Supreme Court New South Wales Medium Neutral Citation: Willie Pei Chiao Tsung v Ian Philip Cappe [2017] NSWSC 1053 Hearing dates: 20 July 2017 Decision date: 11 August 2017 Jurisdiction: Equity - Commercial List Before: Hammerschlag J Decision: Declaration that the plaintiff is entitled to one-seventh of the surplus proceeds of realisation, or value of the proceeds of realisation, of the partnership assets and undertakings less the liabilities of the partnership. Catchwords: EQUITY – partnership – CONTRACTS – construction – where partnership agreement gives each full partner a right to share equally in profits and losses – where the partnership agreement provides for a specified majority to pass a motion binding on the partnership to accept an offer to acquire all or part of the partnership business – where the majority resolves to accept an offer which includes a condition that they but not the plaintiff enter into employment with the new owner and receive consideration significantly in excess of that to be received by the plaintiff – HELD: on its proper construction the provision of the partnership agreement authorising the majority to accept an offer of acquisition did not empower it to determine, vary or reduce as between the partners the plaintiff's one-seventh share in the partnership assets – the plaintiff is entitled to a one-seventh share of the surplus proceeds or value of the proceeds of the realisation. Legislation Cited: Partnership Act 1892 (NSW) Cases Cited: Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321 Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640 Federal Commissioner of Taxation v Everett (1980) 143 CLR 440 Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640 Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd (2015) 256 CLR 104 United Builders Pty Ltd v Mutual Acceptance Ltd (1980) 144 CLR 673 Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522 Category: Principal judgment Parties: Willie Pei Chiao Tsung - Plaintiff Ian Philip Cappe - First Defendant Warren Shane Lun - Second Defendant Craig Matthew Dyer - Third Defendant Andrew Wallace Hooper - Fourth Defendant Rohit Singh - Fifth Defendant Joanna Sommerfeld - Sixth Defendant Lincoln Geoffrey Gillam - Seventh Defendant Representation: Counsel: C. R. C. Newlinds SC with D. Barnett – Plaintiff J. Giles SC with P. Silver – First to Seventh Defendants Solicitors: Bridges Lawyers - Plaintiff Thomson Geer - First to Seventh Defendants File Number(s): 2017/170673 Judgment What This Case is About 1. HIS HONOUR: The plaintiff, Dr Willie Tsung, and the defendants, his seven partners, are specialist radiologists. Until 30 June 2017, when the partnership business was sold to a private equity provider group called Quadrant, they practised their profession in a partnership known as North Coast Radiology. Six partners including Dr Tsung have a one-seventh share, and two partners each have a one-fourteenth share in the partnership. 2. Quadrant made an offer to the doctors to buy the partnership business based on an enterprise value of $68.8 million. The offer had the condition that each of the partners would commit to work in the practice for the new owner for five years and would give a 12 month post-termination restraint. 3. As was his right, Dr Tsung wished neither to work for Quadrant, nor bind himself to a post-termination restraint. 4. In the face of this, the defendants determined to sell to Quadrant in a transaction which included the defendants (but not Dr Tsung) binding themselves to be employed by the new owner and providing a covenant in restraint of trade. 5. The defendants each receive $9.168 million (in cash of $6.768 million and shares of $2.4 million) per one-seventh share in the partnership, but Dr Tsung receives only a cash amount of $3 million (less an amount owed by Dr Tsung to the Commonwealth Bank of Australia and paid on his behalf by the partnership) resulting in a net payment to him of $1,886,141.29. 6. What Dr Tsung receives is substantially less than a one-seventh share of the proceeds of the partnership business which has been sold. 7. Dr Tsung seeks a declaration that he is entitled to one-seventh of the surplus proceeds (or value of the proceeds) of realisation of the partnership assets and undertakings, less the liabilities of the partnership. In other words, he seeks his one-seventh share of what was received for the partnership business. 8. Dr Tsung is entitled to that declaration. FACTS The Partnership Agreement 1. The partnership is governed by terms contained in an unexecuted deed dated 2016 (the Agreement). 2. References to clauses are, unless the context otherwise indicates, references to clauses of the Agreement. 3. Cl 7 of the Agreement provides: Share of Profits and Losses The partners shall be entitled to the profits and shall be responsible or liable for the losses of the partnership business in the same proportions as their contributions to capital. 1. Under cl 21, each full partner is entitled to two votes and a half partner is entitled to one vote. 2. The Agreement has provisions for the retirement and expulsion of partners. There is a three-year restraint covenant on retiring, expelled or terminated partners. 3. There is no express provision dealing only with the dissolution of the partnership. [1] 4. Central to the present issue is cl 32. It provides: Merger or acquisition – special meeting and voting provisions (a) Special provisions apply in respect of any possible merger or acquisition involving the partnership, so that any motion at a meeting of partners to consider merger or acquisition ("the motion") can only be put to the vote where:- all partners have been provided with full details of the proposal in question, and have been given ample opportunity to consider that proposal, and all parties vote, whether personally at the meeting or by proxy, if absent. (b) If a partner fails to vote, then his or her vote shall by reason of this Sub-clause be counted as a vote opposing the motion. (c) These special provisions apply where consideration needs to be given to either:- (i) the partnership (including the Associated Trusts) merging with another diagnostic imaging practice, whether corporate or otherwise; or (ii) the partners accepting an offer by a corporation or another diagnostic imaging practice to acquire all or part of the partnership business (including the assets of the Associated Trusts). (d) The motion can only succeed where a minimum of twelve (12) votes (out of a total of fifteen (15) cast) are in favour of the motion. The Quadrant offer and events leading up to the sale 1. On 11 July 2016, Quadrant made a non-binding indicative offer to the partners to buy the partnership based on an enterprise value of $68.8 million. Quadrant's stated intention was to build a new imaging group of scale through the acquisition of complementary radiology practices. 2. Quadrant describes itself as one of the leading private equity providers in Australia and New Zealand which has successfully partnered with business founders and senior management in completing 56 investments and 49 exits across a broad spectrum of industries. The latest fund managed by it is a $850 million fund. It has significant experience in investing in health businesses. 3. The offer had as a condition that each partner enter into a contract with the acquirer, later identified as a Quadrant entity called Qscan Bidco Pty Ltd (Qscan Bidco), to be employed for a minimum of five years and give a restraint covenant for 12 months post termination. Remuneration was to be based on a fee-for-service model of 20% of the doctors' gross receipts during the five year term with a minimum salary of $354,000 per annum. 4. Dr Tsung told the defendants (to whom I shall refer as the other partners) that he did not wish to accept the Quadrant proposal. He asked to be paid $9 million on completion by the other partners of the Quadrant deal. This did not find favour with the other partners. 5. The other partners offered him approximately $5 million on the footing that this was the cash equivalent to the amount in cash that each of the other partners was to receive, on condition that Dr Tsung bound himself to a restraint "in similar terms to the restraint that currently bound him" under the Agreement. Dr Tsung declined. 6. The other partners informed Dr Tsung that they wished to accept the Quadrant offer. Dr Tsung's response was that the proposed commercial arrangements appeared to be less favourable in the long term than continuing the partnership. 7. On 16 March 2017, one of the other partners, Dr Ian Philip Cappe, as acting chairman of the partnership, gave written notice to all partners that there was to be a meeting of the partnership on 30 March 2017, to consider and if thought fit, to approve a motion (the full terms of which were set out) to accept in principle the Quadrant offer to "acquire the Partnership business". 8. Attached to the notice was a document entitled Explanatory Statement. Paragraph 8 of the Explanatory Statement, headed "Proposed Provision for Dr Tsung", stated that it was proposed "that without obligation to do so, a maximum sum of $3 million in cash will be reserved for payment to Dr Tsung subject to and simultaneously with completion of the transaction and subject to such other conditions as the doctors in favour of the sale to Quadrant may determine, depending upon developments with Dr Tsung as the sale process proceeds and is implemented". It stated that the proposal was based on what the doctors considered to be a "generous valuation of Dr Tsung's interest, given his contribution to date, his rejection of the Quadrant offer and the consequences for the other doctors of that position and provisions of the partnership agreement relating to value in other circumstances where continued involvement ceases". 9. The meeting of partners was held on 30 March 2017. The other partners resolved to accept in principle the Quadrant offer. Dr Tsung attended the meeting. He abstained from voting. 10. There followed, over the period 10 April 2017 to 15 June 2017, an exchange of correspondence in which the other partners informed Dr Tsung of their intention to complete the transaction and he took the position that the resolution was invalid on various grounds, including that cl 32 of the Agreement did not provide for Dr Tsung compulsorily to sell his interest, he owned one-seventh of the assets, if sold he would be entitled to his aliquot share, and it was not up to the other partners arbitrarily to determine a lower sum. 11. It is, I think, fair to say that the correspondence reveals a high degree of keenness on the part of the other partners to sell, and a corresponding frustration with what they saw as Dr Tsung's intransigence in not going along with them. They went so far as to assert that Dr Tsung was in breach of his partnership obligations. 12. They took the position that it was a necessary consequence of the partnership accepting the Quadrant offer that Dr Tsung was obliged to sell his interest in the partnership. Their stance was that, on the proper construction of cl 32, following the passing of a resolution to accept an offer to acquire the partnership business, the other partners, including those voting against the resolution, were obliged to sell their interest in the partnership at the price offered, alternatively that there was an implied term to that effect. 13. Dr Tsung ultimately agreed that he was bound to sell and he accepted that the partnership had, via the cl 32 mechanism, resolved to sell the assets and business of the partnership. His position was that while not wanting to impugn the sale, he wanted his one-seventh share of the proceeds of realisation of the assets and business of the partnership after deducting the partnership debt. The other partners responded by saying that his accepting the obligation to sell meant that he accepted an obligation to sell his interest at the price offered in the offer, being $3 million. Dr Tsung's response was that cl 32 could not be used to force him to accept an amount less than what the other partners would receive under the transaction. He sought his one-seventh share of the proceeds of the sale. The other partners' response was to deny that Dr Tsung was being forced to accept $3 million, because he was able to resign from the partnership and be paid an amount calculated under cl 23(d) of the Agreement. 14. Quadrant revised its offer to cater for the rejection of the offer by Dr Tsung by proposing that he be paid $3 million for his interest, and be under no obligation to enter into an employment contract, or provide a restraint covenant. The enterprise value was in effect reduced to $62,632,000. 15. On 26 June 2017, the partnership resolved at a further meeting called on notice, to accept Quadrant's revised offer. The other partners attended the meeting and voted in favour of the resolution. The structure of the sale transaction 1. The sale of the partnership business was implemented by a suite of interlocking and interdependent agreements, including a Business Sale Agreement (BSA), a Securities Purchase Agreement (SPA) and a series of Service Practice Management Agreements (SPMA). The agreements were signed on 30 June 2017. The BSA and SPA were completed on the same day. 2. The sale was effected in two stages. 3. First, by the BSA, the partnership transferred all of its assets and liabilities to a newly incorporated entity called North Coast Radiology Holdings Pty Ltd (Radiology Holdings). Under the BSA, the total Purchase Consideration for the transfer of the assets and liabilities of the partnership was the issue and allotment to the other partners (but not Dr Tsung) of shares in Radiology Holdings, plus a Cash Amount of $1,886,141.29 ear marked and held on account for Dr Tsung. 4. Next, by the SPA, each of the other partners sold her or his shares in Radiology Holdings to Qscan Bidco in return for shares in Qscan Group Holdings and cash. Cl 17.1 of the SPA imposes restraints on each of the other partners and cl 17.2 records that the undertakings by them are fundamental to Qscan Bidco's decision to enter into the SPA. The SPA (cl 8.2(m)) required the other partners, on completion, to evidence the entry into an SPMA by each of them. The SPMA is an agreement under which a partner will provide her or his professional services and give restraint covenants to Qscan Bidco. 5. Each of the other partners was to receive (and did receive) $9.168 million made up of $6.768 million in cash and $2.4 million worth of shares in Qscan Group Holdings. 6. Cash has been set aside by the other partners sufficient to satisfy Dr Tsung's claim if successful. 7. The parties informed the Court that they are confident they will reach agreement on the amount to which Dr Tsung will be entitled if he succeeds. They suggested that if Dr Tsung succeeds, there should be liberty to apply should their confidence transpire to be misplaced. The Contest 1. Dr Tsung argues that: 1. he has a right, as a partner, to receive his aliquot share of the surplus after realisation of assets and the payment of debts and liabilities of the partnership; 2. the other partners, under the authority conferred by a motion passed in accordance with cl 32(c)(ii), have sold the partnership business for which $62.632 million has been received, of which he is entitled to a one-seventh share; 3. so far as they purport to vary or diminish his entitlement, the sale transaction documents are ineffective, as being beyond the authority conferred by cl 32. 1. The primary argument of the other partners is that: 1. cl 32 confers authority to pass a motion effective to require the partnership to enter into a transaction "in respect of any… acquisition involving the partnership"; 2. the motion passed and the agreements which it authorised, including the provisions under which Dr Tsung will receive, and receive only, $3 million (less the amount owed by him to the Commonwealth Bank and paid on his behalf), are "in respect of any…acquisition involving the partnership"; 3. cl 32 imposes no limit on the nature of the acquisition which can be authorised so that it may include provisions for the distribution of what is received in respect of the acquisition, other than in accordance with the partners' shares in the partnership; 4. Dr Tsung is thus bound by all of the provisions including those which fix what he will receive. 1. They observe that Dr Tsung does not assert any breach of duty on their part or seek to impeach or set aside any part of the sale transaction. 2. Their secondary argument is that the partnership business was sold under the BSA for the shares in Radiology Holdings and the Cash Amount, and that Dr Tsung has no entitlement to a one-seventh share of what was received under the SPA because what was bought (and sold) under that agreement, was not the partnership business, but the shares which had been issued and allotted under the BSA together with onerous service agreements and other contractual obligations of substantial value to Qscan Bidco, to which the other partners (but not Dr Tsung) bound themselves. 3. They say that coupled with the consideration they received under the SPA, they undertook increased risk by joining a larger group of radiologists, on whose performance their success in part will depend and by tying themselves to a corporation over which they have no control. They say that the value of their shares in Radiology Holdings is uncertain. Disposition 1. The other partners argue that cl 32 gives the specified majority authority to bind all of the partners to the acceptance and terms of an offer in respect of a possible acquisition involving the partnership. They argue that the provisions of the transaction which regulate what Dr Tsung will receive from the sale of the partnership business fall within that description and accordingly bind the partners. 2. This involves the proper construction of cl 32. The constructional choice here is whether or not provisions in a contract resulting from the partners' accepting an offer to acquire the partnership business, which determine, vary or limit a partner's entitlement to share in the proceeds, are in respect of an acquisition involving the partnership within the meaning of those words in cl 32. 3. For the reasons which follow, I do not think they are. 4. The Agreement is a commercial contract and is to be given a business-like interpretation. Interpreting it requires attention to the language used by the parties, the commercial circumstances which it addresses and the objects which it is intended to secure. Preference is given to a construction supplying a congruent operation to the various components of the whole. Cl 32 is to be construed in accordance with, and so as to operate congruently with, the whole of the Agreement and not so as to make commercial nonsense or work commercial inconvenience: Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522 at 529; Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640 at 657; Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd (2015) 256 CLR 104 at 117. 5. The starting point is that cl 32 is in a partnership agreement. Partnership is the relation which exists between persons carrying on a business in common with a view of profit. [2] 6. A partner has a special and non-specific interest in each of the partnership assets. It is a chose in action consisting of a right to a proportion of the surplus after the realisation of assets and the payment of debts and liabilities: Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321 at 327; Federal Commissioner of Taxation v Everett (1980) 143 CLR 440 at 447; United Builders Pty Ltd v Mutual Acceptance Ltd (1980) 144 CLR 673 at 688. 7. Partners can, by agreement, divide or apply partnership receipts and other assets at any time or in such manner as they see fit. However, absent a provision in the partnership agreement or other consensus, a partner's separate interest in relation to partnership assets is to share, equally or in such other proportion as the partners may agree, in any surplus remaining upon a dissolution, after the realisation of the assets and payment of the debts and liabilities of the partnership: Federal Commissioner of Taxation v Everett (1980) 143 CLR 440 at 446. 8. The Agreement enshrines, by cl 7, Dr Tsung's right to a one-seventh share in the profits of the partnership business and correspondingly one-seventh of any surplus remaining on a dissolution. 9. Cl 32 must itself be construed as a whole. Whilst cl 32(a) provides in general terms that special provisions apply in respect of any possible merger or acquisition involving the partnership, cl 32(c) is more specific. It provides that the special provisions apply, relevantly, where consideration needs to be given to the partnership accepting an offer by a corporation or other diagnostic imaging practice to acquire all or part of the partnership business. 10. Cl 32 must be construed in the light of the fundamental right of a partner to share in the assets enshrined in the Agreement by cl 7, and where applicable under the provisions of the Partnership Act 1892 (NSW). 11. Cl 32(c) confers authority on the specified majority to bind the partners, relevantly, to acceptance of an offer to acquire all of the partnership business. 12. The object which it intends to secure is to give that majority power to force the sale of the partnership business by accepting an offer. This authority extends to determining what consideration will be accepted for the sale. 13. It does not, either expressly or by implication, confer authority on the majority to regulate or change how they will share in that consideration, and certainly not so as to violate the enshrined rights of partners to share in the profits and property of the partnership. The provisions of the transaction which seek to do this are neither in respect of an acquisition involving the partnership nor are they within the meaning of an offer to acquire all or part of the partnership business within the meaning of cl 32. 14. To give it the field of operation which the other partners suggest, would be to permit it to operate incongruently with the Agreement as a whole and to work commercial inconvenience. 15. It is beside the point that Dr Tsung has not challenged the validity of the transaction documents. He does not need to. They are binding so far as they fix what Quadrant had to pay for the assets, but they are ineffective to vary or limit Dr Tsung's right (as against his partners) to share in the proceeds of the realisation of assets of the partnership. Once a surplus is identified, Dr Tsung is entitled to his share. This entitlement is unaffected by the terms of the transaction documents. 16. It is to be observed that the Cash Amount which the other partners decided should suffice for Dr Tsung, bears no ostensible relationship to the value of what was sold. It is an arbitrary figure selected by them and nothing in law or equity entitles them to bind Dr Tsung to accept this in exchange for his full partnership interest. 17. The secondary argument is that Dr Tsung is not entitled to share in what was received under the SPA because that was not consideration for the partnership assets but rather consideration for the shares which had been issued pursuant to the BSA, plus the bundle of rights acquired by Qscan Bidco comprising the employment and restraint arrangements with the other partners, whereas the partnership assets were sold under the BSA for shares in Radiology Holdings and the Cash Amount. 18. This argument is also unsustainable, not least of all because even if it be correct (which I do not think it is) that what the other partners received under the SPA is not the proceeds of what was sold under the BSA, it does not affect Dr Tsung's entitlement to the relief he seeks. 19. On this argument, Dr Tsung is entitled to receive, and the other partners are obliged to account to him for, the benefit of his aliquot share of the shares issued and the Cash Amount received under the BSA. 20. Attached to those shares are the rights which the holders have under the SPA to receive shares in Qscan Group Holdings and cash. It is beside the point that the other partners chose under the SPA to enter into separate employment arrangements. 21. In any event I consider that the argument entails an artificial view of the transaction which, despite involving a complex structure, implements the offer which Quadrant made to buy the partnership business consisting of the diagnostic imaging practices carried on by the partnership. The assets of the partnership were momentarily exchanged under the BSA, into shares in Radiology Holdings in the hands of the other partners and cash. Those shares were then immediately converted by the SPA into cash and shares in Qscan Group Holdings. The transactions were interlocking and interdependent. It is artificial and unrealistic to suggest that what the other partners ultimately received is not a resultant surplus of partnership property. 22. The other partners appeared to put that the employment and restraint arrangements entailed some sacrifice on their behalf (for which they should somehow be compensated out of partnership assets), apparently because on some calculations they will henceforth earn less than what they might have earned had the partnership continued. 23. In economic terms, this is an argument that Dr Tsung is not entitled to a share in the ultimate proceeds because the other partners gave something in addition to Qscan Bidco in return for the ultimate price it paid, which Dr Tsung did not give and for which they should be compensated. 24. To the extent that whether they made a sacrifice or not is relevant (which I do not think it is), the Court is not in a position to, neither is it appropriate to attempt to, assess whether they did or did not or how much it was worth: Bowes v Chaleyer (1923) 32 CLR 159 at 191. But by no means have they established that they made any sacrifice. Their keenness to do the transaction rather belies the suggestion that they did. They obtained fixed and settled employment by an entity of significant financial proportions without having the risk of personal liability for losses sustained by the partnership. 25. The employment arrangements provide for remuneration to be based on the fees they earn with a guaranteed minimum of $354,000 per annum in the case of a full partner based on five days a week. They make provision for the percentages to be reviewed and changed by agreement. Whatever the outcome of these proceedings, the other partners will receive a significant amount in cash and shares. 26. Their shares may be of uncertain value into the future, but a certain value was attributed to them for the purpose of the transaction. In the future they might be worth less or more. 27. That the other partners determined to accept Quadrant's offer including the condition that they bind themselves to employment and restraints, was a matter of their choice and in their own economic interests. Their employment arrangements stand on their own and into the future. Their willingness to enter such arrangements may have had the effect of inducing Quadrant to ascribe to the partnership business an enterprise value or even to buy at all. Just as the other partners could not bind Dr Tsung to be employed and give a restraint, they are powerless to bind him to take less than his legal and equitable entitlement. Correspondingly, they are not entitled to take more from those proceeds than their share, because Dr Tsung did not follow suit. Conclusion 1. Dr Tsung is entitled to the declaration he seeks. 2. I reiterate that the parties were confident that they would reach agreement on the value to be ascribed to his share. I will stand the matter over to enable Short Minutes to be brought in during which time the parties will have the opportunity to reach agreement on the value of Dr Tsung's share. 3. I will also hear the parties on costs should this prove necessary, and on any other matters which remain to be determined to bring these proceedings to finality. 4. The exhibits are to be returned. ************ Endnotes 1. See s 39 of the Partnership Act 1892 (NSW) which provides: "On the dissolution of a partnership every partner is entitled, as against the other partners in the firm, and all persons claiming through them in respect of their interests as partners, to have the property of the partnership applied in payment of the debts and liabilities of the firm, and to have the surplus assets after such payment applied in payment of what may be due to the partners respectively after deducting what may be due from them as partners to the firm; and for that purpose any partner or the partner's representatives may, on the termination of the partnership, apply to the Court to wind up the business and affairs of the firm." 2. Partnership Act 1892 (NSW) s 1(1). 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: 11 August 2017