TOTAL AIR SUPPLY COMPANY LIMTED V TOTAL AIR SUPPLY COMPANY (2007) LIMITED HC AK CIV-2008-404-7627

TOTAL AIR SUPPLY COMPANY LIMTED V TOTAL AIR SUPPLY COMPANY (2007) LIMITED HC AK CIV-2008-404-7627 24 May 2011IN THE HIGH COURT OF NEW ZEALANDAUCKLAND REGISTRYCIV-2008-404-7627BETWEEN TOTAL AIR SUPPLY COMPANYLIMTEDPlaintiffAND TOTAL AIR SUPPLY COMPANY (2007)LIMITEDDefendantAND JAMES DAVID RITCHIESecond DefendantAND PETER PIKE & ASSOCIATES LIMITEDThird DefendantAND KANU PATELFourth DefendantAND AUTO TEMP AIR CONDITIONINGLIMITEDFifth DefendantAND GILLIGAN & COMPANYThird PartyHearing: 23, 24 May 2011Counsel: G Bogiatto for PlaintiffGD Wadsworth for Third and Fourth DefendantsMC Harris for Third PartyJudgment: 24 May 2011 at 2:10 PMReasons: 25 May 2011REASONS FOR JUDGMENT OF TOOGOOD JThis judgment was delivered by me on 25 May 2011 at 2:10 pmPursuant to Rule 11.5 High Court RulesRegistrar/Deputy RegistrarBackground[1] The plaintiff claims damages for alleged breaches of contractual, tortious and fiduciary duties arising from advice given by the defendants in relation to the sale and purchase of a business. The third and fourth defendants sue the third party for negligent misstatement and claim a contribution or indemnity under s 17 Law Reform Act 1936. The first and fifth defendants have been liquidated, and the second defendant has been adjudicated bankrupt. The case against the third and fourth defendants and the third party was set down for a seven-day trial, beginning 23 May 2011.[2] On Monday morning, prior to the scheduled start of the hearing, Mr Wadsworth, on behalf of the third and fourth defendants (referred to in thisJudgment as "the defendants"), filed submissions objecting to the plaintiff's stated intention to rely on evidence in the proceedings "by way of purported replyevidence briefs which seek to introduce material relating to alleged errors or discrepancies in the calculation of and provision for creditors in the first defendant's 31 March 2007 financial statements."[3] The defendants argued that the plaintiff required leave to admit the evidence under r 9.5(3) High Court Rules, and opposed the grant. Alternatively, if the evidence was to be admitted, the defendants sought an order adjourning the proceedings so that they could prepare cross-examination and evidence in rebuttal.[4] These positions were supported, in general, by Mr Harris for the third party.[5] Mr Bogiatto submitted that the evidence was admissible and that leave should be given to adduce it, in reply, under r 9.5(3). His primary position was that the defendants and the third party had had sufficient notice of the issue and that the hearing should proceed.[6] After hearing helpful submissions from counsel over a full day, both Mr Wadsworth and Mr Bogiatto supported adjournment of the proceedings, in theevent that I granted leave to admit the evidence; Mr Harris indicated his preference for allowing the hearing to proceed, even if the evidence was admitted.[7] After considering the matter overnight, I concluded that the plaintiff should be granted leave to adduce the evidence. I also came to the tentative view that, given Mr Harris's opposition to an adjournment, this might be an appropriate case to order split trials, as between liability and quantum, under r 10.15 High Court Rules. My inquiries with the Registry indicated that, if all issues were adjourned, the case would not be set down for a hearing until about September 2012. On the other hand, if the hearing went ahead as to liability only, it would be possible to schedule any quantum-only hearing, occupying two or three days, towards the end of this year.[8] Before making my ruling, I indicated my tentative views reached in light of the new information as to delay, but sought further submissions from counsel.[9] Mr Bogiatto submitted that it would not be desirable to split the trial. He said the plaintiff was prepared to tolerate the considerable delay that an adjournment would entail but was more concerned about the cost of calling the accounting witnesses (of whom five had been briefed by the parties variously) to give evidence twice if there were liability findings against the defendants and/or third party. He said that the plaintiff would prefer all issues to be dealt with in one trial.[10] Mr Wadsworth supported the plaintiff's position, on behalf of thedefendants, and was also concerned about the added cost of calling the accountants to give evidence twice.[11] Mr Harris submitted that, as the case was currently pleaded, it could proceed now on a liability-only basis, but he drew my attention to the difficulties of severing quantum from liability in a professional negligence case, and in one in which there was a counterclaim by the defendants for contributory negligence.[12] Given the opposition of the plaintiff and the defendants to split trials, andthe third party's reticence on the issue, I delivered a brief oral Judgment confirmingthe granting of leave to adduce the evidence and directing that the case be adjourned, reserving costs for argument at the end of this week.[13] I indicated that I would reduce my reasons to writing. My reasons follow.Background facts[14] In late April/early May 2007, the principal of the plaintiff, Mr McAlister, responded to an advertisement that the first defendant's business was for sale and was provided with a company profile. After conducting his own inquiries with the broker and the principal of the first defendant, a Mr Ritchie (the second defendant) Mr McAlister, gave the profile to the fourth defendant, Mr Patel, and asked for his advice.[15] Mr McAlister made an offer to purchase the business and, sometime after 7 June 2007, a period of due diligence began. A due diligence report was provided by the defendants on 20 June 2007; the agreement for sale and purchase became unconditional on 22 June 2007; and the transaction was settled on 31 July 2007.[16] On settlement, the purchase price totalled $880,000.00, comprising:Tangible assets $25,000.00Goodwill $460,000.00Stock $355,000.00[17] In October 2007, Mr McAlister engaged an accountant, Mr Macdonald, to conduct an investigation into the state of the business and, particularly, to consider the accuracy of the financial statements of the second defendant as at 31 March 2007. The financial statements had been produced to Mr McAlister at the time of the acquisition and he said he relied upon them. The terms of the sale and purchase agreement contained the usual warranty as to turnover, and this was also to be the subject of Mr Macdonald's inquiries.[18] It is unnecessary to traverse the detailed history of the inquiries undertaken for the plaintiff by Mr Macdonald over the period from October 2007 until early this year. It is sufficient note that, in February 2008, Mr Macdonald came to theview that the financial statements included an overstatement of turnover by approximately $500,000.00. Further inquiries revealed that Mr Ritchie had sought to manage the overdraft facilities available to the first defendant and another company he owned, the fifth defendant, by transferring funds between the two companies. The transfers of funds from the fifth defendant to the first defendantwere recorded as "sales" and included as such in the first defendant's financialstatements.The course of the proceedings[19] On the basis of Mr Macdonald's inquiries, the plaintiff issued proceedings, in October 2008, against the first, second and fifth defendants in relation to what was said to be an overpayment for the business. The defendants were also sued for professional negligence in carrying out their due diligence obligations. Damages of not less than $520,000.00 were sought.[20] In May 2009, the third party, a firm of accountants which had been engaged by Mr Ritchie and the first defendant to prepare the first defendant's financialstatements as at 31 March 2007, produced a revised set of financial statements showing a sales figure of $1,677,737.00. This sum was $531,837.00 less than the figure shown in the financial statements provided to Mr MacAlister at the time of the purchase of the business.[21] In an amended statement of claim dated 9 October 2009, the plaintiff alleged that the defendants had breached their respective duties of care to the plaintiff, by providing negligent advice during the due diligence phase in relation to–(i) sales figures;(ii) variance in sales margin;(iii) failure to visit the first defendants' premises;(iv) overdue reliance on statistical information provided by the first defendant;(v) preparation for budgets without verification;(vi) failing to make adequate inquiries as to accuracy and reliability of the financial information provided.[22] The plaintiff's losses were alleged to be $651,989.66 which was said to bethe amount by which the value of the company had been over-assessed, at the time of purchase, as a result of the defendants' negligence.[23] During 2009, the first and fifth defendants went into liquidation, and the second defendant was declared bankrupt, meaning that the proceedings against each of them could not be continued.[24] In about November 2009, a Mr Macdonald, an accountant engaged by theplaintiff to investigate and report on the true state of the second defendant'sfinancial position at 31 March 2007 identified an apparent under-provision for creditors of approximately $130,000.00. Information relating to this apparent discrepancy was sent to the third party in January 2010. This under-provision isreferred to as "the creditors issue".[25] On 11 January 2011, the defendants issued a statement of claim against the third party alleging that it owed the plaintiff and them a duty to exercise reasonable care and skill in the preparation of the financial information produced at the time of the acquisition, and that it had breached that duty in providing incorrect information on which the recipients relied. The defendants sought an indemnity against, or contribution towards, any judgment entered against them in favour of the plaintiff. These claims were made on the basis of the allegations of negligence made by the plaintiff against the defendants as set out in the first amended statement of claim.[26] On 24 January 2011, the solicitor for the plaintiff sent to the solicitors for the defendants, a letter relating to the creditors issue in the following terms:In commencing the preparation of the plaintiff's briefs it has been brought to my attention that additional documents have beengathered by the plaintiff since the plaintiff's list of documents wasfiled.In compliance with the ongoing obligation of discovery I enclosethe following:-1. A copy of the most recent version from Mr Gilligan of the Financial Statements of Total Air Supply Company Limited to 31 March 2007.2. A copy of the Creditors Schedule breakdown of $159,567.00.3. A Schedule labelled "Creditors' Adjustment" prepared byBuchanan Macdonald Limited highlighting various errors found between the Schedule provided by Mr Gilligan in the Statements and correspondence received directly from the suppliers.[27] The letter did not refer to, nor enclose, a copy of a further Schedule labelled"Restated Profit and Loss Data", which had been provided to the plaintiff'ssolicitors by Mr Macdonald, and which was said to show "what would happen tothe Profit and Loss Statement ... [provided to the defendants] with the changes inthe creditors identified."[28] On 7 March 2011, pursuant to timetable orders, the plaintiff filed and served a second amended statement of claim which significantly recast the calculation of the losses alleged to have flowed from the negligence of the defendants. The pleaded loss was reduced to $399,245.00, comprising:(a) $324,998.00, being the $460,000.00 goodwill element of the purchaseprice less $135,002.00 "mitigation" based on an adjusted EBITDAS net profit of $85,038.00 with an applied multiplier of 1.59; and(b) $74,247.00 for overpayment of stock.[29] The particularised breaches of tortious, contractual and fiduciary duties by the defendants were extended by additional generalised claims, but none of the particulars of breach related to the creditors issue.[30] At the time of serving the second amended statement of claim, the plaintiffalso served on the defendants and the third party the plaintiff's written briefs ofevidence. Although the briefs of evidence were not produced to the Court, it is common ground that they did not refer to the creditors issue or explain how thealleged understatement of creditors affected the plaintiff's calculation of its losses.[31] As timetabled, the briefs of evidence to be given on behalf of the defendants, and the third party were served in due course. They did not deal with the creditors issue.[32] It appears to be common ground that, in the context of the issues to be determined at trial, the creditors issue was not raised by the plaintiff directly until it was mentioned, by the expert witnesses briefed to give evidence on behalf of the plaintiff, at a conference of expert witnesses held on 6 May 2011. The expert witnesses briefed on behalf of the defendants and the third party respectively refused to debate the implications of the creditors issue, arguing that it did not arise on the pleadings or on the evidence-in-chief served by the parties.[33] On 9 May 2011, the plaintiff served supplementary briefs of evidence, purportedly in reply to the statements of evidence served on behalf of the other parties, dealing specifically with the creditors issue and purporting to adduce relevant documents in support. This step gave rise to the protests of the defendants and the third party which became the subject of the objection of those parties to the reply briefs, both on the grounds, in part, of hearsay and, more significantly, an objection to the granting of leave under r 9.5(3) High Court Rules.The application for leave to offer the evidence on the creditors issue[34] Rule 9.5 provides as follows:9.5 Supplementary briefs(1) A party to a proceeding who wishes to offer new or further evidence after a brief has been served on that party under rule 9.2 or 9.3 (not being evidence in response to any matter contained in that brief) may serve on every other party who has given an address for service a supplementary brief.(2) A supplementary brief served under subclause (1) must be served as soon as possible after the party wishing to offer the new or further evidence becomes aware of its existence or its relevance.(3) The evidence contained in a supplementary brief served under this rule may be offered as evidence only with the leave of the court.[35] The objection of the defendants and the third party to the admissibility of the creditors issues evidence is founded on the following submissions:(a) The evidence which is sought to be adduced does not reply to any evidence contained in the witness statements filed on behalf of the defendants and the third party.(b) The creditors issue was not referred to in the pleadings or evidence initially served on behalf of the plaintiff.(c) Informal disclosure of information which now appears to be related to the creditors issue was not sufficient to put the defendants and the third party on notice of the creditors issue.(d) The defendants and the third party are taken by surprise and embarrassed in their respective defences by the late raising of the issue by medium of supplementary briefs of evidence.(e) In order to deal adequately with the creditors issue in cross- examination and rebuttal evidence, the defendants and the third party require time and resources which would not be available to them if the trial was to proceed at this stage.[36] Mr Wadsworth referred me to two decisions of this Court: Madretsma Farm Limited v Frizzell1 and Carey v Goodwin.2[37] As indicated above, the defendants and the third party also sought an adjournment in the event that I granted leave to admit the challenged evidence.[38] Mr Bogiatto argued for the admission of the evidence on the basis that the creditors issue had not been uncovered until late 2009, in the course of Mr Macdonald's inquiries, so that it was not a matter which could have beenpleaded with the proceedings were first issued. He submitted that once the understatement of creditors had been identified, it was open to the plaintiff to argue that, notwithstanding that the issue was not relied upon to found a separate cause of action or allegation of breach of duty, the plaintiff was entitled to have it brought into account when the Court assessed the extent to which the plaintiff had overpaid to purchase the business.1 HC Auckland CP 9/94, 28 March 2001 Doogue J.2 HC Auckland CIV-2002-404-1820 , 27 August 2004 Laurenson J.[39] Mr Bogiatto said that the figure of $147,568.00, representing the total of the creditors at 31 March 2007 not brought into the financial statements, increasedthe amount of the plaintiff's claim on a "dollar for dollar" basis, so that excluding that evidence and the issue from the proceedings would significantly prejudice theplaintiff's claim.[40] Mr Bogiatto argued that the defendants and the third party had had ample notice of the creditors issue. Mr Gilligan, the principal of the third party, had beeninvolved in dialogue with the plaintiff's accountant Mr Macdonald and was aware of the impact of the figures by early 2010, and so should have addressed that issue once the third party was brought into the proceedings in early 2011. He also argued that the defendants had been put on notice of the issue when key information related to it had been sent to their solicitors on 24 January 2011.[41] Mr Bogiatto argued that the creditors issue was bound up in the detailed calculations of damages contained in the second amended statement of claim (at paragraph 28) and had been referred to by the plaintiff's expert witness Mr Basrur in his evidence. Mr Bogiatto said that the creditors issues were subsumed in the cost of sales calculation and in the net surplus figure provided by Mr Basrur.[42] It was submitted for the plaintiff that when the second amended statement of claim was circulated on 7 March 2011, the defendants could have requested further particulars of the calculation of loss. It was said that the plaintiff's reply briefs sought to clarify the issue which had been raised at the experts' conferenceon 6 May.[43] Mr Bogiatto's initial submission was that, if the other parties were genuinely embarrassed by the way in which the issue had been brought to the fore, the Court could afford time to them to deal with the issue within the hearing time of seven days which had been allocated. He said that the issue had been with theexpert witnesses at least since the experts' conference and that it was not necessary to adjourn the hearing although, if necessary to do justice to the other parties, the Court could part-hear the quantum evidence.[44] In their submissions in reply, counsel for the defendants and third party emphasised the nature of the inquiries which would need to be undertaken toadequately challenge the creditors issue. In particular, they alleged that it was by no means clear that the invoices or other financial information, which was said to support the allegation that creditors had been understated in the financial statements, proved what was claimed, and that there was simply not time to undertake those inquiries while the trial continued.[45] I raised the possibility, with both Mr Wadsworth and Mr Bogiatto during their oral submissions, of splitting the trial between liability and quantum, because of the superficial attraction of that course in light of Mr Bogiatto's position that thedisputed evidence related only to quantum. Counsel made it clear that both the defendants and the plaintiff were opposed to that course. I did not hear from Mr Harris on that issue.[46] Towards the end of his reply submissions, however, Mr Wadsworth said that while a split trial was the least attractive option, if the evidence was admitted, on the grounds of cost and practicalities, there might be some mileage in proceeding if the plaintiff undertook not to pursue a separate claim against the defendants at a later date on the creditors issue.[47] Mr Bogiatto made it clear that if the evidence was excluded by the Court, the plaintiff would bring a separate claim to have the creditors issue resolved. He re-emphasised that the plaintiff did not want to exclude the $147,000.00 claim from the current proceedings which the plaintiff preferred to be dealt with in one proceeding. He said that he would not, therefore, oppose an adjournment of thecase if the evidence was allowed in. On the basis of the plaintiff's indication,Mr Wadsworth said that the trial should either proceed without evidence or, if the evidence was admitted, be adjourned on the basis that the defendants would claim wasted costs.[48] Mr Harris indicated that his preference was to proceed with the trial, in any event, if the evidence was included, although he acknowledged that the other parties had different views.[49] I took time to consider the parties' positions overnight, mindful of the plaintiff's position that the creditors issues were not advanced as the basis for anadditional cause of action but were relevant to quantum.[50] I had expressed the tentative view, in the course of argument, that it was difficult to see how the impact of any understatement of creditors could be factored into the calculation of damages in circumstances where the defendants were not alleged to have breached any duty of care in respect of that issue. On reflection, I was not prepared to rule out the evidence on that basis. The damages claim arising from the creditors issue represents over a third of the damages claimed by the plaintiff, and Mr Bogiatto asserts that it should not be severed from the total claim at this point. He submits that the plaintiff was encouraged to buy the company, by the due diligence report provided by the defendants, and the total overpayment represents the loss which flows from their negligence in reporting as they did. I do not think it is either appropriate, or even possible, to delve further into that assertion at this pre-hearing stage.[51] As to the submission that the plaintiff is seeking to adduce supplementary evidence which is not strictly in reply to the evidence served by the defendants and the third party, I do not consider that to be the only test for the granting of leave under r 9.5(3). Rule 9.5(2) provides that "a supplementary brief served under subclause (1) must be served as soon as possible after the party wishing to offer the new or further evidence becomes aware of its existence or its relevance".[Emphasis added][52] Mr Bogiatto submitted that the plaintiff had become aware that the further evidence should be led only after it occurred to the plaintiff, and him, after seeing the evidence served by the other parties, that the parties had not engaged with the plaintiff on the creditors issue notwithstanding that it represented a significant component in the damages assessment.[53] That submission does not adequately explain why, if the issue was soimportant to the plaintiff, it was not dealt with in the plaintiff's evidence-in-chief. Nevertheless, I was prepared to accept that the plaintiff may have believed it haddone enough to alert the other parties to the issue by the informal discovery of the relevant documents.[54] However, merely discovering documents, whether formally or informally, at the interlocutory stages of a proceeding is not sufficient to meet the requirements of the High Court Rules as to proper pleading. Having regard to the current discovery regime, based as it is on the broad approach required by the Peruvian Guano3 test, many documents are discovered under the rules which met the broad relevance test but which then sink without trace. The documents which are included in the bundles of documents presented in evidence are there because they are relevant to an issue identified by the pleadings or the evidence to be given by the witnesses.[55] By r 5.26(b) High Court Rules, a statement of claim "must give sufficientparticulars of time, place, amounts, names of persons, nature and dates of instruments, and other circumstances to inform the Court and the party or partiesagainst whom relief is sought of the plaintiff's cause of action." Further, distinct causes of action, founded on separate and distinct facts, must if possible be stated separately and clearly.4 Read together with r 5.21(1), r 5.26(b) requires that a party is to be given "fair notice" of the particulars of a pleading.[56] In the present case, there is nothing on the face of the second amended statement of claim, either in respect of the alleged causes of action or in the stipulated basis for the calculation of damages, to indicate to the defendants and third party that the creditors issue was one which the plaintiff considered to be relevant to its claim. The defendants and the third party say they cannot be criticised, therefore, for not having addressed the issue in the evidence statements which they served.[57] Nevertheless, the plaintiff had drawn the issue to the attention of the defendants in the informal disclosure on 24 January 2011. Further, the third party had been alerted to the issue in January 2010, albeit in a different context, and would have been reminded of it once it was joined to the proceedings. I do not think the defendants and the third party, being accountants, could have failed to3 Compagnie Financiere et Commerciale du Pacifique v Peruvian Guano Co (1882) 11 QBD 55 (CA).4 Rule 5.17(1).understand the significance of the apparent understatement of creditors, in determining the true financial position of the first defendant as at 31 March 2007, when the information was provided to them in January 2011.[58] However, given that the plaintiff repleaded its case, and adduced its evidence, after that discovery but without referring to the issue, I am prepared to accept that the other parties may have concluded that the plaintiff was not relying on the issue, notwithstanding its possible significance.[59] Nevertheless, having regard to the fact that the creditors issue had been raised obliquely, and accepting that the plaintiff and its advisers may have considered that what was to them an important issue had been sufficiently drawn to the attention of the other parties, I considered this case to be distinguishable from those relied upon by Mr Wadsworth in opposition to the granting of leave. In the end, whether leave should be granted under r 9.5(3) is likely to turn very much on the particular facts of the case.[60] I concluded that the question of whether leave should be given was to be determined by considering the overall justice of the case, weighing the prejudice which would be suffered by the plaintiff if leave was refused, against such prejudice as might occur to the other parties if the plaintiff was permitted to adduce it. The prejudice to the plaintiff of effectively removing over a third of its claim from consideration by the Court would be significant. The prejudice to the other parties of admitting the evidence could be dealt with by adjournment.[61] On balance, therefore, I considered that it would be unjust in all of thecircumstances to exclude the plaintiff's reply evidence on the creditors issue and Igranted leave accordingly.[62] I also concluded, however, that the defendants and the third party would be prejudiced in the proper presentation of their respective cases if they were required to respond to the issue this week without adequate time to investigate the proposed evidence, take instructions, and prepare cross-examination and rebuttal evidence.[63] In those circumstances, I considered that two, alternative courses of action might be appropriate. The first would be to adjourn the proceedings as requestedby the defendants; second, it might be possible to direct that the trial of theplaintiff's claim should be split as between liability and quantum, the disputedevidence as to the creditors position being expressly advanced by the plaintiff in respect of quantum only.[64] As noted above, counsel did not favour a split trial, and I adjourned the proceedings to be set down for hearing on the first available date, recognising that that would not be for at least a year.[65] After hearing counsel's submissions as to how the issue of costs in respectof these interlocutory issues would be dealt with, I adjourned the question of costs to 10:00 am, Friday 27 May 2011 for hearing. I directed that the defendants and the third party should file and serve their submissions as to costs by 4:00 pm on Wednesday 25 May 2011, with the plaintiff serving its submissions on costs by 4:00 pm on Thursday 26 May 2011.[66] The parties agreed that, to the extent that it might be necessary to do so, any directions as to interlocutory steps between now and a new fixture could be dealt with also on Friday, with the parties including any representations in that regard in the submissions which they were to file.[67] I record that, in response to a query by Mr Harris as to my tentative views as to costs, I said that while I had come to the view that the plaintiff ought to have pleaded the creditors issue or, at least, covered the issue in its evidence-in-chief, I had not reached a view as to the extent to which the defendants and the third party, ought to bear some responsibility for not investigating the issue of creditors after the January 2011 disclosure. I indicated that it seemed to me that the lion's share ofthe responsibility, however, must rest with the plaintiff.......................................... Toogood JSOLICITORS:G Bogiatto, Auckland, for PlaintiffG Wadsworth, Kennedys, Auckland, for Third and Fourth DefendantsM Harris, Gilbert Walker, Auckland, for Third Party