Lord Justice Laws:
Introduction
- This is the judgment of the Court, prepared by Mann J.
- This is an appeal from an order of HH Judge Purle QC given in 4 separate judgments. The first was one in which he found that the respondent in this matter, (Ms Kohli) a petitioner in a Companies Act section 994 petition, had been unfairly prejudiced and in which he ordered that her interest in the subject company (Sunrise Radio Ltd – "Sunrise Radio") be bought out by the majority shareholders. The principal shareholder was a Dr Lit, and although he was not the only respondent to the petition, for ease of presentation this judgment will assume that he was. Having so determined in the first of his judgments ([2009] EWHC 2893 (Ch)), Judge Purle then held further hearings in order to determine the price to be paid. He decided various elements of the price across the remaining 3 hearings ([2011] EWHC 3821 (Ch), [2012] EWHC 1337 (Ch) and [2012] EWHC 1338 (Ch)). When it is necessary to distinguish between those judgments and the hearings they related to we shall refer to them as the liability judgment and the first, second and third quantum hearings and judgments respectively. The end result was an order that the price paid should be £560,000. The appellants in this appeal (the respondents to the petition) do not seek to appeal the finding that they should buy out Ms Kohli. Nor do they dispute much of the valuation technique adopted by the judge. What they do seek is to challenge his treatment of 4 particular elements of his assessment, saying that they were dealt with inappropriately or inconsistently with other elements, resulting in a price that was too high. This appeal is brought with the permission of Lewison LJ given on 11 October 2012 (who refused permission to appeal on a fifth ground).
The key findings for the purposes of this appeal
- It is unnecessary to recount much of the background to the valuation exercise, which appears in the liability judgment. The following short points will suffice.
- At the material time the majority shareholders in Sunrise Radio were a Dr Lit and a company controlled by him, Asian Broadcasting Corporation Ltd. By the time of the trial they held almost 89% of the share capital, having increased their shareholding from 78% as a result of a disputed rights issue. Ms Kohli was a minority shareholder. There were some other small shareholdings that do not matter.
- Sunrise Radio had its own trading income, but it also had a number of subsidiaries. Some of them had their own trading income. They included Club Concorde Ltd and Sunrise TV Limited. A further subsidiary, Hayes Gate House Ltd, held a valuable property. Other subsidiaries were loss-making.
- In his main judgment on liability the judge had determined that the value of Ms Kohli's shareholding should be taken to be her rateable proportion of the value of the Sunrise Radio shares as a whole without any discount for her being a minority shareholder. His order of 25th May 2010 embodied the effects of his determination of unfair prejudice and provided for the share buy-out. It also provided:
"(4) The valuation shall take into account the following assumptions, bases and footings:
(i) that there was a debt due from the Company to Global Radio Services Ltd of £527,643 as at 31st December 2007, subject to any subsequent payments
(ii) that there was a debt due from Club Concorde Ltd to Asian Broadcasting Corporation Ltd, now called Litt Corporation Ltd ("ABC") of £270,000 at the 31st December 2007, subject to any subsequent accruals and payments …"
- Global Radio Services Ltd and Asian Broadcasting Corporation Ltd were not subsidiaries of Sunrise Radio. For these purposes the debts were therefore not intra-group debts. They had the nature of external indebtedness, albeit to other Lit entities. They seem to have been specifically referred to because one of the issues that arose in the case was the propriety of invoices raised by the two external companies, including invoices which gave rise to the two debts just referred to. That propriety was challenged by Ms Kohli. Having considered the propriety of the alleged underlying transactions, the judge ruled that not all of the Global Radio Services debt was good and that:
"It follows from my ruling that, assuming the outstanding amount has not subsequently been reduced, any buy-out order that I make requiring a valuation after 2007 should be on the basis (amongst other things) that the sum outstanding to GRS is £527,643." (para 199).
- The debt due from Club Concorde to Asian Broadcasting Corporation seems to have been dealt with in paragraph 203:
"As regards CCL [Club Concorde Ltd] and LMC, £270,000 and £180,000 respectively were invoiced by ABC down to the end of December 2007. These are significantly less in each case than the maximum chargeable over the 18 months in question. As in the case of GRS, I see no warrant for increasing the accruals down to that date. As the actual accruals were within the Limits, they were authorised."
- It is necessary to set out that piece of detail from the liability trial because of the use that Mr Peter Griffiths, who appeared for the appellants before us, sought to make of the reference to the debts in the order. As will appear, one of his complaints is that the valuation exercise was conducted without reference to some external debt, including the 2 debts referred to. He pointed to the oddity of that, bearing in mind that the judge had made particular findings in relation to the existence of the debt. However, it is useful to record at this point in the judgment that such a submission has to be treated with care once one sees the context in which the judge made the relevant findings. The paragraphs which we have cited appear in a long section of the judgment entitled "Remuneration, consultancy fees and accounting". The section is dealing with complaints about the amount which Dr Lit took out of the company by way of consultancy fees or service charges. The judge had to deal with an enormous amount of detail, and the two conclusions to which we have referred are among many others that he reached in considering the propriety of various charges. He was really making findings on matters of complaint by the petitioner as to how the business was conducted. So far as he was making findings that might impact on a subsequent valuation exercise, his findings clearly have to be read subject to a qualification of relevance. One cannot simply point to the provisions of the order without more (as Mr Griffiths did) and complain that the judge's specific determinations were not reflected in his findings on valuation. He was providing factual assumptions for the purposes of the valuation, not indicating how those factual assumptions were to be applied in that exercise.
- When it came to arguing the price to be paid, each party had expert evidence. Miss Kohli instructed a Mr Alan Thompson; Dr Lit instructed a Ms Moira Hindson. It is plain from his first quantum judgment that the judge had significant misgivings about important aspects of the evidence of both experts (more in relation to Mr Thompson than in relation to Ms Hindson) and while he proceeded from the starting point of both experts he then took what seems to have been his own route, guided by Mr Hanke (then counsel for the petitioner), while from time to time treading the same path as one or other of the experts.
- So far as the trading side of Sunrise Radio was concerned, the experts agreed that the appropriate method of valuation was to ascertain maintainable earnings and to apply an appropriate multiplier to them. There were disputes as to the appropriate period across which to ascertain the net earnings, and as to the multiplier, on which the judge made findings which are not the subject of this appeal. The judge took the earnings for the years 2006 to 2009 and he chose an appropriate multiplier.
- His valuation technique does not appear, in terms, in any of his judgments. It emerges in the course of all three of them, though mainly in his first. It can be seen from a table that he sets out at the end of his third quantum judgment. He takes the value of the trading side of Sunrise Radio's activity, valued as just referred to (applying a multiplier to net earnings), and adds the value of Club Concorde similarly determined. He then brings in an agreed value of Sunrise TV Ltd. He ignores all other subsidiaries on the footing that they are loss making (or, in the case of one, on the footing that it had a zero value). Then he adds to that the value of the property held by Hayes Gate House Limited at a valuation, and takes away from the aggregate of those positive sums the amount of a bank facility afforded to the group by Allied Irish Bank (AIB) together with a redemption fee that would be chargeable on redemption. That gave him what he regarded as the value of the holding company, to which he then applied Ms Kohli's proportionate shareholding to arrive at a rounded figure of £560,000.
- The dispute on this appeal turns on what are said by the respondents to the petition to be the following errors. Three of them are complaints about the manner in which he arrived at net earnings (complaints that the judge wrongly failed to add items on the expenditure side, or that he added items to the income side which ought not to have been allowed, with the result that the net earnings were too high), and one relates to the next stage of the operation when it is said that he failed to take out particular debts from the overall calculation of value. The complaints are:
(a) The judge was wrong in deducting only the AIB debt in arriving at the value of Sunrise Radio. He should have deducted other group liabilities. Had he done so the final aggregate would have been smaller.
(b) In ascertaining the maintainable earnings of Sunrise Radio the judge wrongly failed to deduct interest on the AIB facility (or its equivalent) from the expenditure side, thereby inflating net positive earnings. It is said that a provision for interest should have been left in, which would have reduced net earnings.
(c) In ascertaining the maintainable earnings of Sunrise Radio the judge failed to take out from the income side certain management service fees received by the company from other companies in the group. Had he done so the net earnings would have been reduced (and so would the value of the company).
(d) In valuing Club Concorde the judge wrongly reduced the amount of consultancy fees payable by Club Concorde, thus reducing the deductibles and inflating the net earnings figure.
- Ms Kohli had also sought permission to challenge a finding that a purchaser would be likely to allow loss-making subsidiaries to go into liquidation, but permission to challenge this was refused.
External debts – complaint (i)
- Under this head Mr Griffiths challenges that part of the decision of the judge which deducts liabilities from the overall valuation reached by applying the earnings/multiplier technique. He does not complain about the deduction of bank borrowing as a liability. His point is that it is illogical and contrary to the evidence to stop there and not to deduct all the net liabilities of the group (and particularly those on which the judge had made specific findings - see above), though if one takes out the loss-making subsidiaries (which one has to do in the light of the ground of appeal on which he did not get permission) then the liabilities attributable to them should not be brought into the picture. Mr Griffiths points out that Mr Thompson had not taken account of any of the subsidiaries in his valuation, and this does not seem to have found favour with the judge. Ms Hindson's evidence did look to the subsidiaries, including their liabilities, but she did not single out the bank liability for special treatment. She made a deduction for net liabilities across the group.
- The judge's findings on this point appear across two of his judgments. In the first quantum judgment he rejected Mr Thompson's methodology in paragraph 14, and in paragraph 15 he criticised part of Ms Hindson's methodology insofar as it related to the bank debt, though not the deduction of the bank debt as a liability. He said:
"Ms Hindson, on the other hand, approached the matter on the footing that a historical debt amounting to £9.539 million owed to the bank would have to be cleared by any purchaser. The debt once cleared would be out of the way, yet her maintainable earnings took into account interest charges which would continue to be incurred by the group thereafter by reference to past accounts, which, of course, included interest on the debt that would be paid off. It seems to me that there is a real risk there of double counting, both by reducing the purchase price which Ms Hindson claimed was necessary to reach a true purchase price because of the need of the purchaser to pay off the bank debt, and by deducting from maintainable profits the continuing cost of funding that debt when it would ex hypothesi be paid off."
- That does not deal with the treatment of the liabilities of the group as a whole. He then went on in paragraph 16 as follows:
"16. Having heard the evidence, which, as I say, consisted solely of 2 experts, Mr Hanke for the petitioner, at my request, came up with an alternative calculation of value, which it seems to me forms a proper basis for the valuation in this case, though I do not, as will appear, accept every part of it. The basis of his approach was that liabilities of the company's subsidiaries would only be taken into account if there was a legal obligation upon the company to meet them. That, it seems to me, is correct, because loss-making subsidiaries can be liquidated or otherwise shed. It does, however, as Mr. Hanke recognised, involve payment off, or taking into account, of the full bank liability of £9.539 million. He said that one must then value the separate profitable businesses upon the footing that it will be open to the purchaser to close down or get rid of all the rest without cost. I accept that that is a permissible and correct approach. The only four profitable group companies were Sunrise, Club Concorde Limited, Kismat Radio Limited and Sunrise TV Limited.
17. Mr. Hanke also said that the other assets available to satisfy the bank debt should be taken into account, and that relevantly included a property charged to the bank called Hayes Gate House, which in 2009 had a substantial value, though on one view of the matter slightly less than its book value. As that was charged to the bank, I agree that it is appropriate to take the availability of that capital asset into account."
- He then moved on to other matters relating to maintainable profits. His ultimate methodology follows the pattern of those paragraphs in that it does deduct the bank debt from the values which he has established for the trading side of companies' activities and adds the value of the property. He does not, however, explain why it is that he brings only the bank debt into account. This is despite the fact that Ms Hindson did bring other debts into account in her report.
- However, as a result of reading Mr Griffiths' skeleton argument supporting his application for permission to appeal the judge gave some further reasoning. In the second quantum judgment he said:
"3. He pointed out that what I had done is deduct only from the valuation of Sunrise the amount of the Allied Irish Bank debt and not, as Ms Hindson (his expert) had done when valuing Sunrise as a whole, including all its subsidiaries, the net liabilities of either the group or of the particular companies which I took into account when making the valuation. He contended that that was absurd. When I read that submission in the skeleton argument I was initially attracted by it and, therefore, invited further argument as to whether I should make a deduction for all of the net liabilities within the companies that were being valued. It seemed to me then, though I did not have the papers before me, that Mr Griffiths' submission might logically follow from the approach I had adopted. However, Mr Hanke has pointed out that the experts were agreed that a price-earnings multiple was appropriate, which had no necessary reference to net liabilities. The only reason that a net liability was brought in by Ms Hindson was because of the interdependency of all the companies and the existence of guarantees across the board. That feature disappeared once I approached the issue on the basis that all the bank indebtedness would in fact be paid off on completion. That, Mr Hanke correctly pointed out, was the only reason for bringing in that indebtedness at all and, that being so, on the evidence before me, the only debt which had to be repaid on a hypothetical sale of Sunrise was the bank debt. Mr Griffiths pointed in further argument to what appeared to be other inter-company indebtedness, but there was in fact no evidence at the hearing before me as to the nature of that inter-company indebtedness and whether it would have to be repaid on completion. That was a point which could have been made additionally by Ms Hindson, but was not, and, more importantly, could have been made by any of the Sunrise witnesses, no one in fact, for good reason or bad, being available to give evidence at the quantum hearing.
4. One of the problems that has bedevilled this case, and in particular the quantum hearing, is the lateness at which the evidence was prepared, despite the substantial lapse of time between the liability hearing and the quantum hearing. However, what was clearly in issue, as is evident from the joint statement of the experts, is whether or not the subsidiaries could be discarded if they were not profitable. It was clearly Mr Thompson's view, with which Ms Hindson disagreed, that they could. It was for the Sunrise parties (as I shall call the respondents) to consider what the consequences were if Mr Thompson's view should prevail, and it was for them to put evidence before the court to show that some further deduction over and above the Allied Irish Bank indebtedness would be appropriate. They had, after all, put in detailed evidence of the Allied Irish Bank indebtedness and of the particular terms upon which it was made. They did not put in any evidence about the terms upon which other indebtedness was incurred. In those circumstances, it was appropriate to make a distinction between the Allied Irish Bank indebtedness and other indebtedness, and it does not therefore seem to me that I should re-visit my earlier ruling on that ground. This is not a case, in my judgment, where it is appropriate to have any regard to net indebtedness as I am adopting a multiple of earnings basis for valuation. It was only because of the special features that presented themselves to Ms Hindson that she brought in all the net indebtedness, those features having now disappeared. Once the Allied Irish Bank indebtedness is treated as paid off, there is no longer any basis for bringing net indebtedness in at all. It is common to see, as indeed one sees from Ms Hindson's individual valuations of Sunrise and Concorde, valuations on a price-earnings multiple without regard to net assets. Sometimes the net assets or liabilities may have a significant impact, but there is nothing in the evidence to suggest that they should have a significant impact in this case. Mr Griffiths says that the result of the omission of other indebtedness is absurd, because if (he says hypothetically) a million pounds' worth of the bank indebtedness had been paid off a week before the valuation date, with, let us suppose, third party money or intercompany indebtedness, then the valuation would be higher, even though the net indebtedness would be no different. It is always possible when one is dealing with a price-earnings multiple to make points of that sort. However, I would expect, in those circumstances, that the indebtedness which would hypothetically be created in relation to the third party instead of the bank would, in the event of an immediate sale, also be repayable, and so it is not likely in practice that the example that Mr Griffiths gives would be significant. In all events, those are different facts from the facts that I am dealing with. Had those been the facts, I would have had to consider those facts and the significance of the newly substituted indebtedness in the context of the particular circumstances in which it was incurred. That would have required proper evidence, just as Mr Griffiths' point required evidence in this case."
- Thus his reasoning in paragraph 3, which takes a bit of unpicking, seems to be this:
(i) The basis of valuation was an earnings/multiple basis, to which liabilities were not necessarily referable.
(ii) Net liabilities were brought in by Ms Hindson because of the "interdependency" of all the companies and guarantees.
(iii) The bank indebtedness would be paid off on completion, so that feature disappeared.
(iv) There was no evidence of the nature of the other "inter-company indebtedness" and whether it would have been repaid on completion (those last words must indicate that he must have meant external indebtedness, not inter-company indebtedness).
To which one adds from paragraph 4:
(v) Non-profitable subsidiaries could be discarded, and the respondents should have put in evidence dealing with the consequences of that.
(vi) It was for the Sunrise Radio parties to put in evidence to show that some further deduction over and above the AIB debt would be appropriate, but they did not.
(vii) It was therefore appropriate to make a distinction between the bank debt and other debt.
(viii) Since the valuation technique was an earnings/multiplier technique, it was not appropriate to bring in net indebtedness.
(ix) Ms Hindson only brought in net indebtedness because there were some special features. He does not identify what he thinks those were, but the inference from the paragraph is that they have disappeared, and the further inference is that they are deemed to have disappeared because the bank debt would be repaid on completion.
(x) Once the AIB debt is paid off there is no basis for bringing in net indebtedness at all.
(xi) Net assets or liabilities might be brought into an earnings/multiple calculation where they have a "significant impact" but there was nothing in the evidence to suggest such an impact in the present case.
- It is not easy to follow the logic of this part of the judgment, and not easy to reconcile it properly with some of the expert evidence given. It is right that the shared assumption of the valuers was that an earnings/multiplier technique was the appropriate one to adopt. It is also right that net assets or net liabilities determinations would by and large have no part to play in such a technique. But the judge applied a modified version of that in deducting the bank debt. He justified that by reference to his finding that a purchaser would want to pay it off on completion. That is a finding which is not challenged on this appeal. Its effect is said by the judge to justify taking out any other element of net liabilities from the end calculation (step (iii) and step (x)), but we do not see why that consequence follows. Nor is it fully consistent with the expert evidence on the point, and the judge's technique was not properly pursued with any of the experts.
- The judge's reasoning pre-supposes that there are aspects of assets and liabilities which can be brought to bear in an earnings/multiplier based calculation of value. That is the assumption underpinning his allowance of the AIB debt as a deduction in his figures. Mr Thompson did not deal with this. Ms Hindson did. In her report she said (first in relation to a valuation in 2005, necessary for considering the effects of the disputed rights issue):
"3.21 By [carrying out multiplier exercise] I arrive at a starting point for the valuation of the business of the company at 19 October 2005 of £15,375,000 (a date which was relevant to unravelling the effects of the disputed rights issue). However, there are a number of factors that should be considered before arriving at a final valuation, which I discuss below.
SRL group assets and liabilities
3.22 For the purposes of arriving at a valuation of the entire share capital of SRL it is necessary to consider the assets and liabilities held on the company's balance sheet that are surplus to the trading activities. These include the company's investments in subsidiary companies ..."
This was repeated for the valuation in 2009 (the critical one for the share purchase consideration):
"4.22 By applying the p/e ratio of 8.44 to SRL's maintainable earnings of £293,000, I arrive at a value for the business at November 2009 of approximately £2,459,000.
4.23 However, in order to arrive at a valuation of the SRL group it is necessary to consider the assets and liabilities held on the company's balance sheet that are surplus to its trading activities. These include the company's investments in subsidiary companies."
- She then went on to value the profit-generating subsidiaries on an earnings basis, but said that loss-making subsidiaries should be valued on an asset basis "which recognises the overall value of their net assets or liabilities". Having produced her positive values for the holding company and the three profit-making subsidiaries, she said:
"4.48 However, as explained earlier, when assessing the value of the entire issued share capital of SRL at 13 November 2009 it is also necessary to consider the assets and liabilities held on the company's balance sheet that are surplus to its trading activities."
- She then carried out an exercise of consolidating the activities of the group to produce a group balance sheet, eliminating such things as inter-company debt and arrived at a net liability for the group. The total net liability owed by the group as at 31 December 2005 was £2,090,000, which she said should be deducted from the value of the business of the company to arrive at a value for its entire issued share capital. However, she then carried out an adjustment to remove the £150,000 which the judge had ordered be taken out of the debt owed by Sunrise Radio to Global Radio Services. That demonstrates that she was treating the larger debt as being part of the external indebtedness which, in her view, needed to be taken into account.
- Thus her valuation exercise was not one conducted by taking into account an earnings/multiplier calculation by itself. She indicated it would be appropriate to take at least some liabilities into account. Her key concept seems to have been "assets and liabilities… that are surplus to its trading activities".
- It is not apparent from the cross-examination of Miss Hindson that the whole principle of taking some liabilities into account was properly challenged. The point was touched on in cross-examination, in a passage starting from something said in the agreed experts' statement:
"Status of subsidiary companies (para 6.14 of AT's [Mr Thompson's] report).
2.35 AT asserts that "As all subsidiary companies are separate legal entities, they can be divorced from Sunrise in the event that they become insolvent as any purchaser of Sunrise's shares would have the choice of accepting or rejecting the shares in any or all of the subsidiary companies."
MH's view
2.36 In MH's view , whilst this statement is technically correct, AT has overlooked the reality that the total liability to Allied Irish Bank cannot be divorced from Sunrise because of the cross guarantees (see Appendix 11 of MH's report). Any prospective purchaser of Sunrise would have to take on responsibility for the entirety of the liability to Allied Irish Bank of £9,539,000 at 13 November 2009."
She was taken to this in her cross-examination at page 47, and was asked:
"Mr Hanke: ... We discussed before lunch, you will recall, that that liability was to Sunrise, London Media Company and Hayes Gate House and the split was roughly 5 million to Sunrise and roughly 4 million for Hayes Gate House. The position, is it not, is that the liabilities of Sunrise are already taken account of when you calculate maintainable earnings and value Sunrise?
A. But the trading assets and liabilities but not this ---
Q. But when you carry out your initial valuation of Sunrise on its own and reach a value for it, that effectively takes into account the fact that Sunrise has borrowings?
A. No, that is ---
Q. Because the requirement for Sunrise to be repaying those debts is taken into account in the amounts that have gone out of the money that has come into the account. It has taken into account the debts?
A. Yes it is, but it does not take account of the fact that it still has to pay the whole of that loan.
Q. If you were valuing Sunrise on its own, ignoring the subsidiaries, you would reach the figure that you have valuing it, you would stop there, would you not, you would not make some further adjustment because it had borrowings ---
A. Yes, I would, if it had borrowings of that size.
Judge Purle: What size are we talking about now?
A - it is about 5 million. If it had 5 million of cash, for example, if it was the other way around, then you would make an assessment of its need for cash on an on-going basis. That is its trading, the working capital that it needs and then any excess you would add on because that was surplus cash. It works much the same way, there is a large loan, liability in this instance which you would deduct from the value of trade."
- This cross examination only goes so far in dealing with the point now under consideration because it focuses on large liabilities, and in the last two questions she was asked to assume a sale of Sunrise Radio only (ignoring the subsidiaries and therefore debts in the subsidiaries). She seems to have been interrupted when trying to deal with some of the points. However, it does not seem that she abandoned her concept of taking into account assets and liabilities which were surplus to trading activities, and she was certainly not accepting that one automatically ignores all debts. This reference to the evidence also demonstrates that the reason that Ms Hindson took liabilities into account was not because of some "inter-dependency", but because of something else – her concept of a liability (or an asset) being surplus to trading activities.
- Mr Thompson's report does not go into the point. Nor does his cross-examination contain anything on it.
- This does not provide support for the finding that it was appropriate to take the bank liability into account because of some element of inter-dependency (stages (ii) and (iii) of the judge's reasoning). It would be appropriate to take it into account on the footing that it is a sort of surplus liability, in the sense of one not being part of the normal trading liabilities of the company (which we can see might be left out of account in an earnings-based calculation of a business), particularly since a very large part of Sunrise Radio's liability arose under a guarantee and was not its primary liability. But it is not apparent why this inter-dependency (if that is what the judge meant) meant that it, and only it, had to be taken into account, and that was not what Ms Hindson said. Accordingly, so far as the judge's reasoning justifies the deduction of the bank debt by reference to an inter-dependency, which is thereby removed, making further deductions inappropriate, we do not think that it can be correct. It is, of course, correct that the judge did not accept Ms Hindson's evidence in its entirety, and that is something that he was entitled to do, but to the extent that he does have resort to it his reasoning does not seem to work.
- Nor was it fair, in the circumstances, to base his decision on a failure by the Lit parties to adduce evidence as to the appropriateness of the deduction of other particular debts (his steps (iv) and (vi)). Ms Hindson and Mr Thompson had not approached the matter in that particular way. As we understand it the idea of taking a price/multiplier figure and deducting a specific debt emerged in Mr Hanke's final speech. We do not understand at what point the Lit parties should have addressed this point evidentially, bearing in mind the manner in which and time at which it came up. The passage in Ms Hindson's cross-examination cited above shows that a start was made in putting such a case to her, confined to the AIB debt, but no more.
- What we can accept is the judge's unchallenged finding that a purchaser would want to pay off the bank debt, and we can see that he would be likely to want a discount from the price in that amount, but we do not understand why that means that all other liabilities (reflected in net liabilities) have to be ignored. Presumably if this is to have an effect on the earnings/multiplier element on the valuation it must be because it is a liability surplus to its trading activities, in Ms Hindson's analysis, or has a "significant impact" in the judge's terminology (step (xi)). If other liabilities were sufficiently serious, and had the quality of being "surplus" to the business activities, then a purchaser may well want to deduct those as well, because the company would still be subject to them. This is particularly likely to be the case where the debt is in a subsidiary which has a positive value on a multiplier-based calculation, which is the case with Club Concorde.
- We therefore consider that the reason for drawing a distinction between bank debt and other debt is flawed. The judge held that it would be right to discard loss-making subsidiaries, so the portion of the net indebtedness attributable to them would not cause a purchaser to make a deduction from the price (save for any bank debt caught by the guarantee). The deemed purchaser would let the companies go, so that they would have a nil value to the purchaser, not a negative value. To that extent the logic of the judge is sustainable. His "significant impact" point (point (xi)) may be a reasonable way of capturing the "surplus" point referred to by Ms Hindson, or her "if big enough" point made in the cross-examination passage cited above. However, it is unfair to say that there was no evidence of any such debts bearing in mind the way the cross-examination went, the fact that the point was not investigated with Ms Hindson, and the fact that this sort of analysis only emerged in final submissions (if then - it may have been the judge's own).
- All this means that while the judge was correct to acknowledge the principle of some debts being deductible for the purposes of carrying out the valuation, he was not necessarily right in confining those debts to the bank debt. If he was going to go about the matter in the way in which he did then he ought to have considered other candidates.
- The next question is what this court should do about that. It would be open to us to remit the valuation question for further hearing below. That has an obvious lack of attraction. It would also be probably inconsistent with the limited basis on which this appeal has been run, because it would be likely to re-open wider aspects of the valuation exercise in respect of which permission to appeal has not been sought.
- To remedy the above shortcomings on this appeal it is not possible to re-invoke the idea of deducting group net indebtedness as a whole, as Ms Hindson did, because that indebtedness included the debts of loss-making subsidiaries which have to be taken out of the picture because of the refusal of permission to appeal on that point. We are not in a position to survey all other debts in the profit-making companies. However, there are two other debts which have to be considered as candidates, and in fact Mr Griffiths confined his submissions to bringing in those two debts. They are the two debts which were the express subjects of the judge's original findings – see paragraphs 6, 7 and 8 above. It seems to us that if significant debts, which a purchaser would expect to have to arrange the repayment of, and which have a strong historic element to them so that they are no longer the sort of normal day to day trading debts of the company which would normally be ignored on an earnings-multiplier calculation, have to be deducted, then those two debts should fall into that category. We so determine.
- We appreciate that this has an element of the "do it yourself" about it, which may be of questionable worth in a valuation exercise, but, to be frank, that is partly what seems to have happened in final submissions before the judge. We think that doing it on this appeal is an appropriately proportionate response to the problem with which we are faced, and the result is fair and in accordance with the evidence.
Bank loan interest
- The profit of the company, reflected in its accounts, was calculated after bank loan interest was deducted in the sums of £131,002 for 2006, £193,725 for 2007 and £245,568 for 2008. In his first quantum judgment the judge found that it would be appropriate to take bank interest out of the expenditure figures, with the result that the net maintainable earnings figure would be greater. He did so because he apparently took the view that the bank debt was not a borrowing that was necessary to fund the conduct of the business; it was some form of historic debt which a purchaser of the company would be likely to eliminate, and thus eliminate the interest burden. As to this, he said:
"22. So far as bank loan interest is concerned, Mr Griffiths [counsel for the respondents to the petition] submitted throughout the hearing, very forcibly and correctly, in my judgment, that a purchaser would have to deal with the bank loan of £9.35 million, the more so as on the then terms of borrowing they were only short-term facilities to be met out of the proceeds of any sale of the business. I should mention that at that stage Dr Lit was trying, so it would appear, to sell Sunrise as a whole, unsuccessfully as events turned out. Any purchaser would know that and would have to fund it. Therefore, there will be, at the end, a deduction of the full amount of the debt, as Mr Hanke himself accepted, to eliminate it. In those circumstances, the debt having been eliminated, the bank loan interest, save in respect of such borrowings as are necessary for Sunrise's business, as opposed to such sums as are necessary to fund historic eliminated debt, will not be incurred and the profit will be higher, a point correctly recognised by Mr Thompson in his report, though he did not deduct the interest charges – unsurprisingly, as he did not deduct the bank debt either. I therefore accept that, upon the footing that the bank debt will be repaid, it is appropriate to eliminate the continuing bank interest. Just as it would not be appropriate to allow as a deduction against maintainable profits the funding costs referable to funding the purchase price, so too it would not be appropriate to allow as a deduction from maintainable profits of the funding costs of paying off the historical debt, as the true value of Sunrise without that debt is necessarily higher, and could, for example, be achieved by selling off Sunrise's business whilst retaining that historical debt and paying off the debt (putting an end to funding costs) out of the proceeds, or by capitalising the paid-off debt. It has always been clear that Sunrise is substantially under-capitalised.
23. The interest figures for Sunrise are as follows [and he sets out figures]. There is no evidence that the underlying borrowings, or anything like that, or indeed any borrowings, were needed for the ordinary day-to-day operations of Sunrise."
- On this appeal Mr Griffiths contended that that determination was wrong. The basic method of valuation was by reference to maintainable earnings, to which the deduction of the principal amount of a debt due is irrelevant. There is a measure of earnings which does leave interest out of account (EBITDA – Earnings before Interest Tax, Depreciation and Amortisation), but that was not the measure taken by the experts and, if it had been, a different multiplier would have been applicable to it. Furthermore, as at the valuation date (and therefore as at the date at which a notional purchaser would be assessing the value of the company) the liability to the bank existed, as did the ongoing interest costs. The company did not have the funds to repay the loan. This was the company that the hypothetical buyer was buying. If that notional purchaser decided to "clean up" the bank debt then there would still be a cost in relation to that which would have to be funded; but that is nothing to do with the vendor.
- Mr Butler for the respondent in this appeal says that the judgment is correct. He draws attention to the fact that the judge found that the debt was not necessary to support the company's day-to-day business and arose only because of historical indebtedness. There is no appeal from that finding in relation to the nature of the indebtedness, and it was a finding which the judge was entitled to reach. Mr Thompson had opined that, because each subsidiary had been incurring losses with the exception of one of them, it would appear that bank loans incurred by Sunrise Radio had been used to fund the substantial losses in subsidiaries or to finance the cost of acquiring a substantial property held by Hayes Gate House Ltd (one of the subsidiaries).
- In our view the answer to this point lies in pursuing the logic of the judge's hybrid approach to valuation which, as such, is not the subject of this appeal. The bank debt was, however one looks at it, a cost to the business. A purchaser would, on any footing, pay less for the business than he would have paid if it were not there. The interest was a cost on the profit and loss side; and the amount of the debt was a liability on the balance sheet side. If the basis of valuation had been a pure earnings/multiplier valuation then its adverse effect would have been reflected by leaving the interest in the expenditure side, with the effect of depressing the earnings (to which the multiplier is then applied). If it had been on an assets basis, then the amount of the liability would have been taken out in arriving at the net value. Either way, a purchaser would take it into account in determining what he is going to pay for the business.
- The judge's hybrid approach takes out the liability as such. This would be on the hypothesis that the putative purchaser would pay less for the business because it was there. But if one is going to do that one has to consider what one is going to deduct it from – the earnings/multiplier figure. If that latter figure has the bank interest reflected in the net earnings then the resulting figure will be lower than if it is omitted. The burden of the debt is already reflected at this stage in the calculation. It would be double counting to allow the purchaser a further deduction from the price to reflect the amount of the liability itself. He has already received a benefit because the multiplier calculation has yielded a lower result. No vendor would allow the purchaser to benefit again from the existence of the liability. One reflects the liability either by allowing the interest burden to reduce the multiplier-based figure, or by allowing a deduction from the price of the amount of the liability itself. In this latter event double counting would be avoided by removing the interest burden from the multiplier-based calculation.
- The judge seems to have adopted the latter technique. It follows, logically, that he is right to remove the bank interest from the earnings calculation, thus swelling the multiplier calculation itself. On this footing the judge was right.
- However, one still has to consider the multiplier point raised by Mr Griffiths. He took the point that the multiplier which was applied was one which assumed interest was built into the sum to which it was applied (it was not an EBITDA multiplier). If he is right about that then one would have to consider recalculating the multiplier calculation using a different multiplier.
- That is a little troubling for this court, because we have not seen any material in the court below which demonstrates that the point was considered or debated, much less what the right answer might be. However, we think that ultimately there is nothing in the point. The multiplier used by the experts was derived from some (limited) comparables in which p/e ratios were deduced from comparable businesses. Comparable businesses presumably have similar types of income and expenditure. They might or might not be supposed to have some sort of interest burden, but in the present case the bank debt had been found by the judge to be not one referable to the day to day business of the company. In those circumstances it might be thought to be appropriate to adopt the technique of leaving the interest out of the expenditure side of the multiplier calculation (swelling the resulting figure) because one is then leaving out of account a sum which is atypical of the general run of such businesses and enhancing comparability with the comparables. One is then justified in taking the capital sum out as a liability to be deducted from the multiplier-based figure. One avoids double counting in that way. There is nothing in the evidence which suggests that the multiplier would be any different if that were done.
- Accordingly this ground of appeal fails.
Management charges incurred in Sunrise Radio
- The income figures for Sunrise Radio from which the judge was working in order to produce maintainable net earnings included income from subsidiaries paid by way of management charges. In his first judgment the judge below said nothing about these charges, with the effect that they remained within the income figures and thus swelled the maintainable income. He revisited the point in his third quantum judgment when, according to him, he was asked to clarify the point. He gave the following explanation, in support of a conclusion that strictly speaking the income ought to come out, but it would be matched by an equivalent cost deduction, leaving the overall net figure the same:
"4. I am asked to clarify one point in my judgment. I adjusted the Kismat valuation down to nil. This was because in her valuation Ms Hindson had added back management charges. I have not, however, deducted management charges from the Sunrise valuation, i.e. management charges paid by its subsidiaries, including Kismat.
5. Mr Hanke accepted during argument that, assuming management charges were not, as Mr Griffiths was seeking to argue, deductible, they should, in order to avoid double counting, be taken out of the Kismat valuation, which reduced the Kismat valuation to nil. That did not, however, explain why I did not deduct the management charges.
6. Ms Hindson in her report said:
"Management charges are generally intended to reflect the cost of the provision of management time to the subsidiary companies by the directors of [Sunrise radio]. I have been instructed that the amounts charged for directors' remuneration do not include an additional increment to reflect their services to [Sunrise Radio's] subsidiary companies. On this basis I consider that no further adjustment is required in this regard."
She had already adjusted in her valuation income earned by way of management charges for the purpose of calculating Sunrise Radio's expected future average annual maintainable earnings. No further adjustment was needed to deal with a profit element.
7. As Ms Hindson points out, generally management charges reflect the cost of the provision of management time. Mr Griffiths speculated, probably correctly, that Ms Hindson was not talking simply about the directors. That must be so, because the directors in some of the years that she was considering did not receive any remuneration. She was probably including Dr Lit, and other management as well. But the significance of Sunrise shedding many of its subsidiaries is that the cost of the provision of management time will no longer be a cost that Sunrise need incur, which means that its management team can either be slimmed down, thus reducing its costs, or can devote their time to increasing, even beyond the level of maintainable earnings that I have found, the profitability of Sunrise.
8. There is simply no evidence that the cost which is provided for as management time will now have to be incurred on the hypothetical valuation that I was undertaking. Taking out the management charges, therefore, which is logical, should also be met by taking out the corresponding cost, so that if management charges come out, the costs go down, and the maintainable income is unaffected. Accordingly, it is not necessary, on the evidence I heard, to deduct the management charges, because the cost savings would correspond to the deduction. That again is a fact-finding exercise based on relatively standard evidence. It was, however, the evidence that came from Sunrise's side. If they wished to maintain that there would still be the same level of costs if the management time was deducted, it was for them to put forward evidence to that effect."
- Mr Griffiths submitted that the judge was wrong in holding that there was no evidence that there would be no costs saving once Sunrise Radio was not responsible for managing the subsidiaries which it is deemed would have disappeared on a purchase. He relies on the very paragraph which the judge himself cites as being evidence to that effect, albeit hearsay. Ms Hindson was entitled to gather material for the purposes of the report, and to rely on whatever she thought was appropriate. That being the case, and since the judge had himself acknowledged that it would be logical to deduct the management charges collected by Sunrise Radio, the position on the evidence was that the charges should have been deducted (as Ms Hindson said in the paragraph preceding the one cited) and there should be no counter-figure to reflect cost saving. This would have the effect of reducing net maintainable earnings figure.
- The essence of the respondents' case on this point is that the point in issue is an evidential one on which the appellant did not adduce any, or any sufficient, evidence. There was no factual evidence to support the assertion about directors' remuneration made by Ms Hindson on instructions, and no evidence that there would be no other cost savings.
- The trial judge recognised that logically the management charges fell to be taken out of the maintainable earnings (paragraph 8) and that his calculation had not done so (paragraph 5). In his further consideration of the point he justified the numbers by finding that there would be a commensurate reduction in cost. This part of the appeal therefore really has to focus on whether he was justified in reaching that latter decision.
- A review of the transcript (to which we were not referred in the appeal) reveals that there was limited cross-examination of Ms Hindson on the point by Mr Hanke - just a page and a half (pages 62-3). He pointed out to her the weakness of the material on which she relied (a statement by a Mr Dattani) and she acknowledged that one might deduct costs "if one could identify a few". She also expressed her experience as being that management charges were:
" … just put through for convenience more than actually relating to anything in particular."
- There was no re-examination on the point. Mr Thompson was cross-examined briefly on the charges (20th July, pages 40-41), but no factual case was put to him as to the whether there would be any saving of management time.
- The judge's finding is a factual one. He found that management effort spent in providing services for the subsidiaries would be saved or used profitably elsewhere. There was really virtually no positive evidence on the point (or none that we have been directed to) so the question becomes whether that was a decision that was open to the judge. With some hesitation, we find that it was. In order to justify not adding back in the costs of providing services the case of the respondents to the petition must have been that, despite the service charges (which seem to have been substantial), no cost was incurred in providing those services, and no future expenditure would be saved by not providing them. That requires evidence, and the only evidence was the single sentence about directors appearing in Ms Hindson's report and, perhaps, her expression of her general experience of such matters (which is not strong in these circumstances). It is true that the petitioner did not seek to adduce any evidence of her own on the point, but that is less surprising (and less significant) in the circumstances than the failure of the respondents to the petition to address it more fully. In the end the judge had to arrive at a decision, and we consider that his decision was one that was open to him.
- This ground of appeal therefore fails.
Consultancy fees in Concorde
- As part of the process of valuing the subsidiaries the judge had to reach a conclusion as to the value of one of them, Club Concorde. He dealt with this in his first quantum judgment at paragraph 28. In doing so he had to deal with consultancy fees payable by Club Concorde in respect of the services of Dr Lit. The effect of the first and second quantum judgments was that he left in the calculation a third of the amounts said to be payable to Dr Lit (£60,000 as opposed to £180,000) as a deduction in arriving at net earnings.
- In the first quantum judgment he said:
"28. I then have to consider the value of the second valuable subsidiary, Club Concorde Ltd. Club Concorde Ltd was dealt with in Ms Hindson's report, and she produced a valuation of something like £2.3 million. Mr Hanke adjusts consultancy fees and takes out substantial amounts relating thereto, upon the footing that perusal of the accounts shows that this company is fully managed at a modest rate. I am bound to say that I consider that Mr Hanke is right about this. The evidence at the trial over 2 years ago before me was that Dr Lit had put in an immense amount of effort into bringing Club Concorde round and had now established it as a successful venue. Having brought it round in that way, I have heard no evidence to persuade me that it now needs continued supervision by Dr Lit to a high degree, or by anyone else in a like position, with corresponding consultancy fees of something in the order of £120,000 per year. It seems to me also that the fees payable by the parent (Sunrise) should be sufficient to extend to any incidental consideration of the businesses of subsidiaries, especially given that the Group would be slimmed down following a takeover. Making those adjustments, Mr Hanke calculated, again utilising Ms Hindson's price earnings ratio and methodology, there being none from Mr Thomson, who chose to pretend that the subsidiaries did not exist except when it came to paying tax, that the resulting figure is £2,820,566. I accept that as the value of Club Concorde Limited."
- In the second quantum judgment he added the following:
"17. Criticism was also made of my treatment of Club Concorde. It is said that that was in sharp contrast and contradicted by my approach to consultancy fees as regards Sunrise Radio Limited itself. I refused to alter the consultancy fees in relation to Sunrise Radio Limited upon the footing that there was no evidence as to what an appropriate consultancy fee was, and that, therefore, I was left with the consultancy fees in fact paid. When it came to Club Concorde, however, I reduced the consultancy fees in fact now paid of £180,000 to £60,000. However, that was based upon my finding that the degree of supervision previously given by Dr Lit was, in November 2009, no longer necessary. I should add that the evidence now is that club Concorde is not doing so well. But that is today and not as of November 2009. Having reached that conclusion, I might logically have taken the whole of the £180,000 out, and certainly my reasoning points in that direction. However, Mr Hanke, in the course of his submissions, no doubt not wishing to venture into the area of 'babies and bathwater', prudently left in £60,000. As that was conceded by Mr Hanke, I was not going to [go] further that he was inviting me to do. I do consider, however, that that is an ample allowance, indeed generous, for any overriding management responsibilities not covered in the accounts which demonstrated, as I noted in my previous judgment, that Club Concorde was fully managed."
- Mr Griffiths' point about this is one of inconsistency. When considering the position of Sunrise the judge had provided for all consultancy fees of Dr Lit paid by Sunrise Radio and not reduced them. He submitted that there was no reason for treating the consultancy fees charged to Club Concorde any differently on the evidence that the judge had. This had a significant knock-on effect in relation to the valuation of Club Concorde, increasing it by several hundred thousand pounds (according to Mr Griffiths).
- Mr Butler submitted that the judge's findings were essentially evidence-based and should not be interfered with on appeal.
- In relation to Sunrise Radio the judge found that there was no evidence that the amount of the fees would be saved by a purchaser, but that there was evidence to show that in Club Concorde it would not be necessary to incur the full amount of the fees.
- There is no point of principle involved in this ground of appeal other than the principle that a finding must be supported by evidence. It seems to us that Mr Butler's position, which is that the judge reached evidence-based conclusions in relation to both items, is correct. In the case of Sunrise Radio, the judge started with an apparent need for consultancy (management) services which, on the evidence, he found would continue. Since there was no evidence that it would be obtained any more cheaply by a purchaser he left in the full cost of the services as a debit item. So far as Club Concorde is concerned, he found, on the evidence, that the same level of management would not be required after a purchase, and he came to the best conclusion that he could (apparently not having been well served by the experts) as to the reduced level of management. That is a different conclusion to that reached in relation to Sunrise Radio, but that is because the evidence was different. It cannot be said that he was not entitled to reach that view on the evidence.
- Accordingly, this ground of appeal fails.
Conclusion
- It follows that this appeal succeeds in relation to the external liabilities point, but fails on the other points. The sum payable to the petitioner falls to be adjusted accordingly, and the parties should agree the calculation for the purposes of the order that we make on this appeal.
