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High Court of New Zealand Decisions |
Last Updated: 13 April 2023
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IN THE HIGH COURT OF NEW ZEALAND
AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
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CIV-2019-404-002717
[2023] NZHC 48 |
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BETWEEN
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GRANT BRUCE REYNOLDS
First Plaintiff
JOANNE LEE YOUNG
Second Plaintiff
THE LEARNING LADDER LIMITED (IN LIQUIDATION)
Third Plaintiff
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AND
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PERI MICHAELA FINNIGAN and BORIS VAN DELDEN
First Defendants
RED 9 LIMITED
Second Defendant
THE LEARNING LADDER (2018) LIMITED
Third Defendant
PEAT JOHNSON MURRAY LIMITED
Fourth Defendant
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Hearing:
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30 November – 2 December 2021; 5-6 December 2022
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Appearances:
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K Robinson for the Plaintiffs
V Wethey and R Anderson for the First Defendants
MJ Fisher and JT Toon for the Second and Third Defendants S Pasley for the
Fourth Defendant
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Judgment:
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1 February 2023
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Reissued:
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12 April 2023
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JUDGMENT OF WALKER J
[Reissued as to calculation of range of best price reasonably obtainable to reflect variable commission rates and to correct witness name at para 107 pursuant to HCR 11.10]
This judgment was delivered by me on 1 February 2023 at 12.30 pm Pursuant to Rule 11.5 High Court Rules - Registrar/Deputy Registrar
REYNOLDS v FINNIGAN [2023] NZHC 48 [1 February 2023]
[1] This case concerns a sale by the receivers of an early childhood education (ECE) centre in Auckland known as The Learning Ladder (the Centre). The first plaintiff is an insolvency practitioner. He was appointed liquidator of the third plaintiff, The Learning Ladder Limited (in liquidation) (TLL).1 TLL operated the Centre until appointment of Peri Finnigan and Boris van Delden, the first defendants, as receivers (the Receivers) on 9 March 2018. The second plaintiff, Joanne Young, is a director and shareholder of TLL.
[2] The other shareholder and director of TLL is Dayle Walker. She is also a director and shareholder of the second defendant, Red 9 Limited (Red 9). Red 9 is the secured creditor which appointed the Receivers.
[3] The third defendant, The Learning Ladder (2018) Ltd (TLL (2018)), was incorporated on 8 March 2018, the day before Receivers were appointed to TLL. Ms Walker is its sole director and shareholder.
[4] The fourth defendant, Peat Johnson Murray Limited (PJML), is a firm of accountants who at one time were the accountants for TLL. Ms Walker’s husband is a partner in the firm.2
[5] The plaintiffs allege that the Receivers sold the business to TLL (2018) at an undervalue causing loss to TLL and its shareholders. They allege that Red 9 was not entitled to serve notice of default. The legitimacy of the events that followed service of the notice is an integral part of the dispute however those substantive issues are for another day. Presently before this Court are two preliminary questions formulated by Associate Judge Bell:3
(a) What was the market value for the business of TLL at the time it was sold on 9 March 2018?
1 Mr Reynolds was appointed by the High Court on 24 July 2018.
(b) What was the best price reasonably obtainable by the Receivers in March–April 2018?
[6] The second question is directed at the cause of action against the Receivers for alleged breaches of their statutory duties under ss 18 and 19 of the Receiverships Act 1993 (the Act).4
[7] The answer to the first question informs but does not necessarily determine the second question
Overview
[8] The parties produced an agreed statement of facts. They are at odds as to the materiality of some of the background. The plaintiffs argue that the background is particularly relevant to the second question. The Receivers contend otherwise. At this point, I simply record that the factual narrative before the Court is limited.
[9] Ms Walker and Ms Young incorporated TLL on 5 May 2015. On 21 May 2015, TLL entered into an agreement to purchase and operate the Centre for a purchase price of $430,000. The sale terms included a turnover warranty of $461,249 for the period 1 April 2014 to 31 March 2015.
[10] Red 9 advanced $430,000 to TLL to fund the purchase of the Centre. The loan was secured by a general security agreement between Red 9 and TLL which granted a security interest against the Centre. The terms of the loan are not recorded in writing.
[11] Ms Walker and Ms Young both worked in the Centre and received wages. By early 2017, they began to have disputes over the management of the Centre and their relationship broke down. They explored options to resolve the dispute without success. The precise nature of their dispute is not in evidence before the Court.
[12] On 23 January 2018, Ms Walker applied for injunctive relief to restrain Ms Young from drawing a director’s salary from TLL. Ms Young opposed the application.
[13] On 8 March 2018, before the hearing of the injunction application, Red 9 served a default notice on TLL demanding repayment of all indebtedness.
[14] On 9 March 2018, Red 9 appointed Ms Finnigan and Mr van Delden, as receivers of TLL.
[15] That same day, Anthony Gilbert, a registered business broker provided to the Receivers an appraisal of the market value of the Centre of around $388,000. The Court heard evidence that Mr Gilbert was one of two specialist brokers for ECE centres in Auckland at that time.
[16] Ms Young made a conditional offer to the Receivers to purchase the Centre for
$426,800.
[17] TLL (2018) made an unconditional offer to the Receivers to purchase the Centre for $470,000. The Receivers accepted this offer.
[18] On or around 10 May 2018, the Receivers completed the receivership of TLL and resigned as receivers. TLL (2018) continues to operate the Centre.
[19] On 24 July 2018, Ms Young applied to the Court to liquidate TLL on the ground that TLL was indebted to her for at least $21,184. The High Court appointed Mr Reynolds as the liquidator of TLL.
Procedural history
[20] This preliminary question hearing was the result of an application by Red 9 and TLL (2018). The question they framed was limited to the market value of the Centre at the time of its sale. The Receivers and PJML consented to that application. The plaintiffs took issue with the narrowness of the question and proposed a second question regarding the best price reasonably obtainable by the Receivers. The
Receivers opposed the addition of the second question contending that it would require factual evidence and may determine the Receivers’ potential liability instead of clearing the way for the claims against the Receivers.
[21] The upshot was that Judge Bell directed that both questions be included. The hearing was scheduled for a two-day fixture starting on 30 November 2021 but the parties were unable to complete the hearing even after spilling over into an extra day. The hearing was then adjourned part-heard. For scheduling reasons, it only resumed on 5 December 2022.
The respective positions
[22] The plaintiffs and Red 9 and TLL (2018) led expert evidence on the market value of the Centre from Michael Nimot and Eric Lucas respectively. Both are undoubtedly experts in their field and well placed to assist the Court. They have different domain expertise. Mr Nimot is a valuer working primarily in the ECE and aged care sectors. Mr Lucas is a chartered accountant with a great depth of experience in business valuation but no specialist expertise in ECE valuations. I apprehend that this explains in part why their approaches were different. Mr Lucas applied orthodox valuation principles relying on historical financial data. Mr Nimot adopted a pro forma budget projection with a different treatment of the owners’ contribution to the business.
[23] The plaintiffs argue that the market value of the Centre in March 2018 was
$760,000, exceeding the actual sale price by about $290,000, and that the best price reasonably obtainable by the Receivers was unlikely to have been significantly different.
[24] The Receivers say they took appropriate steps to obtain the best price reasonably obtainable, balancing the assessment from a specialist business broker against the cost implications of going to market. They argue that the plaintiffs’ challenge to the fairness of the sale does not bear on this question and is disputed.
[25] Red 9 and TLL (2018) rely on Mr Lucas’s valuation prepared on 12 May 2020. He concluded that the market value was in the range $450,000 to $500,000. The sale price fell within this range.
[26] Messrs Lucas and Nimot caucused before the first hearing and again shortly before its resumption. They produced two joint statements. They broadly adopted the same methodology — a capitalised earnings assessment — with two key differences.5
[27] Mr Lucas based his earnings on the Centre’s actual financial performance, normalised for non-recurring and non-arm’s length transactions. Mr Nimot says a buyer could run the operation with reduced staff costs and all savings generated would translate directly into profit. He produced his own pro forma budget, going behind the financial statements and altering expenditure where it did not correlate to what a reasonable operator would be doing at that time.
[28] The contest between the experts is the nub of this issue but draws on underlying assumptions about the operation of this Centre. To that end, the Court heard evidence from:
(a) Anthony Gilbert — a business broker specialising in the sale and purchase of ECE centres. Mr Gilbert gave advice to the Receivers at the time of sale. He was not called for the purpose of nor did he purport to give expert evidence in view of his prior involvement but is clearly qualified as an expert in the field.
(b) Michelle Pratt — director and shareholder of a number of entities in the ECE sector. Ms Pratt holds a degree in Early Childhood Studies and a Postgraduate ECE Leadership and Management qualification. She has deep operational knowledge of ECE centres and 35 years’ experience.
(c) John Schollum — director of Parsons Green Group which owns and operates nine ECE centres throughout New Zealand. Mr Schollum is also a qualified chartered accountant. He has both acquisition and
5 There was no discernible difference between their respective definitions of market value.
operational involvement in the centres. By operational involvement, he meant weekly reviews of occupancy levels, staff ratios and income.
(d) Ms Finnigan — one of the two appointed Receivers.
[29] Neither Ms Young nor Ms Walker gave evidence. Consequently, there are significant evidential gaps about the operation of the Centre prior to receivership.
Issues
[30] I distil the following interrelated issues in relation to the first question:
(a) as a preliminary evidential issue, the extent to which and for what purpose a valuer may permissibly refer to matters after the effective valuation date of 9 March 2018;
(b) whether capitalised earnings should be based on normalised actual historical financial performance only or whether a valuer can make his or her own assessment of the trading potential rather than the actual level of trading performance;
(c) whether there was a sufficient basis for Mr Nimot’s conclusion that staff/wage costs could be reduced with no adverse impact on profitability; 6
(d) whether the business’ relatively high wages and staff costs were explained by:
(i) the configuration and layout of the premises; or
(ii) a strategy to maintain a competitive point of difference from other childcare centres.
(e) whether Mr Nimot’s projected staff/wage costs are supportable; and
6 Mr Lucas does normalise, in short adjust, for non-arm’s length proprietors’ remuneration.
(f) whether the market data relied on was reliable and verifiable and whether appropriate multipliers were applied to assess value.
[31] As to the second question before the Court, if Mr Lucas is correct, it follows that the Receivers achieved the best price reasonably obtainable. If Mr Nimot’s valuation is correct, it becomes necessary to scrutinise the steps the Receivers took against the backdrop of all relevant circumstances.7
The early childhood education regulatory framework
[32] ECE providers must be licensed in accordance with the Education and Training Act 2020.8 The Education (Early Childhood Services) Regulations 2008 (the Regulations) prescribe minimum standards that each licensed service must meet relating to the curriculum, qualifications, ratios and service-size, premises and facilities. The Regulations were made under the Education Act 1989 but continue in force as if they were made under the Education and Training Act 2020.9
[33] Before an ECE centre is licensed it is inspected by the Ministry of Education (the Ministry) which assesses the physical environment and resources to confirm compliance with the minimum standards. The supervision standards are specifically examined at this time. There is a re-evaluation on average every three years at which time an Education Review Office (ERO) report is produced. When an ECE centre is sold, it is reinspected to ensure that the physical environment remains compliant.
[34] The Minister of Education is empowered under reg 41 to prescribe criteria for assessing compliance with the minimum standards (the Licensing Criteria).
[35] Regulation 43(1)(a) requires an ECE centre to plan, implement and evaluate a curriculum that is, amongst other things, consistent with the curriculum framework prescribed by the Minister. Under criterion C9 of the Licensing Criteria, the service curriculum is to provide children with a range of experiences and opportunities to
9 Education and Training Act 2020, sch 1, cl 4(1)(a).
enhance and extend their learning and development — both indoors and outdoors, individually and in groups. The guidance notes for this criterion provide a starting point illustrating how services can meet or exceed the requirement. These notes suggest that the experiences and opportunities available should enable children to make choices about their learning which could be individual or group learning and could happen indoors or outdoors. In a section headed “Practice”, examples are given of what this may look like. The examples refer to ready access to varied environments. In a section headed “Things to Consider”, the reader is prompted to question whether the physical access and programme support children to make choices about their movements between the indoor and outdoor environments.
[36] Regulation 44 deals with qualifications, ratios and service-size. It requires every licensed service provider to whom the regulation applies to comply with the qualification requirements in Schedule 1A or 1, the adult-to-child ratios in Schedule 2 and the service-sizes in Schedule 3 of the regulations.
[37] An ECE centre must comply with the following minimum ratios:10
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Under 2 years
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Over 2 years
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No. of Children
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No. of Adults
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No. of Children
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No. of Adults
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1 – 5
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1
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1 – 6
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1
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6 – 10
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2
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7 – 20
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2
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11 – 15
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3
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21 – 30
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3
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[38] Regulation 54 enables variations to the operation of minimum standards. One such variation envisaged by the regulations is that a service provider may be directed to increase the level or kind of staffing beyond the minimum standard if the Secretary of Education considers it necessary to do so, having regard to the needs and ages of the children and the design and construction of the premises where the service operates.11
[39] Regulation 45 provides:
45 Premises and facilities standard: general
10 Schedule 2 of Education (Early Childhood Services) Regulations 2008.
(a) to use premises and facilities that, having regard to the number and age range of the children attending the premises, provide sufficient and suitable space for a range of activities, facilities for food preparation, eating, sleeping, storage, toileting, and washing, and sufficient and suitable heating, lighting, noise control, ventilation, and equipment to support—
(i) appropriate curriculum implementation by the service provider; and
(ii) safe and healthy practices by the service provider; and
(b) to comply with the requirements of Schedule 4 (which relates to activity spaces).
[40] The Licensing Criteria for premises and facilities provides that the design and layout of the premises is to support effective adult supervision so that children’s access to the licensed space (indoor and outdoor) is not unnecessarily limited.12 The rationale or intent of this criterion is to ensure that the children’s use of the environment is not unduly restricted by design limitations that make adequate supervision difficult. The criterion specifically states that this does not necessarily mean all parts of the service must be visible to all adults at all times. It goes on to say:
However, potential ‘blind spots’ caused by the placement of the building on the land, the shape of the section, or the interior layout do need to be identified and added to a centre’s hazard check sheet along with the mitigation strategy to ensure all staff and educators are aware of any issues.
Adults should be able to scan the environment while working alongside children, instead of needing to be constantly on patrol.
[41] No hazard check sheet was referred to in evidence.
[42] An ERO report dated 11 October 2013 (2013 ERO Report) of the Centre, then known as Adventure Discoveries Early Learning Centre, recorded that 33 children were enrolled. There were no special conditions attaching to the licence. The reported ratios of staff to children recorded were 1:4 for the under two year old cohort and 1:8
12 PF2 of the Licensing Criteria.
for the over two year old cohort. The next ERO report was dated 19 February 2016 (2016 ERO Report) based on a site review in November 2015. This reported ratios of 1:4 for the under two year old cohort and 1:7 for the over two year old cohort.
[43] The Ministry provides funding to ECE centres based on the percentage of the hours worked by staff required to meet the minimum ratio requirements that is worked by all certificated teachers. This relationship between funding and qualified teacher hours is an important metric in the operation of an ECE centre. Most ECE centres operate within the 80 percent plus band as it is may be uneconomic to staff an ECE centre with only qualified staff. Dropping down to the next highest band results in a significant reduction of funding income.
[44] In March 2018, the Centre employed six qualified teachers and sat within the 80 percent plus band. This compares to five qualified teachers in 2015 when the average roll was less.
Preliminary issue — relevance of post-date events
[45] In their original valuation reports, neither expert took into account any post valuation date events or information with the exception of some 2018 sales. However, in his brief of evidence, Mr Nimot referred to:
(a) an ERO report dated 18 August 2019 (2019 ERO Report) in which TLL (2018) reported staff/child ratios of 1:4 for the under two cohort and 1:8 for the over two cohort;13
(b) sales of ECE centres after March 2018 and in 2019; and
(c) Bizstats sales data between June 2018 and July 2019.
[46] Mr Lucas referred in his brief to the TLL (2018) financial statements for the year ended March 2019 as confirmation of his approach to staff/wage costs. In short, as to the validity of this input.
[47] The circumstances in which post-valuation events may be relied on is a live issue in this application. Red 9 and TLL (2018) argue that they may only be relied on where the event is not too remote and solely to confirm the validity of input assumptions used so as to avoid objectionable hindsight. They say that the 2019 ERO report is too remote from the valuation date and that it is not permissible to rely on sales more than 12 months after the valuation date. Therefore, the material is inadmissible or alternatively no weight should be placed on it.
[48] Specifically, Mr Fisher objected to the admissibility of:14
(a) a spreadsheet prepared by Infocare dated May 2018 with sales data;
(b) the 2019 ERO Report (and associated documents);
(c) audited financial statements prepared by Tim England & Co dated 31 March 2020; and
(d) Bizstats sales data in 2019.
[49] Mr Robinson accepts that it may be arguable that documents prepared after the valuation date cannot be used by the valuer to form his or her opinion. But he distinguishes between use to form an opinion and use which confirms the reliability of one of the inputs the valuer relied on to form his or her opinion. He cites by way of illustration the 2020 TLL (2018) audited reports which appear to show a decrease in staffing costs (presaged by Mr Nimot) but an increase in ‘licencing fee’.
[50] Mr Fisher referred to two judgments in the Worldwide NZ LLC v QPAM Ltd proceedings.15 The dispute there arose after receivership of the plaintiff. It spawned a number of judgments. One of the primary issues was the fair market value of shares and units in QPAM Ltd (QPAM), the corporate trustee of a trust which developed
14 Further documents objected to were ultimately not referred to by any witness, nor in opening and need not be discussed.
15 Worldwide NZ LLC v QPAM Ltd HC Auckland CIV-2006-404-1827,); 15 May 2009 (Judgment of Keane J); and Worldwide NZ LLC v QPAM Ltd HC Auckland CIV-2006-404-1827, 24 November 2011 (Judgment of Potter J).
Vector Arena. This was because the receivership triggered the plaintiff’s obligation to sell its shares to named parties who elected to exercise pre-emptive purchase rights.
[51] The interlocutory judgment referred to by Mr Fisher was that of Keane J where one of the issues was the proper scope of discovery. In particular, whether the discovery obligation extended to documents describing matters after the valuation date. This procedural context is material. What may be relevant for discovery is wider than what may later prove to be admissible.16
[52] Another material contextual aspect of Worldwide was that the value of the shares depended on QPAM’s ability to generate cashflow in the future but QPAM had not yet traded.17
[53] Justice Keane referred to a line of High Court authorities including Wood v Wood.18 That was also a case about the valuation of shares in which Hardie Boys J stated:19
In this case, whatever valuation date were chosen, the application of hindsight would mean no more than treating assets at their true worth, as established by subsequent events. ... [The] law is clear that a valuer is required to take into account events that have occurred since the date at which the value is to be assessed; in order to determine the proper weight to attach to the circumstances pertaining at the material date.
[54] Justice Keane determined that the duty to make discovery must extend a sufficient time beyond the valuation date to capture any events that might assist to define the horizon as it was at the date of valuation.20 He added that in the nature of things there cannot be an absolute cut-off date for discovery but said:21
The only practical cut-off date limiting QPAM’s duty of discovery seems to me to be one encompassing these hindsight events to which QPAM’s own valuer referred; and that suggests the end of April 2007, a year after the valuation date.
16 ANZ National Bank Ltd v Commissioner of Inland Revenue [2009] NZCA 150, [2009] 3 NZLR 123 at [4]–[6].
17 This part of the judgment was in essence a review of an earlier decision by Associate Judge Doogue: Worldwide NZ LLC v QPAM Ltd HC Auckland CIV-2006-404-1827, 29 August 2008 (Judgment of Doogue J).
18 Wood v Wood (1985) 1 FRNZ 576 (HC).
20 Judgment of Keane J, above n 15 at [66].
[55] I do not regard Keane J’s judgment as supportive of a general proposition that evidence more than 12 months after the valuation date is too remote to be relied on for the purpose of cross checking the reliability of inputs. The period of relevance must be fact and context dependent.
[56] The second Worldwide judgment referred to by Mr Fisher was Potter J’s judgment following the three-week substantive hearing.22 The Judge referred to an earlier consideration of Associate Judge Doogue on the question of the extent to which information which has become available only after the valuation date may be used in the valuation exercise. She stated:23
When it comes to establishing the theoretical value of property such as company shares at a certain date in the past, an attempt must be made to ascertain the value based on information and expectations that would have applied at the time. The Court must be careful to avoid substituting with hindsight what has subsequently become known. The value of hindsight is simply to use the knowledge of subsequent events to confirm the true worth of the property at the specific date.
[57] The Judge noted that at valuation date, Vector Arena had not been completed and there was no performance history or any certainty about its future earning capacity. Thus, there could be an appropriate basis for looking at subsequent events once the venture had taken shape to assist in assessing the fair market value at an earlier date. She also stated:24
However, a subsequent event that was clearly outside the contemplation of the parties could not reasonably be taken into account in determining fair market value at valuation date.
[58] The Court of Appeal overturned the High Court judgment on other grounds. It explicitly declined to deal with the hindsight evidence point.25
22 Above n 15.
24 At [52]. See also McCathie v Federal Commissioner of Taxation [1944] HCA 9; (1944) 69 CLR 1. In that case, the Court accepted that evidence of events following the date of valuation was relevant. The company which was the subject of the valuation had spent substantial amounts of funds on renovations one year. This temporarily adversely affected its profitability. Evidence of events following the valuation date filled out the picture of the longer term trends and therefore avoided the possibility that the one-off event may have been anomalous and exceptional, and later set off by improved income as a result of the upgraded premises.
25 New Zealand Venue and Event Management Ltd v Worldwide NZ LLC [2013] NZCA 130 at [63].
[59] Propell National Valuers (WA) Pty Ltd v Australian Executor Trustees Limited was an appeal relating to an allegedly negligent valuation of property.26 One of the appeal points was whether it was permissible for an expert to have regard to subsequent sales in expressing an opinion as to the value of the property at the relevant date. The trial judge held it was not because the Court’s task was to assess whether on the sales evidence available as at the date of valuation, a competent valuer could have ascribed the value he or she did using the comparable sales methodology.
[60] The appellate Court distinguished between cases where the relevant issue for determination was the actual value of the land at the particular date, allowing the benefit of hindsight, rather than the competency of a valuation ascribing a value to that land. In the former context, subsequent sales were relevant. In the latter, they cannot be.27 As part of the Court’s survey of authority, Collier J referred to Housing Commission of New South Wales v Falconer where Mahoney J observed:28
[W]here the compensation which is to be given is measured by the ordinary market price of the property taken, the principle on which that market price is to be determined prevents (or at least restricts) reference to subsequent events. That market price is the price acceptable to a willing but not anxious vendor and purchaser on the relevant date. Such persons are to be taken to know what an appropriately informed person would know on that date. That being the principle, it follows that such persons (and the court, as determining what they would have done) cannot be seen as knowing more. The price which such persons would accept at that date will be affected by the uncertainties as at that date, as to, for example, the future demand for land at the relevant time, future decisions of zoning authorities, and the like. ... In that regard, therefore, evidence of what subsequently has occurred in relation to such matters may not ordinarily be referred to. This does not operate so as necessarily to exclude evidence of subsequent sales [citations omitted]. Such sales are evidence, not of the subsequent outcome of matters which, at the relevant date, were inherently uncertain, but of the price a relevant vendor and purchaser found acceptable at that date for comparable land. The assumption of the law is that from that evidence it is possible to infer what the relevant vendor and purchaser would have found acceptable for the subject land.
[61] It seems to me that the principles to be taken from this and other cases in respect of an assessment of actual market value (as opposed to competency of a valuation) are:
26 Propell National Valuers (WA) Pty Ltd v Australian Executor Trustees Limited [2012] FCAFC 31.
28 Housing Commission (NSW) v Falconer [1981] 1 NSWLR 547 at 576–577 (emphasis added).
(a) The approach to post event evidence is more nuanced than a general temporal rule;
(b) In a sales comparison analysis, evidence of sale price after the critical date may be admissible but its weight depends on how remote in time and whether there were supervening changes in market conditions;
(c) The more remote in time, the higher the likelihood of a supervening change in market condition;
(d) If events after the critical date do throw real light on the issues, then the evidence tends to be relevant and admissible.29
[62] Applying these principles, I consider that the four documents in [48] above are admissible for the purposes the plaintiffs rely on them, but I accord little weight to the 2020 audited accounts because of the combination of remoteness in time and lack of evidential context.
Expert valuation evidence
[63] The capitalisation of earnings approach estimates the value of a business by calculating the present value of anticipated benefits.30 It involves applying a suitable multiple to the normalised level of earnings of a business by:
(a) First, selecting the appropriate earnings measure or level for the business.
29 In his Worldwide judgment, above n 17, at [33], Associate Judge Doogue said “In general, the subsequent performance of a company cannot be relevant [to value of shares] because that is not a matter that would be known to prospective purchasers as at the date of the valuation. However, if an inference can be drawn from an occurrence, particularly one soon after the date of valuation, which throws light on the understanding or expectations of the theoretical purchasers before the valuation date, then it may be admissible.”
30 Australia and New Zealand Valuation and Property Standards (Australia Property Institute, 2009) at ch 6.6- International Valuation Guidance Note 6, [5.14.2.1]. These Standards were included in the second and third defendant’s bundle of authorities without objection.
(b) Second, normalising the business’s earnings to exclude abnormal, non- arm’s length and non-recurring items of revenue or expense to determine a representative income level.
(c) Third, determining an earnings multiple based on comparable sales in the market and relying on the valuer’s experience and understanding of the key issues affecting the subject business. This is a matter of judgement based on the best evidence available from comparative businesses and the valuer’s prior experience.
(d) Fourth, multiplying the business’s normalised earnings by the earnings multiple to derive the value.
[64] The appropriate earnings measure is a choice between:
(a) Earnings before proprietor’s income, interest, depreciation and tax (EBPIDT);
(b) Earnings before interest, tax, depreciation and amortisation (EBITDA);
(c) Earnings before interest and tax (EBIT).
[65] Logically, an EBPIDT figure is higher than an EBIT figure and an EBITDA figure sits between the two. Consequently, an EBIT multiple will be the highest multiple employed and the EBPIDT multiple is the lowest. It follows that applying a market-derived EBIT multiple to an EBITDA or EBPIDT figure is likely to distort the end result. This principle becomes important in view of Mr Nimot’s purported use of an EBIT assessment.
[66] Mr Nimot’s evidence is that he relied on an EBIT earnings measure of
$154,000 reached by substituting the historical wages and staff costs with his own forecast wages and staff costs of $446,000. He then applied a market-based EBIT multiplier derived from proprietary sales data and cross-checked the outcome against a market based per child rate. The EBIT multiple of 5.19 was actually expressed as amarket yield of 19.27 per cent31 and led to an assessment of value of $800,000 (rounded down). After cross-checking by adopting different valuation approaches (which did not feature much in the evidence at trial), Mr Nimot reached a range between $720,000 and $800,000 from which he adopted $760,000 as his desk-top valuation. This adopted figure equates to an equivalent yield of 20.28 per cent or an EBIT multiple of 4.93.
[67] Mr Lucas based his assessment on a normalised EBPIDT earnings measure. He relied on the historically incurred wage costs and normalised directors’ remuneration to exclude around $100,000 paid to the directors. He used a market- based EBPIDT capitalisation rate which he sourced from data provided by Bizstats, a publicly available database of nationwide sales in the sector, filtered according to revenue. The end result was a range of values for the business between $450,000 and
$600,000.
[68] Given the breadth of this range, Mr Lucas cross-checked the valuation range by inferring an implied range of EBIT multiples and also against a market-based per child rate. He considered that the inferred EBIT multiple range between 5.3 and 7.1 did not match his experience of small businesses with limited growth and profitability prospects and the more appropriate EBIT multiple was between 5.3 and 5.9, consistent with Mr Nimot’s multiple. This refined his valuation range to $450,000 to $500,000.
[69] The table below summarises the key differences between the experts.
|
|
Mr Lucas
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Mr Nimot
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||
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All dollar figures in $000
|
|
|
|
|
|
EBIT
|
|
85
|
|
154
|
|
EBPIDT
|
|
150
|
|
174
|
|
Staff Costs (expenses)
|
|
528
|
|
446
|
|
|
Low
|
High
|
Low
|
High
|
|
Value Range
|
450
|
500
|
720
|
800
|
|
EBIT Multiple (times)
|
5.3
|
5.9
|
4.7
|
5.2
|
|
EBPIDT Multiple (times)
|
3.0
|
3.3
|
4.1
|
4.6
|
|
Value per Licensed Child
|
11.25
|
12.5
|
18
|
20
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[70] Red 9 and TLL (2018) argue that Mr Nimot’s valuation is unreliable because he:
(a) did not undertake the investigation and inquiry needed for him to be reasonably convinced that his forecast wages and staff costs would have no impact on profitability;
(b) adopted an EBIT assessment which is not optimal because comparative EBIT data does not include information about the level of proprietor’s income taken;
(c) relied on comparative data and information which:
(i) was not properly verifiable;
(ii) did not properly distinguish proprietor’s income;
(iii) included incomparably sized childcare sales with materially different revenues;
(iv) included irrelevant sales, being transactions that occurred after the effective date for impermissible purposes.
(d) ignored the reality that a purchaser would not willingly pay the vendor for all the potential in the business.
[71] Conversely, the plaintiffs contend that Mr Lucas’s wholesale reliance on the historical accounts was flawed, as was reliance on Bizstats sales data since it captured only a small subset of Auckland sales, and sales outside Auckland were of limited relevance.32
Whether capitalised earnings should be based on normalised historical actual financial performance only
[72] The parties referred to a number of valuation principles. The International Valuation Standards (IVS) 200 state that historical financial statements of a business entity are a guide to estimate future income or cash flow and that adjustments may be appropriate to reflect differences between actual [historical] cash flows and those that would be experienced by a buyer.33 IVS 200 states:34
To the extent the future performance of the business is expected to deviate significantly from historical experience, a valuer must understand why historical performance is not representative of future expectations of the business.
[73] The Australia and New Zealand Valuation and Property Standards Guidance Note 6 states at paragraph 5.13.2.3.1, among other things:
The Valuer should be wary of adjusting for items such as non-essential personnel in arriving at a maintainable profits figure. Unless the Valuer knows the acquirer ... actually has the controlling power to make the change and intends [on] getting rid of non-essential personnel, there is a danger of overvaluing the business if the expenses are added back to profit.
[74] And at paragraph 5.13.5:
Adjustments made [to the historical financial record] should be fully described and supported. The Valuer should be very careful in making adjustments to the historical record. Such adjustments should be discussed fully with the client. The Valuer should make adjustments only after sufficient access to the business to support their validity.
[75] Mr Lucas’s reliance on the historical financial reporting was due to his experience-based wariness about projections by valuers who invariably know less about the business than management. This perspective has heft because Mr Lucas is a seasoned expert witness whose evidence has been accepted in leading cases on business valuation.
[76] Mr Lucas had noted at the outset that staff costs showed an upward trend from 2017 and were relatively high as a percentage of revenue. He however accepted
Ms Walker’s explanation that the higher levels were a function of the configuration and layout of the Centre and maintained a competitive point of difference. He considered that Mr Nimot’s assumptions were unrealistic given the 2018 financial statements showed that staff costs were running at $488,471 (excluding any allowance for the arm’s length value of owners’ input). He disputed the weight Mr Nimot gave to direct comparisons of per licensed child data when the relative underlying profitability of a comparator business was not known. He noted that the 2019 financial statements were consistent with his inputs as the staff/wage cost recorded was around$493,000 plus temporary staff costs of around $42,000 compared to his staff cost/wages of $528,000.
[77] Mr Nimot’s expertise is niche. Only two or three valuers including Mr Nimot carry out valuations of childcare centres in Auckland. One of the other two such valuers, Mr Gilbert, was implicitly critical of accountant’s treatment of the input of a working owner. He considered that their ‘orthodox’ treatment leads either to overstatement or suppression of profit. Tellingly, Mr Gilbert allowed for a nominal owner remuneration of $15,000 included within wages in his valuation assessment. Overall, although the outcome was different, Mr Gilbert’s stated usual valuation approach supports some review and recalibration of staff costs and owner input into those costs to present a true picture of an ECE business.
[78] There are four factors which led me to conclude that a pro forma adjustment is justified in this instance. First, staff costs are the most critical element of financial performance of an ECE business. Ms Pratt described the staff to child ratio as a key metric to review or assess. It stands to reason then that any valuation exercise must pay particular attention to this expense item. It is common ground here that the ratio of staff costs to revenue was high.35
[79] Secondly, a comparison of financial performance between the 2017 and 2018 years shows a marked uplift in wage/salary costs in the 2018 financial year with a relatively high temporary staff cost in 2018. In the absence of alternative explanation, this suggests something amiss in the running of the Centre.
[80] Thirdly and relatedly, it is common ground that the owners were at odds about management of the Centre from early 2017. There were clear signs that this dispute affected the Centre’s operation, and most likely staff morale and effectiveness. These factors signalled the potential unreliability of the 2018 financial accounts in terms of future financial performance and any assumption of competent management.
[81] Fourthly, the acquisition price in 2015 in a private sale was $430,000 at a time when there were just over 28 children enrolled. It can reasonably be assumed that Ms Young and Ms Walker saw latent potential in the business.
[82] These factors collectively supported closer scrutiny of the operational expenses and justify Mr Nimot’s use of a pro forma budget. They do not however address the related question of whether there is sufficient support for the figure which Mr Nimot ultimately adopted.
Is there a sufficient basis demonstrating that staff costs can be reduced with no adverse impact on profitability?
[83] Mr Nimot’s report did not contain any analysis or workings behind his adoption of the figure of $446,000.36 To that extent, it was deficient in terms of an expert’s obligation to set out his or her reasoning for any opinion expressed. Implicitly, the adopted figure was based on industry benchmark ratios of wages to revenue, albeit with an eye to the regulatory framework.
[84] During caucusing, Mr Nimot articulated how he came to this figure.37 At a general level he considered first the Regulations, the ERO reports, actual accounts, the staff numbers and rates (gleaned from Ms Young) and then compared those to a prudent operation of similar size. He allowed for seven qualified staff at rates between
$22.00 and $32.00 per hour, one unqualified staff member, plus 10 hours per week for cleaning and food preparation. He also included 18 hours per week for owner input at$20.00 per hour. He included employer KiwiSaver contribution as part of the wage
cost rather than as a separate item. His assessment was based on an occupancy rate of82.5 per cent equating to 34 children rather than the licensed number of 40 children.
[85] Mr Nimot’s approach reduced existing staff numbers as recorded by Mr Gilbert (which had not been available to Mr Nimot when he prepared his report) but increased the number of qualified staff. A supervision plan setting out how this may operate in practice may have lent cogent support for this staff cost assessment. No such plan was provided. It is reasonable to assume that the conflict between owners and inability to observe the Centre in operation would have made preparation difficult.
[86] I heard evidence of industry norms from a number of witnesses. Ms Pratt’s evidence was that industry norms very clearly point to typical ratios of 1:4 for the under two cohort and 1:8 to 1:10 for the over two cohort.38
[87] Ms Pratt is clearly qualified as an expert in the sector. She gave evidence about the factors to consider in assessing an ECE centre along with the management and operational issues at play in this instance. Her particular advantage was her “on the floor” experience in the day-to-day operation of childcare centres along with her regulatory experience. However, she had not visited this Centre, seen it in operation nor had the opportunity to speak with management. Her evidence slipped into advocacy for the plaintiffs at times but primarily on more peripheral issues. I do not consider there was any bias undermining her evidence on the central issue.
[88] Ms Pratt agreed that most ECE centres have staff costs sitting between 50 and 56 per cent of turnover. In her opinion, if the Ministry considered there to be supervision issues in an ECE centre because of its layout or design, then it would note these on the licence. She indicated that such a notation was neither common nor uncommon but was only able to refer to one particular instance related to fire egress rather than supervision considerations.
38 Ms Pratt referred in evidence to a tripartite classification of babies, infants and toddlers rather than the Ministry of Education classification. She pointed out that there is a mismatch between the approach in the curriculum standard and the premises standard and that, in practice, operators looked at the needs of the three groups rather than two groups.
[89] Ms Pratt was adamant that there were factors other than staff ratios which determined quality and business success in an ECE centre such as teacher engagement and experience, understanding of the sector and resourcing. She was confident in her ability to reduce the staff cost for this Centre yet did not identify precisely how and by what means. Materially, she did not accept the essence of Mr Schollum’s analysis of the physical “blind spots” in the Centre.
[90] Mr Gilbert acknowledged in cross-examination that staffing levels could be lowered in theory but not without careful consideration of commercial and regulatory consequences. He pointed out that this ECE Centre was short on qualified staff but overstaffed with unqualified personnel. He accepted that the addition of another qualified staff member could be offset by reduction of unqualified staff without compromising funding from the Ministry. Notably, this is what Mr Nimot’s pro forma budget appeared to achieve.
[91] Mr Robinson’s cross-examination of Mr Gilbert highlighted the impact of relatively small changes in his assessed profit level by reducing staff costs.39 He acknowledged:
(a) Removing one full time non-qualified staff member increases his appraised value to $613,000;
(b) Removing a second non-qualified staff member increases his appraised value to $785,000.
[92] Mr Gilbert stood by his initial appraisal and considered that staffing reductions would have to be carefully assessed within Ministry funding constraints. The exception is the adjustment to the rental which he conceded he had erroneously recorded and which lifted his valuation assessment from $388,000 to around $442,000.
39 Mr Gilbert did not purport to give expert evidence given his actual involvement in the sales process but clearly qualified as an expert. In my assessment, opinions he expressed in response to questions from the Court were admissible evidence albeit he did not (and was not required to) refer to schedule 4 of the HCR. I consider that the tenor of his evidence was consistent with the intent of the Expert Code of Conduct. He conceded errors in his assessment where appropriate and did not take on the role of an advocate for the Receivers when answering the Court’s questions.
Configuration of premises and supervision
[93] Logically, benchmarking data only informs projected staff costs if the layout and configuration of the premises in the context of the regulatory requirements did not render comparators irrelevant. In this instance, the premises are an old, adapted warehouse. The floor areas are separated by walls or partitions which create some “blind spots”. I heard expert evidence on the physical constraints of these premises from Mr Schollum.
[94] Mr Schollum conducted an after-hours inspection.40 He commented on the physical features which he considered detracted from the amenity, including supervision issues. He considered that any adjustment of TLL’s financial performance overlooks the physical reality of the configuration of the premises and compliance requirements. His scenario analysis, based on a schematic of the premises, highlighted areas constituting supervision blind spots. This posited three scenarios — one with six adults supervising, one with 8 adults supervising and the third with 10 adults supervising. He considered that the first scenario (albeit meeting minimum requirements) contravened the regulatory requirements by unnecessarily restricting access to all licensed areas.41
[95] Mr Schollum’s view was that TLL needed 133 to 167 per cent more staffing resources than the minimum theoretical requirements in the regulations, premised on
[96] The difference between Ms Pratt and Mr Schollum boiled down to a difference in interpretation of reg 45 and PF2 of the Licensing Criteria. Ms Pratt’s opinion was that all spaces did not necessarily have to be used at all times the service is operational provided there is “2.5 square metres plus 10 percent available per child”.42 She says that children do not have unfettered access to roam all over an ECE centre at will.
40 There was no suggestion that the layout and configuration was materially different at that time.
42 This is a reference to schedule 4 of the Regulations which sets out the activity space required. The indoor activity space according to schedule 4 is 2.5 square metres per child and 5 square metres per child for outdoor activity spaces. There is no reference in schedule 4 to an additional 10 per cent and it is unclear what Ms Pratt was referring to.
Mr Schollum held a contrary view that TLL had to ensure that children could access all licensed areas of the premises at all times. That would mean an adult available to be in each of those licensed areas should they be occupied by a child.
[97] I conclude that the regulatory framework did not in fact require or explain the level of staffing seen at the Centre in 2018. There are three reasons.
[98] First, the wording of the regulation supports the more flexible approach adopted by Ms Pratt as does the wording of the premises and facilities criterion PF2:
The design and layout of the premises support effective adult supervision so that children’s access to the licensed space (indoor and outdoor) is not unnecessarily limited.
Rationale/Intent:
To ensure the children’s use of the environment is not unduly restricted by design limitations that make adequate supervision difficult.
(emphasis added)
[99] This accords with common sense and Ms Pratt’s practical operational teaching experience holds sway. Her views are also consistent with Mr Gilbert’s observations. Although not a childcare operator or a teacher, his involvement in ECE centre sales gave him insights into operational matters. He observed that good, efficient ECE centres have structure and manage children in terms of where they are allowed at certain times, providing easier and better oversight.
[100] Secondly, I agree that the Ministry’s initial licensing process and regular inspection covered matters of supervision, health and safety and access. No ERO report indicated any supervision, access issues or physical constraints. Merely because the Centre self-reported staff to children ratios much higher than the regulatory minimum would not obviate the Ministry’s attention to those details. If there was something about the physical configuration of this Centre that required specific staffing or supervision requirements, I expect it would have been recorded.
[101] Thirdly, according to the self-reported assessment by TLL (2018) the staff ratios have in fact been reduced from 1:7 to 1:8 for the older cohort of children.43 This may tell against any proposition that the configuration of the Centre required the high level of staff seen in 2018 for regulatory or commercial reasons. I observe too that the 2020 audited financial accounts also suggest that lower staff costs (presumably reduction in staff) has not negatively impacted Ministry funding or revenue which increased in the 2020 financial year. Ultimately however, I place very little weight on this evidence.44
[102] The second reason advanced for the higher than typical staffing level was that it provided a point of difference for marketing purposes. Neither Ms Young nor Ms Walker gave evidence so this proposition could not be tested. There was also no documentary evidence of any marketing collateral supporting the proposition. I put it to one side.
[103] In my view, a prerequisite to supporting the 2018 staff levels is an assumption that TLL was a profit maximiser and would have reduced staff ratios if it was able to do so. As discussed above, while rational in the abstract, this assumption is displaced by the conflict between the owners which offers an alternative explanation for inefficiency of operation.
[104] I conclude therefore that the relatively high staff costs were not a factor of nor cogently explained by the regulatory environment, the configuration of the premises or any marketing or business imperative. I am also satisfied that Mr Nimot’s approach of ‘normalising’ staff costs was justified and appropriate and that industry benchmarks potentially inform the assessment. Mr Nimot originally relied on such benchmarks to support his staff/wage cost but once his workings were made available these became less material.45
43 The self-reporting which takes place in advance of a Ministry review is prospective. A reduction in staff to child ratios can be a product of changes in staff numbers or increased numbers of children attending.
44 It was included in the casebook over Mr Fisher’s objections and without context. While admissible as an exception to documentary hearsay, it has relatively little weight given the absence of explanation.
45 The bands relied on by Mr Nimot for staff costs/wages were generally agreed by Ms Pratt. I accept that they reflected industry benchmarks but consider their utility is more limited unless the specific characteristics of the ECE centres is known.
[105] Based on comparisons with other ECE centres, Mr Nimot considered industry benchmarks for wage costs as a proportion of income to sit between 45 to 64 per cent. Mr Nimot discarded the outlier at 64 percent due to a lower than expected income (thus higher wage cost to revenue ratio). This narrowed the appropriate range to 45 to
57 per cent although Mr Nimot considered 45 per cent to also be unusual for unexplained reasons. He noted that previous wage and salary cost ratios of this Centre sat between 60.6 to 77.01 per cent.46 Ms Pratt generally agreed that wage cost ratios ought to sit in the 50 to 56 percent range with this Centre at the higher end of this range as it was not purpose built. She considered that any centre operating with staff costs above 60 per cent of revenue had managerial issues.
[106] Mr Nimot’s pro forma wage cost sits within that range at 55 per cent of revenue. Mr Lucas’s wage cost (including KiwiSaver contributions) sits between 60 to 65.3 per cent depending on how proprietor’s income is allocated to wages.
[107] In view of the concurrence of Ms Pratt and Mr Nimot as to industry benchmarks, along with the explanation of supervision ratios and how the reduction is broadly achieved, I am satisfied that Mr Nimot’s wage figure of $446,000 is sufficiently supported, albeit at the low end. It translates to staff ratios which exceed the regulatory minimum.
[108] I therefore accept the plaintiffs’ approach to and use of a pro forma budget rather than reliance solely on the past financial performance.
Market data and EBIT and EBPIDT multiples
[109] The next step in the valuation exercise is to capitalise the earnings. Mr Nimot’s report focused on what he described as an EBIT assessment and multiple. Conversely, Mr Lucas’s primary focus was on an EBPIDT figure and multiple, cross checked against an implied EBIT multiple.
[110] As discussed, the appropriate multiple depends on whether profit is capitalised at an EBPIDT, EBITDA or EBIT level. I accept Mr Lucas’s evidence that the earnings
of small, typically owner-operated businesses are so affected by differential levels of drawings that capitalisation at the EBPIDT level is more appropriate. It allows for better and more reliable use of comparative data. The Bizstats market data eliminates all proprietor income, thus removing any subjective element.
[111] Here, the experts had a different approach. Mr Nimot included wages paid to the owners for their actual input as part of the wage cost and did not deduct anything further aside from depreciation to arrive at his stated EBIT. Mr Lucas considered this was unprincipled. He instead accounted for the entire value of owner input (at a normalised level) at the EBITDA and EBIT levels.47
[112] I apprehend that this disagreement about orthodoxy may not much matter in the long run provided there is consistent treatment and use of any multiple. On this aspect, I find Mr Nimot’s approach problematic. By substituting the $140,000 proprietor’s income with $18,000 of wages paid for the owner’s input, Mr Nimot’s EBIT figure is $122,000 short without explanation. The way in which Mr Nimot explained his treatment of actual owner input must conceptually mean that his EBIT figure is not in reality an EBIT figure because there is no accounting for any element of profit paid to the proprietors, even at a normalised level. Without any ‘proprietor’ income, the EBIT is likely to be overstated. By way of illustration, merely by taking the delta between Mr Lucas’s normalised proprietor income and Mr Nimot’s wages for owner input and treating this as proprietor income to reach an EBIT shaves $22,000 from Mr Nimot’s EBIT figure. Then, applying Mr Nimot’s own EBIT multiple range of 4.7 to 5.2, the value assessed by Mr Nimot’s methodology falls within a range between $620,000 to $686,000.
[113] More materially, I accept Mr Lucas’s opinion that the best approach is one primarily based on an EBPIDT assessment and multiple to allow for more accurate comparisons.
[114] Both experts referred to market data to derive their respective multiples but from different sources. Mr Nimot did not discuss appropriate EBPIDT multiples in
his valuation report. He self-selected what he considered to be the most comparable sales from confidential proprietary information. Mr Lucas filtered publicly available Bizstats data to find sales of ECE centres with similar revenues and then assessed where the subject Centre may sit in the band. In theory, this is a subtly different approach. In practice, it assumed more importance, chiefly because Mr Nimot’s rationale for the self-selection of the most comparable sale was short on detail in his report given the confidential nature of the information.
[115] Mr Nimot’s reliance on his own intellectual property, while understandable, throws up problems. The Court and opposing experts are entitled to test the basis for conclusions and therefore the “market data” used. Merely listing sales said to be comparable is not helpful if the comparison cannot be adequately tested. There needs to be a full explanation of the selected sales and why and what adjustments must be made in any comparison.48 This was partly remedied when Mr Nimot provided further information about the sale of certain ECE centres to Mr Lucas following the expert caucus.
[116] The Bizstats data relied on by Mr Lucas was also imperfect. It suffered from the same lack of transparency. He acknowledged its limitations but opined that a valuer’s task is to “make the best of what is there.” He was not aware at the time of preparing his valuation that two brokers who together made up around 80 percent of Auckland sales did not hand their sales statistics over to Bizstats.49 When put to Mr Lucas, he considered that the fact it was incomplete did not invalidate the data. That may be so. But the combination of the small sample of Auckland sales, and absence of key information about the business sold (number of licensed children, precise location and whether purpose built) dilutes the data’s overall value. Moreover, 9 of the 11 Bizstats sales relied on by Mr Lucas significantly predated the date of sale.50 Mr Lucas suggested that multiples for small business sales did not generally tend to fluctuate over time as much as other markets. I am not persuaded that this is so in the ECE sector. There was some evidence from Mr Nimot of large corporate
49 The Bizstats data did not even include the sale of the business to TLL in 2015.
50 Two sales were in 2013, two in 2014, two in 2015 and three in 2016.
market participants acquiring ECE centres to augment their offering. Whether and how this might affect multiples was not explored in the evidence.
[117] What then is the appropriate EBPIDT multiple given the clear limitations in both sets of market information? The multiple range between the experts varies from
3.0 (Mr Lucas’s low end) to 4.6 (Mr Nimot’s high end). Ultimately, selection of a multiple is a matter of judgment, expertise and experience, based on the market information available while cognisant of its limitations.
[118] Mr Lucas reviewed transactional data in respect of sales of ECE centres throughout New Zealand with comparable revenues between 2013 and April 2018.51 He noted that EBPIDT multiples ranged from 2.37 to 4.39 with one outlier of 8.36, which he discarded as unrepresentative. He concluded that a suitable EBPIDT multiple range lies between three and four because there were no particular trends or distinguishing features in these transactions but ultimately adopted an EBPIDT multiple range between 3.0 and 3.3.52
[119] Mr Nimot criticised this assessment on a number of grounds. First, he considered it was not possible on the information provided to conclude that there were no distinguishing features in those transactions given the lack of transparency in the information. He pointed out that Mr Lucas’s conclusion is inconsistent with the Bizstats data (even if taken at face value) since the average multiple in his data is 3.58 and the median 3.7. It is also inconsistent with the Auckland sales on which Mr Nimot relied, which he presented in more detail as an appendix to the joint expert statement dated November 2022.53 The average multiple in that data (excluding the sale of a large purpose-built centre which is not a useful comparison) is 4.5. Mr Nimot remained critical of relying on sales outside Auckland as centres in Auckland typically operate with higher average costs and higher private fees.54 Certainly his Auckland sales data in more recent years generally showed higher multiples than the Bizstats
51 Mr Lucas subsequently considered his inclusion of the April 2018 sale to be in error.
52 Mr Nimot has taken 3.13 as the EBPIDT multiple utilised by Mr Lucas.
53 Mr Nimot refers to five Auckland sales in 2017 and 2018. One is not comparable as it is a large purpose-built centre licensed for 150 children. The EBPIDT multiples of the other 4 range between 3.99 and 5.33. The average is 4.7.
54 Mr Gilbert had a similar view.
data for regional centres, with the exception of one anomalous sale in 2014. Finally, he criticised the use of sales transactions from as far back as 2013.55
[120] Notwithstanding Mr Nimot’s criticism of the use of Bizstats data, he also obtained a complete set of sales from Bizstats to respond to Mr Lucas. He referenced the 11 sales relied on by Mr Lucas and added 5 more sales of Auckland centres. He calculated the average multiple as 4.26 but, if limited to Auckland sales, then the average EBPIDT multiple was 4.7. His adopted valuation of $760,000 equated to an EDPIDT multiple of 4.36 compared to Mr Lucas’s multiple of 3.13 and is close to the sale of a nearby centre in Half Moon Bay in or around July 2017. This is also a purpose-adapted centre with a smaller number of licenced children (33 as opposed to 40 children) but adapted from a residential home. There was evidence that adapted homely environments appeal more to parents than industrial premises. That particular premises was in a residential suburb, with lower rental and higher parent fees. On Mr Gilbert’s analysis it was a well-run centre with more qualified staff so existing teachers could cover any staff sick leave creating efficiencies and a lower risk profile for purchasers.
[121] I pause to interpolate that Mr Gilbert in his appraisal on behalf of the Receivers on 8 March 2018 applied a multiplier of 4 to capitalised earnings. It was not initially clear whether this was intended to be an EBIT, EBITDA or EBPIDT multiple. In cross-examination Mr Gilbert acknowledged that he had not accounted for depreciation. It follows that his profit figure was at least at an EBITDA level, but arguably at an EBPIDT level given his expressed views on owner input. While there were a number of issues with Mr Gilbert’s appraisal as a consequence of the haste with which it was prepared, none of those issues necessarily undermined his selection of the appropriate multiple.56
Conclusion on market valuation as at March/April 2018.
[122] Taking all these factors together, focusing on more recent sales, Auckland sales, and purpose-adapted centres with similar numbers of licenced children, I
consider that Mr Nimot’s low-end EBPIDT multiples of 4.0 to 4.1 are the most realistic multiples. The EBPIDT value of the Centre is to be calculated by reference to Mr Nimot’s pro forma EBPIDT of $174,000.
[123] As a result, I consider the market value of the Centre in March/April 2018 is in the range of $696,000 to $714,000 compared to the sale price of $470,000.
What was the best price reasonably obtainable by the Receivers in March/April
[124] I initially expressed concerns at the hearing about determining this second question in a truncated evidential hearing. This question was only intended to be an assessment of value (in other words quantum of loss should the plaintiffs prevail) rather than a determination of the liability. In his judgment dealing with the application for a preliminary determination, Associate Judge Bell stated:57
... [The] measure of loss can be satisfactorily separated from questions of liability ... . For the receivers it will be on the basis of what price would be obtained without any breach of s 19 of the Receiverships Act. It will not however be necessary to decide if any of the defendants are in fact liable to the plaintiffs.
[125] The question is not whether the Receivers in fact achieved the best price reasonably obtainable. However, whether the Receivers took all reasonable steps is cogent evidence of the best price reasonably obtainable. I agree with Mr Robinson’s acknowledgement that this mixes aspects of liability and quantum. The demarcation line is barely visible. On the other hand, if I find that the best price reasonably obtainable was the assessed market value or at least significantly more than the price actually obtained, then the discrepancy needs to be explained by the circumstances of the sale making attainment of market value unreasonable.
[126] In the end, the Receivers urged that this question be determined in the interests of efficiency and economy and the plaintiffs disavowed seeking an express finding of liability. I therefore proceed to determine this second question.
57 Above n 3, at [16].
[127] The plaintiffs say there is no reason in principle why the best price reasonably obtainable is not effectively the market value, while also acknowledging that receiverships involve some associated costs. They challenge the adequacy of the sale process which they describe as antithetical to obtaining the best price reasonably obtainable given that Ms Walker was on each side of the transaction. They maintain that there is strong evidence of a pre-determined sale to the Walker interests, although they do not ask the Court to make a finding in that regard. Nonetheless, in those circumstances they say the Receivers should have gone to the market to establish value or (and I paraphrase) done more with less haste.
[128] The Receivers also acknowledge that the only way to assess whether they obtained the best price reasonably obtainable is to assess the circumstances surrounding the sale and that this naturally considers whether ss 18 and 19 of the Act was breached. They rely on Ms Finnigan’s evidence only and say that the purpose of Mr Gilbert’s evidence was primarily for him to substantiate his assessment of value provided to the Receivers pre-sale. That may be so, but for reasons already canvassed, Mr Gilbert’s expertise and knowledge of the market assisted the Court. Ms Finnigan set out the steps taken, described how she came to a view on value and her consideration of the risks involved in seeking a third party sale.
[129] The first preliminary question was about market price. A market price is that between a willing seller and buyer, or as described by Mr Lucas:
The price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer, and a knowledgeable, willing but not anxious seller, both acting at arm’s length.
[130] A receivership sale does not conform to this construct. I accept that the best price reasonably obtainable is therefore not necessarily the same as the market price but informs it. I accept too that, as the parties implicitly acknowledged, the best price reasonably obtainable balances the market forces against the costs of a prolonged sales process and of operating the business in receivership. The Courts must allow a margin of tolerance for business and risk assessment in the realisation of the security and in
finding a breach of s 19.58 That means too a margin of tolerance in the assessment of best price reasonably obtainable.
[131] There was very little expert evidence on this question.59 Mr Nimot explained that he had no experience in receivership sales but some experience with valuations in mortgagee sales where he has seen discounts of between 0 to 25 percent. He noted that in a buoyant market there may be limited if any discount due to high demand. He considered the market for ECE centres was reasonably buoyant in or around March 2018 based on his experience of inquiries and level of sales. He concluded that there may therefore have been little to no discount due to the fact of receivership.
[132] I do not consider that mortgagee sales are good comparators on the question of discount as a by-product of a forced sale because there are additional factors at play in a business receivership. However, Mr Nimot’s views on the state of the market are useful. They are also relatively consistent with those of Mr Gilbert.
[133] Mr Gilbert has never sold an ECE centre in receivership.60 He suggested that an automatic discount is inapplicable “because the teaching team is still there” and the “children are still there.” (This conceivably overlooks the destabilising impact of a receivership). He too considered that the market was starting to heat up in 2018. He referred to his database of a substantial number of pre-qualified buyers to whom he can send information immediately if they are interested in a business he is selling. His evidence was that some ECE centres can sell relatively quickly with modest marketing – say three to four weeks – while others may take three to four months, for instance where there are isolation factors.61
[134] Mr Lucas identified the two options for the Receivers as selling the business promptly to one of the directors or permitting the business to continue to trade and
58 See Taylor v BNZ [2010] NZHC 2256; [2011] 2 NZLR 628 (HC) at [177]; and Peter Blanchard and Michael Gedye, The Law of Private Receivers of Companies in New Zealand ,(3rd ed, Lexis Nexis, Wellingon, 2008 ) at [11.29]. Anna – a more up to date edition?
59 I mean this in the technical sense of independent expert evidence and intend no disrespect to Ms Finnigan’s clearly extensive insolvency experience.
60 Similarly, Ms Pratt had no experience of an ECE centre in receivership. This may suggest receiverships are few in this sector, with poor performers exiting or selling prior to a secured creditor’s enforcement of its security.
61 A review of the Bizstats data presented by Mr Lucas indicates an average 8-–10 week sales period but these were sales outside Auckland.
seeking a third party sale. He considered the challenge in a third party sale was preserving the value in the meantime. He opined that where the Receivers obtained offers from both directors in excess of values advised to them by third parties and where they faced significant risks and costs, the commercial judgments exercised by the Receivers were reasonable.
[135] Mr Robinson was critical of the sale to a party with a close relationship to the secured creditor. He suggested heightened scrutiny was warranted but he did not go so far as to suggest that the Receivers had the burden of proof of establishing a sale at a proper price. The observations of Judge Bell in Crown Finance Limited v Cronin are apposite although that was in the context of a summary judgment application. He stated that, while not on all fours, the law as to sales by mortgagees gives a lead in:62
Just as a sale by the receiver to the secured creditor should be subject to thorough scrutiny, so also should a sale by the receiver to a related company of the secured creditor. The same concerns as to potential conflict of interest and risk of sale at an undervalue apply. Again those seeking to uphold the sale have the burden of justifying it.
[136] This point relating to burden was not advanced and I did not hear argument on it. I therefore do not approach the question on the basis that the Receivers have any burden other than to re-emphasise that in the circumstances of a discrepancy between the actual sale price and the market price, there needs to be some explanation as to why the market price was not reasonably obtainable.
[137] In the light of the slim expert evidence, I consider that the most relevant matters at hand are:
(a) the risk factors associated with going to the market; and
(b) the steps the Receivers took to overcome the information disadvantage associated with not going to market.
[138] All things being equal, going to the market for a value assessment is the best indication of market value. However, that must be balanced against the risk of devaluing the business in a sale process. A business of this nature is particularly
62 Crown Finance v Cronin [2018] NZHC 1289 at [22]-–[23].
sensitive to instability amongst the teaching staff and parent customer base. I accept Ms Finnigan’s evidence that a full marketing programme delaying a sale would have made preservation of business value difficult. This was particularly acute because of cashflow pressures and the uncertainty surrounding use of Ministry funding and fees paid in advance. Ms Finnigan’s unchallenged evidence was that:
At the date of sale I calculated that the MOE funding needed to be topped up by $26,081.96 (I now know that this should have been $31,495.49). ...
Given the funding discrepancy, I undertook some calculations to anticipate how it would likely affect the purchase price of the business. In my view, a purchaser would factor in the undervalue in the available funding and would expect an adjustment at date of sale ... .
[139] There was also the dysfunction between the owners which was already destabilising staff relationships, although it appears that Ms Finnigan had misunderstood or been misinformed that one of the two licensees had to be on the premises during operation. In the absence of evidence from either Ms Young or Ms Walker I am not satisfied that they would have refused to co-operate to maintain the Centre’s value. This misapprehension resulted in an overestimation of actual receivership costs.
[140] There were then factors militating against a full marketing programme of 9 to 12 weeks. But this did not mean that a limited and confidential “go to market” strategy was not reasonable. There was some evidence of an expression of interest from an owner of a competing ECE centre when Ms Finnigan inquired about valuation methodologies. That owner suggested he might make an offer if he was provided with more information. There was no follow-up.
[141] There was also Mr Gilbert’s database of pre-qualified buyers which could have led to a short “soft” campaign. Mr Gilbert raised the possibility of agreeing a much reduced commission if they went to market but one of the owners ended up as the successful purchaser.
[142] I therefore accept Mr Robinson’s submission that the sale process was limited and hasty. Although Ms Finnigan stressed that both owners of the Centre were given an equal opportunity to put forward their best offers, it was not an authentically
competitive situation. The Receivers had been informed that Ms Young had limited financial capability under the time pressure placed on her.
[143] There appears to be no principle that requires a receiver to obtain an independent valuation before exercising a power of sale: all that is required is that reasonable steps are taken to ascertain the value before selling.63 However, where the business is not taken to market and the sale is to a party close to the secured creditor, there is an attendant risk.
[144] In this instance, the Receivers relied on Mr Gilbert’s appraisal but the short time frame afforded to Mr Gilbert meant that there was not a fully-fledged valuation assessment or appraisal. Mr Gilbert himself acknowledged that his appraisal was prepared in a very short timeframe — no more than three hours, including travel time to the premises and inspection.
[145] The fact that Mr Gilbert’s appraisal was significantly less than other assessments at the time and significantly less than the 2015 purchase price ought to have raised a flag as to its reliability. The errors in the appraisal, some minor, spoke to its rushed nature. Some of the errors ought to be have been evident to the Receivers. For example, the inaccurate recording of rental at $106,700 when it was in fact only
$93,000.64 The appraisal had been based on a sample one-week period beginning 9 June 2017. Mr Gilbert agreed that if he had been engaged to market the business then he would have included more sample representative weeks. I consider, based on his evidence of usual practice, that he would also have scrutinised the staffing ratios more carefully. He did not have that opportunity, through no fault of his own.
[146] Turning to the other factors relied on by Ms Finnigan to support her contention that the Receivers achieved the best price reasonably obtainable:
(a) I do not accept that the fact that the sale price was sufficient to clear the total secured debt and to recover the shortfall due to overspending the
64 This correction changes Mr Gilbert’s valuation to $442,800.
Ministry funding advance informs the assessment. There is no link in my view.
(b) I put to one side the hearsay (and disputed) evidence that the owners’ representatives had agreed on a valuation. No direct evidence was led about any agreement, and what evidence there was lacked context and was uninformative.
(c) The enquiries made of competitor ECE centres were of assistance in assessing value. There is some confusion in Ms Finnigan’s handwritten notes of those discussions whether they were reporting an EBIT or EBPIDT multiple.
(d) As discussed, Mr Gilbert’s assessment was necessarily rushed and when it came in significantly below other “back of envelope” calculations, and the offers made by the owners, needed further investigation rather than relying on it as a benchmark.
(e) Ms Finnigan referred to sales statistics on broker websites as supporting her own views as to value but was unable to produce these to the Court. Nothing can be taken from these statements.
(f) I accept that the irreconcilable differences between the owners were an important factor but without hearing evidence from either of them, the Court is not in any position to assess whether either would be prepared to be on site during a sale process if it was in their interests to do so and, in any event, there were alternatives to appoint a staff member.
(g) I agree that an 11 or 12 week marketing process would be too risky in the circumstances. But that does not mean that interrogating Mr Gilbert’s database of buyers combined with a short two to three week “soft” and confidential marketing programme would not have reaped some benefit while mitigating risk. That database comprised pre-qualified buyers thus avoiding delays with obtaining a temporary licence from the Ministry.
(h) I consider that the estimated Receivers’ costs of around $5,000 to
$5,400 per week to continue trading is unsupported and based on a misunderstanding of the regulatory regime. There would inevitably be some cost but not likely at this level.
(i) The fact that a Receiver is not able to give turnover warranties is neither here nor there. I do not accept that this makes it a riskier purchase in the ECE sector since the business model is a simple equation between the number of licensed children and staff ratios.
Conclusion
[147] It is unrealistic to assume that the best price reasonably obtainable in this receivership was the market price. There were too many uncertainties about the impact of trading (which would only increase with time) and the costs of continuing to trade. However, the speed and nature of the sale process drove the particular outcome and the difference between the sale price and the assessed market price is not satisfactorily explained by any of the factors relied on.
[148] Acknowledging the imprecise and difficult task the Court faces and a reasonable margin of tolerance, I consider that the only course available on the evidence is to deduct from the market price the potential range of broker commission in an alternative sales process, (between 4 and 8 per cent), the discrepancy between Ministry advance funding and the bank account, and receivership costs at $3,000 per week over a period of 4 weeks to find a range for the best price reasonably obtainable at the requisite time.
[149] As a result of this approach (and rounding) I find on the balance of probabilities that the best price reasonably obtainable in March/April 2018 lay in a range between $625,000 and $643,000.
Costs
[150] The plaintiffs have succeeded on the preliminary question determination but for a lesser amount than that “claimed”. In the ordinary course, they are entitled to costs. As neither party advanced a claim to costs at the hearing, I reserve the question
of costs observing only that the amount at stake in the context of a High Court claim will be relevant to any costs claim. If the parties are unable to agree costs, memoranda may be filed within 21 days with responses no later than 14 days after. Memoranda should be no longer than 3 pages in length.
ADDENDUM
[151] After issue of the judgment, counsel for the first defendants sought clarification of the calculation in respect of the range of the best price reasonably obtainable. I thank counsel for their memorandum dated 23 February 2023.
[152] I calculated the best price reasonably obtainable by taking the market price and deducting certain costs, including the potential range of broker commission in an alternative sales process (between four and eight per cent), the discrepancy between Ministry advance funding in the bank account, and receivership costs at $3,000 per week over a period of four weeks.
[153] As I determined that the market value was between $696,000 and $714,000, the deductions listed must be made to these figures to provide a range which reflects the range of potential broker commission. I omitted that full range in my judgment.
[154] As such, the range for the best price reasonably obtainable is between $597,000 (rounded and assuming eight per cent commission) and $642,000 (rounded and assuming four per cent commission).65
[155] I am satisfied that it is appropriate to make this “correction” to paragraph [149] of this judgment under the slip rule. It does not alter the reasoning nor approach in the judgment but reflects the appropriate range if variable commission is taken into account. This addendum supersedes paragraph [149].
............................................................
65 There is a typographical error in that paragraph [149] should have read $642,000 and not
$643,000.
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