Kohli v Lit & Ors

Following the trial of this matter I made an order on 25^th May 2010 under which the first respondent and (failing him) the other individual respondents were to purchase the petitioner's shares in Sunrise Radio Limited (Sunrise) at a price to be determined by the court. The price was expressed to be: "The fair value of the shares as at 13^th November 2009 without any discount for the shares being a minority holding". Various directions were given as to how the value would be ascertained, and as to evidence.

As at the trial, I have had expert evidence from two witnesses: Moira Hindson and Allan Thomson. Moira Hindson appeared for the respondents and Allan Thomson for the petitioner. They were very different, both in terms of content, temperament and persuasion.

I deal first with Ms. Hindson. She is a very accomplished witness who adopted a balanced approach to her task but still succeeded in coming up with a value of nil for the shares. She is the head of the forensic accounting services department at Kingston Smith LLP. She set out in her report at some length all her qualifications, which are considerable and which amounted to portraying her as what could fairly be described (and was described at one stage during argument by Mr. Griffiths) as an "expert expert".

The first question before me is the valuation of Sunrise as a whole, which I conceive requires regard to be had to other members of the Sunrise Group. There are a number of subsidiaries. One might have thought that the person most fitted to give evidence about that would be someone with experience of actual dealings in the market place.

Ms. Hindson, when I asked her what her practical experience was of advising on actual dealings in the marketplace, candidly acknowledged that she had none as that was the function of her corporate finance department. Mr. Griffiths explained to me that people who were dealing in the marketplace had, as it were, got fed up with being beaten up by barristers and judges and hence the emergence of a breed of experts. I acknowledge that such a breed is now common but I deprecate the development of people whose primary expertise is in giving evidence, rather than the practical application of that expertise. It seems to me that the court would ordinarily in a case such as this find more helpful the evidence of someone who has actually (if I can put it in the vernacular) got their hands dirty in the marketplace by advising clients in the real world of acquisition and merger activity. Of course, giving expert evidence itself requires a degree of expertise, and Ms. Hindson, as I have said, had that in abundance. She was always polite and dealt fairly with all questions, including my own. In demeanour and delivery terms, she was an excellent witness. There is, however, more to being an expert than excellence in the giving of evidence, though that is of course a help. In fairness to Ms. Hindson, I must add that her methodology was also, in general terms, well-reasoned.

Although Ms. Hindson’s evidence, as I have said, fair and balanced, it would have been even more persuasive if she had had the practical experience that I have mentioned. I can demonstrate that by reference to two matters. Firstly, in paragraph 4.7 of her report she stated that it was likely that a prospective purchaser of the group would continue to require the services of the directors managing the business at that time. Therefore a deduction was required to reflect the open market cost of directors' remuneration. I do not know on what basis she claimed to have any expertise to express that as a likelihood in the absence of market experience. However, on the evidence I heard at the trial, the directors managing the business, leaving aside Dr. Lit, who charged fees as a consultant, were clearly not vital for its future, and I doubt very much whether a purchaser of the entirety of Sunrise would require the services and idiosyncratic personality of Dr. Lit either. It seems to me that a purchaser would in all probability put in its own management, and whilst I would ordinarily defer to the expertise of someone having experience in the marketplace, that someone is not in the particular circumstances Ms. Hindson.

Equally, elsewhere, she confidently asserted in paragraph 4.57 that a valuation of the Sunrise Group would necessarily require the subsidiaries' net liabilities to be taken into account as by reason of the group guarantees those subsidiaries with net liabilities were not capable of being separately disposed of from the group's profitable trading businesses. Leaving aside the fact that not all the subsidiaries had given group guarantees, which she seems to have assumed, it seemed to me somewhat naïve to approach this matter upon the basis that following payment off of any historical indebtedness to the bank the purchaser would not feel free to let go of, or allow to go into liquidation, loss-making subsidiaries which were of no long term benefit. Ms. Hindson sought in giving her evidence to regain some of the ground by seeking to persuade me that Sunrise would lose goodwill from its suppliers and others if it allowed loss-making subsidiaries to fail. That, however, was not something which fell within any particular expertise of hers as an expert, and so I could place very little reliance upon that. On the contrary, I accept the submission of Mr. Hanke for the petitioner that a purchaser would almost certainly look very carefully at the group and seek to exploit the profitability of the companies that were profitable and not those that were unprofitable.

I now turn to consider the evidence of Mr. Thomson. Mr. Thomson is of another ilk to Ms. Hindson. He is more of (if I can put it, I hope not too unkindly) a street fighter who has a varied and interesting background having been jacks of all sorts of accountancy trades but now apparently concentrating on forensic work, though his experience of valuations, at least recently, is limited to probate and Inland Revenue valuations.

He was a combative individual who struck me as being unduly partial in favour of his client. One understands, and pays due respect to, those who are loyal to their clients, but Mr. Thomson seemed at times to have little regard to his overriding duty to the court and I found his evidence in a number of respects unhelpful. There was, amongst the many figures he bandied around, a cross-fertilisation between forecasts and actuals which seemed to show nothing in particular. More astonishingly, he took as the maintainable earnings for Sunrise profits for years which were all in the past and ignored the performance of the company after December 2007, as there were only management accounts in existence at the valuation date for any period after then. He did mention the management accounts, but they did not form part of his primary calculation, though he did provide alternative calculations as a fall-back.

On that footing, he persuaded himself that it was appropriate to ascertain the maintainable earnings of Sunrise by reference to three years' accounts to 31^st December 2007. This, of course, was a date before the collapse of Lehman Brothers and all that has ensued since. It struck me as being a most amazing period to limit himself to, but, to compound that, he said in paragraph 4.24, "For the sake of being ultraconservative I have not brought into the above calculations any profits earned from 1^st January 2008 to 13^th November 2009 which would otherwise have the effect of increasing average maintainable earnings". The reason for that is that he did not consider that there were any reliable figures for that period. There were management figures that showed a gloomy picture but he felt that those management figures were concealing something and acknowledged in his oral evidence that a purchaser would probably think that the position was even worse than the management figures. In those circumstances it strikes me as bizarre that he could regard the exclusion of those figures, even rough and ready as they were, as meriting the description "ultraconservative". Armed with that more favourable approach for his client, he produced a valuation of just a little under £1.5 million for Ms. Kohli's shares as opposed to the nil value put on them by Ms. Hindson.

Shortly after the CPR came into effect the Court of Appeal in North Holdings Ltd v Southern Tropics Ltd and Others  [1999] 2 BCLC 625 expressed the need for an early joint expert valuation of the shares in cases like this, so that people could focus upon the real issues and thereby hopefully promote a settlement. This case is a very good example of how unhelpful valuations at each end of the spectrum can be. With the wisdom of hindsight, I consider that it would have been preferable for a joint expert to have been appointed in this case at an early stage, and for the parties then to direct further questions to the joint expert to ascertain how the resulting valuation might change on the various assumptions each side was contending for. It would also have been possible, relatively cheaply and speedily, for the joint expert, had this proved necessary, to update the valuation in the light of my factual findings and rulings as to the valuation date, and basis of valuation: compare in this connection the observations of the Court of Appeal in W & S (Long Eaton) Limited v Derbyshire County Council (1975) 31 P & CR 99, per Buckley LJ (at pp 105-6).

Another undesirable effect of the parties routinely instructing separate experts is that, when a joint expert is appointed, the order commonly provides for that expert to specify what information he requires from the company, and the onus is then on the party challenging the choice of information to justify more or less information being given. As so often happens, in this case, there was protracted party and party correspondence as to what should or should not be disclosed, all at corresponding expense to the parties. The result was that the expert reports were prepared only shortly before the hearing, and there was little opportunity for the parties to reach anything approaching common ground, save on a limited number of points. The process of disclosure was impeded also by suspicions on the respondents’ side that the petitioner had misused and would continue to misuse confidential information. Whilst it is fair to say that the respondents had solid grounds for suspicion, it is equally only fair to say that the petitioner denies any misuse of information, actual or threatened. I am unable to resolve this issue, but it is difficult to suppose that the same suspicions would have been encountered in the case of a jointly instructed expert, who would be seen as wholly independent of both sides

It is to be hoped that the Court, in the exercise of its case management powers, will take the initiative in future in following the Southern Tropics guidance at an early stage and ordering the appointment of a joint expert. Nothing will prevent any party, if the circumstances justify this course, from applying subsequently for that party’s own expert, but such cases should not be common.

Returning to the valuation exercise in this case, I find it very difficult to accept that the shares really had no value in November 2009, given that the Sunrise business was both established and profitable, and that there were other profitable subsidiaries. I also find it very difficult to accept the methodology adopted by Mr. Thomson. Mr. Thomson not only took the average earnings for years pre-dating the Lehman Brothers collapse. He valued Sunrise alone, cutting it off from its subsidiaries, but not allowing for any tax on maintainable earnings because of the beneficial tax effect of the loss-making subsidiaries. That seems to me to be an example of having it both ways.

Ms. Hindson, on the other hand, approached the matter upon the footing that a historical debt amounting to £9.539 million owed to the bank would have to be cleared by any purchaser. The debt once cleared would be out of the way, yet her maintainable earnings took into account interest charges which would continue to be incurred by the group thereafter by reference to past accounts, which, of course, included interest on the debt that would be paid off. It seems to me that there is a real risk there of double counting, both by reducing the purchase price which Ms. Hindson claimed was necessary to reach a true purchase price because of the need of the purchaser to pay off the bank debt, and by deducting from maintainable profits the continuing cost of funding that debt when it would ex hypothesi be paid off.

Having heard the evidence, which, as I say, consisted solely of two experts, Mr. Hanke for the petitioner, at my request, came up with an alternative calculation of value, which it seems to me forms a proper basis for the valuation in this case, though I do not, as will appear, accept every part of it. The basis of his approach was that liabilities of the company's subsidiaries would only be taken into account if there was a legal obligation upon the company to meet them. That, it seems to me, is correct, because loss-making subsidiaries can be liquidated or otherwise shed. It does, however, as Mr. Hanke recognised, involve payment off, or taking into account, of the full bank liability of £9.539 million. He said that one must then value the separate profitable businesses upon the footing that it will be open to the purchaser to close down or get rid of all the rest without cost. I accept that that is a permissible and correct approach. The only four profitable group companies were Sunrise, Club Concorde Limited, Kismat Radio Limited and Sunrise TV Limited.

Mr. Hanke also said that the other assets available to satisfy the bank debt should be taken into account, and that relevantly included a property charged to the bank called Hayes Gate House, which in 2009 had a substantial value, though on one view of the matter slightly less than its book value. As that was charged to the bank, I agree that it is appropriate to take the availability of that capital asset into account.

Mr. Hanke also said that there should be included within the calculation a hypothetical profit for 2010, there being a management forecast, the exact provenance of which was unclear, of something in excess of £2.2 million. Mr. Hanke arbitrarily adjusted that down to a figure just in excess of £1.5 million for reasons of conservativism.

Ms. Hindson's approach, so far as Sunrise was concerned, was to take four years' profits (2006, 2007, 2008 and 2009), and to weight each year equally. It was on her view inappropriate to put a greater weighting on more recent years, given that at the valuation date things were thought to be getting better and that we were not then facing the sovereign debt crisis that we now face today, or at least if we were, we were not conscious of its significance. That was not her verbatim evidence but that was the effect of it. I agree with her that that is an appropriate approach.

However, Ms. Hindson, finding a substantial loss in 2009, of something in excess of £600,000, treated that year as being neither in profit nor in loss. The reason for that, she said, was that 2009 would not be regarded as a typical year and that a purchaser would regard it in that neutral way. It seems to me that that allowance sufficiently takes into account the fact that there would or might be a return to profit in 2010, and I do not agree with Mr. Hanke that it is appropriate to take anything else in for 2010 profit. I shall therefore take the figures from Ms. Hindson's Appendix 7, and the relevant figures to which adjustments have to be made are for 2006 £1,583,048, for 2007 £702,022, for 2008 £246,328 and for 2009 nil. There were some other suggested adjustments for 2009 but they are easily taken up in the reduction from £613,000 down to nil as suggested by Ms. Hindson.

There are then various adjustments that are made. In 2006 there is an agreed reduction of £58,297, relating to the profit on a disposal of a leasehold property, and that is a deduction because it was non-recurring. Likewise, in 2007 a subsidiary debt that was written off is added back, because that was also non-recurring: £107,484. There was also a modest loss of disposal of shares in subsidiaries of £100 that is added back. In 2008 a loss on disposal of an investment of £500 was also added back. I need not consider 2009. For the reasons I have mentioned, all the adjustments are covered in the reduction to nil. That leaves some more contentious elements.

The first is bank loan interest, and the second is consultancy fees. So far as bank loan interest is concerned, Mr. Griffiths submitted throughout the hearing, very forcibly and correctly, in my judgment, that a purchaser would have to deal with the bank loan of £9.35 million, the more so as on the then terms of borrowing they were only short term facilities to be met out of the proceeds of any sale of the business. I should mention that at that stage Dr. Lit was trying, so it would appear, to sell Sunrise as a whole, unsuccessfully as events turned out. Any purchaser would know that and would have to fund it. Therefore, there will be, at the end, a deduction of the full amount of the debt, as Mr. Hanke himself accepted, to eliminate it. In those circumstances, the debt having been eliminated, the bank loan interest, save in respect of such borrowings as are necessary for Sunrise’s business, as opposed to such sums as are necessary to fund historic eliminated debt, will not be incurred and the profit will be higher, a point correctly recognised by Mr Thompson in his report, though he did not deduct the interest charges – unsurprisingly, as he did not deduct the bank debt either. I therefore accept that, upon the footing that the bank debt will be repaid, it is appropriate to eliminate the continuing bank loan interest. Just as it would not be appropriate to allow as a deduction against maintainable profits the funding costs referable to funding the purchase price, so too it would not be appropriate to allow as a deduction from maintainable profits the funding costs of paying off the historical debt, as the true value of Sunrise without that debt is necessarily higher, and could, for example, be achieved by selling off Sunrise’s business whilst retaining that historical debt and paying off the debt (putting an end to funding costs) out of the proceeds, or by capitalising the paid-off debt. It has always been clear that Sunrise is substantially under-capitalised.

The interest figures for Sunrise are as follows: for 2006 it is £131,002, for 2007 it is £193,725 and for 2008 it is £245,568. There is no evidence that the underlying borrowings, or anything like that, or indeed any borrowings, were needed for the ordinary day to day operations of Sunrise.

I now turn to consultancy fees so far as they affect Sunrise. Mr. Hanke suggests I should write all or a number of these back. I did expect to find from the experts some assistance as to what level of consultancy fees, or directors' fees, might be expected by a new owner. It is common for judges to be told that it is appropriate to take out the historical fees charged, whether by consultants or directors, and to substitute in their place a market rate for the services in question. That requires evidence of the market rate. I had none from either expert. On Mr. Thomson's side, he asserted, I think probably correctly, that some or all of the fees would have to come out. I cannot imagine that all of them would have to come out, but I would be surprised if competent services could not have been secured at a rate less than the consultancy fees that have been incurred, and which are set out down to 2007 in my earlier judgment.

Ms. Hindson, persuading herself, as I have said, that the existing management would go on, and persuading herself also that my earlier judgment in some way gave the green light to the consultancy fees continuing, did not deal with the point, also recognising in this instance that this was not within her expertise. She merely checked that the consultancy fees in fact paid did not exceed, which they did to a slight extent in one year, though insignificantly, the amounts which had been properly approved by the Sunrise Board. I cannot adjust those consultancy fees without evidence. Mr. Thomson, in the witness box, espoused the virtues of limiting the fees to a Prime Minister's salary. This has a populist resonance and is one which is often reflected in Press comment in different contexts. However, as I endeavoured to explain in my previous judgment, it is wrong to judge someone in the position of Dr. Lit by the standards of a public servant. What is more, the headline rate for the Prime Minister is an unrealistic one. The Prime Minister has as favourable a pension as it is possible to have, as well as the private use of Chequers and the availability of a London flat, if he chooses to use it, in connection with his work. He also, as an MP, enjoys a tax-free expenses regime which is favourable by the usual standards applicable to Schedule E. It does not seem to me, in those circumstances, that the headline figure is a reliable comparator. It seems to me that Mr. Thomson was being gimmicky and not doing his job properly. I reject his evidence on the point. Accordingly, it seems to me that I have no alternative, so far as Sunrise is concerned, in the absence of evidence, other than to leave the consultancy fees as they are, and were. I accordingly do not take any of them out. I have, however, taken interest on the bank borrowings out as I am not satisfied that any substantial lending was required for the ordinary day to day operations of Sunrise's business. It would have been easy for someone from Sunrise to give evidence to the contrary, were that the case. There was no such evidence.

With those adjustments, if my arithmetic is correct, the 2006 profit before tax as adjusted was £1,778,347, for 2007 it was £1,003,331 and for 2008 it was £487,408. For 2009, of course, it was nil. They have to be totalled and then divided by four because each year has an equal weighting. Divided by four, they come out, in round figures, and I have rounded upwards slightly for the purposes of arithmetical ease, to £810,000, which is the before tax figure. Tax comes off at 28 per cent, and a price earnings multiple has to be applied to that.

So far as the price earnings multiple is concerned, I preferred in this respect the evidence of Ms. Hindson, which seemed to me to be more tightly reasoned than that of Mr. Thomson. Mr. Thomson, no doubt conscious of the fact that he was using flaky figures for maintainable earnings, actually took a lower figure than Ms. Hindson because of a genuine desire in this instance to be conservative. I am not, however, dealing with Mr. Thomson's flaky figures but with figures based more closely on Ms. Hindson's figures with adjustments. I therefore prefer her price earnings ratio of 12, which, after allowing for deduction of 30 per cent for a private company, reduces the figure to 8.4. Again, if I have not gone wrong arithmetically, that produces a total of £4,898,880 as the value of Sunrise as a whole.

I then have to consider the value of the second valuable subsidiary, Club Concorde Limited. Club Concorde Limited was dealt with in Ms. Hindson's report, and she produced a valuation of something like £2.3 million. Mr. Hanke adjusts consultancy fees and takes out substantial amounts relating thereto, upon the footing that perusal of the accounts shows that this company is fully managed at a modest rate. I am bound to say that I consider that Mr. Hanke is right about this. The evidence at the trial over two years ago before me was that Dr. Lit had put in an immense amount of effort into bringing Club Concorde round and had now established it as a successful venue. Having brought it round in that way, I have heard no evidence to persuade me that it now needs continued supervision by Dr. Lit to a high degree, or by anyone else in a like position, with corresponding consultancy fees of something in the order of £120,000 per year. It seems to me also that the fees payable by the parent (Sunrise) should be sufficient to extend to any incidental consideration of the businesses of subsidiaries, especially given that the Group would be slimmed down following a take-over. Making those adjustments, Mr. Hanke calculated, again utilising Ms. Hindson's price earnings ratio and methodology, there being none from Mr. Thomson, who chose to pretend that the subsidiaries did not exist except when it came to paying tax, that the resulting figure is £2,820,566. I accept that as the value of Club Concorde Limited.

Kismat Radio Limited and Sunrise TV Limited have each been valued by Ms. Hindson at £500,000 and £635,000 respectively. Those valuations are not disputed by Mr. Hanke. That totals £8,854,446.

There is also to be taken into account the value of Hayes Gate House, because that, as I have said, will be available to meet the historical liabilities of approximately £9.5 million. In my judgment, the appropriate value to be inserted there is £5.44 million. Mr. Hanke suggested that it should be £7.85 million because at the time of the valuation date there was a proposal that the premises be let to the Litt Corporation, or someone connected with Dr. Lit, at a rate which would give it a higher value. That was nothing more than a proposal, it did not materialise and it seems to me safer to take the basic King Sturge valuation of £5.44 million.

From that has to be removed the AIB facility, which is £9.539 million, and that results in a total value of £4,755,446. I then have to apply the relevant percentage. I ordered in my previous judgment that Ms. Kohli's shares should be treated not as 15 per cent of the total of Sunrise but as such percentage as she would have had had the shares in Sunrise been issued at an appropriate price in 2005. This is one of the few points on which the parties were able to agree, the experts being very close to each other. The percentage is 14.78 per cent. That comes down to something in excess of £700,000 but not much in excess. I shall round it down to £700,000. That, in my judgment, is the value of Ms. Kohli's shares at the valuation date. I shall now hear counsel as to where we go from here.