JOHN GILBERT v. PRAGUE ENTERPRISES LTD AND OTHERS

1985, No. A2200

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

____________

__________________________

ASSESSMENT OF DAMAGES

__________________________

1. This is an assessment of damages, the background to which may be found in the judgment which I gave on 13th March 1991 in favour of the plaintiff. On 16th May 1991, I ordered that the relief to be afforded to the plaintiff should be damages to be assessed. That assessment has crystallized into a valuation of the shares of Stirling Drainage Services Limited (SDSL) as at May 1984, the measure of damages being the price for which the plaintiff could reasonably have expected to sell his 51% shareholding in May 1984.

2. The plaintiff and the defendants called one expert each, respectively Mr. Raymond Hughes and Mr. Jeremy Barr, both Chartered Accountants. Initially, Mr. Hughes and Mr. Barr adopted the same approach. They rejected a method of valuation other than on an earnings or a net asset basis. Each then found an earnings basis to be inappropriate because, from the date of incorporation on 16th January 1982 to 31st March 1984, the annual accounts which had been submitted to and accepted by the Inland Revenue Department showed overall losses. Thus, there were no earnings or profits to project into the future.

3. Mr. Hughes, in fact, carried out a valuation on an earnings basis. This valuation was based upon profits stated to have been made by SDSL in a letter dated 30th September 1983 written by Mr. Fahy's company, A.P. Fahy & Co., but signed by Mr. Fahy, to McConnell Dowell Contractors (Asia) Limited. The latter company had expressed interest in buying shares in SDSL. The profits stated by Mr. Fahy were HK$233,144.89 for the period 1st January to 30th April 1983 and HK$372,618.73 for the period 1st May to 31st August 1983. Mr. Fahy's letter must, of course; be contrasted with the returns made to the Inland Revenue Department showing losses. It is easy, of course, to understand why these documents should differ. It is quite plain, however, that Mr. Fahy's letter is worthless and indeed, in my judgment, I dismissed it as "nonsense".

4. I accept, as Mr. Poll, for the plaintiff, reminded me, that I must approach all documents, and these include the returns to the Inland Revenue Department which were prepared by Mr. Fahy, with a degree of scepticism. My opinion of Mr. Fahy is plain in my judgment. I have to say, however, that I am of the view that the accounts submitted to the Inland Revenue Department in all probability provide a fairly accurate picture of SDSL. SDSL was, in my view, a company which was badly managed and, not to mince words, something of a shambles.

5. In any event, in cross-examination, Mr. Hughes fairly conceded that although there might be exceptional circumstances where it might be possible to exclude the initial losses of a company, that was not appropriate in this case.

6. Both Accountants then turned to a net asset valuation. This they based upon the net assets shown in the balance sheet as at 31st March 1984, being the date nearest to the date of valuation. Mr. Hughes arrived at a figure of HK$3.99 per share, Mr. Barr at HK$4.06 per share. The difference is apparently explicable by Mr. Barr having included intangible assets. It is common ground, however, that the difference is negligible. Mr. Hughes then went on to say that a higher figure could be attributed to the fact that a majority shareholding of 51% is concerned. The higher figure he found difficult to quantify that a premium of HK$2.00 per share could be justify. In the event, in cross-examination, he admitted that this was a figure plucked from the air, and one which he could not justify.

7. Mr. Barr took the view that, rather than attaching a premium, a minority shareholder being disadvantaged could receive a discount. I was somewhat mystified by this proposition. Mr. Barr explained that he had in mind a position where a person buying shares which would leave him with a minority shareholding might acquire them for less than the "going" price if he perceived that the controller or management might act to his disadvantage or behave unfairly. I have no doubt that such a proposition is correct. It does not, in my judgment, have any relevance in the present situation. I shall return to the question of premium.

8. Having dealt with earnings and net asset valuations, Mr. Hughes_. then abandoned them. He said that whatever valuation an accountant may place on the shares of a company, at the end of the day those shares are worth what a buyer is prepared to pay for them, which may be more or less than the accountant's valuation. Mr. Hughes found highly significant 2 transactions. First, in May 1984, the 1st defendant (effectively Mr. Fahy) purchased a minority shareholding of 31.73% for HK$700,000.00 from the Leungs. That put a price on each share of $25.92. Second, in July 1984, the 1st defendant acquired a further minority shareholding of 17.27% for $300,000.00, a price of $20.41 per share. Mr. Hughes said there was no reason to believe that these transactions were other than between willing sellers and a willing buyer, and could see no reason why the valuations to be derived from those sales should not be adopted as the value of the shares in SDSL at the time. Mr. Hughes pointed out that the effective purchaser, Mr. Fahy, was responsible for keeping the books of SDSL and, more than anyone else, would know the true state of the company.

9. In his final submission Mr. Poll argued that the accountancy exercises should be rejected and that an assessment should be based upon the contemporary transactions and the background which emerged during the course of the earlier trial. To do otherwise, he said, would be to give no credit to the plaintiff for his original idea; and to ignore the fact that SDSL had been successfully incorporated and set up to provide a service unique to Hong Kong, that special and expensive equipment had been bought for this purpose, that staff had been trained and that a client base, which included several well-known Hong Kong institutions and companies, had been established.

10. In support of his submission Mr. Poll referred first to a letter dated 28th April 1983 from the legal director of Dyno-Rod plc to the plaintiff in which the author said:

"If you were to be offered somewhere in the region of $700,000 for your shares, it would be a reasonable offer worthy of discussion. You may be able to get more, dependant upon results since December 1982 and any assurances you may be able to give on steps already taken to reduce the flow of continuing losses. As you can see, we estimate at present (on figures available) that you are losing about $4 on every $100 of turnover you earn."

11. I indicated during the hearing that Mr. Poll could not rely upon that document. I confirm that view. The author of the document was not called. There is no indication of how he arrived at a figure of $700,000. Further, the passage cited is at odds with the general tenor of the letter which is that, because of management and other problems, SDSL was arguably worth nothing at all. I regard the letter as irrelevant and inadmissible.

12. Next, Mr. Poll pointed out that other outside parties had expressed interest in SDSL in particular McConnell Dowell. That interest, however, was not consummated. I take Mr. Poll's point that such non-consummation was because Mr. Fahy failed to produce proper audited accounts for consideration by the other party. I do not believe, however, that the production of such accounts would have advanced the matter because, as I have already indicated, SDSL was in a mess.

13. Finally, Mr. Poll relied upon the transaction in May 1984 when the Leungs disposed of their shareholding for $700,000. He pointed out that initially the Leungs had offered to buy up the plaintiff's shares for $1 million subject to production of satisfactory accounting records. Such records not being forthcoming, they disposed of their own shares for $700,000. The Leungs, as Mr. Poll pointed out, were not strangers to SDSL being on the board and having attended regular meetings. They must, therefore, have appreciated that SDSL was worth rather more than the value of its assets.

14. In cross-examination Mr. Hughes conceded that he did not know the background to this transaction. He agreed that, in the absence of information about a transaction, he could not as a general rule offer at any opinion upon it. Unlike Mr. Hughes, I do have the necessary background information. I am aware that this transaction (like the later transaction at $300,000 upon which Mr. Poll did not rely) took place in wholly exceptional circumstances as appear from my judgment. I reject therefore the argument that this transaction or the general background provides a basis for a valuation of SDSL.

15. It is therefore necessary for me to base my assessment upon the accountancy exercises, in particular the valuation based upon net assets. The outstanding issue is whether I should, as Mr. Hughes suggested, attach a premium to the net asset value to recognise the plaintiff's majority shareholding which was available to a potential purchaser. Mr. Hughes, as I have said, was unable to justify any particular premium. In my judgment no premium at all is justified. A premium would effectively attach a measure of good-will to the value of the shares. Goodwill is generally ascertained by reference to earnings, whether those earnings be projected from past performance or calculated by reference to a company's likely future maintainable earnings derived from a scrutiny of items such as existing and future contracts. The material which emerged during the course of trial and during the assessment does not provide evidence to justify any premium.

16. Adopting as I do Mr. Barr's net asset valuation, I find the value of the plaintiff's shareholding at 11th May 1984 to have been $176,225. I assess damages in that amount.

17. I make an order nisi that there should be interest on that sum at the rate of 10% from the date of issue of the writ to the date of this assessment.

18. I make a further order nisi that, except as otherwise provided, the plaintiff should have the costs of the action.