England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
COMPANIES COURT
(MR NICHOLAS WARREN QC)

		Royal Courts of Justice The Strand London Thursday 8 February 2001

Thursday 8 February 2001

1. LORD JUSTICE PETER GIBSON: I will ask Lord Justice Chadwick to give the first judgment.
2. LORD JUSTICE CHADWICK: This is an adjourned application for permission to appeal against an order made on 31 July 2000 by Mr Nicholas Warren QC siting as a Deputy Judge of the High Court in proceedings brought under section 459 of the Companies Act 1985 by Mr Nicholas Crowe, the holder of shares in TFP Ltd. The judge was satisfied that the affairs of the company had been conducted by the second respondent to those proceedings, Mr Michael Hearn, in a matter which was unfairly prejudicial to the claimant. He ordered that Mr Hearn purchase from Mr Crowe the 2,450 ordinary shares and 465 "A" ordinary shares held by Mr Crowe in the company at a price of £225,800; a figure which the judge subsequently varied by an order dated 8 August 2000 to £233,100. Mr Hearn seeks permission to appeal against the order as varied.
3. Mr Hearn does not contend in his application to us that the judge was wrong to make an order that he purchase Mr Crowe's shares. His concern is as to the amount of the price which he has been ordered to pay. The concern is enhanced, no doubt, by the fact that the company has been in liquidation since November 1999. It appears that its shares are worthless. Nevertheless, the judge valued Mr Crowe's shares on the basis that he was entitled to 48.8% of the assumed value of the company as at the date of his order. 48.8% represented the proportion of the capital of the company held by Mr Crowe on the basis that shares issued to Mr Hearn in the year to 30 April 1996 should be disregarded. The judge took the assumed value of the company as at the date of his order to be £477,550. 48.8% of that figure is £233,044, which the judge rounded up to £233,100.
4. The judge directed himself that he should value the company on the assumed basis that the conduct which he had identified as unfairly prejudicial had not occurred: see paragraphs 62(d) and 88 of his judgment. The unfairly prejudicial conduct which the judge found to have occurred was the excessive and unauthorised drawing on account of remuneration by Mr Hearn during the years 1993 to 1997. The judge was satisfied that, had those drawings not been made, the capital adequacy requirement of the Personal Investment Authority would have been met at the end of 1996, and the company would have continued to trade profitably. As he put it at paragraph 88:

".... in practical terms, this means that substantial sums of money which were withdrawn from TFPL by Hearn should be treated as though they had not been withdrawn with the consequence, as I have previously held, that TFPL would have been admitted to membership of the PIA and would have continued in business. The company should be valued on that basis."

5. The judge accepted that the appropriate way to value the company was to apply a multiplier to its maintainable profits: see paragraph 89 of his judgment. That method had been agreed by the expert witnesses who gave evidence before him. The judge accepted also that 5 was the appropriate multiplier. Again that figure had been agreed by the experts. But the judge preferred the view of Mr Hobbs, the valuer called by Mr Crowe, that that multiplier of 5 should be applied to pre-tax profits rather than to post-tax profits. The task, therefore, was to ascertain a figure for maintainable pre-tax profits.That task was made difficult by the fact that there were no reliable accounts for the year to 30 April 1997. But, on the basis of the accounts for the years to 30 April 1995 and 1996, the judge arrived at a figure for maintainable profits for the year to 30 April 1997. That figure was £52,640: see paragraph 105 of his judgment in the amended form in which it was issued on 17 August 2000. The judge reminded himself that that was a figure in respect of a year which was more than three years before the date at which he was seeking to arrive at a value. He thought it appropriate to make an assumption as to the growth of the company between 1 May 1997 and 31 July 2000: see paragraph 108 of his judgment. He took a growth rate of 20% per annum. That led him to increase the figure for maintainable profit as at 31 July 2000 to £95,510. He applied the multiplier of 5 to that figure so as to reach the value of £477,500, which he took as the value of the company. On the basis of the assumptions which he made, the conclusion, as a matter of arithmetic, is plainly correct.
6. The applicant's grounds of appeal, which he has prepared for himself, are, perhaps, somewhat less than specific. They read as follows:

"1. The assumptions made contradicted the written evidence disclosed at the trial.

2. Expert witness made fundamental error when calculating gross margins.

3. No correspondence with auditors by expert witness to clarify gross margins.

4. Timescale between original complaint and trial meant that final calculations in respect of share valuation were to my detriment in an unjust manner."

7. Those grounds are, however, expanded and supplemented by a skeleton argument dated 20 August 2000, and a witness statement dated 5 November 2000. Mr Hearn has developed them further in the course of his oral submissions to this Court.
8. His challenge to the judge's findings may, I think, fairly be summarised as follows:

(1) The judge was wrong to hold that, other than the failure to meet the PIA capital adequacy requirement, there was no reason why the company should not satisfy the requirements of the PIA. It is said that, independently of the failure to meet the capital adequacy requirement in 1996, the continuation of the company's business was in serious doubt for other reasons: see paragraph 11.10 of the skeleton argument. If that ground be made out, it would of course falsify the basis upon which the judge valued the company as a continuing profitable business.

(2) The judge was wrong to make an assumption of 20% per annum growth in 1997 and thereafter: see paragraph 11.5 of the skeleton argument. It is said that that assumption is punitive, in that the company ceased conducting investment business on 28 January 1997. That point seems to be linked to the first. The company ceased conducting investment business because it had ceased to be a member of the PIA; or had decided to withdraw its application for membership because it was unable to proceed. If the judge was correct to make the assumption that the PIA capital adequacy requirement would have been satisfied in December 1996, then the further assumption that the company would have continued to conduct investment business would seem to follow.

(3) The applicant was prejudiced by a valuation taken as at the date of the trial. This is put on two grounds: first, that the claimant did nothing to voice his concerns at a time when he resigned as a director in December 1995 (see paragraph 11.6 of the skeleton argument); and, second, that the date of the trial was delayed (see paragraph 11.5 of that skeleton argument).

(4) The judge was wrong to take as the basis for the estimate of maintainable profit an assumed gross margin of 20% on commissions: see paragraphs 11.1, 11.2, 11.3, 11.4 and 11.7 of the skeleton argument. It is said that if the gross margin had been taken at 15%, the value of the company would have been almost nothing: see paragraph 11.8 of the skeleton argument.

9. The grounds which I have summarised at (1), (2) and (3) may be addressed shortly:

(1) The judge considered the question whether the PIA requirements would have been met if capital adequacy had been established. At paragraph 50 of his judgment he said:

"The last point is of central importance because Mr Crowe's case depends critically on the proposition that, if Mr Hearn had not taken excessive sums from TFPL, its application for PIA membership would not have had to be withdrawn, that it would in fact have obtained membership and would have continued to prosper. In relation to that, I should first dispose of one point: it might be suggested that it was not simply the lack of capital resources that precluded a successful application for PIA membership, but also the general management of the company. As to that, Mr Hearn's case contained no hint of this argument; it arose only very late in the day as the result of a question from me. I mention the point now only to dismiss it since the evidence does not establish it and there is no suggestion from the PIA that, had it been satisfied on capital adequacy, it would have refused membership.... In my judgment it was lack of capital resources, and only that lack, which resulted in the withdrawal of the PIA membership application; if TFPL had had adequate resources, it would have been admitted as a member."

10. The judge was plainly entitled to reach that view on the material before him. In paragraph 11.10 of the skeleton argument, Mr Hearn refers to an intention, if permission to appeal is granted, to apply to adduce other evidence, including a PIA report contemporary with the correspondence at the end of 1996 and the beginning of 1997. But, as he frankly accepts, that report was available to be produced to the judge if Mr Hearn had thought it relevant at that time. There is, as it seems to me, no prospect that that report would be admissible on appeal to this Court.

(2) The judge made an assumption of 20% growth. He did so on the basis of evidence from Mr Hobbs, the valuer called by Mr Crowe, that 25% would be a conservative figure. At paragraph 108 of his judgment (as varied), the judge said this:

"In principle it seems to me to be correct that some allowance for growth should be provided for since, had there been no unfairly prejudicial conduct, the company would still be operating. However, growth for this company a people business effectively means growing the work force (although I imagine that a stable workforce would hope to increase its annual turnover at least to keep up with inflation). Mr Hearn was of the view that the company would need to change direction and become a national, rather than a local, network if it was to achieve the sort of growth Mr Hobbs suggests. I think there is something in what he says. However, I do not consider myself bound to accept Mr Hobbs' assumption which strikes me as high in all the circumstances. I propose to apply a growth rate of 20% pa from 1 May 1997...."

11. It is clear that the judge, there, is balancing the expert evidence from Mr Hobbs against Mr Hearn's own contentions that 25% was too high. He reached a figure of 20%, and I can see no prospect that the Court of Appeal would regard that as outside the range which he was entitled to consider.

(3) The judge was valuing the company on the basis that shares were to be purchased by a willing purchaser. There was no evidence of any offer by Mr Hearn to purchase at any date before the trial. So the date at which the value was to be assessed was, necessarily, the date of the trial -- on the basis that the order for the purchase which the judge was to make would be complied with. I can see no basis upon which it could be said that there was undue delay in presenting the petition it was presented on 7 October 1997 or in prosecuting the petition to trial. This was a matter for which the time estimate was four to five days. It must be kept in mind that the primary defence was that there had been no unfairly prejudicial conduct. That default was put forward on the grounds that the applicant was entitled to draw the sums which he did draw. This was not a petition solely about valuation; it was a petition which raised as the first issue the question whether any order should be made at all. In those circumstances, as it seems to me, Mr Hearn has only himself to blame if it is not until trial that the order for purchase is made; with the consequences that if a growth rate is going to be assumed, then it would continue to apply until trial.

12. In order to address the fourth ground, it is necessary to examine the basis upon which the judge reached the conclusion that the maintainable profit as at May 1997 was £52,640. That figure is the difference between a net adjusted pre-tax profit for the year to 31 April 1997 of £85,640 and a salary for an administrator to do the work that Mr Hearn was doing of £33,000: see paragraphs 104 and 105 of the amended judgment. The judge reached the figure of £85,640 -- from which he was to deduct the salary of £33,000 -- by applying a gross profit margin of 19% to the annualised gross turnover for the year to 31 April 1997 -- a figure of £2,043,912 -- and then deducting adjusted administration costs at an assumed amount of 14.81%. As a matter of arithmetic that computation does produce a figure of £85,640.
13. The applicant challenges the percentage gross profit (19%) which the judge adopted. [I note in passing that the figure which the judge adopted was 19%, as recognised in paragraph 11.8 of the skeleton argument, not 20%, as might have appeared from paragraphs 11.1, 11.2 and 11.3.]
14. The judge reached the conclusion that 19% was the appropriate gross profit margin after consideration of the point in some detail at paragraphs 92 - 94 of this judgment. The evidence put before him by the experts would have led to a gross profit figure in the region of 21% or thereabouts. But, at paragraph 95, the judge addressed Mr Hearn's contentions. He said:

"Now, Mr Hearn says that a gross profit in excess of 15% really cannot be maintained, since that was all that the IFAs were paying. It is certainly reasonably clear that the basic override commission did not exceed 15% (and in Mr Crowe's case was only 14%, reducing to 6% when he resigned as a director in December 1995). However, it must be accepted that the IFAs did also pay other amounts to the company.... If those amounts were to be regarded as reducing TFPL's 'commission expenses', then the gross profit would increase by something slightly over 3%; but as turnover increases, rent from IFAs still only 5 or 6 in number decreases as a percentage of turnover. That would point to the adoption of a gross profit margin for TFPL of something in the region of 17.5% of total turnover .... But if one accepts that gross commission is to be ascertained in that way, one is still left with the problem of how to ascertain the appropriate level of administration expenses and for that one has to return to the accounts as they are really all we have. Taking all these factors together, if Mr Hobbs' methodology is in principle correct, I propose to take, for the purpose of achieving a fair result under section 461 of the Act, the figure of 19% rather than Mr Hobbs' 20%."

15. The judge was pressed, as he properly could be, with a letter which Mr Hearn had written to FIMBRA on 19 December 1996. In that letter Mr Hearn represented to the investigations officer of FIMBRA that commission expenses represented only 80% of fees and were likely to represent a smaller percentage as turnover built up. On that basis, the profit margin which Mr Hearn himself was putting forward to FIMBRA was 20% or more. He was doing that in December 1996. That suggests that Mr Hearn took the view that gross profit margin was not limited to the 15% paid by the IFAs out of their own commissions. The judge had to make what he could of the figures before him; and, as it seems to me, it is impossible to criticise the result which he reached namely a gross profit margin of 19%.
16. The test which we have to apply is this: Permission to appeal should be granted unless the court to which the application is made is satisfied that the appeal has no real prospect of success. For the reasons which I have sought to give, I am satisfied that this appeal would have no real prospect of success and that accordingly this application should be dismissed.
17. LORD JUSTICE PETER GIBSON: I agree.
ORDER: Application refused. (Order does not form part of approved Judgment)