acuity-forensic

Navigating Legal Professional Privilege as a Forensic Accountant

adam.giliberti@avgforensic.com (Adam Giliberti) — Mon, 23 Jun 2025 14:27:16 GMT

How barristers educate and shape our thinking on legal professional privilege

Anthony McInerney SC and Nicholas Bentley’s Australia Law Journal article (2025) - " Can You Really Claim Privilege Over Evidence That You Have Served? Reconciling Conflicting Appellate Authority and Modern Case Management Principles " – brilliantly dissects the tension between traditional privilege doctrines and today’s push for efficient and transparent litigation. As a forensic accounting expert witness with 25+ years working in many different commercial disputes, I see this tension play out in the demands for workpapers, draft reports, and communications involving the expert witness.

Key take-away points from this article

Older jurisprudence, as cited in the article by Anthony McInerney SC and Nicholas Bentley, often maintained that privilege over working papers and draft reports survives until the expert’s finished report is tendered in court. This means that until that formal step occurs, these preparatory materials retain their confidentiality, which support claims for legal professional privilege. These authors contrast this with modern litigation principles, influenced by the push for "just, quick, and cheap" resolutions, identifying a shift that if a final report is disclosed (thereby laying all the cards on the table), then the associated materials which influenced that report should also be available to ensure that litigation proceeds on a level playing field.

The debate over whether working papers and draft reports should retain privilege when an expert report is served is more than academic. It affects:

• Litigation Strategy: A party’s decision on how to organise, review, and eventually serve an expert report can have long-term consequences, i.e. affect the outcome. If the preparatory materials are disclosed, then any inconsistencies or vulnerabilities in the expert’s analysis come under the spotlight.

• Expert Independence: Experts must be able to document their honest opinion free of undue influence from others. The communications with the expert and subjective statements in that process will be examined. Experts must also be aware that if their draft work is later inspected, it might be used to challenge their credibility or the validity of their conclusions.

• Judicial Efficiency: The modern approach seeks to avoid last-minute surprises at trial. By encouraging the disclosure of underlying materials before the hearing, parties can more efficiently resolve disputes or narrow down the contested issues.

Q&A on navigating legal professional privilege from a professional expert witness

I recently joined the authors of this article at a CPD event called 'Privilege vs. Practice: Navigating Conflicting Case Law in the Age of Case Management', to provide my perspective on this topic.

The questions & answers below delve into the operational realities expert witnesses face regarding document control and collaboration between lawyers and experts, often involving reliance on other witnesses. I preface all my answers that I am not meant to be an advocate for my client paying for my work and emphasise the importance for me to remain neutral to the outcome, e.g., my primary goal is to help the court. I align our firm's internal processes with this in mind. Maintaining rigor in arriving at my key conclusions is fundamentally important as too is operating on the pragmatic presumption that any part of my work could be required to be made available to 'other' side and to the court.

Question 1: What documents could be lawfully demanded from an expert witness in litigation?

In short, workpapers, draft reports, and communications are all potential items that may be demanded of an expert witness to be produced under a subpoena.

'Working papers' are essentially the internal notebooks of an expert witness and arguably the team supporting the expert witness, which include raw computations, unpolished analyses, brainstorming notes, and evidence gathering details.

'Draft reports' are the early versions of the final report, where the expert’s initial opinions and methodologies are laid out before refinement.

'Communications' are typically focused around the provision of instructions to me.

These categories of documents can capture the expert's thought process and the analytical journey toward a final opinion contained in the expert witness report.

Question 2: How do you handle requests for underlying documents (e.g., drafts, workpapers, etc) post-service of your final report? Do you see this as a challenge to your independence?

My firm presumes all materials from initial client enquiry stage to the date of the final trial hearing could be subpoenaed. This potential scrutiny ensures that I will be seeking to make all reasonable and desirable enquiries throughout this time period, undertake robust analysis to assist the court, and take precautions to withstand challenges to my credibility and persuasiveness as an independent expert witness.

The primary message to get across to the client(s) paying for my work (via the instructing solicitors) in the event of a subpoena being served is that time will be required to carefully review and consider every document on its own merits. There are usually documents in my possession that do not fall within the requests for certain categories of documents, so specific documents can reasonably be exempt from being produced. Unavoidably, in reviewing documents there is also consideration of potential questions that might seek to discredit me or questions to illicit answers that may be considered helpful to the opposing party without further qualification.

There is also typically a need to forewarn that the reasonable costs of compliance with the subpoena will be above the conduct money that has been provided.

Question 3: Given there is a tension between privilege and modern case management principles for transparency, how can forensic accounting expert witnesses assist in aligning their work with the 'cards on the table' approach while protecting legitimate confidentiality?

My primary focus is on delivering robust expert opinion evidence rather than assisting on procedural battles between adversarial parties. I leave it to the lawyers to argue over the merits of claiming legal professional privilege and using other arguments to object to the subpoena that could be served on me. With that said, the following are practical steps our firm takes take when preparing an expert's report to minimise disputes over privilege or waiver of underlying materials:

• Structured document management . Our firm maintains clear folder structures for all engagements, including segregation of client proposal/acceptance documents, tax invoices and supporting records, working papers, independent research, legal correspondence between parties, documents supplied to our firm, affidavit evidence, pleadings, draft report and final report.

It is important that any draft reports are clearly labelled as such, with any opinion contained therein being clearly stated as preliminary and could be subject to change in the final version. We are typically instructed to mark our communications with "subject to legal professional privilege", and we accordingly follow our instructor's advice to do so.

• Explicit reliance. If I make an assumption in my report drawn from reliance on a document, I cite that document clearly in my report so parties know that the document is part of my evidence.

• Proactive client warning . Our firm's engagement letter states that I need to be independent and be seen to be independent from the client and outcome sought by the client. In practice, this means the client paying for the my services should avoid direct communications with me, use their legal representative to supply documents to me including any assumed facts. This will help preserve any subsequent claims for legal professional privilege in relation to documents held by the client.

• Email minimisation. Solicitors can be busy and focused on other matters, so email can be used as a communication tool between expert and lawyers to provide updates on progress and/or identify problems in proceeding forward requiring decisions to be made. These communications can potentially be fertile ground for informal commentary that could be misconstrued. The less said in emails may be better, however, I always discuss preferred method(s) of communications with my instructing solicitors at the outset (as different firms and different lawyers have different preferences, especially parameters around email). The key principles to adopt are neutrality and to avoid speculative/or and adversarial language in any communications. Also, we limit sending our email communications to the law firm instructing us, and only to those who are on the legal client engagement team.

• Code of conduct for expert witnesses. Expert reports filed with the court that are dated on the same date of the instruction letter from the solicitor essentially invites the opposing party to seek production of all documents given to the expert. There can be valid reasons for why the instruction letter containing the question(s) to be answered by the expert has evolved over the course of the engagement. It is our recommendation that solicitors should not delay in the issue of a letter requesting the services of the expert to act as an expert witness and supplying the code of conduct for the expert witness, so this letter can be attached to the report to be served. This provides greater transparency to the adversarial parties and to the court over when the engagement with the expert witness commenced.

• Notes of meetings. Solicitors are better suited, over expert witnesses, to take contemporaneously prepared notes of meetings involving the expert witness and to prepare a clear summary of action points and any instructions given in respect of the meeting. The use of webconference, and potential for sharing of screens, is a matter for the lawyers to consider, noting that the expert witness is seeking to be transparent to the court in arriving at a concluded opinion.

Question 4: Where do you see the greatest risk for the potential for waiver of legal privilege?

Arguably, the greatest risk arises when instructed on pre-litigation matters. In pre-litigation matters, the legal team may not have all the facts, documents and key assumptions and there may be less formality around the process for supplying relevant documents and information from the client to allow me to carry out the forensic accounting work. Privilege preservation demands disciplined collaboration between lawyer, expert and client so I remind solicitors to manage our mutual client's litigation risks and for the client to take appropriate steps to preserve claims for legal professional privilege.

Matters where the plaintiff strongly believes the matter will resolve without a final hearing also presents risk.

Question 5: What can you practically do to help the client manage its risk for the potential for waiver of legal privilege?

Some clients may seek to bypass solicitors in the early dispute phase to "save costs." I would typically decline these engagements until there is legal representation overseeing the workflow. Solicitors are key to educate and remind their clients on steps required to preserve claims for legal professional privilege, and that the primary role of an expert witness is to assist the court (which overrides the duty to the client).

Occasionally, I take queries from potential clients informing me that their solicitor has said to them to make their own enquiries to find a forensic accounting expert. Typically, I am asked in this initial point of contact to provide an estimate of fees for an unclear scope of work, which requires asking more questions, and this process should ideally be led by the solicitors, and not the client involved in the dispute.

Conclusion

In an era where courts increasingly demand transparency, our protocols turn privilege management from a vulnerability into a strategic advantage in reaching a financial resolution in the dispute. Solicitors are encouraged to contact me to discuss privilege-proof engagement strategies involving client disputes as we welcome and encourage solicitor-filtered workflow for our forensic accounting engagements.

Beyond oppression: Leveraging Civil Penalty Provisions of the Corporations Act 2001 in shareholder disputes

adam.giliberti@avgforensic.com (Adam Giliberti) — Thu, 13 Feb 2025 04:57:16 GMT

Pleading contravention of Civil Penalty Provisions in shareholder disputes

For litigators, shareholder disputes are often a strategic puzzle as to how to reach the finish line which is favourable to the client(s) they represent. Where there is a reasonable basis to do so, pleading a contravention of the civil penalty provisions of the Corporations Act 2001 can be powerful. While often viewed as the domain of ASIC, these provisions can be strategically deployed by plaintiff shareholders in the dispute as it opens compensation under s1317H, which allows for the recovery of ill-got profits, a remedy not always available in a traditional oppression claim.

This article explores how integrating civil penalty claims into your litigation strategy can create superior leverage for settlement and maximize client recovery, with a focus on the critical role of the forensic accountant in quantifying this more nuanced remedy.

Civil Penalty Provisions - A Litigator's Strategic Toolkit

The civil penalty regime was introduced into the Corporations Act 2001 (“ Act ”) to address serious corporate misconduct and enhance corporate governance and accountability in Australia. Part 9.4B of Act addresses the ‘civil consequences’ of contraventions of the ‘civil penalty provisions’. For a potential shareholder plaintiff, the most fertile area to explore often involve breaches of one or more of the following:

director's duties;
share capital transactions, typically involving diluting shareholder interests; and
related party transactions.

For completeness and ease of reference, section 1317E of the Act includes a lengthy table that comprises the civil penalty provisions, which address the following 14 different areas:

Officers' (eg directors’) duties - s180(1), s181(1), s181(2), s182(1), s182 (2), s183(1) and s183 (2)
Responsibilities of secretaries etc. for corporate contraventions - s188(1) and s188 (2)
Related parties rules - s209(2)
Share capital transactions - s254L(2), s256D(3), s259F(2), and s260D(2)
Requirements relating to financial reporting - s344(1) and s344(1A)
Obligation to declare and publish notice if company not eligible for temporary restructuring relief - s458F(1)
Insolvent trading - s588G(2)
Preventing creditor-defeating dispositions -s588GAB(2)
Procuring creditor-defeating dispositions - s588GAC(2)
Duties of responsible entities - s601FC(1)
Duties of officers of responsible entities - s601FD(1)
Duties of employees of responsible entities - s601FE(1)
Duties of officers and employees of responsible entities - s601FG
Duties of officers and employees of responsible entities - s601JD(1)

Critically, an application for a contravention can be brought not just by Australian Securities and Investment Commission (" ASIC "), but by "any person who has suffered loss or damage" —including a shareholder. This transforms these provisions from a purely regulatory tool into a direct weapon for your client.

Beyond Fines: Compensation for a Contravention of the Civil Penalty Provisions

An Australian court can issue one or more orders involving contravention of the civil penalty provisions amd these orders can include one or moreof the following:

a declaration that there has been a contravention of the civil penalty provisions, which can trigger other consequences, e.g. orders for the disqualification of a director from acting as a director, criminal prosecution, other civil litigation, etc;
a pecuniary penalty to be paid;
relinquishment of the benefit obtained from breaching the civil penalty provisions;
refunds for ongoing fees after termination of an arrangement(e.g. charged by financial advisers, investment managers and subscription providers); and
compensation orders.

The most powerful outcome for a plaintiff shareholder is a compensation order . This is the mechanism that directly translates the defendant's misconduct into a financial recovery for your client.

The Adler and Vizard cases, which I briefly touch on below, are just 2 examples that demonstrate the courts' willingness to impose severe consequences for financial misconduct involving ASX listed public companies which garnered high media attention and public interest.

Rodney Adlar (per aticle above) was a director of HIH Insurance Ltd in January 1999 which collapsed not too long after its acquisition of FAI Insurance. Many separate litigation proceedings commenced following the collapse of HIH Insurance Ltd. Mr Adler, and other culpable defendants, were ordered to pay compensation of $7,986,000 for losses suffered by HIH Insurance Ltd and Mr Adler was ordered to repay improper benefits, pay pecuniary penalties and was disqualified to act as a director for 20 years. Mr Adler also served prison time following his admission of guilt in criminal proceedings initiated against him.

In the matter of ASIC v Vizard [2005] FCA 1037, involving a well-known Australian media personality at that time, who was then a company director of Telstra Corporation Ltd, acted on ‘insider information’ and was banned for 10 years from managing a corporation and ordered to pay a pecuniary penalty of $130,000 for each of 3 contraventions totalling $390,000.

The key takeaway for litigators involved in private company shareholder disputes is if there are proveable contraventions of the civil penality provisions, there is a path to significant compensation involving egregious misconduct. The Act refers to the use of a ‘person’ who has contravened the civil penalty provisions. A person can include directors, officers, or the company itself. Applications to commence civil litigation for a contravention of the civil penalty provisions can be made by:

ASIC, which happens to have a long history of successful proceedings against directors of ASX listed companies;
the company involved; and/or
any person who has suffered loss or damage (e.g, shareholders or creditors).

It is the plaintiff shareholder that is of particular interest within this article because if the shareholder can prove a contravention of the civil penalty provisions under the Act, then this opens up the potential for direct compensation to be received following the court’s orders.

Challenges with quantifying value in oppression cases

Commonly, shareholder disputes feature an allegation of oppression made by one or more shareholders, which typically requires the forensic accountant and valuation expert to consider what the value of the shares in the company currently is (or was at one or more different points in time), to assist in a buy and/or sell negotiated outcome or court order under s233 of the Act. This exercise typically requires a static valuation of shares i.e. what were they worth on date X and/or what they are worth at the date of the expert's report?

In the context of considering ‘value’ in oppressive conduct matters, Richard Brockett, wrote in 2012 for the Bond Law Review, the following about the compensatory nature of the available remedy for minority shareholders:

“in his judgment in Scottish Co-operative Wholesale Society Ltd v Meyer [1], Lord Denning held that a purchase order ‘gives to the oppressed shareholders what is, in effect, money compensation for the injury done to them’. This was followed in Re a Company No 002612 of 1984 [2] and in Rankine v Rankine where it was noted that ‘by ordering the compulsory purchase of the applicant’s shares…the court is in effect awarding compensation for the respondent’s breach of duty’[3]. The compensatory nature of the remedy was regarded by the Court, in Smith Martis Cork & Rajan Pty Ltd and Others v Benjamin Corporation Pty Ltd , as being ‘established ever since the decision of the House of Lords in Scottish Co-operative Wholesale Society Ltd v Meyer’[4].”

It is common for an expert witness instructed by lawyers on behalf of the plaintiff shareholders(s) in court proceedings to be asked for an opinion on the ‘value’ of the asset.

The Act simply defines ‘value’ to be an “amount” in relation to the asset, which is not particularly helpful. Therefore, an issue of contention that can arise is what should be the appropriate basis (or standard) of value? Should this be ‘market value’, ‘fair value’, ‘true value’ or something else?

In relation to the term ‘market value’, the International Valuation Standards issued by the International Valuation Standards Committee provides a useful definition for market value which appears to be uniformly adopted by valuation professionals around the world, and is grounded in different courts’ interpretation of its meaning. However, the concepts of ‘fair value’, ‘true value’ and other types of value can be difficult to define in a way that is not subject to challenge so it is suggested that instructing lawyers to provide further guidance to their expert witnesses through the supply of relevant cases.

An additional contentious issue between adversarial parties involving claims for corporate oppression may be the appropriate point(s) in time the assessment of value should be made. As value can change over time, it can be challenging for a plaintiff lawyer to have confidence in what the appropriate valuation date should be.

Benefit of seeking compensation orders in shareholder disputes

Lawyers should consider pleading (subject to having reasonable grounds) a contravention of the civil penalty provisions under the Act and seek an order of compensation as a remedy, thus triggering s1317H of the Act. This is where the role of the forensic accountant diverges from a standard valuation and becomes strategically central as the quantification exercise under s1317H is a dynamic assessment of damage which could involve an 'ex-post' approach (i.e. using hindsight) to measure actual loss suffered up to a current date and likely losses to be suffered into the future, which may include disgorging illicit profits.

Section 1317H of the Act empowers the court to order a person who has contravened to compensate those who have suffered loss or damage due to that contravention. It is worth looking at the words used in s1317H(1) and s1317H(2) of the Act which are:

" Compensation for damage suffered

(1) A Court may order a person to compensate a corporation, registered scheme or notified foreign passport fund for damage suffered by the corporation, scheme or fund if:

(a) the person has contravened a corporation/scheme civil penalty provision in relation to the corporation, scheme or fund; and

(b) the damage resulted from the contravention.

The order must specify the amount of the compensation.

Note: An order may be made under this subsection whether or not a declaration of contravention has been made under section 1317E.

Damage includes profits

(2) In determining the damage suffered by the corporation, scheme or fund for the purposes of making a compensation order, include profits made by any person resulting from the contravention or the offence."

[underlining above reflects author’s emphasis]

Two useful features to consider in relation to any compensation sought under s1317H for contravention of the civil penalty provisions are: a) damage (for loss of profit) means something different to value; and b) the potential for defendants to be held joint and severally liable to pay compensation.

'Damage' is more nuanced than pure valuation work

While an assessment of loss profits and an assessment of value involve similar methods and processes required to be undertaken by an expert witness in court proceedings to quantify the output, the former may include direct financial losses and could extend to consequential losses that are a direct result of the contravention.

In matters concerning the quantum of compensation, the forensic accountant who has been retained to act as an expert witness in court proceedings, will typically consider a financial scenario that assumes the pleaded contravention of the civil penalty provisions, had not occurred, as part of the quantification exercise. This may be referred to as the ‘but-for’ test that applies in many claims for damages in tort.

It seems Australian courts are prepared to unwind the effects of the oppressive conduct to determine value, as it did in the Rankine matter, however, an expert witness tasked to opine on value should be mindful of whether the opinion on the value of the asset at a particular point in time is likely to be affected by the alleged oppressive conduct and if so, how this alleged oppressive conduct can be quantified and attempt to quantify it, assuming it can be done with the evidence made available to the expert and other documents to be obtained.

An exercise to quantify compensation under s1317H of the Act may require assessing the loss by looking back from the present date, which may be referred to as adopting an ‘ex-post approach’. This can be contrasted with a pure ‘valuation’ exercise, which typically requires an assessment of value at a particular date, having regarding only to those known facts or knowable facts that could be obtained through reasonable due diligence, at the relevant valuation date. A pure valuation exercise involving the value of an asset at a historical point in time may be referred to as adopting an ‘ex-ante approach’, where the benefit of hindsight should be ignored.

The potential for joint and several liability for compensation orders

Let’s say, hypothetically, a director of a company accused of contravening the civil penalty provisions, started a competing company which has been trading for a significant period of time. Consideration might then be made to include the competing company as a defendant and the compensation could be assessed on profits made by the competing company. If multiple parties are responsible for the contravention, the Court may hold the defendants jointly and severally liable for the compensation[5].

Conclusion and summary

Seeking an order for compensation under s1317H of the Act for a contravention of the civil penalty provisions is more than just adding another claim to a pleading. It is a strategic decision that reframes the entire dispute around the defendant's misconduct and its financial consequences and with the gathering of the right evidence, can create superior leverage for settlement.

Endnotes

[1]. [1958] 3 All ER 66

[2]. (1986) 2 BCLC 99, 495

[3]. 1995) 124 FLR 340

[4]. (2004) 207 ALR 136, [71]-[72]

[5]. ASIC v Hellicar (2012) 247 CLR 345 and Bell Group Ltd (in liq) v Westpac Banking Corporation (2008) 39 WAR 1

Strategic guide to concurrent evidence in Australia

adam.giliberti@avgforensic.com (Adam Giliberti) — Mon, 18 Nov 2024 05:15:41 GMT

Behind the 'Conclave' from an Expert's perspective

For litigators managing expert witnesses, the 'conclave' and 'hot-tubbing' can be a highly unpredictable phase of the litigation process. A well-managed expert witness in this process is a strategic asset that forces favourable settlements and wins bench decisions. A poorly prepared one becomes a material liability. Drawing from over two decades of experience, here is what every litigator and expert witness needs to know about concurrent evidence from an expert's perspective.

Understanding the battlefield: Primer on Concurrent Evidence

Concurrent evidence is a distinct feature of the Australian civil litigation system, which encapsulates:

Conferencing between the expert witnesses instructed by adversarial parties, sometimes referred to as the 'experts' conclave' (although the terms conference and conclave can have subtle differences as explained below);
Preparation of a written report by those expert witnesses, being the expected outcome of the experts' conference or conclave; and
Tendering of oral evidence, by those same expert witnesses, during the same court session (colloquially referred to as 'hot-tubbing').

The reality of hot-tubbing

Hot-tubbing is a loaded term. More helpfully, the website of the Judicial Commission of NSW contains instructional videos in relation to the provision of concurrent evidence during a final hearing (i.e hot-tubbing), made in or around 2005 featuring a land resumption case in which the expert witnesses were involved, in what seems to be an open conversation between each other and the judge, after the barrister asked a question. My own experience of being in a ‘hot-tub’ has varied considerably across courts, ranging from being invited by ‘my counsel’ to provide the court with an opening statement about my evidence before being questioned by the judge and barristers organaised by topic area, to a very tightly controlled process by the barristers, akin to a more traditional adversarial process, in which each barrister take turns to question the expert witness instructed by the other side on a serious of topics, with little opportunity for the other expert to speak unless the judge intervenes to ask a question. The presiding judge will therefore influence the tendering of oral evidence from the witnesses appearing concurrently.

Case management involving concurrent evidence

Case management across the superior courts of Australia varies between courts and is often case-specific. While the application of concurrent evidence features in many litigated matters across Australia, it is not necessarily the default system across the superior courts of Australia.

The Honourable Justice Lee of the Federal Court of Australia has authored the Joint Expert Conclave Protocol for this. This protocol includes, amongst other things, two somewhat unique features relating to the management of the conference of expert witnesses, being

use of a 'Facilitator', typically an independent barrister, who manages the experts during the conference to assist them in preparing a useful joint report for the Court; and
supply to the expert witnesses about to conclave, a pre-agreed set of questions to answer in a jointly prepared report. Typically, for forensic accounting and valuation-related expert witness engagements, the expert witnesses are opining on matters concerning quantum, so it is less common for instructing solicitors on adversarial sides to consider and agree on a set of questions for the expert witnesses to answer. In this type of expert witness scenario, it is understood that the expert witnesses will be assisting the court by providing their respective reasoning on the quantum of loss or value. However, that is not to say there should be no communication between instructing solicitor and expert witness, before the commencement of the experts' conference/experts' conclave to address other potentially relevant questions for expert witnesses to answer that could assist the court.

Courts across Australia are harmonised, meaning there is a process of making different systems, rules, or practices consistent or compatible with each other in an effort to achieve uniformity across different legal jurisdictions. However, the process and language adopted are not uniform across all the superior courts of Australia. In Western Australia, the terms 'expert conference' and 'expert conclave' are set out in practice direction 4.5.2 Expert Evidence of the Consolidated Practice Directions updated by the Supreme Court of Western Australia in May 2024 , are distinct to make explicit that the Registrar of the Court is involved in the latter, akin to Justice Lee's FCA Joint Experts Concalve Protocol featuring the use of a Facilitator.

Navigating the unfacilitated conference of expert witnesses

In preparing the primary report for court, containing one's opinion evidence, the key steps are:

identify what you need and how to get it;
analyse what you get, make further enquiries as appropriate; and
proceed to write and finish your report, furnishing the opinion which you are qualified to provide with sufficient reasoning.

Sure, there can be challenges for the expert witness along the way within each of the above steps, but he or she can guide others and take control of how the report is prepared for the court with the assistance of lawyers. Assuming one has to appear in court to be cross-examined, one is thoroughly prepared to answer questions in discharging one's paramount duty to assist the court.

In contrast to preparing one's expert witness report and appearing in court to give oral testimony, the unfacilitated 'experts' conference' culminating in the joint experts' report can be a unique hurdle to jump over!

When it comes to the preparation of a joint expert report, seasoned litigators and expert witnesses are acutely aware that the courts' code of conduct for expert witnesses requires that the joint experts' report set out matters of agreement and disagreement, including the reasons for disagreement. Unfortunately, the unfacilitated experts' conference can be relatively more painful than it needs to be if:

you (as an expert witness) have not previously done this exercise of conferencing with another expert witness, sans direction from the instructing solicitors, and not had prepared a joint experts' report;

the other expert witness is not a professional (full-time) expert witness; and/or

the other expert witness is less concerned about discharging the paramount duty to assist the court, and more concerned with maintaining a position in fear of what the lawyers or clients might think if there is a retreat from a previously expressed position.

The above manifests in different ways, and the other expert witness(es) instructed by the opposing lawyer can make the unfacilitated experts' conference process more stressful than it ought to be.

Over the past decade, I have been called to enter into many unfacilitated conferences with other expert witnesses on different occasions throughout the course of any year. The following is a litigator's checklist to help ensure your expert witness is ready for the conference with the adversarial party's expert witness, assuming the conference will not be facilitated by an independent person.

Litigator's checklist before the unfacilitated conference of experts

Mandate early engagement. Don't wait for a court order. Proactively talk with your expert witness and get the expert's views on when this process should be started, as often there may be meritorious reasons to start sooner rather than later. This also obviously requires engagement with the adversarial parties' legal representative. Early engagement narrows issues sooner, reducing costs and creating powerful settlement leverage.
Secure the experts' bandwidth. The expert witnesses should give themselves the capacity to fully engage in the process of conducting the conference, without distraction. This would include making sure your expert witness has delegated unrelated work to others, to have the capacity to do their best work during the conference.
Coach the desired outcome. Assume the matter could proceed to a final hearing, and if this happens, the joint experts' report needs to be a useful document to assist the court and to present your expert witness' opinion as the opinion which should be preferred by the judge. In relation to assisting your expert witness in preparing a useful document, share your preference on the style of the joint report that would assist the court, especially if there is agreement with the adversarial parties' legal representative as to style. There are two polar distinct template styles which are common being: a) a 'Scott Schedule' where a table is prepared with the issue of the left of the table and each expert's response to the right of the identified issue, or b) sequential paragraph numbering where one expert drafts what he or she wishes to write for a particular topic, followed by the other expert writing what he or she wishes to write on that same topic. Some expert witnesses may be inflexible on style, in the absence of any prior direction, which may result in suboptimal joint expert reports. A Scott's Schedule style of joint report typically works best when there is a pre-agreed set of questions to be answered (which would and should involve the expert witness' input in formulating the questions prior to the conference commencing).
Eradicate advocacy from your expert witness . An expert who appears as a partisan advocate destroys their credibility—and by extension, yours—in the eyes of the judge. Remind your expert that emotional language is a sign of a weak argument. In interacting with your expert witness, get insight on whether he/she might allow emotions to creep in during an expert witness conference, including saying and writing things that make the expert witness look unprofessional. The other expert is unlikely going to point out drafting by your expert witness makes him or her look like an advocate. Suggest to your expert witness to find the right words when drafting a joint experts' report to open the door for the other expert to gracefully retreat from what at first seems like an issue of disagreement and ultimately an unpreferred opinion.
Insist on transparent communication on timing . While the expert witnesses should be free to agree to disagree on matters of opinion, and not seek instructions from instructing solicitors, during the experts' conference. The lack of regular communications between the expert witness and the instructing solicitor during a conference of expert witnesses does not mean there should be complete radio silence between lawyers and witnesses. Insist that your expert witness should agree with the other expert witness on a proposed realistic due date (if a due date has not been set by the court) and communicate this date to the instructing parties, and if it subsequently becomes obvious to the expert witnesses that the due date will not be achieved, communicate this to the instructing parties with a revised date for completion. Remind your expert witness that the parties may want to settle the matter before a judge decides the outcome, and submitting a long and detailed joint report that does not give both parties sufficient time to consider its contents before a final hearing has started makes it more difficult for the parties involved in litigation to consider settling the matter.
Have an escalation plan involving uncooperative experts. If the other expert is obstructive, your expert witness' documented efforts to collaborate with the other expert witness may become powerful ammunition to petition the court for a facilitated conclave , reframing the problem as a procedural necessity to assist the court. To avoid reaching this point, always encourage your expert witness to seek to narrow the issues in dispute with the other expert by suggesting the court is likely to view both expert witnesses favourably if a joint report can identify as many areas of agreement as possible, particularly where there are significant issues of disagreement. Where the expert witnesses are opining on matters of quantum, this may involve explicitly alerting your expert witness to be prepared to accept the other side's assumptions, even though they are rigorously disputed by your side, in order for your expert witness to appear impartial and be of assistance to the court.
Encourage your expert to be pithy . Brevity in a joint experts' report should not be achieved at the sacrifice of providing sufficient reasoning for an opinion by an expert. For opinions based on forensic accounting and/or valuation expertise, the matter of disagreement boils down to matters of quantum. If this is the case, remind your expert to always consider what is drafted in a joint experts' report in the context of its relevance to quantum in dispute. As you would know, the judge is not required to make a finding on which expert witness is technically correct on an esoteric point, so encourage your expert witness to focus on the reasoning for disagreement on an issue which is materially significant to the court in terms of deciding on matters of quantum.

The process of concurrent evidence, when navigated skillfully by litigators and its retained expert witness(es), can transform procedure into a decisive advantage. Concurrent evidence provides a clear, side-by-side comparison for the judge and often reveals the core strengths and weaknesses of each party's position. A successful conference of expert witnesses isn't about winning a debate with the other expert; it's about winning the trust of the judge, assuming the matter proceeds to a final judgment. It transforms your expert from a mere witness into a decisive strategic asset.

Top Brands in 2024 per Brand Finance

adam.giliberti@avgforensic.com (Adam Giliberti) — Sat, 08 Jun 2024 01:21:35 GMT

How we value Brands

Brand Finance identifies for 2024 the world's top brands, by value. We value brands too, and this is how we value 'Brand ' .

What is True Value?

adam.giliberti@avgforensic.com (Adam Giliberti) — Thu, 29 Feb 2024 01:13:08 GMT

The High Court of Australia provides guidance

Before addressing what is meant by ‘true value', it is helpful to address bases of value, sometimes called standards of value, which describe the fundamental premises on which the reported values are based on, and also consider the meaning of ‘market value’.

What is meant by 'standard of value'?

There are many different standards of value, including but not limited to ‘book value’, ‘fair value’, ‘market value’, ‘investment value’. In a valuation report, the standard of value adopted should be clearly identified. For example, the book value of an investment asset in a company’s annual report, may not be the same as the market value of that investment, and there could be a considerable difference in dollar amount between its book value and market value. For this reason, the standard of value should not only be identified in a valuation report, the adopted standard of value should also be clearly defined and explained given a different value amount can be justifiably stated depending on that standard of value adopted.

What is 'market value'?

The most common standard of value adopted when preparing a valuation report is ‘market value’.

Market value (sometimes referred to as ‘fair market value’, particularly in the context of valuing real estate) is a widely used concept inside and outside of Australian courts. From a legal perspective, the concept of market value is a well-established one, often referred to by Australian courts as the Spencer test, with the following cited:

“In my judgment the test of value of land is to be determined, not by inquiring what price a man desiring to sell could actually have obtained for it on a given day, i.e., whether there was in fact on that day a willing buyer, but by inquiring "What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?" [1]

Australian taxation law uses the term ‘market value’ throughout multiple sections within different statues, but these various statutes do not actually provide a definition of the term ‘market value’. Fortunately, valuation professionals, and others, can refer to a uniform definition for ‘market value’ and associated commentary within International Valuation Standards (IVS) published by the International Valuation Standards Council [2] .

IVS provides the following definition for ‘market value’ being:

“The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.” [3]

IVS amplify on the above definition of market value by setting out the following significant matters concerning the meaning of ‘market value’ [4] :

a) The expression of market value is at a “valuation date”, reflecting an expression of value at a particular point in time.

b) Market value reflects a hypothetical or actual transaction between a “willing buyer” and a “willing seller”. A willing buyer and a willing seller are neither over-eager nor determined to buy/sell at any price.

c) An “arm’s length transaction” is presumed to be between unrelated parties, each acting independently. Observations of transactions involving related parties do meet this criterion.

d) “After proper marketing” means that the asset has been exposed to the market in the most appropriate manner to affect its disposal at the best price reasonably obtainable. A ‘fire-sale’ of an asset to quickly realise cash because the seller is in financial distress likely reflects a condition which would not reflect a sale under market value conditions.

e) Where the “parties had each acted knowledgeably, prudently” presumes that both the willing buyer and the willing seller are reasonably informed about the nature and characteristics of the asset, its actual and potential uses, and the state of the market as of the valuation date.

Importantly, in forming a conclusion on the ‘market value’ of an asset at a historical valuation date, the use of hindsight is considered not appropriate in forming an assessment of the market value of the asset because the information on which the valuation is based should, in general terms, have been in existence at or before the valuation date. More specifically, only those things which are ‘known’ or ‘knowable’ at the valuation date should be considered. The use of the term ‘knowable’ includes information that could be obtained with a reasonable degree of due diligence.

Amongst valuation and forensic accounting professionals, the definition and principles supporting the meaning of market value are universally adopted and therefore not contentious, notwithstanding that the different professionals may disagree on the amount representing market value at a point in time.

What is 'true value'?

True value is not a standard of value which a valuation professional typically adopt when preparing a valuation report to support a transaction or for financial reporting purposes.

The concept of true value is a legal one, quite old [5] and typically used in the context of someone fraudulently enticing an investor to purchase an asset and perhaps more generally in misleading and deceptive conduct under different statute where the legal remedy sought is damages. True value is also commonly used in the context of estimating damages in shareholder class action litigation [6] , which also falls within the paradigm of misleading and deceptive conduct legal matters.

In this context, Australian courts have referred to true value as ‘real value’ [7] , ‘fair or real value’ [8] or ‘intrinsic” value’ [9] or ‘actual value’ [10] or what an asset is ‘really worth’ [11] or ‘truly worth’ [12] . Australian courts have also referred to true value as ‘fair value’ [13] .

Australian courts have also consistently held, in the context of misleading and deceptive conduct litigation matters:

a) that the proper measure of damages is the difference between the real value of the thing acquired as at the date of acquisition and the price paid for it [14] ; and

b) ‘true value’ can be different from ‘market value’ where market value is “delusive or fictitious” which may be the result of market manipulation or some other improper practice on the part of the vendor, or where the market operates under some material mistake [15] .

Unlike the succinct definition of market value which can be found in IVS, there is no reference to ‘true value’ (or real value, or intrinsic value) in IVS. In the context of seeking to quantify damages in misleading and deceptive conduct litigation, one must appreciate what Australian courts have said about true value and its distinction from market value.

The High Court of Australia has stated [16] :

“although the value is assessed as at the date of the acquisition, subsequent events may be looked at insofar as they illuminate the value of the thing as at that date. A distinction is drawn, however, between subsequent events that arise from the nature or use of the thing itself and subsequent events that affect the value of the thing but arise from sources supervening upon or extraneous to the fraudulent inducement. Events falling into the former category are admissible to prove the value of the thing, those falling into the latter category are inadmissible for that purpose. Thus, the takings of a business subsequent to purchase are generally admissible, not only to prove that a representation concerning the takings was false but also to prove the true value of the business as at the date of purchase. Even when some difference exists between the conditions under which the business was conducted before and after purchase, evidence of subsequent takings may be admissible, "subject to due allowance being made for any differences in relevant conditions". But if it is established that the decline in takings has been caused by business ineptitude or unexpected competition, evidence of subsequent takings is not admissible to prove the value of the business as at that date, events such as ineptitude and unexpected competition being regarded as supervening events. In some cases of deceit, it may also be proper to compensate the defrauded party not only for the difference between the value of the thing acquired and the price paid for it but also for losses induced by the fraud and directly incurred in conducting the business.” [author’s emphasis is underlined]

In a nutshell, ‘true value’ is all about the courts applying the benefit of hindsight to form a view on value at a historical point in time [17] . In contrast, the accepted principles for a definition of market value include that it is not appropriate to apply the benefit of hindsight to form a view on market value at a historical point in time.

The challenge for independent expert witnesses assisting the court on matters concerning true value is making the distinction between subsequent events which are the cause(s) of the departure between price paid and true value which is considered intrinsic to the asset at the time when it was acquired, from those other cause(s) of departure between price paid and true value which is considered to be extrinsic, accidental, independent, or supervening [18] .

In some matters, it may be appropriate for the independent expert witness to opine on a ‘true value’ of an ownership interest in entity conducting a business at a historical point in time. For example, in the IOOF class action litigation decision [19] , the Federal Court of Australia was accepting of the lead plaintiff’s expert witness use of an ‘event study’ as a tool to calculate the ‘inflation ribbon’ representing the difference between the market price of the IOOF security and its ‘true value’ at a historical point in time, notwithstanding that no damages was awarded due to the inability of the lead plaintiff to prove its case on liability.

However, it may not always be straightforward or appropriate for an expert witness to decide what subsequent events are intrinsic or extrinsic to asset acquired in order to quantify true value at the date of acquisition of the asset. Given this, lawyers instructing expert witnesses to opine on true value in misleading and deceptive conduct litigation, ought to provide their expert witness with appropriate guidance (including well worded instruction letters, ideally with instructed assumptions supported by evidence) so the expert witness report assists the court to quantify damages.

Endnotes
[1] Spencer v Commonwealth of Australia (1907) 5 CLR 418, per 432, Griffiths CJ.

[2] The International Valuation Standards Council is an independent, not-for-profit organisation committed to advancing quality in the valuation profession, with the primary objective of building confidence and public trust in valuation by producing standards and securing their universal adoption and implementation for the valuation of assets across the world.

[3] See IVS 104 – Basis of Value, paragraph 30.1.

[4] Paraphrased from IVS104 – Bases of Value.

[5] Peek v Derry [1887] 37 Ch D 541 at 591 per Cotton LJ, 594 per Sir James Hannen, 594 per Lopes LJ.

[6] McFarlane as Trustee for the S McFarlane Superannuation Fund v Insignia Financial Ltd [2023] FCA 1628 at 11, 102, 104,

[7] Twycross v Grant (1877) 2 CPD 469 at 545 per Cockburn CJ; Cackett v Keswick [1902] 2 Ch 456 at 468 per Farwell J; Potts v Miller [1940] HCA 43 ; [1940] 64 CLR 282 at 289 per Starke J; Toteff v Antonas [1952] HCA 16 ; [1952] 87 CLR 647 at 650 per Dixon J; Kizbeau Pty Ltd v W G & B Pty Ltd [1995] HCA 4 ; (1995) 184 CLR 281 at 291 per Brennan, Deane, Dawson, Gaudron and McHugh JJ

[8] Potts v Miller [1940] HCA 43 ; (1940) 64 CLR 282 at 299 per Dixon J.

[9] Potts v Miller [1940] HCA 43 ; (1940) 64 CLR 282 at 300 per Dixon J.

[10] Cackett v Keswick [1902] 2 Ch 456 at 468 per Farwell J.

[11] Stevens v Hoare (1904) 20 TLR 407 at 409 per Joyce J.

[12] Gould v Vaggelas [1985] HCA 85 ; (1985) 157 CLR 215 at 255 per Brennan J.

[13] Broome v Speak [1903] 1 Ch 586 at 605 per Buckley J; Ted Brown Quarries Pty Ltd v General Quarries (Gilston) Pty Ltd (1977) 16 ALR 23 at 31 per Gibbs J. It is important to note that ‘fair value’ has a very different legal meaning in the context of other types of litigation (e.g. corporate oppression matters) and for financial reporting purposes.

[14] Kizbeau Pty Ltd v W G & B Pty Ltd & McLean [1995] HCA 4 at 16 per Brennan, Deane, Dawson, Gaudron and McHugh JJ citing Holmes v Jones [1907] HCA 35 ; (1907) 4 CLR 1692 at 1702-1703; Toteff v Antonas [1952] HCA 16 ; (1952) 87 CLR 647 at 650-651; Gould v Vaggelas [1985] HCA 85 ; (1985) 157 CLR 215 at 220, 255, 265.

[15] Cargill Australia Ltd v Viterra Malt Pty Ltd (No 28) [2022] VSC 13 at 3918 per Elliot J.

[16] Kizbeau Pty Ltd v W G & B Pty Ltd & McLean [1995] HCA 4 at 16 per Brennan, Deane, Dawson, Gaudron and McHugh JJ.

[17] See also HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd [2004] HCA 54 .

[18] HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd [2004] HCA 54 at [40] per Gleeson CJ, McHugh, Gummow, Kirby and Heydon JJ, citing Potts v Miller [1940] HCA 43.

[19] McFarlane as Trustee for the S McFarlane Superannuation Fund v Insignia Financial Ltd [2023] FCA 1628 at [291] to [326].

Tax Gross-Up on Claims for Damages & Compensation

adam.giliberti@avgforensic.com (Adam Giliberti) — Tue, 14 Nov 2023 12:56:21 GMT

What is meant by a tax gross-up and its contraversial use by forensic accountants?

Claims for damages and compensation quantifying loss of profit presented by an expert can include an amount referred to as a tax 'gross-up'. For claimants who are an Australian company, the tax gross-up can be as high as 30% of the total claimed as damages or compensation. This article explores the tax considerations behind the applicability of a tax gross-up and the rate at which the tax gross-up should be based.

Mathematically, imagine:

1. a company claiming damages or compensation in the amount of $7 million for loss of profit quantified by a forensic accounting expert; and

2. the tax gross-up amount of $3 million, which is simply the calculated damages amount of $7 million, divided by 1 minus the tax rate, which is 30% for large Australian companies.

A tax gross-up comprising up to 30% of the total damages claim, is a material amount in the context of any sized calculation of damages! Often, the forensic accountant expert's report quantifying the damages will dedicate scores of pages (maybe hundreds of pages) to explaining how the $7 million damages amount has been quantified. Yet, the only explanation by the expert for the $3 million tax gross-up could be something along the lines of the following "Damages amount will be subject to tax on receipt of the amount claimed as damages or compensation".

At the risk of stating the obvious, this is generally not a satisfactory explanation for the calculation (i.e. the calculated damages amount divided by 1 minus the tax rate). Rather, it is simply two assumptions made by the forensic accounting expert: income tax is payable on receipt of an award of compensation or damages and the tax rate that would be applicable on the award of compensation or damages.

What is the implied justification for calculating a tax gross-up (assuming not explicit)?

As a general statement, the net profits of a business operating in Australia are subject to tax. In more precise and technical terms, the net profits of a business will form part of the taxpaying entity's 'ordinary income' under section 6-5 of the Income Tax Assessment Act 1997 (Cth) ("ITAA").

The terms 'ordinary income' and income according to 'ordinary concepts' used in section 6-5 of ITAA are not defined anywhere in the ITAA. These terms are subject to a very long list of case law in Australia which establishes legal principles to determine whether a particular receipt is considered 'income' or 'capital' in nature.

A common analogy used in tax cases considered by Australian tribunals and courts is that of a tree bearing fruit. If the character of the receipt in the hands of a taxpayer relates to the tree, then it will be considered on 'capital account', whereas if the character of the receipt relates to the fruit, then it will be considered on 'income account'. This analogy, while appearing overly simplistic, is worth bearing in mind when it comes to considering the tax consequences associated with a potential award of damages or compensation.

Tax practitioners (lawyers and accountants) will agree, as a matter of legal principle, that the receipts generated by a taxpayer from the normal carrying on of a business activity in Australia are 'ordinary income'. Where damages are paid for something pertaining to income (i.e. business profit), the damages will be assessed as ordinary income with many Australian tax cases supporting this principle[1]. Therefore some forensic accountants will assume that damages or compensation which is based on a calculation of loss of profit will be taxable when received by a claimant and apply a tax gross-up to a calculated damages amount.

A forensic accountant's assumptions on the applicability of a tax gross-up may be incorrect where the damages amount is considered capital in nature, and the following are a handful of many tax cases in which the Australian courts considered the damages award or compensation receipt to be 'capital' in nature[2]:

1. damages paid for the loss of a taxpayer's profit-making structure - Case Y24 91 ATC 268;

2. damage to goodwill - FC of T v. Spedley Securities Limited (1988) 19 ATR 938

3. payments received by a person for loss of earning capacity - Atlas Tiles v Briers (1978) 144 CLR 202;

4. payments received in consideration of restrictions on his/her future income-earning capacity - Higgs v Olivier (1952) TC 137; and

5. lump-sum damages received in settlement of an unliquidated claim covering both income and capital elements, which cannot be dissected into those elements- McLaurin v FCT (1961) 104 CLR 381.

If the receipt of an award of damages or compensation reflects something that is of a capital nature, further consideration is then required as to the applicability of Capital Gains Tax ("CGT") in Australia, which seeks to tax specific types of capital gains as a form a statutory income under the ITAA. While there is certainty regarding the tax treatment in respect of personal injury compensation awards or settlements (which is an exempt CGT asset and not taxable[3]), there can be much greater uncertainty with claims for damages or compensation outside of this specific area of legal practice focused on negligence compensation.

The key point here is that the fundamental distinction between whether damages or compensation reflects income or capital (or a combination of both) is important because CGT does not capture all types of capital gains and the tax payable may be different if the receipt does attract CGT due to concessional CGT treatment. Therefore, great care is required by the expert forensic accountant, in assuming a tax gross-up is appropriate as a matter of tax law principle and if so what gross-up amount should be included in the damages or compensation quantification exercise.

The danger in making assumptions about tax without knowledge of tax law

The value of a business is, theoretically, a function of the expected future returns and risk. Value for a going concern business can be calculated, practically, as the expected future after-tax cash flow (with the proxy being net profit) into perpetuity, discounted using an after-tax discount rate, to arrive at a lump sum capital amount at a point in time. Forensic accountants tasked with the exercise of quantifying damages or compensation, often import discounted cash flow valuation principles into a calculation of loss of profit, which is how the lexicon of 'loss of profit' frequently enters the domain of damages estimation and quantification. It is a term used by lawyers and other experts and is considered by arbitrators and judges in a final hearing.

It is relevant to highlight that while opposing forensic accountants may refer to their calculations contained in their expert reports as 'loss of profits' suffered by a business, the quantification exercise, which seeks to measure the after-tax profits, that have been/will be lost by the business, does not necessarily mean that a court's award of damages or compensation (or a financial settlement is reached between the parties) will be ordinary income. That is, how the forensic accounting expert(s) characterises the nature of the amount quantified (typically as a 'loss of profit'), is not determinative of the tax consequences assuming the award is made by a court, or a financial settlement is reached between the parties.

It is also worth highlighting how a solicitor's firm pleads its client's case in respect of the claim for damages or compensation is also not determinative of the tax treatment, although the pleadings may be informative as it will outline the specific cause(s) of action and particularise the remedy (including whether it is damages or an account of profits). A court's judgment, which will consider the relevant matrix of facts leading up to the decision and an award of damages or compensation may be decisive from the perspective of how the damages or compensation amount should be taxed, if at all, where it is not agreed between adversarial parties.

The Australian Taxation Office ("ATO") may have a public view on how a particular award of damages or compensation should be treated for tax purposes. The ATO issues rulings and determinations that set out the ATO's views and bind the ATO to those published views. However, the rulings and determinations issued by the ATO, do not establish law and there are examples of the ATO withdrawing its rulings and determinations as a result of an Australian court establishing law that is inconsistent with what the ATO has previously published in a ruling or determination. Furthermore, taxpayers can challenge the ATO's views published in a ruling or determination and convince a tribunal or court that the taxpayer's alternative view, based on a unique set of facts, is appropriate. It is important to recognise that the ATO's views set out in its binding rulings and determinations are akin to lifesaving flags at an Australian beach – if you swim outside the 'red and yellow' flags, you put yourself at greater risk, but it does not mean it will be fatal to do so.

Unsettled tax law involving compulsory acquisition of a leasehold interest

Compensation for the compulsory acquisition of an interest in land by an acquiring authority (usually a government department or agency) is typically found within sections of a particular statute. The relevant statute will provide for compensation for a range of express items, but the express items are not always drafted as 'loss of profits'. Notwithstanding this, 'loss of profits' is frequently quantified by forensic accounting experts and claimed as compensation for the compulsory acquisition of the land.

While Australian courts often decide on the merits of claims comprising loss of profits in the compulsory acquisition of land matters, unfortunately, there is little jurisprudence about tax treatment of the heads of compensation calculated by reference to loss of profits.

Many companies operating a business will occupy business premises under leasehold interest. If the company has to stop business trading or reduce its business trading, which can be proven to be caused following an announcement of a compulsory acquisition, that company will likely seek to claim the actual and/or expected loss of profit as compensation.

Let's assume that an acquiring authority agrees to pay some lesser amount for 'loss of profit' to acquire the leasehold interest held by the company. Will the compensation received by this company, for the surrender of the lease, be considered as 'income' or 'capital' for tax purposes? The High Court of Australia considered the tax character of a lease surrender payment and said the following:

" A lease surrender receipt of a lessee for the surrender of a lease which occurs as a singular transaction (other than one that occurs as an ordinary incident of business activity) would not constitute assessable income unless the transaction involved a business operation, commercial operation or adventure in the nature of trade "[4]

The ATO has since adopted legal principles from the above tax matter publishing Taxation Ruling TR2005/6 – Income Tax: Lease Surrender Lease Payments and Receipts. Assuming a lease surrender payment is on capital account, consideration may be given to potential CGT consequences. On this issue, the ATO has issued a ruling dealing with compensation and CGT called Taxation Ruling TR95/35 – Income Tax: Capital Gains: Treatment of Compensation Receipts. The spirit of this (TR95/35) ruling is that the ATO will adopt a 'look through approach' to determine the most relevant underlying asset which is the subject of the compensation receipt. It may be argued, based on the relevant facts, that the underlying asset which is the subject of the compensation award is a leasehold interest. Relevantly, section 108.5 of ITAA specifically includes a leasehold interest in land as a CGT asset and section 124.70 of the ITAA provides CGT 'roll-over relief' in relation to any CGT asset that has been compulsorily acquired by an Australian government agency, effectively meaning that no CGT or income tax could be payable.

Seek independent tax advice

Recently, I was involved in a New South Wales court-litigated compulsory acquisition of land involving Sydney Metro's acquisition of a leasehold interest by an individual conducting a business. A corporate 30% tax rate was applied and a tax gross-up (of 30%) was calculated by the forensic accounting expert on behalf of the business owner and included in the compensation claim. There was no satisfactory rationale stated for the 30% tax rate and tax-gross-up assumption adopted. The barrister for the business owner submitted to the court and relied on ATO Class Ruling 2020/15 and Class Ruling 2020/16 in support of the gross-up calculated.

Paragraph 31 of these Class Rulings stated that compensation by Sydney Metro could include loss of profits and paragraph 9 of these rulings stated that the ATO would assess compensation for such loss of profit as 'ordinary income'. In this matter, the court did not award any loss of profits, so the court did not have to consider the proper characterisation of the compensation which would inform on potential tax consequences and therefore applicability, if any, of a tax gross-up.

The lesson for forensic accountants to heed is that even if the court did award a loss of profit, the 30% tax gross-up was something that was contested and the business owner did not seek to rely on any independent tax opinion that could have supported the forensic accountant's tax calculations and tax gross-up. If forensic accountants, who are usually experts in quantification of loss of profit, have insufficient knowledge of tax law, they should not assume without further thought that a calculation of loss of profits if awarded would be taxable as income and they should encourage the claimant to obtain an independent tax opinion to support the forensic accountants claim.

Endnotes

[1] Credit to Andrew Ryder, Barrister-in-NSW, for identification of the following cases: compensation paid to a farmer for lost trading income - Gill v Australian Wheat Board [1982] NSWLR 795, damages awarded to a landlord for lost rental income- Raja's Commercial College v Gian Singh & Co [1976] 2 All ER 801, and damages for lost company profits- Liftronic Pty Ltd v FCT 96 ATC 4425.

[2] Also credit to Andrew Ryder, Barrister-in-NSW for identification of these cases.

[3] Section 118.37 of the ITAA.

[4] Paragraph 106, FCT v Montgomery (1999) 198 CLR 639

Valuation discounts – what are they, how to quantify them,& are they always relevant in disputes & litigation?

adam.giliberti@avgforensic.com (Adam Giliberti) — Mon, 07 Aug 2023 03:12:35 GMT

Valuation discounts - what are they, how to quantify them & are they always relevant in disputes & litigation?

This article addresses the highly contentious issue of ‘valuation discounts’ and their relevance in a valuation dispute, requiring expert evidence to opine on the ‘value’ of shares in a private company for potential or actual use in court proceedings. As detailed below, valuation discounts can be observed from empirical market data.

Consider an example of 3 equal shareholders in a very large private company operating a business. Let’s say that one shareholder wants to exit the investment in this private company (not related to any dispute). That shareholder would want the maximum possible amount, so should reasonably expect to receive a ‘market value’ consideration for those shares held in the private company.

The concept of market value is based on long-established common-law principles [1] involving a hypothetical or actual transaction between a ‘willing buyer’ and a ‘willing seller’, with both parties acting knowledgeably and neither being overanxious to transact. In this common, but hypothetical case example, let’s also assume:

that it is possible to derive the value of the business operated by the company based on the price paid by a public company to recently acquire a comparable business; and
there are no surplus assets or debt held by the subject private company (i.e. the value of the business and the value of the company are the same).

The question then becomes, is the market value of the exiting shareholder’s interest one-third of the value of the business?

The commercial reality is the ‘market’ would likely apply the following to the exiting shareholder's one-third interest in the private company:

A discount for lack of control; and
A discount for lack of marketability

What does a lack of control discount represent?

A lack of a controlling interest in a company, all other things being equal, is less attractive than a controlling ownership interest in the same company. This relative unattractiveness attracts a discount for a lack of control.

A lack of control discount represents the absence of additional rights that are afforded to controlling owners. The value of a controlling ownership interest depends on both the legal power and rights conferred by the holding, as well as the economic potential of exercising those rights. Examples of things a controlling owner may be able to do that a minority owner cannot, and are therefore considered valuable, may include:

select directors, officers or employees;
decide on levels of compensation for officers, directors and employees;
decide with whom to do business and enter into binding contracts, including contracts with related parties;
decide to pay dividends to shareholders and, if so, how much;
register for listing on a stock exchange (assuming financial criteria for listing are met);
make acquisitions or divest subsidiaries or divisions;
buy, sell or hypothecate any or all company assets (assuming it is in the best interest of the company to do so);
determine capital expenditures;
change the capital structure;
amend the company’s constitution;
sell a controlling interest in the company with or without participation by minority shareholders;
determine policy, including changing the direction of the business; and
block any of the above [2] .

How to calculate a lack of control discount?

It is possible to observe a premium paid for quoted prices of shares in a publicly listed company by an acquiring entity seeking to obtain control of that public company.

In Australia, studies have been conducted by different firms about control premiums paid by Australian companies operating in different industries. There are also similar studies conducted about companies listed on international stock exchanges. It is also possible for forensic accountants and valuation professionals to review Independent Expert Reports prepared for shareholders of public companies which are the subject of a merger or acquisition. These studies provide a range of different control premiums which can be observed, with different means and medians.

This article does not address in detail what these studies show. However, for illustrative purposes only, a forensic accountant and/or valuation professional might conclude that a control premium in the order of 20%, or significantly more, could apply based on one or more of those studies.

The fact that it is possible to observe a control premium allows for a calculation for a lack of control discount, which is the inverse of a control premium i.e. 1 minus (1 divided by (1 plus ‘control premium’)). For example, if one considered a 20% control premium would be applicable, an implied lack of control discount would be approximately 16.67%.

It is critically important to emphasise that valuation practice is based on sound professional judgements, which are subjective in nature. The application of a formulaic approach and observable data without any rationalisation of numerous and important professional judgments does not mean that a credible valuation opinion is produced.

What does a lack of marketability discount represent?

The marketability of an ownership interest in an asset (and in this article, considered in the context of a parcel of shares in a private company) refers to the owner’s (shareholder’s) ability to convert the asset (shares) into cash.

There are two dimensions to marketability; the price realised for the shares and the amount of time required to sell the share. These two dimensions are related as it may be possible to reduce the time taken to sell the share, by discounting the price. The more marketable a particular parcel of shares, the greater the ability to sell the parcel of shares at the desired price. In this sense, the lack of marketability is also referred to as illiquidity (and the lack of marketability discount can also be referred to as an illiquidity discount).

A parcel of shares in a public company listed on the Australian Securities Exchange can be easily and readily sold when there is typically a high volume of shares in that company bought and sold between parties daily. In contrast, it usually takes much longer to sell a parcel of shares in a private company and there may be additional costs to advertise and market the shares for sale.

How to calculate a lack of marketability discount?

Various studies of empirical data seek to identify a lack of marketability discount. These studies can be categorised into two types:

Initial Public Offering (“IPO”) studies. IPO studies examine the prices of transactions in shares of private companies, compared to the eventual IPO price of the same companies to estimate the premium paid for tradable, marketable shares, and conversely the implied discount for the lack of marketability.
Restricted stock studies. These studies compare the trading prices of a company’s publicly held stock sold on the open market with those of unregistered or restricted shares of the same company sold in private transactions. These publicly available restricted stock studies relate to non-Australian companies.

It is relevant to acknowledge that a lack of control in a private company will manifest into a lack of marketability attached to the minority ownership interest, as this ownership interest does not have control of the company (and business) and therefore the parcel of shares is less marketable. While valuation theory and practice recognise that a lack of control discount and a lack of marketability discount are separate discounts, it can be difficult to objectively allocate separate discounts for lack of control and lack of marketability. Care is required to avoid a situation where risks are double-counted in valuation.

The lack of marketability discount is, unavoidably, ultimately a matter of professional judgment, based on the analysis of the relevant facts for the subject company.

Does a discount for lack of control and/or lack of marketability always apply?

About the hypothetical example of 3 equal shareholders in a very large private company operating a business, where one shareholder wanted to exit the company, valuation professionals would likely agree that the ‘market’ would apply a discount for lack of control and lack of marketability to that shareholder’s interest. However, valuation professionals (and brokers) are likely to have different views on the quantum of such valuation discounts. In the context of disputes and litigation, the applicability of such valuation discounts is less straightforward.

In tax disputes, the standard of value known as ‘market value’ is typically prescribed by statute, so its adoption ought not to be contentious. However, while it is generally accepted that market value would require consideration for a lack of control and lack of marketability, it does not follow that a minority ownership interest in a private company requires consideration and quantification of these valuation discounts. For example, in the case Commissioner of Taxation v Miley [2017] FCA 1396 , where there were 3 equal shareholders, the Court determined, based on the relevant facts of that case involving an actual sale of the company’s shares to an arm’s length third party, by all shareholders, no discount for a lack of control should be applied to the one-third interest sold by Mr Miley.

In the context of the compulsory acquisition of shares, under section 667C of the Corporations Act 2001 , the term ‘fair value’ is specifically used for establishing the value of the shares to be acquired. This section prescribes the steps in which this should be done that effectively and disregards any discount for a lack of control attached to the parcel of shares held [3] .

In the context of shareholders who are employed by a company to operate a business and who can no longer work with each other, the resolution of the shareholders' dispute is often dependent on an agreement reached on the value of a particular shareholder’s interest in the company. Thus requiring one or more shareholders, to buy out the other shareholder, which implies the seller is agreeable to the price (i.e. there is agreement on market value).

However, in the absence of a shareholder agreement prescribing the standard of value that should be adopted, the issue of whether a discount for lack of control should apply can be vexed [4] . Even if such a discount should apply, what quantum should apply can be contentious and may prevent the shareholders from reaching an agreement over the value of the shares.

In cases involving claims for oppression under section 232 of the Corporations Act 2001 , the courts have wide-ranging powers to remedy oppressive conduct which includes an order for the members’ shares to be acquired under section 233 of the Corporations Act 2001 and setting the price for those shares. Potential claims for oppression by a disgruntled shareholder and the potential remedy to have the court adopt a standard of value that is different from market value (such as ‘fair value’ as addressed earlier) can result in strong disagreement over the applicability of a discount for a lack of control attached to the parcel of shares (representing a minority ownership interest) in absence of a shareholders agreement.

In family law matters, Australian courts have referred to the concept of ‘value to owner’ which can be distinguished from the established principles of market value [5] . Without going into detail, the principles relating to 'value to owner' do not require any consideration of a 'hypothetical buyer' and therefore it may follow that it would be inappropriate to consider and quantify a discount for lack of marketability.

Conclusion

As forensic accountants and valuation professionals, we need to be mindful of the legal framework and purpose for which our valuation opinions are sought. While we can offer an opinion on matters of quantum of share value based on our expertise, the issue of whether a discount for lack of control and/or discount for lack of marketability should apply in a particular valuation engagement, involving a dispute, is ultimately a matter of law (i.e. ultimately for the Court to decide) and not necessarily a matter for the expert to opine on. We encourage instructing solicitors to provide forensic accounting and valuation experts, tasked with expressing an opinion on the quantum of share value, with case law that would be used in submissions to a court in a potential final trial hearing regarding the applicability of the above valuation discounts in the context of a particular valuation dispute.

Valuation discounts can be a source of disagreement in shareholder disputes where one or more shareholders wish to exit from the company. The highly subjective and contentious nature associated with quantifying a discount for lack of control and/or discount for lack of marketability provides specific context over why a shareholder agreement is worth having in place for companies (or unit trust) with more than one shareholder (or unitholder).

Endnotes

[1] In Australia, the principles can be traced to Spencer v Commonwealth of Australia (1907) 5 CLR 418.

[2] Pratt, S., 2009, Business Valuation Discounts and Premiums , Second Edition.

[3] Eight principles can be derived from the concept of ‘fair value’: Capricorn Diamonds Investments Pty Ltd v Catto & Ors [2002] VSC 105

[4] Where there is a shareholders’ agreement prescribing ‘fair value’ to be adopted, the valuation should ignore consideration of a discount for lack of control: Toll (FHL) Pty Ltd v PrixcarServices Pty Ltd & Ors [2007] VSCA 285, Candoora No 19 Pty Ltd v Freixenet Australasia Pty Ltd & Anor (No 2) [2008] VSC 478.

[5] Most recently in Gare & Farlow [2023] FedCFam C2F 109.

Loss Of Profits Claimed As Damages

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 28 May 2023 22:10:00 GMT

Deeper dive into the ‘but for’ scenario

This article addresses the considerations of an expert, tasked with quantifying claims for loss of profit, as part of a claim for damages or compensation, as it relates to a ‘but for’ scenario. This article also addresses key documents that instructing plaintiff lawyers would likely need to help procure from their client to assist the expert to quantify damages.

The remedy of damages seeks to restore, in monetary terms, the claimant to the position it would have enjoyed but for a particular event giving rise to a cause of action in litigation. In relation to a claimant operating a business, the damages claimed will typically include a claim for loss of profits. A claim for loss of profit may also be imported into the paradigm of compulsory acquisition of land matters where a business is involved.

In factual circumstances where the business ceases to exist following the date of the cause of action, it may be appropriate to claim the value of the business, however, this article will not address a claim for damages representing the value of the business immediately before the date of the cause of action. While there are many similarities between a claim for loss of profits and a claim for business value forming part of damages, this article addresses the latter and not the former.

The key principles for quantifying damages can be illustrated diagrammatically and simplistically, using a line graph. As shown in Figure 1 below, the X-axis represents time and the Y-axis represents a level of annual profit at different points in time.

Figure 1 shows:

a) a business has a certain level of profits as shown by the yellow arrow and at a historical point of time, an event happens which gives rise to a cause of action (i.e. the right to commence litigation proceedings in a court); and

b) the profits of the business fall after the date of the cause of action relative to the profits of the business prior to the cause of action.

One of the primary objectives of the expert in calculating damages is to determine what the claimant’s profits would have been, but for the cause of action. Figure 2 below shows a dotted line reflecting the expert’s view on what the claimant’s profits would have been but for the cause of action.

In very basic terms, the difference in profits in the but for scenario (i.e. absent the cause of action) and actual scenario (i.e. as a consequence of the cause of action), as shown in Figure 2 above, represents the loss of profits that will be claimed as damages.

Common steps to calculate loss of profits in damages

The illustration in Figure 2 above is a simplistic illustration because it is not common to identify such an obvious pattern of profits before and after the date of the cause of action. Furthermore, the expert will also need to consider the following issues which are often matters which can be highly contested:

Period of loss, i.e. when does the loss end? This is the convergence between the solid yellow line and dotted orange line shown in Figure 2 above. Standing at present day, it may be difficult to know with certainty as the point in time when the two lines will converge. In a breach of contract damages claim, it may be the point in time when the contract is assumed would have been completed, however, if the claim for loss is pleaded as a tort in the alternative, the loss may extend beyond the assumed contract completion date. The answer to this question will depend on the facts and may be the subject to expert evidence. Experts do need to be mindful, when claiming a long period of future loss, including a loss into perpetuity, that a plaintiff has a duty to mitigate its loss.
What is the revenue in the but for scenario? There are three different methods that an expert might consider to opine on what the revenue would have been in a but for scenario, which is addressed in more detail below.
Which costs are relevant? The subject of the claim for damages is a loss of profits. It is generally accepted that ‘net profit’ is the difference between revenue and costs. However, accountants can and do adopt many different measures for the net profit of business. In the context of a claim for damages, experts will often disagree on which costs are relevant. For example, rent for use of a business premises is typically a fixed dollar amount. In many scenarios, there may not need to be a deduction for rent expense in calculating damages, however, if the estimated revenue for a manufacturing business in a but for scenario is above the current production capacity of the business, then it would be necessary to make a deduction for rent for additional premises. The simple answer is that those costs which have a nexus with the revenue claimed to be lost are relevant and should be deducted from the revenue. This may include capital costs, finance costs and income tax (on taxable net profits calculated)
Calculating present value of losses. This requires considering the appropriate assessment date and discount rate. The considerations regarding an assessment date in damages are addressed in this article. The considerations regarding a discount rate are addressed in this article.

An expert should consider the history of the business prior to the date of the cause of action and, in reality, observing a pattern that looks like that shown in Figure 1 above can be rare as the patterns observed in Figure 3, Figure 4 or Figure 5 below are far more common.

Documents to be procured and supplied to the expert as part of the initial briefing

Before plaintiff lawyers seek to brief an expert, plaintiff lawyers can assist by obtaining from their firm’s client and supplying the expert at the time of briefing with the following documents:

Assuming the claimant is not a publicly listed entity, the claimant’s income tax returns for 5 years prior to the date of the cause of action and all years subsequent to the date of the cause of action;
Assuming the claimant is not a publicly listed entity, the legal entity’s financial statements (comprising a balance sheet and profit and loss statement) for 5 years prior to the date of the cause of action and all years subsequent to the date of the cause of action; and
Where the claimant operates more than one business division and/or geographical department and tracks the performance for each business division and/or geographical department, the internal management reports prepared by the claimant showing the income and expenses for the each business division and/or geographical department for 5 years prior to the date of the cause of action and all years subsequent to the date of the cause of action. If the claimant routinely prepares forecasts for its business as part of its management processes, the management reports should also show the actual performance compared to forecast performance.

The above documents are unlikely to be the population of relevant financial documents that the expert would need to consider to quantify a claim for loss of profits forming part of damages. However, it will be a very useful starting point to identify the performance of the business before and after the date of action and guide the expert on the further documents and information required to progress the claim for damages.

So what are the methods that an expert could apply to assess the revenues and net profits in a but for scenario?

Before-and-after method

As the name of the method suggests, a ‘before-and-after’ method assumes the business’ revenues which happened before the date of the cause of action would have continued after the date of the cause of action, absent the event giving rise to the cause of action.

The before-and-after method requires obtaining historical financial data for the business for a sufficient and appropriate period of time before the date of the cause of action. The defendant’s expert may try to undermine the damages calculation by opining that the ‘after period’ is different to the ‘before period’. For example, the before period may be before the arrival and spread of COVID-19 and it would not be appropriate to assume that revenue generated by the business would continue in the period after the arrival and spread of COVID-19.

Comparable method

As the name of the method suggests, the comparable method relies on the performance of a comparable business or a group of comparable business (say the industry) and using that comparable as a benchmark to estimate the revenues the plaintiff would have earned but for the wrong perpetrated by the defendant.

This method is useful where there is an insufficient track record to apply the before-and-after method. Alternatively, this method can be used to support the findings of the before-and-after method.

A pitfall of the comparable method is that it is not based on the actual performance of the business in question but on a notional performance determined by comparison, which raises the question of whether the benchmark selected is in fact an appropriate comparable for the business. A proxy business may appear comparable on a qualitative basis (location, number of employees, sales offerings and other physical characteristics) but not necessarily comparable on a quantitative basis (i.e. its revenue is different due to other factors).

Acceptable proxy firm candidates should be similar in size, product line, markets and other relevant factors. Caution should be used before applying the comparable method, given the difficulty in identifying appropriate proxy firms.

Market method

As the name suggests, a market method to estimate revenue in a but for scenario is developed using assumptions arising from a study of the industry and of the plaintiff’s operating results in the context of the industry.

Typically, the market method requires an understanding of the revenues of the entire market in which the claimant is just player in and an understanding the claimant’s market share position in the periods prior to and after the cause of action. The market method is best suited to situations:

where there is a high degree of concentration of key players in the market;
the claimant was known to also be a key player in the market prior to the date of the cause of action; and
the claimant is ‘sophisticated’ and ‘methodical’ in the sense that it has a clear business plan (outlining its strategy and tactics to achieve its vision) and prepares forecasts and tracks its progress against forecasts.

Whatever method or methods is/are employed by the expert to quantify the loss of profits, assumptions will need to be adopted. Some of those assumptions will be made by the expert forensic accountant or may derive from instructions to the expert from the claimant or other experts (say industry specialists, actuaries or economists). A seasoned forensic accounting expert witness should be able to identify to the instructing solicitor the evidential gaps that need to be filled before his or her expert evidence is finalised so that all assumptions underpinning the calculation of damages is well supported.

Endnotes

[1] This is a generalised statement as damages in breach of contract can include ‘reliance’ damages whereby the claimant seeks to recover the wasted costs incurred as a result of entering into the contract.

[2] Claims for loss of profit in compulsory acquisition of land matters must coincide within a statutory framework. Lawyers representing adverse parties may debate on whether the relevant statutory framework permits claims for loss of profit under a particular section of the statute relating to a compulsory acquisition of an interest in land.

[3] Standing in mid-2023 where there was the arrival and spread of COVID-19 in 2020 through to 2022 prior to the rollout of a COVID-19 vaccine, business operating across numerous industries were dramatically affected (negatively or positively) and therefore the results of the past 3 years may not be a sufficient period of normal trading conditions, hence why a 5 year period is suggested.

Assessment date in damages & compensation

adam.giliberti@avgforensic.com (Adam Giliberti) — Mon, 23 Jan 2023 22:32:42 GMT

What is ‘damages’ reflecting a loss of profits? A simplified view

Before addressing the concept of an ‘assessment date’ as it relates to the issue of damages and compensation, it is useful to remind and emphasise that the principle behind a remedy of ‘damages’ is to restore the claimant to the position but for the claimed wrong, i.e. the cause of action.

This principle of damages can be simplified and is shown diagrammatically in Figure 1 below, where the X-axis represents time and the Y-axis represents a level of, say, annual profit up to that point in time. Figure 1 shows the financial performance of a hypothetical business with a consistent level of historical profits (shown by way of the solid yellow line) up to a point in time when an event happens that gives rise to a cause of action.

A primary objective of the expert when quantifying damages is to determine what the profits of the business would have been, but for the cause of action event, being the dotted arrow line in Figure 1 above (and often dubbed a ‘but for scenario’). The expert will then deduct the actual profit as a result of the same event, being the solid arrow line in Figure 1 above (and often dubbed an ‘actual scenario’). The difference between the estimated profits in the but for scenario and actual scenario, represents, theoretically, the loss of profits caused by the event. The illustration in Figure 1 above uses straight lines and a highly simplified abstraction of reality for many businesses (particularly businesses emerging from COVID-19-related lockdowns over the course of 2020 to 2022).

What is meant by an assessment date in the context of damages?

Akin to the notion that an expert’s opinion on the value of asset is an opinion that reflects the value at a particular point in time, the assessment date in the context of damages represents the point in time that all of the losses, typically which may have accrued and continue to accrue over a period of time, are converted to a single number representing a ‘once-and-for-all’ lump sum amount as part of damages.

How is professional judgement relevant to an assessment date?

Quantifying damages requires the expert to consider different approaches, methods and procedures. This work includes applying mathematical calculations using various acceptable financial techniques and applying appropriate professional judgements about the relevant financial data to quantify one or more heads of loss.

One of the many professional judgements relevant to quantifying damages is selecting the appropriate assessment date, i.e the point in time to tally up all the heads of losses claimed.

In pure valuation engagements, the appropriate valuation date (being a current date and/or past date), is usually a function of the purpose of the valuation. Therefore, it is more obvious to know what the correct valuation date should be. However, in the context of quantifying damages and compensation, particularly involving claims for loss of profits, it can be less straightforward to determine the appropriate assessment date.

Theoretically, there are two (2) alternative points of time that could be adopted as an assessment date by an expert instructed to quantify damages or compensation which includes a claim for loss of profits:

the date when the expert has tallied up the losses and presented an amount as damages, which is typically close to or the date of an expert’s report date. Adopting such a date requires what could be described as an ‘ex-post’ approach to assessing the quantum of damages; or
the date of the cause of action, which is a historical date (and could be over a decade ago in some cases). Adopting such a date requires what could be described as an ‘ex-ante’ approach to assessing the quantum of damages.

Notwithstanding that Australian courts and tribunals are required to assess damages at the date of judgment in some particular matters[3], adopting a future proxy judgment date should not be used by experts for the damages assessment date. This approach would require adopting a hypothetical judgment date, which would be an unknown date in the future that assumes the court will award damages.

As there is no uniform rule as to the correct point in time when Australian courts award damages in all tort and breach of contract[4] (and therefore how the expert should assess damages), this paper addresses the relevant considerations for adopting an ex-ante and ex-post approach to assessing the quantum of damages and compensation.

What is an ex-post approach when assessing damages?

As shown in Figure 2 below, an ex-post approach requires standing at a point in time as close as possible to the current date and looking backwards from that date to calculate a ‘past loss’ and looking forward from that same date to calculate a ‘future loss’.

The use of an ex-post approach, in the case where business losses continue to accrue, will typically expressly distinguish the period of past losses separately from the future losses calculated. Figure 2 above reflects, standing as at present day, the pure mathematical outcome of adopting an ex-post approach is that the sum of all losses of profit in year 1 and year 2 are tallied to derive a past loss amount of $2. Future loss of profits (which are typically converted to a present value amount) will be added to the claim for past loss of profits and the sum of the past losses and future loss will be claimed as damages.

The use of an ex-post approach to assessing damages is widely accepted in personal injury negligence matters where heads of loss include things like past economic loss, future economic loss, past superannuation loss and future superannuation loss, amongst other heads of claim for damages.

In some other types of litigation matters, often involving tort, it may be appropriate to consider an ex-post approach, for example, in cases where there are multiple causes of action that extend over a long period of time (and maybe continuing). The use of an ex-post approach should be justified by the expert, for example:

in cases where there is a repeated infringement of intellectual property rights, it may be possible to identify the specific quantities of infringing sales of products sold to date to calculate a loss using an ex-post approach assessment date; or
in some compulsory acquisition of land matters, it may be appropriate to identify and quantify a loss of profit suffered by a business after the actual date of compulsory acquisition of land taking place prior to a physical relocation of the business – the quantification of such a loss would require the use of an ex-post approach assessment date.

What is an ex-ante approach when assessing damages?

As shown in Figure 3 below, an ex-ante approach requires assessing the claimant’s total loss (as a single amount) as of the date of the wrong, i.e. cause of action. The assessment date would be a historical point in time, often many years from the present day.

The pure mathematical outcome of adopting an ex-ante approach is there will be a single amount assessed as the sum of all losses that arise from the date of the cause of action. The use of an ex-ante approach, in the case where business losses continue to accrue, does not necessarily require separate quantification of past losses and future losses – rather it is the present value amount of all losses suffered as a consequence of the cause of action. It is important to note from Figure 3, that the present value amount of the past losses will likely be something less than $2.

This use of an ex-ante approach, which assesses the loss as at the date of the cause of action is, generally speaking, a default position for assessing damages in a wide variety of litigated matters. Covell, K. Lupton & J. Forder’s text ‘Principles of Remedies’ states the following in support of an ex-ante approach for the relevant assessment date for damages in tort and breach of contract:

“Generally, damages [in tort] are assessed by reference to the date on which the cause of action arose, but the court has a discretion to fix its own date in order to provide fair compensation… In exercising this discretion the court will consider the fundamental principle of providing proper compensation for the loss.”

“The general principle is that damages [in breach of contact] are assessed at the date of the breach. The principle is not, however, applied rigidly…”

Why does getting the assessment date right really matter?

Generally speaking, the adoption of an ex-post approach, in preference over an ex-ante approach, will result in a higher calculated amount of loss of profits to be included as damages or compensation. Accordingly, uniformed claimants will gravitate to the use of an ex-post approach in the quantification of loss of profits because of this mathematical outcome. Experts wishing to maintain their independence as expert witnesses should not be drawn into adopting the assessment date which suits their client’s desired monetary outcome. The relevant and appropriate assessment typically features a related problem concerning the appropriate discount rate when calculating damages.

Most people are aware that $1 today does not equal $1 in, say, 5 years, due to the effects of inflation. Therefore, the use of the word ‘discounting’, as it relates to a claim for loss of profits forming part of damages, specifically factors in the time value of money. Most, if not all competent experts, would agree that it is necessary to discount future losses to reflect the time value of money principle.

However, experts may (often) disagree on the appropriate discount rate to apply to a stream of loss of profits, particularly those accruing in the future.

In negligence matters, such as a personal injury claim, falling under the Civil Liability Act 2002 (NSW), the discount rate in respect of future loss is prescribed at 5%[5]. However, a 5% discount rate involving a loss of profits suffered by a business involving a different cause of action (outside of personal injury) is usually not appropriate.

As the objective of discounting a stream of claimed loss of profits that arise at different dates over the future is to convert that stream of loss of business profits into a single lump sum that a court can award as damages or compensation, the opposing experts may consider an appropriate risk-adjusted discount rate that reflects the risks and timings associated with generating those profits.

The issues around determining the appropriate risk-adjusted discount rate are within a technical area of specialisation involving valuation and finance theory and practice, which this paper does not address. In many litigation matters, opposing experts do not agree on the appropriate risk-adjusted discount rate – one expert may adopt 10% and another expert may adopt 20%.

The present value of a stream of annual loss of profits, amounting to $100,000 (p.a.), over 5 years is:

a) approximately $379,000 using a 10% discount rate; and

b) approximately $298,000 using a 20% discount rate.

In this above example, a 10% increase in the risk-adjusted discount rate, opined on by an expert due to his or her subjective views on risks, has reduced the claim for loss of profits by $81,000 or approximately a 21% reduction in damages.

When experts disagree on an appropriate assessment date as to damages, the experts may also disagree on the appropriate risk-adjusted discount rate. The conflated issues, almost always result in a material disagreement on the quantum of damages and calculations of interest on damages.

AVG Forensic has experts with a proven track record of giving persuasive expert opinion evidence which has been preferred by Australian courts over the other side’s experts.

Endnotes

[1] The principle of damages which is to restore the claimant to the position but for the wrong may also be reflected in the interpretation of statutory provisions of different Acts of parliament which may give rise to compensation entitlements (say for the compulsory acquisition of land).

[2] For example, if a valuation is required to support an impending sale or purchase of an asset, a current-date valuation is expected. If a valuation is required for tax-related litigation, the historical date of an actual transaction is typically the appropriate valuation date.

[3] Such as in personal injury and defamation matters.

[4] W. Covell, K. Lupton & J. Forder, ‘Principles of Remedies’, 6th edition.

[5] Other states of Australia have similar legislation which also prescribes the discount rate.

[6] The issues of assessment date for calculating loss of profits and the appropriate risk-adjusted discount rate were addressed by AVG Forensic’s expert in the following matters where the Court preferred the expert evidence of AVG Forensic’s expert over the other side’s expert: Hudson v National Australia Bank [2022] FCA 1222 (14 October 2022), United Petroleum Pty Limited v Roads and Maritime Services [2018] NSWLEC 35 (23 March 2018) and The Trustee for Whitcurt Unit Trust v Transport for NSW [2021] NSWLEC 82 (30 July 2021).

Valuation Of Intangible Assets – Cryptocurrencies

adam.giliberti@avgforensic.com (Adam Giliberti) — Tue, 29 Nov 2022 22:53:00 GMT

Valuation of intangible assets – how to value cryptocurrencies

What is the nature of cryptocurrency?

In order to value any asset, whether it be an intangible asset or otherwise, the important starting point is to understand the nature of the asset and its characteristics. The information we publish below provides guidance to those interested in the valuation of cryptocurrencies, being a new type of digital asset.

Fiat currency (as distinct from the term ‘cryptocurrency’) includes sovereign-country, government-issued currencies like Australian Dollars (AUD), United States Dollars (USD) or Euros (EUR). It has been long established that fiat currency is used by a sovereign-country as its legal tender and relies on a centralised banking system to create the currency. Fiat currency is used to determine the value in a medium of exchange of goods and services across the global economy.

While cryptocurrencies may be effectively bought and sold and used as a medium of exchange like fiat currency, cryptocurrencies should not be considered like cash or cash equivalents, particularly as cryptocurrencies are not the legal tender of any sovereign country. As cryptocurrencies lack physical substance, it may be thought of as type of intangible asset.

The link between cryptocurrency and blockchain technology

Cryptocurrency is a relatively new form of digital currency, applying cryptography (i.e. use of encryption) using blockchain. A blockchain is a distributed ledger system using a sequence of blocks or units of digital information, stored consecutively on a public database.

Blockchains can be characterised as permissionless, permissioned, or a combination of both (i.e. hybrid). Permissionless blockchains allow any user to pseudo-anonymously join the blockchain network (i.e. become a node of the network) and do not restrict the rights of the nodes on the blockchain network. Conversely, a permissioned blockchain restricts access to certain nodes and may also restrict the rights of those nodes on the network – the identities of the users of the permissioned blockchain are known to other users of that permissioned blockchain. Permissioned blockchains can be controlled by one authority or by a consortium (i.e. controlled by a group).

As cryptocurrencies are reliant on blockchain technology, they are considered decentralised in nature (compared to fiat currencies, which relies on a central bank system) and cryptocurrencies are used as a medium of exchange. To better understand the nature of cryptocurrency, it is necessary and useful to consider that there is a difference between ‘crypto coins’ and ‘crypto tokens’, notwithstanding the nature of both things are considered cryptocurrencies.

What are crypto coins?

Crypto coins refer to any cryptocurrency that has a standalone, independent blockchain. The blockchain is a decentralised digitised ledger that records transaction information about a cryptocurrency in chronological order that is time-stamped and cannot be changed.

The Bitcoin (BTC) token was the first cryptocurrency in existence, created by software developers, under the pseudo name of Satoshi Nakamoto, in 2009. The Bitcoin blockchain was created specifically for the purpose of creating a peer-to-peer electronic cash system, sans a need for any financial institution and third-party intermediaries. Bitcoin was developed as a censorship-resistant store of value and medium of exchange that has a secure, fixed monetary policy. Today, Bitcoin is the most liquid cryptocurrency and has the highest market capitalisation[3] in the cryptocurrency sector.

The Ether (ETH) token was created on the Ethereum blockchain which was launched in 2014. The Ethereum blockchain was created for the purpose of utilising smart contracts for creating general-purpose decentralised computer programs. Unlike the Bitcoin blockchain, the Ethereum blockchain was not created for the purpose of its tokens being used as a medium of exchange, although the Ether token has since become a medium of exchange. Ether (commonly also referred to Ethereum) is now the cryptocurrency which has the second highest market capitalisation in the cryptocurrency sector after Bitcoin.

Crypto coins that are not considered to be a Bitcoin can be referred to as alt-coins. Examples of other alt-coins include Tether (USDT), Binance Coin (BNB) and Litecoin (LTC). Crypto coins (and crypto tokens) are stored on the blockchain wallet (or digital wallet). While Bitcoin was created as an alternative to cash and is widely used and accepted across the globe, some countries (less than 10 in total) specifically have banned the use of Bitcoin, whereas some other countries (including China) have limited restrictions in relation to the use of Bitcoin. In Australia Bitcoin is considered legal, however it is not accepted as legal tender.

Crypto coins such as Bitcoin, Ether and Litecoin are all examples of crypto tokens issued by a permissionless blockchain.

What are crypto tokens?

While crypto coins represent the native tokens (or native asset) of the permissionless blockchain which give rise to its ‘coin’, crypto tokens (i.e. tokens not classified specifically as a crypto coin) refer to a type of cryptocurrency which rely on an existing blockchain, such as the Ethereum blockchain (as one example).

The nature of a token is defined by the token issuer, which is typically connected with an underlying project that uses existing blockchain technology. It is relevant to note that there are thousands of different projects and crypto tokens built on top of the Ethereum blockchain. Crypto tokens represent a digital asset, with its ownership verified by the blockchain, which can be broken down into the following classification types:

non-fungible tokens (or NFTs), where each NFT unit is considered unique from another unit, which is unlike typical currency (and therefore not generally considered to be cryptocurrency, although a tradeable type of digital asset); or
fungible tokens, where each unit is considered indistinguishable from another unit and therefore each unit is interchangeable, which like typical currency (and therefore considered to be cryptocurrency). Fungible tokens can be further broken down into different types, such as:

security tokens – which act like traditional shares in companies or units in trusts;
utility tokens – which provide access to certain products or services of the token issuer; or
governance tokens – which assign voting rights in a decentralised autonomous organisation (or DAO).

Crypto tokens may relate to permissioned blockchains which limit the rights of token holders. It is relevant to note that there are tens of thousands of crypto tokens which exist today[6] and there has been a very dramatic recent increase in the number of crypto tokens in the past year alone reflecting that a new crypto token can be easily created, which is analogous to the fact that nearly anyone can fairly easily register a company and issue shares to others.

What is the meaning of the ‘market value’ of cryptocurrencies?

The Australian Taxation Office (“ATO”) has published a guide called ‘market valuation for tax purposes’ which expands in greater detail on the ATO’s views on the concept of market value. The ATO guideline outlines the different classes of assets covered.

The International Valuation Standards Council (“IVSC”) is an independent, not-for-profit organisation committed to advancing quality in the valuation profession. Its primary objective is to build confidence and public trust in valuation by producing standards and securing their universal adoption and implementation for the valuation of assets across the world. The IVSC approved and issued International Valuation Standards Framework and General Standards (“IVS”) with an effective date of 1 July 2017 which have been updated with an effective date of 1 July 2020. IVS provides valuation professionals with relevant and authoritative guidance on valuation of any assets.

The following definition is a definition for ‘market value’, which is widely accepted:

The following are significant matters in relation to what constitutes an opinion on the ‘market value’:

The expression of market value is at a “valuation date”, reflecting an expression of value at a particular point in time. Accordingly, value may change over time, which can be due to one or more factors. In forming a conclusion on the market value of an asset at a point in time, the use of hindsight is considered not appropriate in forming an assessment of the market value of an asset as the information on which the valuation is based should, in general terms, have been in existence at or before the particular date of the valuation. More specifically, only those things which are known or knowable at the valuation date should be considered. The use of the term ‘knowable’ includes information that could be obtained with a reasonable degree of due diligence.
Market value reflects a hypothetical or actual transaction between a “willing buyer” and a “willing seller”. A willing buyer and a willing seller are neither over-eager nor determined to buy/sell at any price.
An “arm’s length transaction” is presumed to be between unrelated parties, each acting independently.
“After proper marketing” means that the asset has been exposed to the market in the most appropriate manner to affect its disposal at the best price reasonably obtainable. A ‘fire-sale’ of an asset to quickly realise cash because the seller is in financial distress likely reflects a condition which would not reflect a sale under market value conditions.
Where the “parties had each acted knowledgeably, prudently” presumes that both the willing buyer and the willing seller are reasonably informed about the nature and characteristics of the asset, its actual and potential uses, and the state of the market as of the valuation date.

What are the valuation approaches for cryptocurrencies?

A ‘valuation approach’ is a general way of determining value and there can be many different valuation methodologies available under any one particular valuation approach. IVS require consideration of three potentially relevant valuation approaches to value any asset being:

market approach;
income approach; and/or
cost approach.

Market approach

The use of a market approach requires a comparison of the subject asset with an identical or comparable (similar) asset(s) for which price information is available. Generally speaking, cryptocurrencies that are tethered to a liquid crypto coin can provide a relevant starting point of reference and justification for using a market approach and further adjustments made by appropriate for:

marketability (or liquidity) associated with a parcel of tokens to be valued (which is discussed below); and
other specific risks relating to the subject crypto token, not inherent in the observed price of the crypto coin (which is discussed below).

Income approach

The use of an income approach provides an indication of value by converting future cash flow to a single current value. Under the income approach, the value of an asset is determined by reference to the value of income, cash flow or cost savings generated by the asset. Utility and/or governance tokens in particular are not created to return fiat currency to the token holder and without any data on the potential costs savings available to token holders, the use of traditional valuation methods available under income approach, such as the use of a discounted cash flow method or capitalised earnings methods are not applicable to valuing such tokens.

Cost approach

The use of a cost approach uses the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction, unless undue time, inconvenience, risk or other factors are involved. The cost approach provides an indication of value by calculating the current replacement or reproduction cost of an asset and making deductions for physical deterioration and all other relevant forms of obsolescence. It is relevant to distinguish the underlying project upon which the tokens are issued (which would likely have a significant cost and time implication to recreate the technology infrastructure and collaborations with other parties) from the underlying token in considering the application of a cost approach to value a token.

Lack of marketability (or illiquidity) for cryptocurrencies

The marketability of a parcel of crypto tokens refers to the token holder’s ability to convert the parcel of tokens into cash (or perhaps another highly liquid crypto coin). There are two dimensions to marketability, being the price realised for a parcel of crypto tokens and the amount of time required to sell that parcel of crypto tokens – these two dimensions are related as it may be possible to reduce the time taken to sell the crypto tokens, by discounting the price. The more marketable a particular crypto token, the greater the ability to sell a large volume of crypto tokens near the quoted price.

CoinMarketCap identifies (in November 2022) that there are over 500 cryptocurrency exchanges, which are by their nature a decentralised exchange which creates a secondary market for the purchase and sale of over 20,000 cryptocurrencies. CoinMarketCap provides quantitative and qualitative data and information (including news) on cryptocurrencies and ranks cryptocurrencies by their market capitalisation.

In addition to ranking crypto tokens, CoinMarketCap identifies where a token is a tracked or untracked listing. A tracked listing is one which meets the following CoinMarketCap criteria:

the token leverages cryptography, consensus algorithms or distributed ledgers, peer-to-peer technology and/or smart contracts to function as a store of value, medium of exchange, unit of account, or decentralized application;
the token must have a functional website and block explorer;
the token must be traded publicly, and actively traded on at least one (1) exchange (with material volume) that has tracked listing status on CoinMarketCap; and
the token issuer provides a representative from the project with whom CoinMarketCap can establish open lines of communication for any clarifications.

An untracked listing would typically feature a token considered by CoinMarketCap to not include a material volume of transactions. Such a token reflects a lack marketability (or illiquidity) Notwithstanding a price for a crypto may be observed on listed on a decentralised exchange, from a valuation perspective, a risk factor for lack of marketability is applied.

Illiqudity of particular cryptocurrencies should be assessed in the prism of the price instability of cryptocurrencies. This price instability can be analysed by reference to market capitalisation of all cryptocurrencies. Figure 1 below is a chart depicting the market capitalisation (expressed in USD) of all cryptocurrencies over its existence (to November 2022) sourced from CoinMarketCap.

Figure 1: Market capitalisation of all cryptocurrencies per CoinMarketCap

Figure 1 above shows the market capitalisation going from less than USD$1 trillion to nearly USD$3 trillion back down to less than USD$1 trillion over the 2020, 2021 and 2022 years. The graph data includes Bitcoin, the cryptocurrency with the largest market capitalisation, representing no less than 32% of the cryptocurrency market over the time period shown in Figure 1 above (i.e. 2014 to 2022) and during the year 2021, Bitcoin represented up to approximately 70% of the cryptocurrency market. Figure 1 above indicates that there has been significant price volatility in the cryptocurrency market over the past 2 years (i.e. 2021 and 2022).

Professional judgement is required and applied in determining the size of the discount for lack of marketability. For listed companies, restricted stock studies might be referenced to inform on an illiquidity discount in relation to the valuation of ‘thinly-traded stocks’. In cryptocurrency, some crypto tokens may involve stalking which effectively represents a period of time in which tokens may not be sold, however it is not possible to observe a price for stalked tokens which therefore renders the determining the size of the discount for lack of marketability as a subjective matter.

What might be the specific risks for holding crypto tokens?

In addition to lack of marketability (or illiquidity) risk, consideration should be given to the following (non-exhaustive list of) specific risk factors which may be present in relation to holding crypto tokens:

from the perspective of the token holder, the investment may not be considered to be regulated, e.g. lack of statutory protection for token holders;
use of multiple early-stage entities;
use of multiple early-stage technologies;
explicit no assurance for the success statements issued by token issuers;
various licences and permits may be required to operate which may not be forthcoming;
businesses may merge, transfer and/or combine operations without needing the approval of token holders;
the project may use different blockchain technology without needing the approval of token holders;
future members and investments are not assured on the basis that reliance on joint venture arrangements and subsidiaries is needed which may or could change in the future without needing the approval of token holders;
intellectual property rights may not be owned by the entities involved in the project;
lack of diversification of business and dependence on the performance of a single investment or small group of investments;
co-investing with joint ventures and third parties;
reliance on key personnel and risk of loss of key personnel;
financial commitment is required with no requirement of financial return;
there may be limited access to liquidity for the project by selling its investments in subsidiaries;
risk of insolvency (particularly if liquidity issues constrain the project/business from achieving its objectives);
lack of operating history;
susceptibility to a ‘black swan’ event;
risk of governance failure with no governance rights attached to the tokens; and
regulatory risk attached to the prohibition of tokens in some sovereign-country states.

Conclusion on valuation of cryptocurrencies

Valuation of cryptocurrencies is an inherently subjective exercise, however, with a thorough understanding of the nature of the digital asset, it is then possible to apply internationally recognised valuation approaches, methods and procedures (subject to available data and evidence) to arrive at a fundamentally sound conclusion of value, which may be expressed as falling within a range.

Disclaimer

AVG Forensic’s areas of expertise are in the fields of forensic accounting and valuation of assets, including intangible assets and businesses. Cryptocurrency is a digitally created asset and represents a paradigm shift in capital markets. This paper provides general information on blockchain technology and its numerous applications, including its application as cryptocurrencies, however, AVG Forensic does not claim any technological expertise in respect of blockchain technology. We reserve the right to not accept valuation engagements considered high risk.

Useful links

Information and links to documents about cryptocurrencies contained on the ATO website: https://www.ato.gov.au/individuals/Investments-and-assets/crypto-asset-investments/what-are-crypto-assets-/ .

Information on cryptocurrencies contained on the Reserve Bank of Australia website: https://www.rba.gov.au/education/resources/explainers/cryptocurrencies.html.

Information on cryptocurrencies published by the Australian Securities and Investments Commission, via its Money Smart website: https://moneysmart.gov.au/investment-warnings/cryptocurrencies .

Information on blockchain technology and cryptocurrency via the education part of the Binance website known as Binance Academy https://academy.binance.com/en .

Information and links to documents contained on the CoinMarketCap website conmarketcap.com.

Endnotes

[1] An intangible asset is defined in International Valuation Standards issued by the International Valuation Standards Committee to be a “non-monetary asset that manifests itself by its economic properties. It does not have physical substance but grants rights and/or economic benefits to its owner”.

[2] Blockchain is a distributed ledger system using a sequence of blocks or units of digital information, stored consecutively on a public database.

[3] Market capitalisation is calculated as simply product of the supply of the coin (i.e. number of circulating coins) multiplied by the current price (i.e. measured by reference to a fiat currency, typically United States Dollars (USD)). Cryptocurrency exchanges may also refer to ‘fully diluted’ market capitalisation which is calculated as the maximum supply of the coin multiplied by the current price.

[4] Not considered an exhaustive list and different terms can be used to characterise fungible tokens.

[5] A DAO is an organisation constructed by rules encoded as a computer program that is often transparent, controlled by the organisation’s members and not influenced by a central government or regulatory body. In general terms, DAOs are member-owned communities without centralised leadership which is a feature of blockchain technology. A DAO, is somewhat akin to a legal entity, like a company, however it is not subject to any regulation by a central regulator, like the Australian and Securities and Investment Commission, and it is not bound by geographical jurisdiction. A DAO’s financial records and program rules are maintained on a blockchain (e.g. Ethereum) and the decisions of the DAO are governed by proposals and voting to ensure everyone in the organisation has a voice.

[6] According to CoinMarketCap, there are over 21,000 crypto tokens (including crypto coins) and over 500 crypto exchanges.

[7] The ATO’s market valuation guide can be found here which identifies a number of different classes of assets, such as real property, plant and equipment, businesses, goodwill, shares, units, liabilities, benefits provided and financial instruments. It does not list cryptocurrencies and digital assets.

[8] IVS 104 – Basis of Value, paragraph 30.1.

[9] Paraphrased from IVS104 – Bases of Value.

[10] IVS 105 –Valuation Approaches and Methods.

[11] The CoinMarketCap website home page is https://coinmarketcap.com/ and more information about CoinMarketCap can be found here: https://coinmarketcap.com/about/ .

[12] References to ‘marketability’ and ‘liquidity’ are considered interchangeable for the purpose of this document.

[13] At a basic level, ‘stalking’ of crypto tokens is the concept of earning a potential reward on those tokens which are stalked. The nature of the reward will be different depending on the project however it may or may not include issue of more tokens, and/or voting (governance) rights.

‘Capitalisation Rates’ And ‘discount Rates’ Used In Valuations & Claims For Loss Of Profit As Part Of Damages Or Compensation

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 13 Nov 2022 23:33:29 GMT

What lawyers need to know!

Capitalisation rates & discount rates are specific valuation terms that factor in ‘risk’ which attaches to the cashflows or profits relating to the subject business or asset to be valued or to be included in a claim for loss of profits forming part of a claim for damages or compensation.

Lawyers are accustomed to reviewing expert reports prepared by expert valuation and loss quantification professionals often containing what appears to be ‘boiler plate’ drafting on esoteric concepts, which can be confusing to the reader. Rather than hope that the court will prefer your expert’s opinions, over your adversary’s expert opinion, on the relevant capitalisation rate or discount rate that should be applied, we have provided a comprehensive presentation to arm you with the relevant need-to-know information in a presentation that covers this rather technical topic that often results in significant differences in quantum between opposing experts.

Capitalisation rates & discount rates both factor in ‘risk’ attached to the cashflows

‘Risk’ is factored into a ‘valuation’ or claim for ‘loss of profits’ as part of damages or compensation using one or two broad approaches:

‘Top-down’ approach, i.e. using a ‘comparable asset’ or ‘venture capitalists’ method

This method can include observing transactions in the market & adjusting for the following types of risk factors: a) small company risk, e.g. for lack of diversified revenue, lack of geographical spread, etc; and b) other specific risks, e.g. key person risk, dependence on key customers, dependence on key suppliers, etc.

This method should also factor in what stage the product and/or business is within its ‘life cycle’ together with ‘strengths, weaknesses, opportunities and threats analysis’ (also commonly referred to as SWOT analysis). We also consider Michael Porter’s (Harvard Business Review) Five Forces Analysis to be useful.

‘Bottom-up’ approach, i.e. deriving a ‘weighted cost of capital’ or WACC

This requires an assessment of cost of equity (returns expected by owners) and cost of debt (returns expected by financiers, not owners).

Cost of equity comprises the following three components:

Beta. This represents the ‘un-diversifiable risk’ of ownership in the company, assuming the investor has a fully diversified and efficient investment portfolio. The beta should represent the asset beta (or unleveraged beta), as opposed to the equity beta (or leveraged beta). A comparable company or industry beta might be adopted as the proxy for a particular company’s beta.

Market risk premium. For Australian equity, a market risk premium (or MRP) is likely to be somewhere in the range of 5% to 8% depending on the particular study relied on and the views of the valuation expert.

Risk-free rate. Typically, this is a government treasury bond of equivalent investment period. There is no uniform consensus as to whether a spot rate, adjusted (normalised) spot rate, historical average rate could apply as the proxy for the risk-free rate.

Cost of debt comprises the following two components:

Average debt yield for all debt on all assets of the company. This could be complicated where debt finance used by the company is unsecured and not on commercial terms and the company may not be operating at an optimal gearing level.

Tax shield on debt. This is usually the Australian corporate tax rate.

Once inputs are gathered, they are applied in a mathematical formula to generate a WACC. Additional adjustments could apply to calculated WACC e.g. for country-specific risk (if applicable), small company risk e.g. for lack of diversified revenue, lack of geographical spread and other specific risks, e.g. dependence on key customers, dependence on key suppliers, etc.

The terms ‘capitalisation rate’ and ‘discount rate’ are specific to the following two alternative valuation methods

A method using single-period analysis to conclude on value e.g. a capitalisation of future maintainable earnings method. This method can be a relatively unsophisticated valuation method, requiring fewer assumptions to support the calculated value. A capitalisation rate applies to a perpetuity to determine present value at a point in time.

A method using multi-period analysis to conclude on value e.g. a discounted cash flow method. This can be a relatively sophisticated valuation method, requiring multiple assumptions to support the calculated value. A discount rate converts future cash flows over multiple periods into a present value at a point in time.

Single-period analysis (requiring a capitalisation rate) is appropriate where the following factors are present:

Mature asset

If the business or asset is newly established and does not have demonstrated track record of generating a consistent level of earnings, it will be more difficult to reliably estimate a level of future maintainable earnings.

Profitable

If the business or asset has a history of incurring losses, it will be more difficult to reliably estimate a level of future maintainable earnings. Furthermore, if the quantum of historical and expected profits is considered insufficient relative to the capital assets owned by the business, a capitalisation of future maintainable earnings is unlikely to yield the correct conclusion of value.

Stable industry

If the asset or business operates in a volatile industry, it will be more difficult to reliably estimate a level of future maintainable earnings.

Depreciation equals ‘capex’ or no capex required

Capex refers to capital expenditure (which sits on a balance sheet, separate to operating expenditure which is shown in the profit & loss statements). The use of EBIT (earnings before interest and tax) assumes that depreciation equals the capex. Use of EBITDA (earnings before interest tax depreciation and amortisation) assumes that the business has no capex requirements. If the business expects fluctuating capital expenditure requirements in order to continue operating, then this will not be captured in the future maintainable earnings.

Stable working capital

If the business has fluctuating working capital requirements in order to continue operating, it may be necessary for working capital shortfalls to be funded via debt finance and those finance costs may not be captured in the future maintainable earnings. A business reporting profits can be technically insolvent, i.e. unable to pays its debts as and when they fall due particularly if suppliers require payment before sufficient debtors are collected.

Consideration of ‘discounts’ or ‘premiums’ may be warranted for valuation of a whole or part ownership interest in the entity conducting the business. Examples include:

Where observations of profit multiples for a minority interest in publicly listed companies are made it may be necessary to apply a premium for control.

Where observations of profit multiples for control of a publicly listed company it may be necessary to remove a premium for investor or strategic value.

Where observations of profit multiples for a minority interest in publicly listed companies are made it may be necessary to apply a discount for lack of marketability (or illiquidity).

Capitalisation rates and discount rates can be challenging topics for barristers and solicitors to get their heads around, however, we pride ourselves on explaining difficult concepts in a simple way. Contact our forensic accounting and valuation experts if this issue is relevant to one of your current matters.

CA Forensic Accounting Specialist triumphs in a shareholder oppression matter

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 06 Nov 2022 23:47:50 GMT

We were engaged in early June 2019 to provide covert forensic accounting investigations of a finance director (and founding shareholder). A mutual arrangement was reached between the 2 company directors whereby the finance director resigned from the company at the end of June 2019. The nature of the dispute from this point in time, was that this former director and company shareholder, sought an unreasonably high amount in consideration for the value of his shares in this company.

We recommended to our client that an experienced litigator from a reputable national law firm, Piper Alderman, be retained to assist in the process of having this shareholder sells his shares in the company at a fair value. Piper Alderman initially pursued alternative dispute resolution. Unfortunately for our client, this shareholder remained steadfast in wanting an unreasonably high amount in consideration for his shares in this company and had gone to lengths to obtain and supply dubious quality valuation advice to support an inflated opinion of the value of the company. There were many valuation issues in dispute, including an egregious claim that a multi-million loan facility was not debt and did not require to be taken into consideration in calculating the value of the company.

Frustrated at being unable to reach an agreement on the value of his shares, the former director and shareholder commenced legal proceedings, claiming oppression and relief under section 292 and 293 of the Corporations Act 2001 (Cth). A positive step towards resolution of the matter was achieved on 17 September 2021, when consent orders were made to crystalise the relevant valuation date to 29 June 2021. We cannot underscore the commercial importance of a crystallised valuation date in such a dispute and we credit Piper Alderman for this procedural victory. Up to this point, the parties had been in an acrimonious dispute over value for over two years, however a fixed valuation date allowed the client to fully benefit from any increase in the value of the business from this valuation date.

This company operated a business selling beverages, oils and spreads derived from the coconut plant to retailers, primarily located across Australia. The Court’s orders allowed each adversarial party to put forward their own expert valuation evidence and have the Supreme Court of New South Wales determine the value of the plaintiff’s shares. We recommended a valuation expert recognised by Chartered Accountants Australia and New Zealand as a dual Business Valuation Specialist and Forensic Accounting Specialist, and the suitable independent expert witness, Mr M, was then instructed by Piper Alderman to provide evidence in the Court proceedings.

The Court considered competing expert witness valuation evidence in the matter. The valuation expert for the plaintiff, Mr G, initially submitted evidence opining that the value of the plaintiff’s shares in this company was $5,131,686 as at 29 June 2021. The valuation expert for the defendants, Mr M, opined that the value of the plaintiff’s shares in this company should be valued at $162,073 as at 29 June 2021. A conference between the two experts followed culminating in a joint experts’ report co-authored by Mr G and Mr M which was considered by the Court.

In summary, the Court accepted in its entirety the expert evidence of defendants’ expert, Mr M. The Court also acknowledged that this expert was recognised by Chartered Accountants Australia and New Zealand as a dual Business Valuation Specialist and Forensic Accounting Specialist, which were not credentials that could be claimed by Mr G. The Court decided in late September 2022, that the value of the plaintiff’ shares as at 29 June 2021 was $170,437.50, providing detailed reasons for this decision and adopting Mr M’s opinions in its entirety. This is a fantastic outcome for AVG Forensic’s client given the long-running valuation dispute between the two shareholders.

Critically, the valuation method adopted by Mr M, and importantly, the conclusion of value reached by Mr M, was entirely consistent with AVG Forensic’s view on what the value of the plaintiff’s shares in the company as at 29 June 2021, should be. At no point was Mr M made aware of our valuation work, which is a testament to both Mr M’s reasoned consideration of the facts and professional judgement applied.

On the other hand, heed the valuable lessons of the plaintiff’s valuation expert which are as follows:

1. The dispute between the two shareholders was, in pure quantum terms, substantially a dispute over whether a multi-million-dollar finance facility arranged by the company with an Australian bank, considered something other than debt for valuation purposes. The plaintiff’s strongly held view that this working capital finance facility was something other than ‘debt’, notwithstanding the existence of strict contractual repayment obligations including payment of interest to the lending the bank, was a position that was beyond what any reasonably competent valuation professional would consider as acceptable valuation practice for a retail business of this kind. Surprisingly, Mr G initially took the position of the plaintiff, which was that this was not debt and therefore the face value of the debt did not need to be offset against the value of the assets of the company. After conferring with Mr M, Mr G later deducted the value of the debt in preparing the joint expert report. It was never going to be sustainable for Mr G to adopt such a position following cross-examination during a final hearing – Mr G’s change of opinion on this issue in finalising a joint experts’ report created the impression that Mr G’s initially prepared expert report was prepared as an advocate of the party (which was always going to be a mistake).

2. In addition to changing his treatment of debt in a company valuation, Mr G also ultimately recoiled from previous opinions included in his initial expert report (mostly around the profitability of the business) and ultimately agreed with Mr M on all but one remaining issue. Mr G’s change of opinions on these other issues further reinforced the impression that Mr G’s initially prepared expert report was an advocate of the party. This is not to say that experts should not change their opinion evidence, rather experts should expect that questions will be asked of them as to the reasons why there are changes in opinion and the reasons for the change in opinion better be credible if the evidence is to be given sufficient weight.

3. Mr G and Mr M did not agree on an applicable profit multiple to capitalise the profits of the business. Mr G opined that the profit multiple should be approximately 8.0x and Mr M opined that the profit multiple should be approximately 4.0x. Both experts referenced International Valuation Standards issued by the International Valuation Standards Committee and Mr G’s evidence was that his profit multiple was based on a ‘market approach’ (i.e. based on analysis of profit multiples of claimed comparable companies) and Mr M’s profit multiple was based on an ‘income approach’ (i.e. based on a derivation of a Weighted Average Cost of Capital or WACC supported by finance theory and market-based inputs). Mr G considered Mr M’s derivation of a profit multiple using an income approach to be an inferior method to his market approach to determine the profit multiple. Unfortunately for Mr G, the heterogeneous nature of businesses rendered Mr G’s use of a ‘market approach’ over an ‘income approach’ a difficult proposition for Mr G to convince the Court. The Court considered that the 2 businesses relied on by Mr G as being comparable were found by the Court to be based on very weak opinion evidence by Mr G, including Mr G’s analysis of one business being comparable based on his recognition of the product brand being sold in supermarkets.

The above is our highly summarised analysis, written from the perspective of us acting as a shadow expert, however, the actual words of Her Honour, Penden J to describe Mr G’s analysis [at 66 to 70] are very illuminating words which are replicated below:

“I do not consider the transactions Mr G relied upon were appropriately comparable to provide a cogent basis for assessing a market value of the Company.

Mr G accepted he had “limited oversight regarding the terms and structure of each transaction”. He eventually accepted in cross-examination that his research into the financial position and performance of the companies was inadequate, and he ought to have had regard to other information.

While he accepted that there was no factual basis for his assumptions he used in his valuation, but nevertheless doggedly refused to accept that they were not truly comparable. He maintained they were “of some use”, without explaining how they could be used in light of the problems with his approach, which he accepted.

I note that he made various mistakes in his first report and varied his valuation down by millions of dollars in the joint report. Overall he did not appear careful with his reports or his evidence.

I consider his valuation on a market basis untenable, and I reject the submission that it ought to form the basis of my determination of the price.”

We were delighted for our client when Her Honour, Penden J, made her decision on 30 September 2022 as the right decision was reached for its client and because the expert evidence from a dual qualified Forensic Accounting and Business Valuation Specialist with Chartered Accountants Australia and New Zealand was considered far superior to the alternative.

Loss of profits update in Class 3 NSWLEC proceedings

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 01 Aug 2021 05:57:44 GMT

The Trustee for Whitcurt Unit Trust v Transport for NSW [2021] NSWLEC 82

On 30 July 2021, Pain J delivered her judgment in the above matter making it very plain that the nature and scope of the ‘interest in land’ are of fundamental importance for lawyers advising their clients on the quantum of compensation, including claims for loss of profit under the Land Acquisition (Just Terms) Compensation Act 1991 (NSW) (“Act”). The effective outcome for the applicant was that it received no compensation.

Background facts

The respondent compulsorily acquired a whole lot of land in Tempe (“Land”) on 20 March 2020, for a public purpose road project, involving improvements between the Sydney domestic and international airports (“Project”).

As at the date of compulsory acquisition of all the interests in Land:

The applicant operated a golf coaching and golf driving range business from the Land (“Business”). The applicant’s Business commenced on or around 20 November 2017 which is the date of when the applicant acquired its leasehold interest in the Land. The applicant continued to operate its Business from the Land until 30 August 2020 when it was required to vacate the Land for the construction of the Project.
The applicant occupied the Land under a ‘holding over’ clause as the lease period had expired which meant, under the terms of this lease, that the applicant’s leasehold interest in the Land was terminable with 2 month’s written notice.
The critical assets required to operate the Business, such as the nets, lighting, turf, and other infrastructure were owned by the landlord (being a local council), not the applicant.

The respondent announced its intention to acquire the Land for the Project on 20 September 2018, which led the applicant to commence its search for alternative premises to relocate its Business, culminating in the applicant being invited to establish and operate a golf driving range on land in Campbelltown as a licensee, with a proposed 15+15 year term, in or around February 2019 (the license agreement was not executed by the applicant).

Applicant’s key submissions

The applicant claimed that it was entitled to relocate its Business to Campbelltown as it had demonstrated its intention to do so. The incurring of substantial fitout costs would be subject to receiving compensation, although some preliminary expenditure had already been incurred by the applicant.

Shortly before the respondent announcing its intention to acquire the Land for the Project, the applicant was in the process of securing a 5+5 year lease for use of the Land with its landlord. As a result of this announcement, long-term tenure for use of the Land was not secured by the applicant. But for the announcement, long-term tenure would have been secured for use of the Land.

Applicant’s claim for compensation

The applicant claimed compensation under the Act, totalling just over $4 million, comprising:

legal costs and valuer’s fees of $118,381, under sections 59(1)(a) and 59(1)(b) of the Act (which were amounts not in dispute between the litigants);
fitout and preliminary costs of $3,405,235, as ‘disturbance’ under section 59(1)(c) of the Act, or in the alternative as ‘market value’ under section 56(3) of the Act, or in the alternative as ‘special value’ under section 57 of the Act; and
loss of profits of $498,384, as ‘disturbance’ under section 59(1)(c) of the Act, or in the alternative as ‘market value’ under section 56(3) of the Act, or in the alternative as ‘special value’ under section 57 of the Act.

Orders made

Compensation for ‘disturbance’ was awarded in the amount of $118,380.98 (for legal costs and valuer’s fees) only as all other compensation claims were dismissed.

Important findings

The nature and scope of the legal interest need to be assessed at the date of compulsory acquisition, as emphasised by the New South Wales Court of Appeal. The applicant’s claim that ‘but for’ test should be applied (i.e. the applicant would have secured a 5+5 year lease over the Land absent the announcement of the Project) is not a valid test as there is no case law supporting this construction of the Act.

The applicant submitted that the factual circumstances in this Whitcurt matter are similar to the facts in Hua v Hurstville City Council [2010] NSWLEC 61 which required the purchase of essential equipment for the business to continue at the proposed relocation site. Hua was also decided by Pain J, however, Her Honour considered the facts in Hua were distinguishable from the facts in this matter. In relation to the applicant’s claims for fit-out and preliminary costs of $3,405,235, as ‘disturbance’ under section 59(1)(c) of the Act, the following three tests in Director of Buildings and Lands v Shun Fung Ironworks Ltd [1995] 1 All ER 846 are (still) relevant:

the claimant must genuinely intend to relocate;
relocation must be practically possible; and
relocation must be reasonable in the circumstances.

Her Honour found that the applicant’s claim for fit-out and preliminary costs of $3,405,235 as ‘disturbance’ under section 59(1)(c) of the Act was not reasonable having regard to the nature and scope of the leasehold interest (terminable with 2 months’ written notice). Her Honour was assisted by expert forensic accounting and valuation evidence on reasonableness in the context of a lack of legal ownership over the critical assets required to operate the Business and also the value of the Business, with and without a long-term tenure of the Land.

In relation to the applicant’s claims for fit-out and preliminary costs of $3,405,235, as ‘market value’ under section 56(3) of the Act, Her Honour reiterated the importance of her finding that the applicant’s leasehold interest was terminable with 2 months’ written notice and that represents the nature of what should be ‘reinstated’. Her Honour also considered if such a claim for reinstatement of the Business could be supported under section 56(3) of the Act (which was not on the facts), this amount would need to be reduced by the final limb under section 56(3) of the Act which is to reduce the amount by “any likely improvement in the owner’s financial position as a result of the relocation”. In that regard, Her Honour had regard to the proposed 15+15 year license agreement and expert evidence demonstrating the applicant’s Business had no value as at the date of acquisition (based on secure tenure in the Land for 2 months), but would have a value assuming the proposed 15+15 year license agreement had been entered.

In relation to the applicant’s claim for special value, being the “financial value of any advantage to the person entitled to compensation which is incidental to the person’s use of the land in addition to market value”, Her Honour considered that the applicant’s limited leasehold interest at the date of acquisition made it difficult for her to conceive there could be a claim for special value.

Currently unresolved issues in relation to ‘loss of profits’ claims

In this Whitcurt matter, Pain J found it was not reasonable to relocate or reinstate the Business and therefore the applicant’s claim for loss of profits of $498,384 was considered moot. That is, if there is no relocation or reinstatement of the Business, then the Business has stopped trading, so there can be no lost profit and therefore there is no claim for loss of profit under section 59(1)(c) of the Act.

It is significant and relevant to highlight that two recent New South Wales Court of Appeal judgments have raised doubt as to whether the Act allows for claims for loss of profits at all, i.e. Alexandria Landfill Pty Ltd v Transport for NSW (2020) NSWCA 165 and Roads and Maritime Services v United Petroleum Pty Ltd (2019) NSWCA 41.

In matter of United Petroleum, the court of first instance held that there was no relocation of the business and compensation under section 59(1)(f) of the Act was awarded based on the extinguishment of the business – this comprised of a loss of profits into perpetuity[1]. The New South Wales Court of Appeal overturned this decision and held that the period of claim for loss of profit cannot exceed the remaining period in which the interest in land was held and made observations on the statutory construction of section 59(1)(f) of the Act which raised doubts on the validity of a claim for loss of profits under this part of the Act[2]. As the court of first instance held that there was no relocation of a business, the New South Wales Court of Appeal did not have to consider loss of profits in the context of a business relocation and left open a possibility to claim loss of profits under section 59(1)(c) of the Act.

In the matter of Alexandria Landfill, the New South Wales Court of Appeal considered its decision in United and also considered the meaning of the words ‘financial costs’ which appears in both sections 59(1)(c) and 59(1)(f) of the Act and suggested that their meanings in these respective parts of the Act should be the same[3].

Pain J did not directly address whether a claim for loss of profit:

could be awarded under section 59(1)(c) of the Act, had Her Honour found a relocation of the Business was reasonable; and/or
could be awarded under section 56(3) of the Act, as the applicant submitted during the final hearing (which was disputed by the respondent).

Curiously, in this Whitcurt matter, the applicant’s earlier submissions were no entitlement to compensation is available under section 59(1)(f) of the Act as a consequence of United, to which the respondent did not object. However, the applicant did submit that if the Court found that loss of profit could not be claimed under the other parts of the Act, the Court should award loss of profits under section 59(1)(f) of the Act, if the facts in this matter could be distinguished from the facts in United. Her Honour simply stated that the nature of the leasehold was such that a claim under section 59(1)(f) of the Act could not survive. The period of any loss of profits (e.g. 2 months) or appropriate measure of loss, (e.g. EBIT) was not contemplated due to the nature and scope of the leasehold interest.

Assuming that a claim for loss of profits could be compensable in a business relocation scenario, in Hua, Pain J set out 5 tests (posed as questions) for awarding disturbance compensation based on a business relocation being:

Can the business be relocated?
Do the applicant intend to relocate the business?
Would a reasonable person relocate in the position of the applicant in the prevailing circumstances relocate the business?
Is it feasible and practical to relocate within a reasonable timeframe?
Will the relocation cost be less than the cost of extinguishment?

The above 5 questions are also found in a NSW government publication called “NSW Government Guidelines – Determination of compensation following the acquisition of a business“. This document is often directly referenced by valuers (some working for the Valuer General’s office) or the above questions are quoted without source in an expert valuer’s report dealing with disturbance compensation under the Act. It is arguable that the last test may not be appropriate, or is at least not a straightforward test and may be subject to further judicial interpretation given:

the orbiter in United Petroleum and Alexandria Landfill which questions the validity of claiming loss of profits in a business extinguishment scenario;
Pain J not awarding any compensation in this Whitcurt matter for an effective business extinguishment; and
Pain J in this Whitcurt matter stating that section 59(1)(c) of the Act referring to “reasonably” incurred does not relate to the amount sought[4].

The current state of the law in relation to claims for compensation under the Act makes it ‘high risk’ for business interests to pursue claims for loss of profits. In this Whitcurt matter, the Valuer-General had determined compensation totalling $345,000 based on an assumed business extinguishment, which effectively put some money on the table for the applicant to accept. Ultimately, the Court awarded no money for the applicant which is likely a devastating blow for the applicant.

Loss of profits as a claim for compensation under the Act appears to be dead, but it is not buried. Sound legal advice from highly specialised and experienced lawyers familiar with the Act is a must, along with advice from quantum expert(s) who have an appreciation of the statutory framework. We do not provide legal advice and this article is for general information and educational awareness purposes only, based on its interpretation of the current state of the law on loss of profits as an item of compensation under the Act. However, check out our expertise in compulsory acquisition of land matters .

Alternative Dispute Resolution (ADR) methods

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 01 Aug 2021 00:12:52 GMT

What is ADR?

Alternative dispute resolution or ADR for short, usually describes a dispute resolution method where an independent person (an ADR practitioner, such as a mediator) helps people in dispute to try to sort out the issues between them.

ADR can help people to resolve a dispute before it becomes so big that a court or tribunal becomes involved.

ADR can be very flexible and can be used for almost any kind of dispute; even those that would never go to a court or tribunal.

ADR Practitioners

The behaviour of some ADR practitioners is regulated by standards and guidelines set by ADR professional organisations.

You can and should expect your ADR practitioner to be:

impartial
independent
qualified
professional at all stages of your ADR process
clear about the process they are using.

Advantages of ADR

Flexibility – ADR processes can be flexible, because the process can be made to suit your particular dispute. Court processes are generally less flexible.

Privacy and confidentiality – ADR processes and outcomes are usually private and confidential. Hearings and decisions of courts and tribunals (including the reasons for the decision) are usually public.

Self-directed – In an ADR process you and the other people involved usually choose who the ADR practitioner is. You can also agree about some of the things the ADR practitioner can do. When you use a court or tribunal, a decision-maker (such as a judge) is appointed for you. What the decisionmaker can do is based on the law. In an ADR process you and the other people involved decide on the outcome of the process. Courts and tribunals usually control the outcomes of court and tribunal processes.

Costs – ADR processes can be less expensive than other ways of resolving your dispute. Going to a court can be very expensive. Tribunals can be less expensive but can still involve hearings and legal costs if you are represented. There are also costs in time and effort to think about.

Less formality – ADR processes can be informal. Court and tribunal hearings can be very formal.

ADR processes may assist the parties involved in the dispute to maintain relationships.

Types of ADR

Medical practitioners will claim that prevention is better than the cure! This thinking should be applied when it comes to adopting an attitude towards disputes. In this regard, preparing well-conceived, plans, agreements and contracts may help parties avoid a dispute down the track.

However, sometimes disputes do arise. The first step usually should be a negotiation between the disputing parties. Negotiation does not require a third person to help resolve the dispute, although parties in a dispute may benefit from obtaining legal advice and having lawyers stay in the ‘background’ as part of a direct negotiation process.

Not every dispute needs to be resolved by a court or tribunal. ADR methods need not be mutually exclusive from a formal court process being initiated by one of the parties involved in the dispute. Below is a non-exhaustive list of different ADR methods:

Mediation. Mediators can be approved to practice under the Australian National Mediator Standards. You can find a copy of the National Standards at msb.org.au. Mediators can be former members of the judiciary and practicing lawyers. The mediation between the parties will be facilitated by a mediator, who will seek to guide the parties to resolve the matter, if possible. The reputation and track record of the mediator to help parties resolve disputes should be considered. There is flexibility in how the mediation should be conducted, including the appropriate venue for the mediation, which can occur over multiple days.
Conciliation. This can be initiated as part of a court or tribunal initiated process, say as part of court process requiring compensation for land acquisition or a family law matter in court. It can also be initiated as part of a voluntary process, say in a dispute between employee and employer. The conciliation between the parties will be presided by a member of the court or tribunal, usually at a court, who will seek to guide the parties to resolve the matter, if possible.
Collaborative Practice. This is found in the family law arena where a married or de-facto couple wishing to end the relationship contractually enter into a process to resolve the parenting and/or property matters between them with the assistance of (a team of) trained professionals (from legal, counseling and financial backgrounds) in this form of ADR.
Expert Determination. This is a process in which the parties to a dispute present arguments and evidence to a dispute resolution practitioner, who is chosen on the basis of their specialist qualification or experience in the subject matter of the dispute (the expert) and who makes a determination. The determination may or may not be binding on the parties. For example AVG Forensic has been appointed by parties involved in a dispute, usually to make an expert determination in the value of a party’s interest in a company, trust or group structure.
Arbitration. The process for commencing arbitration is usually set out in a contractual arrangement between the parties in the event of a dispute between the parties. The parties will appoint an Arbitrator to make a final determination of the matters in dispute which will be binding on the parties. The fact that a third party makes the final determination, distinguishes it from other forms of ADR such as mediation, conciliation and collaborative practice where the third party facilitator(s) provide direction and guidance to the parties. In Australia, arbitration is governed by both state and federal legislation. International arbitrations are governed by the International Arbitration Act 1974 (Cth). Domestic arbitrations are governed by the relevant state or territory Commercial Arbitration Act, which are largely uniform.

The most prominent professional arbitration and mediation institutions in Australia include the following bodies:

Australian Centre for International Commercial Arbitration (ACICA);
The Chartered Institute of Arbitrators;
Institute of Arbitrators and Mediators (IAMA); and
Australian Commercial Disputes Centre.

AVG Forensic has experience in all 5 of the above-listed ADR methods. As we understand and worked in these ADR processes, we can adopt our style to accommodate the party’s objectives for using ADR, although we aim to deliver the same quality of advice and expert opinions as if we were giving evidence in court.

How To Challenge Family Law Valuation Reports

adam.giliberti@avgforensic.com (Adam Giliberti) — Thu, 31 Oct 2019 08:17:17 GMT

A forensic accountant, with valuation expertise, can review a valuation report and act, initially, as a shadow expert to advise on the merits of the valuation report. A significant part of our work involves reviewing valuation reports prepared by other firms and finding one or more justifiable ways to have these valuation reports set aside.

What are the common contexts in which valuation reports prepared for family law purposes can be cast aside?

In family law matters, particularly in litigated matters in the Family Court of Australia, a single-jointly appointed expert is engaged to profer an opinion on value via the preparation of one or more valuation reports. We often start as a shadow expert to keep track of the enquiries made by the single-jointly appointed expert leading up to the preparation of the valuation report and evaluate whether there is a significant problem with the valuation report when it is issued. If there are problems with the report, we may come out of the ‘shadow’ and present a justification (for consideration by the court), on why the valuation report of the single-jointly appointed expert should not be the only expert opinion on value and that an alternative, more credible opinion on value should be preferred. In other cases, we may be approached to assist when one of the parties races off to get a valuation report without agreement from the other party and then seeks to use that valuation report to push for a property settlement. Putting aside the likely lack of independence this valuer will have in preparing the valuation, it is likely that one party will want to discredit the opinion of the other party’s valuation expert and put forward a different valuation opinion, particularly when there are problems with the valuation report.

What are the typical problems with valuation reports?

Rule 15.65 of the Family Law Rules 2004 provides the parties with the opportunity to ask the single jointly valuation expert questions in writing within 21 days from the issue of the report. This very narrow time frame requires a systematic approach when reviewing a valuation report. We characterise problems with valuation reports into three main three issues being: 1) Manifest errors by the valuer 2) Insufficient enquiries made by the valuer 3) Poor judgements by the valuer. It is said by valuers that when it comes to value, there is no single indisputable amount which is why valuers will adopt a range of values before expressing a conclusion of value at a point estimate. In relation to problems around poor judgments, this likely reflects that a business valuer has made one ore more poor judgments which result in a value conclusion which falls outside of what might be considered a normal range of values, however challenging individual poor judgments by the valuer in of itself may not amount to enough to have a court set aside the valuation and therefore it is much more powerful to also identify manifest errors and insufficient enquiries made by the valuer.

What are examples of ‘manifest errors’ in valuation reports prepared for a family law purpose

Adopting the wrong standard of value. Market value, fair value, value to owner, economic value, etc all mean different things at law and also as valuation professionals use these standards of value. Assuming the valuation report is prepared for a family law purpose, the valuer needs to consider the standard of value the court would adopt for the purposes of dividing the marital assets. Market value or fair market value may not necessarily always be appropriate if there is a different value which would arise adopting say, value to owner.
Valuing the wrong asset. Valuing the business only and not the legal entity is simply valuing the wrong asset for a family law purpose.
Failure to consider and identify surplus assets held in the legal entity which are not needed to operate the business.
Treating some items of working capital required by the business as a surplus asset of the business, e.g. cash, without explanation or without sound rationalisation.
Adopting a wholly inappropriate valuation approach and methodology. For example, a very commonly applied business valuation methodology, called ‘the FME method’, is applied without explanation or without sound rationalisation.
Adjustments for personal goodwill derived from a business value calculation including a goodwill value.
Adopting the wrong type of capitalisation rate to the profit. For example, adopting a price-earnings (P/E) multiple to Earnings Before Interest and Tax (EBIT).
Not ‘normalising’, i.e. adjusting the historical profit for market rent, market remuneration, once-off events/transactions, poor accounting e.g. recognising long cumulative years of employee leave (annual, long service) in one year.

What are examples of insufficient enquiries made by the valuer when preparing a valuation report for family law purposes?

Is the date of the valuation more than 6 months after 30 June? The date of the valuation is important because value changes over time and value can change significantly as circumstances can change over time. Therefore, the longer the period between the date of the valuation report and the date of the assessment of value, the less reliance you will be able to place on the value for the purposes of a property settlement. A valuation report expressing an opinion on the value of a business which is over 6 months, particularly involving a business which has not historically been stable in terms of revenue and profits, is likely to raise significant questions over its relevance for use in a property settlement.
What enquiries were made by the valuer and what were the responses to these enquiries? Where a sufficient number of documents reviewed in preparing the valuation report? Look for caveats and disclaimers and other limitations included in valuation report – do they water down the conclusion of value?
Did the valuation expert simply rely on statements provided to him or her without making any further reasonable enquiries in relation to the accuracy of the statements? Placing reliance on inappropriate financial reports which are subject to creative accounting, sloppy accounting or fraudulent accounting.
What sense checks or cross-checks have been applied? Have industry rules of thumb been used as a primary valuation methodology?
Is the related party debt balance going to be recovered? Is the face value of the related party loan its market value?

What are examples of poor judgments made by the valuer when preparing a valuation report for family law purposes?

Adopting a historical profit, rather than project profit for determining the future maintainable earnings (FME) of the business.
Using a simple average of the past three year’s historical profit for determining the future maintainable earnings (FME) of the business.
Adopting an inappropriate capitalisation rate based on the available evidence.
Adopting inappropriate discounts for say, lack of control, lack of marketability, etc.
Assuming there are no surplus assets or adopting assumptions supporting a nil surplus asset amount.
Assuming there are no normalisation adjustments.

If you are staring at a valuation report (involving a business or intangible asset) that suffers from one or more of these problems, contact us.

Valuation Essentials For Family Lawyers

adam.giliberti@avgforensic.com (Adam Giliberti) — Thu, 24 Oct 2019 08:42:11 GMT

Lessons drawn from the May 2019 Family Law conference in the USA

In May 2019, the American Academy of Matrimonial Lawyers held its national conference (in Las Vegas) in what is akin to the biennial National Family Law Conference in Australia.

The American national event was attended by family lawyers as well as valuation professionals and forensic accountants.

Business Valuation Resources (BVR) sponsored the May 2019 American family law conference and reported on a number of interesting takeaways for attendees. I provide below 4 key takeaways, originally identified by BVR, which I consider are relevant to family lawyers in Australia:

Takeaway Point 1 “Cryptocurrency is easy to overlook, so you should specifically ask about it during the discovery process for a divorce case.”

I take this to mean that cryptocurrency is considered property and therefore a value needs to be assigned for family law purposes. Blockchain technology, particularly involving currency applications may provide the opportunity for some parties to ‘hide’ assets.

Takeaway Point 2 “Calculation engagements are a “dangerous and treacherous” area, but everyone seemed to agree that they have their place (except in court).”

In Australia, I am professionally bound by APES 225 – Valuation Services. I wholly agree that valuation reports which reflect the author expressing a conclusion based on a calculation engagement, as defined by APES 225 – Valuation Services, have no place in a family law matter[i].

Unfortunately, I have a valuation report on my desk prepared for a family law purpose and this person has written a 100-page report based on a calculation engagement. This report is a waste of money!

Takeaway Point 3 “Many attorneys underestimate the importance of going through an in-depth examination of an expert’s qualifications in court.”

Parties in a family law matter who are considering paying for valuation report to be relied on for a property settlement should only obtain a valuation report if it will be authored by a suitably qualified and experienced professional who has given admissible and credible expert evidence on valuation matters in court.

People preparing business valuations come from a broad church, but only some experts have given expert evidence in a court which was considered to be persuasive. The reality is that those people who haven’t been subject to the rigours of cross examination in court tend to prepare inferior quality valuation reports which do not promptly resolve the matter of contention and therefore costs the client more money in the long run.

Takeaway Point 4 “Valuing intellectual property is difficult and potentially expensive—and there’s a dearth of case law on how to value it.”

There are international valuation standards which provide authoritative guidance to valuation professionals in relation to the valuation on intangible assets, including intellectual property. While there are widely accepted valuation methodologies, case law cannot be ignored and legal context of the case law is important. For example, in December 2018, High Court of Australia issued a judgment in relation to a tax matter involving a multinational and internationally listed gold mining company where the Court unanimously decided that this company lacked any legal goodwill, notwithstanding that a Big 4 accounting firm valued the goodwill for accounting reporting purposes at $6.5 billion (in US dollars).

[i] There are three types of valuation engagements defined under APES 225 – Valuation Services, being a valuation engagement, a limited scope valuation engagement and calculation engagement. A valuation engagement is what should be prepared for a family law purpose. The definitions of a valuation engagement, a limited scope valuation engagement and a calculation engagement included in APES 225 – Valuation Services are included below:

Calculation Engagement means an Engagement or Assignment to perform a Valuation and provide a Valuation Report where the Member and the Client or Employer agree on the Valuation Approaches, Valuation Methods and Valuation Procedures the Member will employ. A Calculation Engagement generally does not include all of the Valuation Procedures required for a Valuation Engagement or a Limited Scope Valuation Engagement.

Limited Scope Valuation Engagement means an Engagement or Assignment to perform a Valuation and provide a Valuation Report where the scope of work is limited or restricted. The scope of work is limited or restricted where the Member is not free, as the Member would be but for the limitation or restriction, to employ the Valuation Approaches, Valuation Methods and Valuation Procedures that a reasonable and informed third party would perform taking into consideration all the specific facts and circumstances of the Engagement or Assignment available to the Member at that time, and it is reasonable to expect that the effect of the limitation or restriction on the estimate of value is material. A limitation or restriction may be imposed by the Client or Employer or it may arise from other sources or circumstances. A limitation or restriction may be present and known at the outset of the Engagement or Assignment or may arise or become known during the course of a Valuation Engagement. A Limited Scope Valuation Engagement may also be referred to as a “restricted-scope valuation engagement” or an “indicative valuation engagement”.

Valuation Engagement means an Engagement or Assignment to perform a Valuation and provide a Valuation Report where the Member is free to employ the Valuation Approaches, Valuation Methods, and Valuation Procedures that a reasonable and informed third party would perform taking into consideration all the specific facts and circumstances of the Engagement or Assignment available to the Member at that time. Where a Member has entered into a Valuation Engagement but during the course of performing the Valuation Engagement the Member becomes aware of a limitation or restriction that, if it had been known at the time the Engagement or Assignment was entered into, would have made the Engagement or Assignment a Limited Scope Valuation Engagement then the Valuation Engagement will become a Limited Scope Valuation Engagement.

This article first appeared in Wolters Kluwer Central .

Finding Hidden Assets In Family Law Matters

adam.giliberti@avgforensic.com (Adam Giliberti) — Thu, 24 Oct 2019 08:35:25 GMT

What are hidden assets?

Hidden assets include any asset which one party does not disclose to the other party, in connection to a proposed property settlement following the breakdown of a marriage or de-facto relationship.

At one extreme, one party may be deliberately trying to conceal the existence of an interest in an asset from the other party in a divorce.

Sometimes one party may be fully aware of their interests in assets at the time of making their disclosure but needs prompting from the other party to bring those assets to light.

Often we see one party withholding information about interests in assets from the other party as part of a (flawed) negotiation approach to reach an agreement on other aspects of the divorce, such as parent/child agreements.

What are the indicators that there may be hidden assets?

Certain environmental factors may present an opportunity for assets to be hidden from other parties. These include:

Directorship and shareholding in numerous companies, past and present.
Use of unincorporated entities particularly multiple trusts and a combination of unincorporated entities.
Multiple loan accounts, other payables and other receivables accounts in the balance sheets provided and suspicious/unknown income and/or expenses items suggesting they might be related party transactions.
Lots of overseas travel for unknown reasons.
International dimensions to the business and/or international entities.
More than one known business activity.
Puppet directors or trustees of trusts. Evidence is needed to demonstrate the ‘controlling mind’ is the husband or wife, rather than the parents, close relatives or business associates.
Phoenix operations, particularly in recent history
One party plotting to leave, the other other party holding on prior to agreement of separation.

Rule 13.04 of the Family Law Rules 2004 requires ‘full and frank disclosure.’ A forensic accountant can work with family lawyers to review initial disclosure and provide advice on whether that disclosure if considered full and frank for the purpose of allowing values for the matrimonial asset pool to be determined and potential claims for spousal maintenance.

In some instances, there can be cases where full and frank disclosure is not made on a timely basis. The challenge is to then work out whether this is:

Inadvertent non disclosure
Deliberate non-disclosure

How do you find hidden assets?

You need to plan and gather a complete record of evidence currently available.
Analyse the financial statements provided and check that the financial data contained therein is consistent with the income tax returns lodged with the ATO.
Obtain all accounting ledgers to explain transactions and all bank statements for the relevant periods. Consider the relevant time period of investigation of financial records carefully taking into account cost and benefit in relation to the length of period determined.
Identify all related party entities and individuals and note transactions involving these related parties and individuals.
Utilise forensic tools in litigation such as issuing a notice to produce and subpoena. In family law, writing to the other side requesting specific and well defined documents under the obligations for full and frank disclosure is essential. It is practically impossible to find hidden assets (other than by accident) when the parties have not commenced litigation.
Follow the flow of cash and assets out of entities into other entities.
Review end of period general journals and end of period adjustments by the accountant.

What are the challenges when assets are located overseas?

Unlike in Australia where you can trace shareholders of companies, in other countries it may not be possible to simply search public registers. It will likely be necessary to work with firms that operate with people in that legal juridication and lawyers that understand the additional complexities that will arise from uncovering suspected assets located overseas.

Can we help?

If there is a known multi-million dollar asset pool, there is a known operating business and there is use of more than one legal structure, we are happy to apply the 7-step process above to identify 'leakage of value' from the known asset pool to bring to light suspected hidden assets.

Spotlight on the Property Law sector

adam.giliberti@avgforensic.com (Adam Giliberti) — Fri, 06 Sep 2019 07:29:36 GMT

What is the Property Law services sector?

The ‘Property Law’ services sector of the Australian Legal Services Industry, according to IBISWorld, accounts for 15.5% of the total industry’s revenue (which in 2019 was estimated to be AUD $20.8 billion).

The Property Law segment of the Australian Legal Services Industry includes property conveyancing and other property-related legal work. Small local law firms primarily provide these services to households and businesses engaging in property transactions.

Additionally, while property owners and investors account for a large portion of clients for this segment, property law specialists also advise property developers on issues such as structuring finance for property sales.

What drives demand for the Property Law services sector?

This sector is significantly affected by interest rates and the strength of the domestic economy as well as the number of housing transfers and the building of new dwellings from property developers.

What is the current performance of the Property Law services sector?

Although the number of housing transfers has decreased over the past five years, a rise in the number of new dwelling commencements has boosted demand from property developers for services over the same period.

However, operators in this segment face strong competition from real estate agents and mortgage brokers that also provide these services.

Over the past five years, this segment has declined as a share of industry revenue.

Note 1: This information is reproduced from the IBISWorld Industry Report M6931 Legal Services in Australia February 2019 Kim Do

AVG Forensic’s primary referral source is the Australian legal services industry. The Australian Legal Industry – Drivers of Value provides our insight into the value drivers for this industry based on our research, experience and knowledge. To receive a copy of our full report, please supply your details below you will receive a link to your copy.

Spotlight on Personal Legal, Family Law and Industrial Relations Legal Services sector

adam.giliberti@avgforensic.com (Adam Giliberti) — Fri, 06 Sep 2019 04:09:50 GMT

What is the Personal Legal, Family Law and Industrial Relations services sector?

The ‘Personal Legal and Industrial Relations’ services sector of the Australian Legal Services Industry, according to IBISWorld, accounts for 21.7% of the total industry’s revenue (which in 2019 was estimated to be AUD $20.8 billion).

The ‘Personal Legal and Industrial Relations’ services sector of the Australian Legal Services Industry, according to IBISWorld, includes legal work related to wills and estates, personal injury, workers’ compensation and family law.

Legal services related to ‘industrial relations’ usually involve unions and large corporations. Since the Fair Work Act 2009 was implemented, employers have grappled with good-faith bargaining, industrial action and permitted agreements. Legal firms can provide services to both employers and individual employees.

Sole proprietors and small firms primarily are the primary providers of personal legal services, as services in this segment are less profitable than services in other segments.

What drives demand for Personal Legal, Family Law and Industrial Relations services?

The ‘Personal Legal and Industrial Relations’ services sector of the Australian Legal Services Industry, according to IBISWorld, has increased as a share of industry revenue over the past five years, despite a decline in the workplace accident rate.

Divorce processes tend to be complex and often involve dividing matrimonial assets and custody of dependents. A rise in the number of divorces generally increases demand for law firms and practitioners that specialise in family law.

What is the current performance of the Personal Legal, Family Law and Industrial Relations services sector?

Growth in this segment is largely due to law firms increasingly offering a no-win no-fee incentive to consumers for personal injury and workplace claims.

Note 1: This information is reproduced from the IBISWorld Industry Report M6931 Legal Services in Australia February 2019 Kim Do

Spotlight on Commercial Law Services Sector

adam.giliberti@avgforensic.com (Adam Giliberti) — Fri, 06 Sep 2019 03:48:50 GMT

What is the Commercial Law services sector?

According to IBISWorld[1], commercial law services accounts for 32% of the Australian Legal Services Industry.

The commercial law services sector provides legal advice to businesses, mostly relating to major corporate transactions such as mergers and acquisitions and IPOs, and financing methods and taxation solutions. The top-tier law firms primarily provide services in this segment.

What drives demand for Commercial Law services?

The business cycle, investment levels and overall corporate activity heavily affect demand for these services. Some commercial law services, such as those associated with bankruptcy and restructuring initiatives, are countercyclical. Due to the complexity of commercial transactions, legal firms that specialise in this area of law often command high premiums.

What is the current performance of the Commercial Law services sector?

Over the past five years, this segment has increased as a share of industry revenue due to positive business confidence and growing demand from financial services firms.

Note 1: This information is reproduced from the IBISWorld Industry Report M6931 Legal Services in Australia February 2019 Kim Do

Structure and key characteristics of the Australian Legal System

adam.giliberti@avgforensic.com (Adam Giliberti) — Mon, 20 May 2019 04:28:36 GMT

We provide below a break down of the characteristics that make up the Australian Legal System which provides the context and framework for the work of forensic accountants in Australia as distinct from other countries.

Classification of countries legal system

It may be convenient to broadly classify a democratic country’s legal system into either a common law or civil law country.

Common law countries:

The system of common law originated in England where courts of equity were set up by the Crown to hear writs. The centuries-old tradition of English law is that judges decide each dispute as it comes to court, and give reasons for their decision. These reasons, or judgments, are published in books called law reports. The accumulation of judges’ decisions over many years is what is called the common law – law made by judges in deciding common disputes.

In England, a Bill of Rights was signed in 1689 acknowledging the Monarch could only rule with the Parliament’s consent thus establishing the power of Parliament.

Countries like Australia, United States of Amercia, South Africa, Canada, New Zealand and many countries of the British Commonwealth can be called Common Law countries which feature:

Legislation made by a Parliament; and
Case law made by courts (where legislation takes precedence). Courts can interpret legislation and fill in gaps in the law. An adversarial system of justice with an active role played by the parties in a dispute with judge to adjudicate the evidence presented

Civil Law countries:

The system of civil law originated in Roman times and therefore most countries in Europe are considered civil law countries (as distinct from common law countries) which feature:

Legislation made by Parliament
Courts involving a system of justice which is inquisitorial, involving an active role for judge to find the truth.

Some countries, like Scotland, adopt a hybrid system.

In Australia, customary law was acknowledged and recognised in Mabo v Queensland (No.2) (1992) 175 CLR 1

How legislation is made in Australia

In Australia, a proposal for a Bill is given to government ministers and the Bill is drafted for queue for passage of Bills by Parliament (read and debated by both houses of Parliament) and when Royal Assent (by the Crown’s representative) is given to the Bill, it then becomes an Act of Parliament and the Act is proclaimed to be in force and published in government Gazette.

Delegated or subordinate legislation is made by authorities created under an Act eg a Council, Minister of the Crown, a University, an Owners Corporation of Strata Title property in NSW and delegated legislation includes things such as By-Laws, Regulations, Rules, Ordinances, etc. Later legislation takes precedence over earlier legislation in relation to inconsistency, Act or statute takes precedence over delegated legislation unless expressly stated to the contrary.

What does ‘rule of law’ mean?

Rule of law is used when referring to a democratic country and means:

absolute supremacy of government by law as opposed to government by arbitrary fiat or decree; and
government can operate only if they have specific legal authority to do so; and
a person can only be punished for a breach of the law and not otherwise.

Rule of law reflects principal of legality. Therefore every government action requires a legal authority to act.

How making of laws can be classified

Laws can be classified into public law or private law.

Public law governs the operation of the state and the relationship between state and its citizens. Public law concerns criminal law, taxation law, immigration law and administrative law; and

Private law concerns the relationship between citizens and deals with private disputes known as civil law matters including contract, torts, property, etc

What does ‘separation of powers’ refer to?

Originally statutes (which we now also refer to as government legislation) were simply royal decrees, i.e. what the Monarch wanted. From start of the 17th century, parliament was introduced which commenced the separation of power from the Monarch.

Separation of powers now refers to the separation of power which features in common law countries between the Legislative (i.e. Parliament), Executive (i.e. Ministers & Officials) and Judicial (Courts).

Federal system of government in Australia

In Australia, the Constitution of Australia Act 1900 (Cth) (“Constitution”) establishes that the Commonwealth of Australia has a federal system of government with:

a) defined powers for the Federal Parliament of Australia. Section 51 of the Constitution sets out the federal government’s powers to make laws relating to (for example) defence, taxation, customs, migration, social security and marriage.

b) residual powers of the various Parliaments of the States of Australia, being powers not defined under section 51 of the Constitution. State Parliaments have powers to make laws relating to (for example) health, education, roads and traffic, building, local government and the environment.

The Territories of Australia have limited self-government.

An Act of Parliament is binding on all courts and judges in Australia. Judges can overrule or challenge the validity of an Act only in rare circumstances, i.e. if it is considered unconstitutional.

Court hierarchy in Australia

In Australia we have a federal court hierarchy and a state court hierarchy.

The Federal hierarchy of courts comprise:

High Court of Australia. Seven justices sit on the High Court of Australia
Federal Court of Australia. Single judge or Full Court (at least three judges)
Family Court of Australia (Appeal division can hear from Magistrates Courts of the territories and the Federal Circuit Court)
Federal Circuit Court of Australia (established in 1999 as the Federal Magistrates Court and in Sep 2018 this Court was abolished)
Administrative Appeals Tribunal and other tribunals
State hierarchy (e.g. in NSW)
Supreme Court of NSW Court of Appeal (3 Judges)
Supreme Court of NSW – Common Law Division and Equity Division
District Court of NSW
Local Courts
NSW Civil and Administrative Tribunal (NCAT)
Most superior courts have both original jurisdiction (directly taken without first being heard by a lower court) and appellate jurisdiction (originally heard in a lower court).

Administrative tribunals are official bodies, not considered courts, tasked with making decisions to resolve legal disputes. Carry out ‘quasi-judicial’ functions as the courts are technically considered the only bodies which carry out ‘judicial’ functions. For example, the Commonwealth Administrative Appeals Tribunal (“AAT”), Australian Industrial Relations Commissions (“AIRC”)

What is the doctrine of precedent?

Each court is bound by decisions of courts in its hierarchy. A decision of a court in a different hierarchy or lower in the same hierarchy may be persuasive but not binding. A court is not bound by its own past decisions but will depart from them with reluctance. Only the ‘ratio decidendi’ i.e. the reason for the decision, of a case is binding. A court is not bound by its own past decisions but will depart from them with reluctance. Important cases will be published in series of law reports which contain valuable precedents.

Goodwill Hunting

adam.giliberti@avgforensic.com (Adam Giliberti) — Wed, 01 May 2019 04:45:06 GMT

This article analyses the High Court of Australia’s decision in Commissioner of State Revenue v Placer Dome Inc (now an amalgamated entity named Barrick Gold Corporation) [2018] HCA 59 which addresses ‘goodwill’ from the perspective of a valuation professional and forensic accountant giving expert evidence in Australian courts.

On 5 December 2018, the High Court of Australia issued its decision in Commissioner of State Revenue v Placer Dome Inc (now an amalgamated entity named Barrick Gold Corporation) [2018] HCA 59 (“ Placer Dome ”). The Placer Dome decision required the High Court of Australia to revisit its definition of ‘goodwill’ based on a decision it reached 20 years earlier in Commissioner of Taxation v Murry (B19-1997) [1998] HCA 42 (“ Murry ”) being a decision it described as ‘watershed’ in relation to the nature, source and value of goodwill. The Murry and Placer Dome decisions expounded on the legal meaning of goodwill and confirmed that it is not the same as what accountants refer to as goodwill. The High Court of Australia in the Placer Dome decision referred to consistency between economic goodwill and legal goodwill, with the former being discussed by economists in the context of a ‘reciprocity’ between seller and buyer which has ‘custom’ at its heart. Whereas accountants typically view goodwill as a ‘residual’ amount (as reflected in accounting standards they are bound by) and therefore an accountant’s understanding and calculation of goodwill is deficient for the purposes of its objective ascertainment at law.

Kiefel CJ, Bell J, Gageler J, Nettle J and Gordon J presided in the Placer Dome case and issued Orders which included:

the appeal by the Commissioner of State Revenue (in Western Australia) (“ Commissioner ”) be allowed; and
the Order of the Court of Appeal of the Supreme Court of Western Australia made on 11 September 2017 be set aside.

The Orders effectively upheld an assessment by the Commissioner[1] that Placer Dome Inc (“ Placer ”) was a ‘land rich company’ under Division 3B of Pt IIIBA of the Stamp Act 1921 (WA) (“ Stamp Act ”) and that Barrick Gold Corporation Inc (“ Barrick ”) was liable to pay ad valorem duty of AUD$54.852 million in respect of its on-market share acquisition of Placer which lead to a controlling ownership interest on 4 February 2006. The duty was payable on the value of land Placer owned in Western Australia.

A key issue the High Court of Australia had to consider was whether the property of Placer, at the date of acquisition by Barrick, included goodwill with a value of USD$6.506 billion, being the amount allocated to goodwill in Barrick’s financial statements . A unanimous decision was reached that Placer had no material property comprising of goodwill.

The High Court of Australia’s decision on Placer’s lack of goodwill was reached within a specific legal and factual context. I have sought to condense and summarise the High Court’s reasoning[2] below, focusing my attention to matters of relevance to forensic accountants and valuation professionals who opine on ‘goodwill’ and allocation of other asset values as well as those matters of relevance to tax advisers who rely on valuation advice when giving tax advice to clients in connection with a potential tax-related dispute and tax-related litigation.

What was the legal context for the Placer Dome decision?

The legal context for the High Court of Australia was to consider valuations applied for a specific statutory test in the Stamp Act drafted for the purpose of government revenue raising[3]. The valuations and statutory test the High Court of Australia had to consider is illustrated in Table 1 below.

In relation to the dominator shown in Table 1 above, there was agreement between Barrick and the Commissioner, and the amount agreed was USD$12.8 billion[4].

In relation to the numerator shown in Table 1 above, it was contested between the parties. Barrick contented that USD$6.5 billion of value which had been included in the numerator, following the Commissioner’s original assessment, was in fact Placer’s goodwill. If the High Court of Australia was satisfied that Placer had goodwill of USD$6.5 billion, then the result would be that Placer was not considered to be a ‘land-rich’ company.

The High Court of Australia stated that the evidentiary and persuasive onus was on Barrick to prove Placer had goodwill, which is of critical significance.

What was the factual context for the Placer Dome decision?

The High Court of Australia acknowledged that just before Placer was acquired by Barrick, Placer:

was fifth largest global gold mining company assessed by market capitalisation;
was third largest global gold mining company assessed by gold reserves;
was fourth largest global gold mining company assessed by gold production;
operated 16 gold mines, five development projects and seven exploration projects in North America, South America, Australasia and South Africa;
employed approximately 13,000 people;
had land-holdings, including mining, development and exploration interests, around the world; and
only material source of revenue was from the sale of gold, which it sold as refined elemental metal (Placer also produced and sold copper, though to a much lesser extent).

At the date of acquisition, Barrick was a listed entity on the New York Stock Exchange, Toronto Stock Exchange, Australian Securities Exchange, among others. As a Canadian foreign filing entity and registrant on the New York Stock Exchange, Barrick was required to comply with the United States generally accepted accounting principles (“ US GAAP “) which in relation to the acquisition of Placer required Barrick to comply with standards issued by the Financial Accounting Standards Board, including Statement of Financial Accounting Standard No 141 – Business Combinations. Barrick’s compliance with US GAAP required the need for a purchase price allocation exercise to be undertaken, in which the identifiable assets and liabilities of the acquired Placer are ascribed their fair market values with the excess of purchase consideration over the net fair value of assets acquired being ascribed to goodwill[5].

Before addressing in further detail, the factual evidence tendered by Barrick in support of its argument that Placer has goodwill, it is relevant to address the competing valuation evidence and valuation approaches relied on by Barrick and the Commissioner throughout the course of the litigation.

Placer Dome relied on valuation expert evidence of Messrs Jay Patel and Edward Lee. The Commissioner principally relied on valuation expert evidence of Mr Wayne Lonergan.

Barrick’s valuation evidence

Mr Jay Patel of Ernst & Young LLP, in Toronto, Canada was engaged by Barrick in 2006 (following the acquisition) to provide an opinion on the ‘fair value’ of Placer’s tangible and intangible assets as at the time of the acquisition, for the purposes of Barrick’s financial reporting obligations under US GAAP and, in particular, in accordance with FAS No 141 which culminated in a purchase price allocation report dated 19 February 2007. This report resulted in the identification of a goodwill value in Placer of USD$6.506 billion based on the calculations shown in Table 2 below.

Mr Edward Lee, managing director of Duff & Phelps LLC, a valuation firm based in San Francisco, California was also engaged by Barrick (in 2007) to estimate the fair market value of certain assets acquired by Barrick in the course of its acquisition of Placer. Mr Lee’s evidence took the form of the advice which he gave at that time, and a later report in which he responded to the valuations performed by experts engaged by the Commissioner. Mr Lee’s evidence included an opinion on goodwill value, shown in Table 3 below, which was materially similar Mr Patel’s opinion, shown in Table 2 above.

The Commissioner’s valuation evidence

Mr Wayne Lonergan, director of Lonergan Edwards & Associates Pty Ltd, a valuation firm based in Sydney was engaged by the Commissioner to opine on the value of land held by Placer at the time of the acquisition. As shown in Table 4 below, Mr Lonergan arrived at a range for the value of all of land held by Placer.

A summary of the competing valuation evidence considered by the High Court can be summarised in Table 5 below.

All valuation experts:

used the discounted cash flow (“DCF”) method to value all the property of Placer;
adopted life-of-mine models prepared by Placer in 2005 as part of the DCF method; and
were likely in agreement over the discount rates for use in the DCF method.

The major differences between the experts related to:

the appropriate valuation approach to determine the value of land, i.e. whether a ‘top-down’ approach or ‘bottom-up’ approach was appropriate for the statutory valuation purpose; and
the long-term gold prices used in the DCF method. Messrs Patel and Lee used management and industry consensus forecasts of gold prices at the time of acquisition whereas Mr Lonergan used gold futures contracts at the time of acquisition. The High Court of Australia noted that the Court of Appeal of the Supreme Court of Western Australia considered that Mr Lonergan had erred in the use of gold futures prices and therefore Mr Lonergan’s valuation must be considered an unreliable guide to the value of the statutory numerator.

The Commissioner contended that a ‘top down’ valuation approach should be adopted which starts with the value of the total property, before subtracting the value of assets which are not land, in order to produce a residual value which is then attributed to land. In adopting this approach, the Commissioner contended that immediately before Placer’s acquisition by Barrick, Placer had no material property comprising goodwill with the inevitable result that the value of Placer’s land exceeded the 60 per cent threshold resulting in Placer being a ‘land-rich’ company as reflected in Table 5 above.

Barrick disagreed with the Commissioner’s valuation methodology and contended that Placer’s land should be valued directly, using a DCF methodology, and that the resulting valuation of Placer’s land was less than the 60 per cent threshold resulting in Placer not being a ‘land-rich’ company as reflected in Table 5 above. The application of a DCF methodology to value the land can be called a ‘bottom-up’ approach when contrasted with the ‘top-down’ approach relied on by the Commissioner to value the land as a residual. Barrick contended that the DCF calculation directed to valuing each mining tenement according to its best potential use was the standard, and not an inappropriate methodology and that the residual accounting amount – the gap of $6 billion – was attributable to and equal to the value of Placer’s legal goodwill. Barrick identified seven “sources” for Placer’s goodwill being:

Placer’s personnel, who were said to have proven capacity to develop and expand the business (“Personnel“);
the technical capacity of the personnel (“Technical Capability“);
Placer’s innovative mining techniques, which were said to have enabled Placer to extract lower-grade ores, giving it a competitive advantage over other miners (“Techniques“);
the strong and experienced project group and mine managers (“Management“);
the size, structures and systems that enabled Placer to harvest efficiencies and economies of scale (“Systems“);
the synergies (“Synergies“); and
the going concern value comprising “the value of all the rights and privileges to conduct Placer’s business” (“Going Concern Value”).

In relation to Barrack’s arguments regarding the “sources” of Placer’s goodwill, the High Court of Australia summarised:

“…none of these matters taken individually or collectively is of that character. Some of the “sources” are expressly excluded from the statutory valuation exercise. For some of the “sources”, there is no evidential basis that they in fact exist. And none of the “sources” could generate goodwill of any material value because Barrick could not and did not establish that any of the “sources” could generate or add value (or earnings) by attracting custom to Placer’s business.” [111]

The High Court of Australia’s comprehensive reasoning, based on the factual context, as to why each of items (1) to (6) above was not considered a source of Placer’s goodwill is set out in paragraphs 113 to 138 of the judgment and the comprehensive reasoning as to why item 7 above, based on the factual context, was not considered a source of Placer’s goodwill is set out in paragraphs 96 to 108 of the judgment.

Barrick further contended that even if a ‘top down’ approach were adopted, the result would not be different because, immediately before the acquisition, Placer owned property being goodwill with a value of $6.506 billion. The High Court of Australia considered the difficulty for Barrick was that the DCF methodology of valuing the land assets, as applied by its experts, yielded a large gap between the valuation of Placer’s land assets and the purchase price paid. That gap necessarily raised a question about the reliability of the DCF valuations and, in turn, a question about the content of the $6.506 billion allocated to goodwill in Barrick’s accounts. The High Court of Australia considered Placer lacked goodwill at the time of the acquisition by Barrick particularly noting that Placer’s only product was gold – an undifferentiated product which it sold into a world market at a world price.

High Court of Australia’s findings on goodwill – take-away points for valuation professionals

The High Court of Australia made the following key findings on the nature, source and value of goodwill for legal purposes:

Goodwill for legal purposes is property because “it is the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means that attracted custom to it”, being a “right or privilege that is inseparable from the conduct of the business”[6]
Goodwill for legal purposes extends to those sources which generate or add value (or earnings) to the business by attracting custom, whether that be from the use of identifiable assets, locations, people, efficiencies, systems, processes or techniques of the business, or from some other identifiable source. Those sources of goodwill for legal purposes have a unified purpose and result – to generate or add value (or earnings) to the business by attracting custom[7]
Goodwill for legal purposes is different from, and is not to be confused with, the “going value” or the going concern value of a business. Goodwill represents a pre-existing relationship arising from a continuous course of business – to which the “attractive force which brings in custom” is central. Without an established business, there is no goodwill because there is no custom. A collection of assets has no custom[8].
Goodwill for accounting purposes is essentially subjective, reflecting the excess that a purchaser is willing to pay for a business or the discount a seller is willing to accept for the same. In this sense, it is essentially a balancing item. However, as a matter of law, the existence or otherwise of goodwill is objectively ascertained. By way of contrast, courts define, and identify, goodwill in differing factual and legal contexts. The definition in one context is more often than not inappropriate in another context. As the majority said in Federal Commissioner of Taxation v Murry , “the nature of goodwill as property may be the focus of the legal inquiry“, “the value of the goodwill of a business may be the focus of the inquiry“, or “identifying the sources or elements of goodwill may be the focus of the inquiry“. That list is not exhaustive. Of particular significance in seeking to define goodwill as a legal term has been the importance of the varying statutory contexts in which the legal question has arisen. The factual and legal context for the Placer Dome decision on Placer’s lack of goodwill is both particular and specific.

While the Placer Dome case specifically related to ‘land-rich company’ provisions in the Stamp Act involving a gold mining company, it has relevance in ‘land-rich company’ provisions in other state base statutes for revenue raising and also in relation to Division 855 of the Income Tax Assessment Act 1997 (Cth) in relation to CGT that might be payable by foreign resident entities in relation to taxable Australian real property, particularly if it involves a mining company. The goodwill principles in the Placer Dome decision could also potentially apply in other contentious tax matters relying on valuations based on purchase price allocations and therefore any residual goodwill value should be cross-checked against the legal meaning of goodwill.

It is always fascinating delving into what the High Court says about goodwill.

[1] The State Administrative Tribunal in Western Australia originally upheld the Commissioner’s assessment following Barrick’s original objection [2015] WASAT 141 (11 December 2015) , which then lead to Barrick appealing to the Court of Appeal of the Supreme Court of Western Australia, which found in favour of Barrick [2017] WASCA 165 (11 September 2017) .

[2] The reasoning of Kiefel CJ, Bell J, Nettle J and Gordon J are set out in pages 1 to 45 and the reasoning of Gageler J is set out in pages 46 to 64 of the Placer Dome decision.

[3] The Placer Dome decision uses the words “ statutory valuation exercise ”.

[4] The price Barrick paid to acquire Placer (grossed up for liabilities) was USD$15.346 billion. The exclusion relating to the quantum of mining information is inferred to be

[5] In Australia, there are similar accounting standards to US GAAP in relation to requirements for fair values being allocated to identifiable assets on acquisition of legal entities (i.e. AASB 3 – Business Combinations) and also when accounting for goodwill (i.e. AASB 138 – Intangible Assets). Therefore the compliance requirement for Barrick under US GAAP is not considered unique compared to a hypothetical situation of Barrick having to comply with Australian accounting standards.

[6] Federal Commissioner of Taxation v Murry (1998) 193 CLR 605 at 615 [23].

[7] Commissioner of State Revenue v Placer Dome Inc [2018] HCA 59 at 29 [91].

[8] Federal Commissioner of Taxation v Murry (1998) 193 CLR 605 at 627 [60].

Australian Legal Services Industry – Spotlight on Administrative, Constitutional & Other Services

adam.giliberti@avgforensic.com (Adam Giliberti) — Thu, 04 Apr 2019 07:40:47 GMT

According to IBISWorld[1], Administrative, Constitutional & Other services accounts for 16.3% of the Australian Legal Services Industry.

What is the Administrative, Constitutional & Other services sector?

This segment includes work related to government administration, the constitution, tribunals and other fields of law, such as environmental law.

The main market for these services is corporate clients dealing with government departments and agencies. Some larger industry firms also provide advisory services to government departments, agencies and statutory authorities regarding forming and implementing government regulations.

What drives demand for Administrative, Constitutional & Other services?

Finance and insurance companies require a range of legal advice including advice related to regulatory compliance, as government authorities heavily regulate financial and insurance services firms. Demand from financial and insurance services is expected to slightly decrease over 2018-19.

What is the current performance of the Administrative, Constitutional & Other services sector?

This segment has slightly declined as a share of industry revenue over the past five years, as government departments have increasingly been using in-house legal teams.

[1] The information is reproduced from an IBISWorld Industry Report M6931 Legal Services in Australia released in February 2019 and authored by Kim Do.

What is Creative Accounting, Sloppy Accounting and Fraudulent Accounting?

adam.giliberti@avgforensic.com (Adam Giliberti) — Sat, 30 Mar 2019 05:11:03 GMT

A discussion on terms such as creative accounting, sloppy accounting and fraudulent accounting is usually in connection with the presentation of ‘financial report’ for a company (or group of entities) operating a business, so before launching into creative accounting, sloppy accounting and fraudulent accounting, I would like to first address what is a financial report and types of financial reports.

What is a financial report?

Section 295 of the Corporations Act 2001 (Cth) sets out the contents of a financial report, which comprise the following three important documents:

Financial statements. The financial statements can be broken down into the following three reports:
statement of financial position, commonly known as a ‘balance sheet’ setting out the assets and liabilities of the company,
statement of financial performance, commonly known as a profit and loss statement; and
statement of cash flows. For private companies which are classified as ‘small proprietary limited’ companies using the criteria set out under 45A(2) of the Corporations Act 2001 (Cth) , it is not unusual for the financial statements to exclude a statement of cash flows.
Notes to the financial statements. The notes to the financial statements sets out the following:
the accounting policies adopted in the preparation of the financial statements; and
more detail in relation to the aggregated numbers included in the financial statements.
Directors’ declaration. This report is typically only 1 page long, but it includes two important statements:
a statement about the company’s ability to pay its debts as and when they fall due, which is essentially a declaration of the company’s solvency.
that the company complies with all the accounting policies as described in the notes to the financial statements and that the financial statements and notes to the financial statements present a ‘true & fair’ view.

Types of financial reports

Financial reports are typically published by a company and provided to third parties for a particular period, usually a financial year which for most companies runs from 1 July to 30 June. There are two types of financial reports:

General purpose financial reports. General purpose financial reports are to comply with all the Australian accounting standards which are relevant to the company; and
Special purpose financial reports. Special purpose financial reports may comply with only some Australian accounting standards or it may refer to none of the Australian accounting standards.

The financial reports ought to disclose within the ‘notes to the financial statements’ and in the ‘directors’ declaration’ whether the financial report is considered a ‘general purpose’ or ‘special purpose’ financial report. Generally speaking[1],

public companies publish general purpose financial reports; and
private companies publish special purpose financial reports.

Some of the public may view an accountant as a person who captures transactions to simply record financial history by following black & white rules. The reality is that accounting is somewhat abstract and there is always more than one way to report history in the financial reports, even when adopting Australian accounting standards because application of Australian accounting standards requires professional judgement.

Irrespective of whether a financial report is considered ‘general purpose’ or ‘special purpose’, the objective of the financial report is to present a ‘true and fair’ view of the financial position and financial performance of the company. There is no prescriptive accounting definition on what ‘true and fair’ means – what is ‘true and fair’ is ultimately a matter for the courts to determine, usually with the assistance of expert evidence, often given by a forensic accountant.

Australian accounting standards provide that if there are ‘material’ misstatements included in the financial reports then the financial reports are likely to be misleading to users relying on the financial reports. Therefore misleading financial reports cannot present a ‘true and fair’ view of company’s financial position and financial performance. Australian accounting standards provide guidance on what is considered ‘material’ for the purposes of avoiding the preparation of misleading financial reports, which is a matter of professional judgment, based on qualitative and quantitative factors.

Now we have talked about financial reports, the presentation on what is included therein will be influenced by, what I characterise as Creative Accounting, Sloppy Accounting and Fraudulent Accounting.

What is Creative Accounting?

Creating Accounting is a bit of loaded term because there is a misconception that it suggests something illegal, fraudulent or misrepresented. This misconception could arise from instances where creative accounting has been noted by financial commentators in connection with a company when fraud is discovered or the company later collapses and enters into liquidation.

Creative accounting is simply an acknowledgement that there may be a range of possible answers i.e. descriptions and numbers included in a financial report) when adopting generally accepted accounting principles (and Australian Accounting Standards provide authoritative guidance when describing generally accepted accounting principles).

It is important to stress that:

creative accounting is not illegal;
the application of creative accounting can be intentional by management of the company;
creative accounting is legitimate provided the financial reports give a ‘true and fair’ view of the company’s financial position and financial performance; and
financial reports which have been audited by an independent auditor are not immune to creative accounting.

Creative accounting techniques

The following are just a few of the many sorts of ways creative accounting can be used with respect to general purpose financial reports (which are audited by an independent auditor):

The company’s decision to enter into related party transactions which are not on a commercial basis;
Application of lease accounting and use of off-balance sheet finance;
Recognition of revenue which might involve the recognition of revenue under an arrangement up-front rather than spread out over a period of time;
Decisions over the useful lives of plant and equipment effecting depreciation;
Provisions and warranties requiring estimations as to future outgoings for items such warranties, obsolescence and bad debts; and
Consolidation of separate legal business entities into a single group which could mask poor performance in a particular entity.

The scope for creative accounting is significantly greater when it comes to a company which produces special purpose financial reports, particularly if they have not been subject to audit, because the company is not obliged to comply with Australian accounting standards.

What is sloppy accounting?

Slopping accounting only applies to special purpose financial reports which have not been audited and is probably best described in relation to a company’s financial reports where the accounting policies adopted have not been complied with and/or the accounting policies adopted are not appropriate.

Examples of sloppy accounting include the absence of all appropriate year-end accrual adjustments such as:

Inventory reflecting closing stock values have not been recorded.
Assets subject to depreciation have been booked as expenses in the year of purchase.
Current year’s depreciation not recorded.
Unearned income not recognised as a liability.
Company related expenses not paid by the directors, not booked as company expenses.

Unsigned directors’ declarations within a financial report with no accompanying income tax return (or income tax return with no evidence of lodgement of the tax return with the Australian Taxation Office) may reflect a draft version of the financial report which could be subject to sloppy accounting.

Sloppy accounting (by my definition) cannot result in the financial reports being a true and fair representation of the company’s financial position and financial performance.

What is fraudulent accounting?

Fraudulent accounting is a deliberate deception involving the presentation of financial reports that cannot be a true and fair representation of financial performance.

While creative accounting (sometimes referred to as ‘window addressing’) are permissible under the law, fraudulent accounting is illegal because the company is claiming the presented financial reports provide a true and fair view of the company’s financial position and financial performance with the knowledge that they are not a true and fair view. This knowledge held by the company is for the purpose of deceiving the users or readers (i.e. third parties to the company) as to the true and fair view of the company’s financial position and financial performance.

There are many examples of publicly listed companies (e.g. Enron, being a well-documented example) presenting financial reports which have been independently audited and have been subsequently found to have prepared fraudulent financial reports. While independent auditors have to consider the possibility of fraudulently prepared financial statements, an independent auditor’s primary role is not to look for fraud and the scope and nature of an audit does not involve reviewing each and every transaction which comprise the financial statements.

How a forensic accountant considers creative accounting

A forensic accountant must understand human behaviour and step into the shoes of management and understand the motives of management when preparing financial reports for a company. Management may be highly motivated to want to leave a favourable or unfavourable impression depending on whether it seeks to want to impress or depress a particular reader of the financial reports.

For example:

Management and business owners who wish to impress existing shareholders, banks, and potential investors may adopt a more aggressive attitude regarding how the net assets and net profits are reported in the financial Reports. Usually, the motivation for adopting an aggressive attitude is an expectation of some kind of carrot, like a bonus or additional finance.
Management and business owners who are involved in a dispute (e.g. spouse seeking divorce), want to pay less tax, are interested in buying-out other partners or have a pessimistic outlook may adopt a more conservative attitude to depress the values of net assets and net profits. Usually, the motivation for adopting a conservative attitude is to avoid being at the end of a large stick, like a tax bill, large settlement to a spouse or an outgoing business partner.

Being too conservative or aggressive can cross the line into fraud if it can be proved that there is a deliberate intention to harm or gain a benefit. However, proving fraud can be quite challenging, particularly where there are numerous conflicting motivating forces at work.

Summary and conclusion

Confusion can arise when creative accounting is pushed to the extremes producing significant financial consequences. In these situations, the lines between creative, accounting and fraudulent accounting can be quite murky. As a forensic accountant working in disputes, one party in the dispute may argue window dressing and the other party argues it is fraud. Unaudited special purpose financial reports present the greatest risk that the information presented may not reflect a true and fair view of the company, however, the presentation of independent audited general purpose financial reports, with an unqualified audit opinion, does not mean that a fraud has not been perpetrated on the company or by the company.

Learn more about our expertise .

[1] This article does not seek to address the criteria and guidance for companies on whether financial reports should be considered ‘general purpose’ or ‘special purpose’.

Assessing The Financial Viability Of A Business And Solvency Of A Company

adam.giliberti@avgforensic.com (Adam Giliberti) — Fri, 22 Mar 2019 05:20:04 GMT

Meaning of insolvency

The term ‘going concern business’ is an accounting term which assumes the subject business will continue to trade into the foreseeable future and there are no plans, events and/or circumstances which would result in that business ceasing to trade. There are many reasons why a business may cease to trade – one of those reasons could be that the company which owns the business is insolvent.

The word ‘solvency’ is defined under section 95A of the Corporations Act 2001 (Cth) as being a company which is able to ‘pay all its debts as and when they fall due’. Therefore, ‘insolvency’ is when a company cannot pay all its debts as and when they fall due.

A forensic accountant may be called to provide an opinion on solvency or insolvency of a company and/or the financial viability of a business. For example:

if a company is placed into liquidation, the liquidator may commence recovery proceedings against the directors of the company because the directors are personally liable for the debts of the company throughout the period of time when a company trades while it is insolvent. In this example, a forensic accountant may be required to help establish the point in time when the company became insolvent;
a business was sold at a price which exceeded its value because the purchaser incorrectly assumed that a seemingly profitable business was a financially viable, going concern business. For the purposes of this article, I consider a financially viable business to be one which is able to pay its debts it incurs in carrying on its business as and when they fall due from the profits generated by the business. In this example, a forensic accountant may be called to review due diligence material and valuations relied on at the time of the sale of the business to establish a true value of the business and potentially negligence of particular parties; or
a business is facing an existential threat, has ceased to trade or trades at a significant reduced capacity due to, say, a compulsory acquisition of land, third party breach of contract or some other wrong doing and a claim for loss is being pursued. In this example, a forensic accountant may be called to help determine whether or not the claimed losses would have been realised but for the event or opine on whether the business would have collapsed in any event.

It is theoretically possible for a financially viable business to exist within a technically insolvent company (e.g. as a result of directors of a company being negligent or reckless by not paying creditors and directing profits and cash into other businesses or companies which do not return a profit). Depending on the circumstances, the forensic accountant may need to make a distinction between a financially viable business and an insolvent company and opine on whether the business is financially viable and/or whether the company is solvent.

The following are positive indicators of financial distress faced by business and red flags that the company may be insolvent:

Poor financial position

The starting point in assessing a company’s solvency is to review the balance sheet of the company and check the net asset position. A deficit in net assets, particularly deficits observed over a period of time, with the size of the deficits growing over time represents a positive indicator of financial distress.

However, adopting this approach alone does not take into account the timing of when debts are payable and more analysis on a company’s financial position can be performed in relation to the working capital of the company. Where a company’s current liabilities (generally assumed to be liabilities due over the next 12 months) exceed the company’s current assets (generally assumed to be assets which will be converted to cash over the next12 months), the company has a deficit in net working capital. A deficient in working working capital, particularly deficits observed over a period of time, with the size of the deficits growing over time represents a further positive indicator of financial distress.

Poor financial performance

It is generally accepted by accountants that a business which has been historically profitable as determined from its profit and loss statements included in its financial reports is a positive sign of solvency as this would indicate lower financial stress to pay all debts due, compared to a business which has been reporting losses.

Historical profitability can be analysed in a number of different ways including, Earnings Before Interest and Tax (commonly referred to as EBIT), Earnings Before Interest, Tax, Depreciation and Amortisation (commonly referred to as EBITDA), Net Profit Before Tax (commonly referred to as NPBT), Net Ordinary Profit After Tax (commonly referred to as NOPAT). If a company shows continuing losses, this is a positive sign of financial distress and forensic accountant will seek to undertake further financial analysis (including analysis of sales, gross profits and expenses) to understand the causes for poor profitability and evaluate whether the causes are a likely to be fatal to the business.

Poor cash flow indicators

The following are positive indicators of financial distress faced by business and red flags that the company may be insolvent:

Taxes not being paid on time, particularly payments of Pay As You Go – Withholding (PAYG-W), Pay As You Go – Instalments (PAYG-I) and Goods and Services Tax (GST) as shown in the Running Account Balances with the Australian Taxation Office (ATO).
Employee superannuation not being paid on time. There may be Superannuation Guarantee Charge (SGC) applied by the ATO.
Poor relationship with banks and other debt providers – this will include overdraft limits being reached, difficulty or refusal to applications for increase to overdraft limits, default interest charges, shopping around for debt finance with multiple banks and debt providers with any pre-approvals subject to onerous conditions, etc.
No access to alternative finance, despite attempts being made.
Suppliers remove credit terms and placing the business on COD terms.
Long creditor days.
Special arrangements with selected creditors;
Inability to raise further equity capital, despite attempts being made.
Issuing posted dated cheques.
Dishonoured cheques.
Judgments/warrants/solicitors letters issued in relation to services provided and/or outstanding debts.
Rounded payments to suppliers not reconcilable to actual invoices.

Poor financial records

Section 286 of the Corporations Act 2001 (Cth) provides an obligation on a company to keep financial records consisting of written records that:

correctly record and explain its transactions and financial position and performance; and
would enable true and fair financial statements to be prepared and audited.

Section 588E(4) of the Corporations Act 2001 (Cth) provides a presumption of insolvency (in recovery proceedings) if it is proved that the company:

has failed to retain financial records in relation to a period for the 7 years required by subsection 286(2).
has failed to retain financial records in relation to a period for the 7 years required by subsection 286(2).

A common feature of a companies which are placed into liquidation are companies with poor financial records, typically being companies that have long delays with regards to preparation of management accounting reports and annual accounting reports for submission of income tax returns and business activity statements on time. One of the reasons why a company which continually lodges income tax returns and business activity statements late is because it is failing to keep financial adequate financial books and records which explains the financial performance and financial position of the company and the company is unable to obtain timely information in order to take corrective action.

A forensic accountant will therefore consider the sufficiency and quality of the financial documents it reviews to inform an opinion on the solvency of the company and financial viability of the business.

Conclusion

There is no one determinative factor which determines whether a business is financially viable and whether a company is insolvent. A forensic accountant will need to analyse and consider tests relevant to historical financial performance, historical financial positions, cash flow and financial records to form a view on the financial viability of a business and company’s solvency.

Compulsory acquisition of land in Victoria and basis for compensation

adam.giliberti@avgforensic.com (Adam Giliberti) — Thu, 21 Mar 2019 08:03:09 GMT

Our forensic accounting & valuation services are well suited to compulsory acquisition of land affecting a business

Growing population across Victoria, including greater housing density and urban sprawl in regional Melbourne requires roads, rail, hospitals, schools and other infrastructure. New infrastructure projects require acquisition by government authorities of privately-owned land. This article looks at the key implications for business owners who are impacted when an acquiring authority requires land for a public works project.

Section 41(1) of the Land Acquisition and Compensation Act 1986 (Vic)

In Victoria, section 41(1) of the Land Acquisition and Compensation Act 1986 (Vic) sets out the general principles on which compensation is to be based, that is, compensation should have regards to:

the market value of the interest on the date of acquisition;
any special value to the claimant on the date of acquisition;
any loss attributable to severance;
any loss attributable to disturbance;
the enhancement or depreciation in value of the interest of the claimant, at the date of acquisition, in other land adjoining or severed from the acquired land by reason of the implementation of the purpose for which the land was acquired;
any legal, valuation and other professional expenses necessarily incurred by the claimant by reason of the acquisition of the interest.

Disturbance and claims for loss of profit

Typically, the largest component of total compensation payable under s41(1) of the Land Acquisition and Compensation Act 1986 (Vic) to affected business owners relates to disturbance compensation which is defined as “any pecuniary loss suffered by a claimant as the natural, direct and reasonable consequence of:

the service upon the claimant of a notice of intention to acquire, where the Authority has refused or failed to give consent to the carrying out of improvements to the land in respect of which that notice has been served or the effecting or obtaining of any sales, transactions, licences or approvals in respect of that land; and
the fact that an interest of the claimant in that land has been divested or diminished, being a pecuniary loss for which provision is not otherwise made in this Part”;

While the legislation appears to be specific on what compensation affected business owners are entitled to under section 41(1) of the Land Acquisition and Compensation Act 1986 (Vic) it is typically meaningless to most business owners because it requires an understanding of common law principles decided by the courts (such as the Victorian Civil Administrative Tribunal and the Supreme Court of Victoria). A forensic accountant, with business valuation qualifications, will be required to work with you and your lawyer to quantify the correct amount of compensation, particularly focusing on disturbance compensation the business is entitled to.

The amount of disturbance compensation a business will be entitled to will depend on many different factors, largely based on the evidence to support the facts. Businesses operating in the same industry should not expect similar compensation, nor should neighbouring businesses. This is because the ‘pecuniary loss’ suffered by a business will depend on whether the business can relocate and where it will relocate, whether this happens before or after the acquisition of the land by the acquiring authority. Most businesses will express a preference to relocate in order to continue trading rather than shutting down, however whether a business is able to relocate will depend on the availability of suitable alternative premises and even if there are alternative premises, they rarely present the same features as the existing premises (e.g. size will typically be different, it will often not be in the same locale, and the annual rent will be different). The ‘pecuniary loss’ in a relocation scenario will typically include the costs required to relocate the business and the reduced profits before and after the relocation of the business.

If you receive a ‘Notice of Intention to Acquire’ from an acquiring authority (often being VicRoads, the State Government or a Council) and the land is used for a business purpose, contact u s for advice.

Overview of the different Valuation Approaches Why rules of thumb don’t cut it!

adam.giliberti@avgforensic.com (Adam Giliberti) — Fri, 20 Feb 2015 08:52:00 GMT

Why valuation rules of thumb don’t cut it!

International Valuation Standards (IVS) provides that when issuing a valuation opinion, whether it relates to the value of a business, intellectual property right, intangible or tangible asset, there are three broad valuation approaches which should be considered being:

The market approach
The income approach
The cost approach

Market Approach

The market approach involves determining value by comparing the subject asset to a similar or comparable asset that has been sold (whether outright or under license).

Residential property is often valued using a market approach as there is readily observable data which can be obtained on recent comparable sales in a particular area and adjustments can then be made for any slight differences between the subject property and comparable property.

Residential property in a particular locale, unlike businesses, fall into relatively homogenous categories eg house with 2, 3, 4 bedrooms etc. A significant difficulty in using a market approach to value other assets such as a business, and particularly intellectual property, is that the asset to be valued is typically unique and therefore a market approach is theoretically inappropriate. Even if there is observable market data available, significant information is needed to understand both how comparable the assets are to each other and how they are different from each other, which often comes down to judgement.

Income Approach

The income approach involves determining value by using one or more methods that convert anticipated future income streams into a present single amount after taking into account risks.

An income approach is probably the most theoretically sound way of valuing an asset (where a market approach is not appropriate), and probably for this reason it is likely to be the most common primary approach used to value businesses, part interests in businesses, intellectual property and intangible assets. The are numerous discrete valuation methods that fall under an income approach that require the use of:

an appropriate capitalisation rate and/or discount rate; and
an estimation of future earnings (i.e. revenues and costs).

In practice, the use of one or more valuation methods falling under an income approach requires considerable professional judgement across a variety of different mechanical steps. In using an income approach, reference may be made to market data to support judgements.

Cost approach

The cost approach involves determining value based on the costs required to create and develop (alternatively, to replace) the subject asset and is often considered in the context of an asset or business before it generates revenues or material revenues. The cost approach is based on the premise that no willing third party purchaser would pay more (or materially more)[1] than the cost to recreate the asset independently. The estimated cost may be based upon the historical development costs or the projected cost to develop an asset of similar value as at the date of valuation. It may also be determined by reference to actual costs incurred in acquiring an asset.

The cost approach has several drawbacks, the primary of which is that cost may have very little, if any, correlation to the future profits which can be generated from the asset which could be viewed as a more appropriate measure of value.

Conclusion

In practice, each valuation engagement is different and therefore the approach depends on the asset to be valued and the relative merits of the alternative approaches given the circumstances at the time of the valuation. It is possible that more than one valuation approach (and subset valuation methodologies) could be applied as a cross-check.

Industry rules of thumb are generally not considered a valuation approach, although in some cases, they may be a short-cut method widely used in a particular industry (e.g. mortgage broking and value of trail book ). Rules of thumb (eg a multiple of revenue to determine value) can be easily calculated however they may not always produce a figure which equates to value. A healthy dose of scepticism should be applied if a valuation report relied on an industry rule of thumb as the only valuation technique.

Disclaimer: The information contained in this article is general and is not intended to serve as advice. Readers are encouraged to contact us for advice concerning specific matters before making any decision.

Forensic Accountant or Business Valuer? What’s the difference?

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 18 May 2014 09:15:49 GMT

How does a Forensic Accountant with valuation expertise differ from a Business Valuer?

The field of forensic accounting, while niche, encompasses a broad range of skills sets. The ‘forensic’ part of the job relates to court work, therefore we are providing accounting expertise for potential use in a court.

Where it can get confusing is that some forensic accountants may claim experience in business valuations and while others don’t (eg they may choose to specialise in fraud investigation, insurance claims and/or solvency work). Further, not all business valuers are forensic accountants or accountants at all for that matter.

When is it appropriate to instruct a forensic accountant with valuation expertise to value a business?

This depends on the purpose of the business valuation!

The circumstances driving a need for a business valuation report can vary widely, but in simple terms, there are only one of three reasons why a business valuation report will be required:

1. For transaction purposes.

That is, you are looking to buy or sell a business. Some business brokers offer cheap valuation services. Be wary of experienced business brokers adopting industry rules of thumb to justify a price as the ‘price may not reflect value received’. ‘Registered Valuers’ are professionals in their own right, however they tend to specialise in the valuation of tangible assets e.g. property, plant and equipment. As many profitable businesses these days have a high component of intangible assets compared to tangible assets, business valuers with accounting and/or finance qualifications are likely to have better skill sets to identify and value intangible assets. Further, historically unprofitable businesses may have a significant value due to future profit potential as a result of development and investment in its intellectual property which supports it intangible asset value. Again, this is where business valuers with accounting and/or finance qualifications come into their own.

2. For compliance purposes.

Aside from meeting obligations under accounting standards, a business valuation report may be desired to demonstrate to a revenue authority (eg the ATO or state revenue office) that the values attributable between intangible assets has been allocated using acceptable market valuation principles and not for the purposes of obtaining a tax benefit. In other words, what portion of the total intangible asset value relates to brand, software, customer database, goodwill, etc? Many experienced business valuers with accounting and/or finance qualifications should be able to assist with this kind of business valuation.

3. For dispute purposes.

A valuation report may be required where owners of the business are in dispute with each other, a business owner is involved in divorce proceedings, the business is being compulsory acquired by a government authority and/or the business is involved in some other kind of commercial dispute (including a disputed will). This is where a forensic accountant with expertise in business valuations can be extremely useful.

We are often called upon to review business valuation reports prepared by experienced business valuers, who may be selected by the client due to a particular industry-based focus. One of the common ways, to challenge the valuation opinions contained in these reports is by focusing on the assumptions adopted by the valuer. In other words, we apply a forensic approach to prove assumptions (as would be required in court) rather than accept assumptions (usually provided by the client).

A business valuer who regularly values business for transaction and/or compliance purposes will be accustomed to being provided with a number of assumptions by its client for the purposes of conducting the valuation. It usually makes commercial sense for the business valuer to not critically test and challenge assumptions if they appear reasonable on the surface. However, this is often not the case where valuations are prepared for dispute resolution purposes. The significantly higher level of scrutiny attached to a valuation report prepared for dispute purposes requires the business valuer to adopt the mindset of a forensic accountant.

Tips for lawyers

Disclaimers, caveats and limitations of work which are typically included in a valuation report often point to, on first read, unsupported but materially important assumptions which can result in the valuation opinion being highly discredited in machinations of the dispute process leading up to a potential trial. This is even before considering any significant differences in professional judgements adopted.

A forensic accountant, with genuine expertise in business valuation work, will prepare a well-supported, clear and unbiased report which should stand up to cross-examination in court. In some cases, a high-quality forensic accountant’s valuation report will avoid the need for the protagonists to go to trial. Unfortunately, we too often see how cheap business valuation reports prepared for dispute purposes end up costing the parties more over the course of the dispute.

If you need advice on the suitability of a particular business valuer for your matter, read more about our expertise and contact us.

Patent Infringement – Account of Profits or Damages?

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 10 Mar 2013 05:36:14 GMT

The relative merits of pursuing an Account of Profits or Damages

Registering a patent in respect of a product is designed to provide some competitive advantage to the innovator to deter a competitor entering the market and selling a ‘copycat’ product. However, a registered patent does not guarantee competitive advantage as the following scenarios may arise.

Scenario 1 – a competitor does enter the market and sells a copycat product as it is ultimately a matter for the court to determine that a patent is valid in law. It is only when a court determines that a patent is valid that the innovator can claim loss – proceedings could take many years before a judgment is given;

Scenario 2 – an injunction may be sought by the innovator to prevent sales by the new entrant competitor. However, if the patent is subsequently found to be invalid by the court, the competitor will have suffered loss as it could have entered the market and generated profits.

There are two accepted, but alternative, ways to calculate loss as a result of intellectual property (IP) infringement (in this case – a patent) being; an account of profits or damages. The decision as to which method should be chosen is made subsequent to when a court establishes a valid patent (scenario 1 above) or may be made as part of undertaking by the innovator in seeking injunctive relief (scenario 2 above). Irrespective of the scenario, the relative merits of an account of profits and damages needs to be carefully considered. These considerations are both quantitative (and based on very limited financial information) and qualitative (for example, the willingness of a party to disclose potentially commercially sensitive information to support its case).

For the sake of simplicity, the rest of this article will address scenario 1 and assume an ‘Election decision’ needs to be made subsequent to liability being established by the court, that is, infringing sales have been made by a competitor.

Account of profits.

As the name suggests, an account of profits focuses on the profits which have been made by the infringer in respect of the copycat (ie infringing) sales. The objective here is to compensate the plaintiff by taking the profits the infringer has made and giving it back to the rightful owner.

Damages.

Damages is the other option available and focuses on the incremental profits the innovator would have made absent the infringement. The objective here is to compensate the plaintiff by taking into consideration a hypothetical scenario in which the plaintiff would have enjoyed a monopolistic position absent the infringer and the following heads of claim are applicable:

Loss of profits. This requires an estimation of the market size over the period of infringement period;
Springboard sales. This requires an estimation of the market size and relative markets share the innovator would have enjoyed after the infringement period;
Price erosion. This requires an estimation of the reduced price effect as a result of competition over the infringement period;
Loss of convoyed sales. These are anciliary goods and services which may be sold with the patent protected product eg installation and maintenance profits;

Bearing in mind that the Election Decision as to an account of profits or damages must be made on the basis of limited discovery and prior to any knowledge as to the defendant’s case, the following are some of the relevant considerations:

An appealing aspect to the account of profits method is that the plaintiff does not need to prove it would have made any of the sales the infringer did actually make. Under damages, the onus is on the plaintiff to prove it would have made the infringing sales. If the plaintiff is not able to prove it would have made any of the infringing sales, then the plaintiff’s claim is limited to a reasonable royalty on the infringer’s sales. Often, the answers lies somewhere in between – that is some, but not all of, the infringer’s sales would have been made by the innovator due to, for example, the innovator and competitor selling to mutually exclusive customers.
Under an account of profits the plaintiff does not need to disclose potentially commercially sensitive information about its business and its customers as the focus of the investigation will be on the infringer. Pursuing damages comes at a greater non qualitative cost to the innovator in the sense that the level of discovery will be higher and the staff resources needed (and directed away from usual business) will also be higher.
A damages claim could be substantially higher than an account of profits claim for many reasons, particularly if the innovator believes the claims for price erosion, springboard sales and convoyed sales could be substantial.
Have all the relevant defendants been included? In some cases, the manufacturer and seller (ie distributor) and may be different entities. For example, the manufacturer may be based overseas and the significant portion of the overall profits in respect of infringing sales may be retained by an overseas entity which is not a party to the proceedings.
Under an account of profits, the defendant is entitled to absorb overheads in the determination of profits. This can be highly subjective and contentious, particularly where the defendants sell more than just the infringing products as it is obviously in the defendants interest to ‘pull-in’ business overheads to reduce the level of claim.

Conclusion

The above are just some of the considerations which need to be addressed in electing to decide whether to pursue an account of profits or damages in IP infringement matters. Obviously, each matter will be different, for example, in one IP infringement case I was involved in for which damages was pursued, the patent on a dialysis machine was bundled and sold on a ‘price per treatment’ basis. One of the points of contention on this matter was the reliability of the accounting records to allocate the sale price ie price per treatment between specific goods and services sold as part of the treatment. Irrespective of the facts, expert advice should be sought at the earliest opportunity.

Estimating Damages in Shareholder Class Actions

adam.giliberti@avgforensic.com (Adam Giliberti) — Sun, 01 Jul 2012 05:44:10 GMT

Directors’ breach of ASX listing rules on continuous disclosure

The obligations on directors to keep the market fully and accurately informed on a timely basis, directors attempting to positively influence the company’s listed price, the courts acceptance of litigation funding, and increasing vigilance by shareholders and plaintiff law firms in respect of directors’ disclosures have all contributed to the rise of shareholder class actions in Australia.

This area of litigation is still within its infancy compared to practice in the US and Australian courts have been exposed to US based finance expertise to opine on issues relevant to damages. As long as plaintiffs continue to instruct US experts, defendants will continue to feel pressure to fight fire with fire, so to speak. Australian case law in the area of shareholder class actions goes back to 1999 where shareholders sued GIO in respect of AMP’s bid to acquire its shares, yet we still do not have any Australian precedent on how damages should be calculated. This paper focuses on how damages is estimated using a US based methodology.

There are three key ingredients that impact the estimate of damages in a ‘fraud on the market’ style class action (eg where a director fails to disclose or falsely discloses information to the market):

Class period
Inflated price per share
Number of damaged shares

Before addressing each of these ingredients, it would appear that Australian courts are prepared to accept the rebuttable presumption of the efficient market hypothesis to establish reliance. This means that individual plaintiffs do not need to prove they specifically relied on the company’s fraudulent announcement – rather it is presumed that they made their investment decisions based on the prevailing share price set by the market on the assumption that it accurately reflected all publicly available information. The considerations around the rebuttable presumption of the efficient market hypothesis is not the subject of this paper.

1. The class period

The class period is the date range between the ‘fraudulent’ announcement (ie inaccurate disclosure) and the ‘cleansing’ announcement (ie accurate disclosure). This could be limited to a few days or extend to a longer period, typically over a one or two months. In some matters, it may be straightforward to identify the relevant dates of the class period but this issue may consists of shades of grey as the accurate disclosure may actually take place over a series of disclosures made over several days.

2. Inflated price per share

As a valuer, this is perhaps the most interesting and contentious issue in respect of estimating damages. Share prices in a regulated market do not necessarily reflect true value. Valuers tend to view true value as the present value of the future cash flows attributable to an asset. However, the observable reality is that share prices of listed companies reflect all publicly available information – therefore each piece of new information, in theory, has an impact on the share price which is determined by the market. In this regard there is often a disconnect between what a valuer may believe is the true value and a market price, particularly where daily share prices for a listed company are highly volatile despite very little change in the fundamental future earning potential.

The inflated price per share represents the difference between the true value of the share and the actual price of the share over the class period. US finance experts tend to derive the true price of the share adjusting the actual price for the price impact of the false information. This can be done in a few different ways, but the most sophisticated way is to do an event study on all new pieces of information about the subject company and uses econometric modelling to determining the true value.

3. Number of damaged shares

Once the inflated price per share is determined, this needs to be multiplied by the total number of damaged shares to arrive at the total damages claim. Assuming the efficient market hypothesis applies to establish reliance, then the number of damaged shares represents all those shareholders who bought shares during the class period and retained ownership of them at the end of the class period. Investors who bought shares before the class period and sold them during the class period are not damaged shares as to are shares bought and sold during the class period.

Difficulties can arise where there are active investors who trade regularly in the subject company shares and assumptions have to be made as to which parcels of shares are damaged.

Conclusion

In Australia, any calculation of damages which quantifies the losses suffered by the class of plaintiffs as a result of alleged breaches of ASX listing rules relating to the continuous disclosure regime can only be an estimate. This is because all major shareholder class action litigation in Australia have been concluded with court approved settlements before judgment. Until we obtain a precedent, expertise in the fields of valuation, economics and finance as well as accounting will probably be needed to assist in how claims are prepared and presented in Australian courts. There are many interested stakeholders watching this space, anticipating the direction the courts will accept.

acuity-forensic

Navigating Legal Professional Privilege as a Forensic Accountant

How barristers educate and shape our thinking on legal professional privilege

Beyond oppression: Leveraging Civil Penalty Provisions of the Corporations Act 2001 in shareholder disputes

Pleading contravention of Civil Penalty Provisions in shareholder disputes

This article explores how integrating civil penalty claims into your litigation strategy can create superior leverage for settlement and maximize client recovery, with a focus on the critical role of the forensic accountant in quantifying this more nuanced remedy.

Civil Penalty Provisions - A Litigator's Strategic Toolkit

Beyond Fines: Compensation for a Contravention of the Civil Penalty Provisions

Challenges with quantifying value in oppression cases

Benefit of seeking compensation orders in shareholder disputes

'Damage' is more nuanced than pure valuation work

The potential for joint and several liability for compensation orders

Conclusion and summary

Strategic guide to concurrent evidence in Australia

Behind the 'Conclave' from an Expert's perspective

Understanding the battlefield: Primer on Concurrent Evidence

The reality of hot-tubbing

Case management involving concurrent evidence

Navigating the unfacilitated conference of expert witnesses

Litigator's checklist before the unfacilitated conference of experts

Top Brands in 2024 per Brand Finance

How we value Brands

What is True Value?

The High Court of Australia provides guidance

What is meant by 'standard of value'?

What is 'market value'?

What is 'true value'?

Tax Gross-Up on Claims for Damages & Compensation

What is meant by a tax gross-up and its contraversial use by forensic accountants?

What is the implied justification for calculating a tax gross-up (assuming not explicit)?

The danger in making assumptions about tax without knowledge of tax law

Unsettled tax law involving compulsory acquisition of a leasehold interest

Seek independent tax advice

Valuation discounts – what are they, how to quantify them,& are they always relevant in disputes & litigation?

Valuation discounts - what are they, how to quantify them & are they always relevant in disputes & litigation?

What does a lack of control discount represent?

How to calculate a lack of control discount?

What does a lack of marketability discount represent?

How to calculate a lack of marketability discount?

Does a discount for lack of control and/or lack of marketability always apply?

Conclusion

Top 7 Problems with Valuation Reports

Attacking the messenger and the message!

1. Inappropriate ‘standard of value’ adopted in a valuation report.

2. Confusion between what is actually being valued in a business valuation report.

3. Mismatch between the discount or capitalisation rate and earnings base.

4. The Future Maintainable Earnings figure is simply a 3 year average of the reported historic profits.

5. There is an insufficient understanding of the business to justify the discount or capitalisation rate.

6. Inappropriate valuation methodology and/or lack of cross check valuation methodologies.

7. The valuation report was too cheap which compromised its quality.

Loss Of Profits Claimed As Damages

Deeper dive into the ‘but for’ scenario

Common steps to calculate loss of profits in damages

Documents to be procured and supplied to the expert as part of the initial briefing

Before-and-after method

Comparable method

Market method

Endnotes

Assessment date in damages & compensation

What is ‘damages’ reflecting a loss of profits? A simplified view

What is meant by an assessment date in the context of damages?

How is professional judgement relevant to an assessment date?

What is an ex-post approach when assessing damages?

What is an ex-ante approach when assessing damages?

Why does getting the assessment date right really matter?

Endnotes

Valuation Of Intangible Assets – Cryptocurrencies

Valuation of intangible assets – how to value cryptocurrencies

The link between cryptocurrency and blockchain technology

What are crypto coins?

What are crypto tokens?

What is the meaning of the ‘market value’ of cryptocurrencies?

What are the valuation approaches for cryptocurrencies?

Lack of marketability (or illiquidity) for cryptocurrencies

What might be the specific risks for holding crypto tokens?

Conclusion on valuation of cryptocurrencies

Disclaimer

Useful links

Endnotes

‘Capitalisation Rates’ And ‘discount Rates’ Used In Valuations & Claims For Loss Of Profit As Part Of Damages Or Compensation