error for Mr Hughes simply to "annualise" the profit to 30 April 2010. 35According to Mr Dolman the accounts to 30 April 2010 "do not include depreciation expense and some other adjustments which were included in the finished figures of 30 June 2010". He proceeded to opine that the months of May and June 2010 would only have been marginally profitable, based on the history of monthly sales provided and that the total earnings of the applicants would have been about $79,000. As to this he commented: The adjusted profits and wages of $79,811 annually, are less than commercial market salaries for the hours and duties of the partners and also less than they could earn in their occupations as a dental technician and early childhood teacher. The termination of the lease appears to be a favourable financial outcome as the parties can earn more in alternative occupations for the same or fewer hours worked than in the caf business even in its best year - 2010. Therefore, there is no loss for the plaintiffs even if the lease was extended as long as they mitigate their losses and obtain employment. 36Repeating, that in his opinion the value of the business was nil, Mr Dolman added "the notion that a business can be sold for (the amounts claimed by the applicants) when it cannot even pay basic commercial salaries for the hours and duties of the partners is contrary to the principles of business valuation". 37In a later report dated 25 February 2011 Mr Hughes took issue with some of the statements made by Mr Dolman. For instance as to the annualisation of the figures for the business up to 30 April 2010 he said: The figures used to prepare my valuation were for the 10 months ended 30 April 2010. One of Mr Dolman's main comments in relation to my calculations was that this 10 month period should not be annualised to reflect a full year profit because May and June would not be profitable months. This is without basis. I have had professional dealings with several businesses in the hospitality industry in the Lennox Head area over many years (cafes, restaurants, bakeries etc) and the months of May and June each year are consistently good trading months. The 'quiet period' for trade that Mr Dolman refers to generally happens more in the September quarter of the year (July and August). On this basis, annualising the profit is fair and reasonable and I stand by the calculations in my previous report. 38In the same report commenting about the valuation of goodwill, Mr Hughes said: The commonly accepted definition of Goodwill is that it is the value that an ongoing, profitable business has over and above the net tangible assets used in the business. It represents the 'super profits' able to be generated over and above all operating expenses and a reasonable remuneration to the working proprietors. There are 3 main types of goodwill that are commonly referred to. These include: (i) Personal Goodwill. This is where the owners of the business have a personal following of customers due to their personal relationships developed over time. (ii) Corporate Goodwill. This attaches to the business independent of the owners and reflects the reputation, marketing, brand recognition and customer loyalty. (iii) Location Goodwill. The success of a business can also be determined by its location and the period of time it has operated there. All of these aspects of goodwill were present in the Torchia's business. The business was located in the heart of Lennox Head, one of the fastest growing regions in the state. It had been operating from that location for over 20 years and had a huge local following. To assume the goodwill of this profitable business would be worth nothing had the business been able to continue to operate and grow is not valid. I disagree with Mr Dolman's assessment of a negative future maintainable earnings figure and I stand by my valuation of the business detailed in my previous report. 39In my opinion the proposition contended for by the applicants that they lost both the opportunity to own a valuable business and the opportunity to receive income from it is fallacious. Their loss in my opinion is confined to a proportion of the value of the business as it would have been at 30 April 2010 had there also been in place a lease for a reasonable term. There was no evidence to the effect that thereafter they were unable to earn income by other means. 40On the other hand I do not accept Mr Dolman's opinion that the valuation of the business was nil apart from the, no doubt negligible, value of plant and equipment. It seems to me that as a matter of common sense an entity which is capable of producing an income stream heading towards $100,000 pa has a significant value even if production of the income requires the personal exertions of its two partners. In stating that the income stream was heading towards $100,000 pa I take into account that in my opinion the business had further scope for increasing its profitability. The evidence as to the improved trading figures while the applicants owned the business seems to bear this out. There is also the unquantifiable circumstance that Lennox Head is by the sea and it would be surprising if other couples such as the applicants would not view with favour the opportunity to acquire not only a new lifestyle but a business returning a profit which, while modest, had potential for improvement. 41In general terms I prefer the approach and valuation of Mr Hughes to that of Mr Dolman. I would accept as the value of the business at 30 April 2010 the bottom of the range suggested by Mr Hughes, namely $137,500. 42As indicated earlier the applicants in my opinion in effect lost, as a result of the respondents' breach of their contractual obligations, a 70% chance to acquire an asset worth $137,500. I would assess their damages at $92,650. 43In this matter although I constitute the Tribunal, I was assisted by Mr T Tyler. I express my gratitude for his wise advice. 44Pursuant to s 72 of the Retail Leases Act 1994 , I make these orders: 1. I order the respondents to pay the sum of $92,650 to the applicants. 2. No order as to costs. ****************** I hereby certify that this is a true and accurate record of the reasons for decision of the Administrative Decisions Tribunal. Registrar/Associate 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: 02 August 2011