Mohican Holdings Limited (Previously Network Product Distribution Limited) v Mainstream Logistics Limited [2012] NZHC 1230 (1 June 2012)

Last Updated: 26 June 2012

IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY

CIV-2011-404-005677 [2012] NZHC 1230

BETWEEN MOHICAN HOLDINGS LIMITED (PREVIOUSLY NETWORK PRODUCT DISTRIBUTION LIMITED)

First Plaintiff/Counterclaim Defendant

AND ANDREW MURRAY GUYAN

Second Plaintiff/Counterclaim Defendant

AND MAINSTREAM LOGISTICS LIMITED First Defendant/Counterclaim Plaintiff

AND GREGORY WILLIAM HALIDAY Second Defendant

Hearing: 21, 22, 23, 24, 25 May 2012

Appearances: D S McGill and J Stafford for Plaintiffs

J K Goodall for Defendants

Judgment: 1 June 2012

_{JUDGMENT OF FOGARTY J}

This judgment was delivered by Justice Fogarty on

1 June 2012 at 3.30 p.m., pursuant to r 11.5 of the High Court Rules

Registrar/Deputy Registrar

Date:

Solicitors:

Duncan Cotterill, PO Box 5326, Auckland

Martelli McKegg, PO Box 5745, Wellesley Street, Auckland 1141

Copy to:

J K Goodall, PO Box 1778, Shortland Street, Auckland 1140

MOHICAN HOLDINGS LIMITED (PREVIOUSLY NETWORK PRODUCT DISTRIBUTION LIMITED) V MAINSTREAM LOGISTICS LIMITED HC AK CIV-2011-404-005677 [1 June 2012]

Introduction

[1] The subject of this litigation is the sale of a “3PL business”. 3PL stands for Third Party Logistics. A 3PL business is one where an enterprise provides warehouse facilities for one of more other businesses. Customers of those businesses place orders for stock, stored in the warehouse. The orders are forwarded to the 3PL business and the stock is “picked” and sent to the customer. It is a characteristic of these businesses that they have significant fixed costs, being the warehouse. It is not easy to adjust the size of the warehouse space as customers are gained or lost. The rent still has to be paid.

[2] The plaintiff, who I will call Network, had a 3PL business in Auckland in a leased warehouse space. It had five key clients, one of whom was a company called Ozito. Ozito imports power tools from China and supplies them to Bunnings. Bunnings is its only customer. Ozito supplies Bunnings in Australia and in New Zealand. In Australia its 3PL and freight forwarding services are provided by Mainfreight. Mainfreight was always, therefore, a potential substitute for Network’s

3PL business in New Zealand. Network’s lease was coming to an end, offering an

opportunity to lower the rent.

[3] Network sold its 3PL business to Mainstream Logistics Ltd. That company is a subsidiary in the Mainstream Group. Mainstream is a significant freight forwarder in New Zealand. It also has an international freight forwarding business. Mr Haliday, the second defendant and owner and chief executive of Mainstream, wanted to extend the reach of Mainstream’s business by adding a 3PL business. He preferred not to start from scratch, but to buy an existing business.

[4] He engaged an expert on 3PL businesses, Mr Selby. Mr Selby went out into the market place to see what 3PL businesses were for sale and which would suit Mr Haliday’s requirements. Mr Selby identified a number of businesses. In the course of his inquiries he learned about Network and also learned that at least one of the other 3PL businesses in Auckland believed that Network was vulnerable to losing any one of its key customers, including Ozito.

[5] Mr Haliday received advice on the price to pay for the business. He received advice from Mr Selby, and from a chartered accountant, Mr Foster of BDO and from his barrister and advisor, Mr Sills.

[6] The negotiations started with Mr Guyan, the owner of Network, wanting

$450,000 for the business, setting aside working capital requirements (of the order of about $200,000). Mr Haliday received advice from Mr Foster that the business was worth about $320,000. Mr Sills recommended paying no more than $300,000. Mr Haliday offered $380,000. A price was agreed at $400,000. As part of the negotiations Mr Haliday sought a written term in the agreement for sale and purchase, whereby prior to settlement Network would obtain 12 month written contracts with the five key clients. Mr Guyan and his advisors refused to provide that term. However, they did agree to a broad set of due diligence conditions which effectively enabled Mr Haliday to pull out of the deal if, after due diligence, he was not entirely satisfied.

[7] The business changed hands accordingly on 1 November 2010. In January

Ozito went, shifting its business to Mainfreight.

[8] The purchase price was to be paid by instalments. After Ozito was lost, Mr Haliday ceased making further payments. Network brought these proceedings to collect the balance of its purchase price, the sum of $183,939.44. Mainstream counterclaimed for misrepresentation and breach of contract as to disclosure obligations during due diligence. It also added supporting causes of action of breach of the Fair Trading Act 1986 and promissory estoppel.

[9] The trial proceeded with Mainstream, the counterclaim plaintiff, assuming the burden of proof and going first.

[10] There are essentially three issues:

1. Did Mr Guyan of Network misrepresent the stability of the Ozito account?

2. Did Network breach any of the disclosure obligations under the contract?
   

3. If there is liability, what are the damages?

Issue 1: Did Mr Guyan misrepresent the stability of the Ozito account?

[11] Mainstream pleaded the following three representations: (a) That the relationship with Ozito was stable;

(b) That Network had no reason to suspect that Ozito was dissatisfied with the services of Network; and

(c) That Ozito was prepared to enter into a new contract for a term of one year.

[12] Mr Guyan did not dispute that he had, during the negotiations, assured Mainstream that he believed the Ozito account was stable and that it would enter into a new contract for a term of one year, if the rates were fixed.

[13] He ackowledged that due to the illness of Ms Carolynne Smyth in March

2010 and her two to three months part-time work thereafter, that there had been a fall off in the quality of service given by Network to Ozito’s only customer, Bunnings. But that was in the past. When Mr Sheehan of Ozito came to see him on 16

September 2010, he was in the middle of negotiations with Mainstream. Those negotiations had started in August 2010. Mr Guyan saw the meeting with Mr Sheehan in September as one of the regular meetings with Mr Sheehan. He recalls the meeting as being focused on the next trading year. Bunnings was introducing a new policy known as “Bunnings SSA”. Bunnings intended to abandon checking each delivery of goods. Rather, it would audit deliveries. Should, however, that audit reveal a short delivery then there would be a discount imposed on all invoices for goods from Ozito to Bunnings for a significant period of time.

[14] It was Mr Guyan’s evidence that complaints of poor performance were always made by e-mail. That after 16 September, and indeed from the middle of the year, there were no significant complaints. There were certainly no e-mailed complaints that Mainstream were able to put in the agreed bundle of documents, and Mainstream had access to all e-mail traffic between Ozito and Network following the acquisition.

[15] Mr Guyan relied on Network’s long term relationship with Ozito of nearly eight years. He relied on the good relationship that Mr Sheehan had with his key employee, Ms Smyth. He accepted that he did receive strong warnings of the importance of providing good service in the future from Mr Sheehan. But he placed those in the context of the new terms of trade being imposed by Bunnings on Ozito.

[16] He agrees that Mr Sheehan did talk in terms of Ozito’s intention to have a general rates review. Mr Guyan denied that he heard Mr Sheehan say that the price review would be over the coming few months. He disputes also that he was told at that meeting on 16 September that Ozito were going to go out to tender, more significant than a rates review.

[17] Mr Guyan acknowledged that he did not tell Mainstream of Mr Sheehan’s

visit.

[18] Mr Guyan agrees that it was subsequent to that meeting on 16 September that he gave Network the assurances pleaded as the misrepresentations. In particular, the next important meeting between the negotiating parties was only a week later, on

23 September. That was the meeting at which the price and the main terms of purchase were agreed.

[19] As part of the negotiations Mr Haliday, for Mainstream, was pushing for a contractual commitment by Network to sign up Network’s key customers to a 12 month contract.

[20] Following the meeting on 23 September, on 28 September, Mr Foster sent Mr Guyan his notes of the meeting and what he said were key issues agreed. These included:

6. NPDL “Network” to supply 12 month contracts for supply of storage and related services for the five main customers of [Network]. Contracts to also show the up rate agreed between the parties.

That up rate was not in fact precisely agreed, but was in the order of about 1.5 per cent.

[21] The next day, on 29 September, Mr Guyan send an e-mail querying item 6 saying:

...and what is outside my control. 12 month contracts would for instance be straight forward to obtain for the five main accounts, If[sic] we were to undertake to hold rates for that period.

[22] As time ensued, Mr Guyan’s solicitors refused to include in the contract an obligation on the part of Network to provide these contracts. However, the contract as negotiated enabled Mainstream to cancel the contract if, before the date of settlement, the contracts had not been obtained. This ability was preserved by clause

3.1.1, which reads:

3.1 Settlement of this Agreement is conditional upon:

3.1.1 The Purchaser undertaking a due diligence investigation of the Business and Assets and all documentation and records relating to the Business and Assets and the results of that investigation being entirely satisfactory to the Purchaser in its absolute discretion;

[23] On 8 October 2010 Mr Guyan sent draft 12 month agreements to the key clients, including Ozito. The contents of these letters were discussed with Mr Haliday before they were sent, and copies of the letters sent were sent to Mr Selby on 21 October. The letter to Ozito, addressed to Mr Sheehan, made no reference to Mr Sheehan’s advice that Ozito was going to conduct a rates review, let alone a tender. In the first paragraph it recorded the need to pass on costs increase and provided that from 1 November storage and handling charges would increase by

1.7 per cent while freight costs would increase by 1.8 per cent into most areas other than the South Island. The letter concluded by saying:

We understand that in the current recessionary business environment it is difficult for our clients to absorb any increase in costs, and accordingly have sort[sic] to keep the increase to a minimum. On a more positive note we will be happy to offer an annual agreement that will at least ensure that going forward, there will be no further storage or handling cost increases for a period of at least twelve months.

[24] Mr Guyan agreed that a rates review, though less significant than going to tender, posed the risk that the customer would be lost. For the customer would check the rates being charged against market rates.

[25] Mr Guyan knew when he sent this letter out on 8 October to Ozito that it paid no reference at all to Mr Sheehan’s advice to him barely three weeks before, that Ozito was going to have a rates review. In the context of that advice, Mr Guyan knew when he sent the e-mail on 29 September, and the letter on 8 October, that Ozito would not in fact be prepared to enter into a new contract with Network for a term of one year, at that point in time. In that context these two documents misrepresented the relationship of Network and Ozito.

[26] I am also satisfied, however, that Mr Guyan had convinced himself that he could handle the ups and downs of the Ozito relationship so that the relationship was stable. He saw the problems earlier in the year as past.

[27] I am not satisfied that Mr Guyan represented starkly that Network had no reason to suspect that Ozito was dissatisfied with the services of Network. His representations were more in accordance with (a) that the relationship was stable, and (c) that Ozito would enter into a 12 month contract. His representation on

29 September was that “twelve month contracts would for instance be straight forward to obtain for the five main accounts [as it includes Ozito] if we were to undertake to hold rates for that period”. That is not precisely how it was pleaded. But Mr McGill agreed properly that there is no prejudice in either allowing the pleadings to be amended or to read that pleading (c), set out above at [11], more broadly to encompass this representation.

[28] Mr Guyan did not make representation (b). His assurances were positive, not in the double negative.

[29] Network argued that these representations, (a) and (c), did not induce Mainstream to enter into the contract. This was because Mainstream were advised by their consultant, Mr Selby, in April 2010 that he had learned that key clients of Network were considering leaving Network and he included Ozito in that list.

[30] There is no doubt that at all material times the negotiators for Mainstream knew that Network was at risk of losing its key clients, including, particularly, Ozito. So, in a fundamental sense Mainstream knew it was purchasing a business whose clients were not tied in. That was undoubtedly the reason why there were discussions between the Mainstream negotiators and Network (with Mr Guyan) as to the stability of Network’s clients, and also the reason why Mainstream sought a condition in the contract whereby Network would provide 12 month contracts for each of the key clients.

[31] There is also substantial evidence, however, that Mr Haliday was intent on buying the Network 3PL operation for synergy reasons. Mainstream was a significant freight forwarder throughout New Zealand, with an international freight forwarding arm as well. A 3PL function would expand its position in freight forwarding and logistics. There were advantages to Mainstream in acquiring an existing 3PL business. This was likely to be a cheaper way of entering the market than a greenfields start up.

[32] Mr Haliday’s evidence was that although he was buying an existing 3PL business for synergy reasons and to expand the range of services that Mainstream could provide, he still wanted to buy a business that could stand on its own feet. Network was not the only possible purchase. He listed other companies that he had been looking at. He was insisting that he would not have purchased Network unless it could stand on its own two feet.

[33] As already noted, other advisors within Mainstream, particularly Mr Foster and Mr Sills, were arguing that the business was only worth $320,000 (Mr Foster) or

$300,000 (Mr Sills) and that Mr Haliday should not be agreeing to purchase it for

$380,00 let alone $400,000.

[34] I have no doubt that Mr Haliday’s goal was to purchase a 3PL business that could stand on its own. However, he was prepared to buy Network’s 3PL business and run the risk that it might not be able to stand on its own. Such a business would nonetheless give him an immediate entry into the 3PL market without having to start a greenfields operation. This is indeed what happened. Within a year, Mainstream acquired new clients so that the 3PL operation is producing now a profit in its own right. The big picture is that Mr Haliday’s commercial judgment was right.

[35] However, I am also satisfied on the preponderance of the evidence that had Mr Guyan disclosed that Ozito would not enter into a 12 month contract because it was undertaking a rates review, he would have lost bargaining power and would have been forced to sell the Network business for less than $400,000. The preponderance of the evidence was that he wanted to sell and I find he would have sold for a lesser price. In that sense the misrepresentations enabled Network to sell the 3PL business at a higher price than they would have achieved but for the misrepresentations. In that sense the misrepresentations induced Mainstream to enter into this particular contract of purchase of Network’s 3PL business.

[36] Accordingly, Network is liable to Mainstream for damages under s 6 of the

Contractual Remedies Act 1979. Section 6 provides:

6 Damages for misrepresentation

(1) If a party to a contract has been induced to enter into it by a misrepresentation, whether innocent or fraudulent, made to him by or on behalf of another party to that contract—

(a) He shall be entitled to damages from that other party in the same manner and to the same extent as if the representation were a term of the contract that has been broken; and

(b) He shall not, in the case of a fraudulent misrepresentation, or of an innocent misrepresentation made negligently, be entitled to damages from that other party for deceit or negligence in respect of that misrepresentation.

(2) Notwithstanding anything in section 56 or section 60(2) of the Sale of Goods Act 1908, but subject to section 5 of this Act, subsection (1) of this section shall apply to contracts for the sale of goods.

[37] Mainstream was induced to enter into the contract by innocent misrepresentations made to it by Mr Guyan on behalf of Network, the other party to the contract, and becomes entitled to damages.

[38] It is not necessary to consider separately the cause of action under the Fair Trading Act 1986. Network was in trade. These misrepresentations were misleading conduct in trade. It is not suggested that in this case the measure of damage under this cause of action should be any different than under the contract causes of action. The cause of action promissory estoppel was not pursued.

Issue 2: Did Network breach the disclosure obligations under the contract?

[39] Mainstream relies on the following terms and warranties in the Agreement for

Sale and Purchase of Business Assets:

Clause 3.2

The Vendor shall supply and disclose to the Purchaser as soon as possible following the date of this Agreement information held or able to be reasonably obtained by the Vendor relating to the Business and considered by the Purchaser to be necessary or desirable (at its discretion) to undertake its due diligence investigation.

Clause 5.1.1

From the date of this Agreement until Settlement the Vendor must, unless it has prior written consent of the Purchaser to act otherwise: carry on the Business in a normal, proper and efficient manner and maintain the goodwill of the Business in accordance with good business practice.

Clause 5.2.1

Prior to Settlement the parties will together undertake a stocktake of the Stored Goods on the following terms. The Vendor warrants that so far as it is aware there are no discrepancies between the Vendor’s records and the Vendor’s clients’ records of the Stored Goods.

Clause 10.1

In consideration of the Purchaser entering into this Agreement, the

Vendor represents and warrants to the Purchaser in terms of the Warranties in

the knowledge that the Purchaser is entitled to rely on the truth of the statements contained in the Warranties. The Vendor confirms that all relevant information concerning the Business has been made available to the Purchaser in the course of due diligence.

[40] The pleadings as to breach of these terms encompasses a submission that I have rejected, that there was a failure by Mr Guyan to disclose to the first defendant that Ozito was dissatisified with the services being provided by Network and likewise a failure to disclose that the Ozito contract would not be renewed or there was a real risk that it would not be renewed.

[41] However, in the course of the misrepresentation analysis I have found that from 16 September Mr Guyan knew that Ozito were intending to review their rates. Accordingly, in that context, the letter of 8 October would have made no sense to Ozito. To send the letter on that date only a few weeks after Mr Sheehan had advised Mr Guyan that Ozito was going to undertake a rates review was presumptious. In my judgment it was not carrying on the business in a normal, proper and efficient manner so as to maintain the goodwill in accordance with good business practice. It was conduct in breach of clause 5.1.1. Furthermore, the information received in the September meeting, even as understood by Mr Guyan, should have been disclosed to Mainstream and the failure to disclose is breach of clause 3.2.

[42] When Mr Haliday went with Mr Guyan to meet with Mr John McVay, the chief financial officer of Ozito in Melbourne on 11 November, he received a very brusque reception. That is not surprising. By this stage, if not earlier, Mr McVay was simply not interested in continuing the business relationship between Ozito and Network. It was only out of commercial courtesy that Ozito agreed to allow Mainstream as the new owner of Network’s 3PL business to tender against the market to retain the business.

[43] There is an issue, however, as to whether or not the breach of clause 5.1.1 was causative of loss. The evidence of Mr John McVay through his memorandum, confirmed in the brief of Mr Sheehan, is to the effect that Ozito had made a decision before the sale and purchase agreement to end its relationship with Network. I will return to causation later. But the breach of clauses 3.2 and 10.1 was causative of loss

to Mainstream because in ignorance of the meeting of 16 September, Mainstream paid more for the business than they would otherwise have paid had they known that Ozito was undertaking a rates review.

[44] It is sufficient to say that I find that Network is in breach of clauses 3.2, 5.1.1 and 10.1. The pleading of non-disclosure regarding Timberlock was not pursued.

Issue 3: Damages

[45] Mainstream seek damages on all causes of action in the sum of:

1. $545,00 being the value of the lost profits on the Ozito contract;

2. $238,556 being the equivalent to the trading losses incurred by

Mainstream to 31 March 2012, plus interest at the Judicature Act

1908 rate on the payments to the plaintiff (made pursuant to the agreement for sale and purchase);

3. $160,000 being equivalent to the goodwill paid by the first defendant;

or

4. $240,000 being equivalent to the entire amount of goodwill that should be found owing to the plaintiffs.
   

[46] In support, Mainstream retained Mr A E Webber. Network retained Mr J J Cregten. Both are expert forensic accountants. Their evidence was of considerable assistance to the Court including, not the least, an excellent joint memorandum identifying their differences.

[47] Mr Webber advised he was instructed to consider Mainstream’s loss under four alternative heads. These heads were later jointly described by the experts as four scenarios:

Scenario 1: This scenario assumes that Mainstream would still have proceeded with the transaction the loss is best measured as the difference in value that was paid compared with what Mainstream would have paid, had

the alleged representations not been made. There is an implicit assumption in this scenario that a transaction would have occurred albeit at a lower price.

Scenario 2: This scenario assumes that Mainstream would not have proceeded with the transaction and as a consequence it would not have incurred the trading losses that it has actually incurred as a result of proceeding with the transaction.

Scenario 3: This scenario assumes that Mainstream’s loss is measured by reference to the contribution they expected to earn from the Ozito contract and assumes that Mainstream would have contracted with its new clients even if it had not lost the Ozito contract.

Scenario 4: This scenario assumes that Mainstream can only recover contribution from the Ozito contract for a maximum period of 12 months.

[48] Scenarios 2, 3 and 4 are not sustained by the evidence. On the probabilities, Mr Haliday would still have acquired Network’s business notwithstanding a very real risk of losing Ozito, but would have utilised the information withheld to negotiate a lower price.

[49] I find most persuasive Mr Cregten’s explanation for the decision to pay

$380,000. A significant attraction in the purchase was the ability to reduce the fixed cost of the rental. Mr Selby used future maintainable earnings (“FME”) of $217,000 per annum. Mr Cregten, “at the risk of over simplifying matters”, was of the opinion that the key drivers in respect of that figure were a continuation of existing EBIT with some minor adjustments, estimated at $78,000 per annum, but enhanced by an estimated rent reduction of $139,000 per annum.

[50] Mr Cregten came to the conclusion that “the existing business” contribution to future expected earnings was not the key earnings growth value driver; rather the opportunity to implement changes to the rent structure was the key to achieving the earnings expectation and producing the price justification”.

[51] This conclusion is supported by the fact that Mainstream knew from Mr Selby that they could not have confidence that the business would retain its existing clientele.

[52] Mr Webber’s approach was to take the view that the loss to the Ozito

business caused the loss of all the goodwill in the business. This is mathematically

correct. However, I favour Mr Cregten’s view that goodwill here is simply that part of the purchase price which cannot be booked to the fixed and depreciable assets. I do not think that Mainstream went into the business assuming that the Ozito contract would continue in the long run. On top of that they pursued, but failed to obtain, a promise that they would be delivered a 12 month contract for Ozito. They knew all that when they agreed the purchase price of $400,000.

[53] I reject the proposition that Mainstream should be compensated for loss of Ozito’s business on the basis that they were entitled to a continuation of the Ozito business, at least for 12 months. They sought an express term to that effect in the contract and failed. There is no basis for them to achieving it by way a misrepresentation or failures during due diligence.

[54] I am ignoring lost revenue from the Ozito business because Mainstream entered into the contract knowing there was a realistic possibility that one or more of the key clients would be lost in the next 12 months.

[55] What Mainstream lost by reason of the misrepresentation and breach of the due diligence clauses of the contract was the opportunity to confront the vendor with the real risk of Ozito’s business being lost and to drive down the purchase price. In this context, Mr Cregten reasoned as follows:

As indicated earlier, Mainstream agreed to purchase specific assets for

$400,000 implying a total Enterprise Value for the business of Network at

$615,000 [that includes $215,000 of working capital]. Network’s historical earnings profile at the time was approximately $78,000. This was enhanced by an expected rent benefit of $139,000 per annum. Implied Goodwill for this transaction was $240,000.

I have already suggested a Goodwill allocation in respect of each of these earning components but it is still in my opinion that the Goodwill paid was excessive. Network negotiated an extremely attractive price for the business based on its actual core earnings.

The factors that appear relevant to take into account in assessing the price agreed and the consequent Goodwill allocation relating to the loss of the Ozito business are essentially three things:

1. Firstly, the extra business that Mainstream’s freight operation would receive; and

2. Secondly, the fact that a core customer base producing aproximately $1.6 million of revenue offered Mainstream the opportunity of immediate critical mass into this market place; and

3. Thirdly, the potential rent savings which would enhance the earnings from the existing customer base.

Mr Foster made an assumption that the core business would continue so arguably the latter is the primary driver of Goodwill. On this basis Goodwill could be allocated across the customer base such that the Ozito’s contribution to Goodwill would be quantified as $240,000 multiplied by Ozito’s proportional contribution to the revenue which is approximately 25% ($426,000/$1.6 million). That would amount to $60,000.

As the remaining 75% of the customers stayed with the business ... the

Goodwill lost as a result of termination of Ozito’s business would be

$60,000.

[56] As a cross check, this indicates that on the basis that the negotiations would differ knowing the fragility of the Ozito business, the purchase price would be reduced to $340,000. That is a realistic figure. It is $20,000 more than Mr Foster recommended should be paid. But it keeps in play the fact that Mr Haliday was prepared to pay more than the business was worth as a stand alone business.

[57] For these reasons I adopt Mr Cregten’s estimate of a loss of $60,000.

[58] The defendants’ case was by way of counterclaim. There was no dispute to the plaintiffs’ claim for the balance of the purchase price. The plaintiffs’ claim for the balance of the purchase price was for judgment in the sum of $183,939.44. It was agreed that any sum recovered by the defendants by way of counterclaim would be set off against this sum. Accordingly, the result of this litigation is that the first plaintiff recovers the sum of $123,939.44 together with interest at the rate of 10 per cent per annum from 13 September 2011.

[59] Usually costs follow the event. But here the successful party, Mainstream, also failed significantly having sought much higher sums as damages, see [45]. This is a case where I think both sides should bear their own costs. There is no order for costs accordingly.