Noseworthy v. Noseworthy et al.
[Indexed as: Noseworthy v. Noseworthy]
Court: Ontario Superior Court of Justice Judge: MacLeod J. Date: May 5, 2017 Citation: 138 O.R. (3d) 291 | 2017 ONSC 2752
Headnote
Case Summary
Contracts — Interpretation — Parties joint owners of real estate development company — Parties deciding to terminate their relationship and entering into share purchase agreement which provided that plaintiff was to receive certain payments and 50 per cent of after-tax profit of subdivision which was then under construction as purchase price for his shares — Defendant not under fiduciary obligation to protect plaintiff's interests — Contract not entitling plaintiff to share in any other revenues or profits accruing to company from other projects.
The parties were brothers and joint owners of a real estate development company. They decided to terminate their business relationship, and entered into an agreement the stated purpose of which was to end their joint ownership and management of the company and to provide for the orderly completion of a subdivision that was then under construction. The agreement provided that the plaintiff was to receive various payments and that, in particular, he was to receive "50% of the after tax profits of the Forest Creek subdivision". The defendant did not make that payment, and the plaintiff sued.
Held, the action should be allowed.
All contracts contain a general duty to act honestly and in good faith in the performance of contractual relations, but that duty does not in and of itself create new rights, nor does it elevate contractual duties to fiduciary duties. The defendant was not under a fiduciary obligation to the plaintiff, and the agreement was not unfair. The agreement could not be interpreted as entitling the plaintiff to share in any other revenues or profits accruing to the company from other projects.
Cases Considered
- Bhasin v. Hrynew, [2014] 3 S.C.R. 494, 2014 SCC 71
- Sattva Capital Corp. v. Creston Moly Corp., [2014] 2 S.C.R. 633, 2014 SCC 53
Other Cases Referred To
- Bianchi Grading Ltd. v. University of Guelph
- Crownwood Construction Ltd. v. Omartech Construction Inc.
- Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., [2016] 2 S.C.R. 23, 2016 SCC 37
- Ramex Systems Ltd. v. Ottawa (City)
- White Burgess Langille Inman v. Abbott and Haliburton Co., [2015] 2 S.C.R. 182, 2015 SCC 23
ACTION to recover money owed under a contract.
Counsel: Paul A. Webber, for plaintiff. Todd J. Burke and Joel Reinhardt, for defendants.
[1] MACLEOD J.: — This matter came before me for trial on November 21, 2016. The parties have a disagreement over the amount owed by the defendant pursuant to a share purchase agreement. At an early stage in the proceeding, the parties distilled the dispute to a list of issues to be tried and they also agreed on a streamlined procedure.
[2] As counsel are aware, the issues were originally to be tried by me under the reference rules pursuant to a consent order signed by Justice Beaudoin. In light of my appointment as a judge on June 16, 2016, it was agreed to set aside the order of reference and to proceed as a summary trial. The procedure established for the reference remained in place.
[3] The evidence before the court consisted of affidavit evidence filed by each party and the cross-examinations and answers to undertakings completed out of court. That material was contained in a joint record. Although they had both sworn affidavits, I also heard oral evidence from two accountants. Mr. Kenneth Durand was called on behalf of the plaintiff and Mr. Greg McEvoy was called on behalf of the defendant. This was the only live evidence received during the trial.
Background and Issues
[4] The parties are brothers. For purposes of these reasons, I will refer to them as Robert and Ronald or as plaintiff and defendant instead of by their last names. Ronald had been a builder of new homes for some time and Robert following a career at Nortel Networks had been a business consultant and teacher.
[5] 6650358 Canada Inc. ("Westerra") was incorporated in 2006. It was to be a vehicle for building residential homes. At all material times, the brothers each held 50 per cent of the shares either directly or indirectly.
[6] When Westerra began operations in 2006, its first project was to construct eight homes in Prescott, Ontario. (Massie Drive) Forest Creek was a much larger project in Kemptville in which Westerra hoped to build as many as 62 homes. Ultimately, there were some differences of opinion between the brothers, which led to the decision to terminate their business relationship.
[7] In May of 2011, they entered into an agreement under which Robert would become the sole owner (the "cessation agreement"). The stated purpose of that agreement was to end their joint ownership and management of Westerra and to provide for the orderly completion of the Forest Creek subdivision. Ronald was to receive various payments but in particular he was to receive "50% of the after tax profits of the Forest Creek subdivision" as the purchase price for his shares.
[8] The litigation arises because the parties have a disagreement about the calculation of profits and certain other amounts said to be owing. In the course of the litigation, it was agreed that the issues to be tried are the following and only the following:
(a) the amount owed to the plaintiff, if any amount, pursuant to art. 18 of an agreement entered into between Robert Noseworthy, Ronald Noseworthy, 22206592 Ontario Limited and 6650538 Canada Inc. o/a Westerra Homes and Developments on May 12, 2011. More particularly, what constitutes 50 per cent of the after-tax profits earned in respect of the Forest Creek subdivision;
(b) the amount owed to the plaintiff is relation to Weedmark property, pursuant to art. 17 of the cessation agreement;
(c) the amount owed to the defendant Robert Noseworthy in relation to lot 32 pursuant to art. 16 of the cessation agreement;
(d) the amount of the overpayment or underpayment of Ronald Noseworthy's shareholder loan;
(e) interest; and
(f) costs.
Preliminary Issue -- Qualification of Experts
[9] Both Mr. Durand and Mr. McEvoy are chartered professional accountants ("CPA") and hold legacy designations as chartered accountants ("CA"). As experienced public accountants they are both qualified to express opinions on the accuracy of financial records and to prepare financial statements in accordance with generally accepted accounting principles ("GAAP"). The trial was necessary because the accountants did not agree on the final numbers. They were both necessary and material witnesses.
[10] At the opening of trial, Mr. Burke sought to disqualify Mr. Durand. His argument was that Mr. Durand had prepared his original report in a partisan fashion and had only latterly been asked to complete the form 53 acknowledgement of expert's duty to the court. I was asked to conclude that he should be excluded as an expert on the basis of bias.
[11] I declined to exclude the evidence. There were three main considerations in that ruling:
(i) First, even though it would have been preferable for Rule 53 to have been brought to Mr. Durand's attention at the time of his original retainer and for him to have incorporated the acknowledgment into his original report, Mr. Durand acknowledged his duty before he gave his evidence.
(ii) Second, Mr. Durand is governed by the code of conduct and standards of public accountancy. The principal objective of public accountancy and of GAAP is to provide assurance of the reliability of financial records. In other words, there is a degree of non-partisan objectivity built in to manner in which both Mr. Durand and Mr. McEvoy are obliged to approach their work by virtue of their professional obligations.
(iii) Third, both accountants participated in a mediation as a result of which they reached agreement on certain numbers and modified their calculation of others. This search for common ground further demonstrated understanding that it was not the role of the expert to simply advocate for the party that retained him.
[12] I was satisfied there was inadequate reason to disqualify Mr. Durand for bias. I found that both Mr. Durand and Mr. McEvoy were qualified as experts for the purpose of this trial. As a consequence, the trial proceeded as originally envisioned. It would have been unjust to exclude the plaintiff's expert particularly since the reports had been exchanged in accordance with the agreed upon timetable and the parties and experts had engaged in good faith attempts to narrow the issues. Consequently, the evidence before the court was that contained in the two volumes of joint record and the expert evidence of the two accountants received orally and tested by cross-examination.
[13] I should observe that in addition to the viva voce evidence of the experts, there are also affidavits from the controller of Westerra and from the plaintiff's business manager dealing with book keeping and accounting. Much of the material reviewed by the accountants involved information or records prepared by one or other of these witnesses.
Interpretation of the Contract
[14] The proper interpretation of the contract is not an accounting issue but is an issue to be determined by the court. This will have significance for the accounting opinions because in certain instances numbers have been calculated based on assumptions about how the contract should be applied or items may have been included in calculations that the contract when interpreted by the court may exclude.
[15] Of relevance to this decision are the significant pronouncements on contractual interpretation contained in the Supreme Court's decisions in Sattva Capital Corp. v. Creston Moly Corp. and Bhasin v. Hrynew.
[16] Although Sattva was actually a case concerning leave to appeal from a commercial arbitration award, the court took the opportunity to revisit the Canadian law of contractual interpretation. Sattva stands for the following principles:
(a) Generally speaking, interpretation of a written contract is a question of mixed fact and law in which the context and purpose of the agreement will inform the interpretation. This is subject to the exception for standard form contracts discussed by the Supreme Court in Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., [2016] 2 S.C.R. 23, 2016 SCC 37, which has no application to the present case.
(b) The objective of contractual interpretation is to ascertain the objective intentions of the parties having regard to the wording of the contract and the factual matrix in which it was constructed. The decision maker must read the contract as a whole giving the words used their ordinary and grammatical meaning consistent with the surrounding circumstances know to the parties at the time of the formation of the contract.
(c) Evidence of surrounding circumstances will be used to deepen the decision maker's understanding of the contract but cannot be allowed to overwhelm the words used. Courts cannot use evidence of context to deviate from the text so as to effectively create a new agreement.
(d) The admissible evidence of context is objective evidence of the facts that were known or reasonably ought to have been known to both parties at the time the contract was formed. It does not include the subjective intentions each of the parties.
(e) The parol evidence rule remains good law. This is the rule that precludes admission of evidence outside the words of the written contract that would add to, subtract from, vary or contradict a contract that has been wholly reduced to writing.
[17] In Bhasin, the court affirmed that there is a general organizing principle of good faith performance in Canadian contract law. All contracts contain a general duty to act honestly in the performance of contractual obligations but this duty does not in and of itself create new rights nor does it elevate contractual duties to fiduciary duties.
[18] This is important. The plaintiff argued strongly that the defendant was under a fiduciary obligation because it was a relationship of trust and Robert had undertaken to protect Ronald's interests. Ronald also relied upon the contra preferentem doctrine in arguing that any ambiguity in the contract should be construed against Robert and in favour of Ronald.
Was there a Fiduciary Duty?
[19] The evidence does not support the imposition of a fiduciary duty. Nor does it support a finding that hidden unfairness lurks in the wording of the contract. Certainly it was negotiated over a relatively short period of weeks and was drafted by Westerra's lawyer on Robert's instructions. But Ronald had adequate opportunity for input and adequate opportunity to obtain legal, accounting and tax advice had he chosen to do so.
[20] Although Ronald deposes that he trusted his brother and did not really understand the agreement, it is not lengthy or complex and it is clear that provisions were included which Ronald requested or had bargained for. The evidence does not support a finding that Robert breached Ronald's trust or misrepresented the terms of the contract. To the contrary, the intention to sever the joint ownership, make certain payments to Ronald and to buy him out of the company through a share of the profits of Forest Creek is clear.
[21] Ronald himself was not unsophisticated and was no stranger to the use of lawyers. The agreement was drafted by the company lawyer (Jim Doris) who incorporated various items as they were agreed. There were several draft agreements and much of the negotiation was done by e-mail as well as meetings in person or by telephone. While some of the e-mails indicate some frustration with the speed of the negotiations and the need to make decisions relating to construction and the ongoing development of Forest Creek, they do not indicate anything that might rise to the level of duress. Ronald was advised and encouraged to obtain independent counsel and appears to have advised Mr. Doris that he would do so.
Was the Contract Unfair or Ambiguous?
[22] There is nothing inherently unfair in the agreement. Ronald was to receive various benefits including the release of certain lands to develop on his own account. It should also be noted that Ron continued to be a shareholder in Ontario Land Development Inc., which was the developer of Forest Creek and the entity from which the lots were purchased. In addition to the specified benefits, he agreed to sell his shares in Westerra to Robert for 50 per cent of the net after tax profits earned by Westerra in the Forest Creek subdivision. This is ambiguous only insofar as the parties and their accounting advisors disagree on the calculation of profits and certain adjustments. There is no ambiguity about the intent. The evidence does not support a finding that Robert preyed on Ronald nor that there was any trickery hidden in the contractual wording.
[23] In addition to 50 per cent of the profits from Forest Creek to be paid within 30 days of the completion of all work associated with the subdivision, Ronald was to receive certain other benefits and make certain offsetting payments. He was to receive an amount for 50 per cent of the estimated profit for the sale of the Weedmark property. He was to pay an amount for the sale of "lot 32". Ronald was to receive an assignment of the Westerra rights to the Woodland development in Prescott. Ronald was given an option to purchase an additional lot. Both Ronald and Robert were to receive a new home in the Forest Creek subdivision at cost calculated as the cost of the land and the model of home completed with identical level of upgrades. Ronald was to receive the return of his capital by payment of his adjusted shareholder loan. He was to continue to receive a salary and other benefits for a period of time. He was to be released from Tarion and financing guarantees. All of these terms were implemented.
[24] The recitals at the beginning of the agreement declare that the purpose of the agreement was "to provide for the cessation of their relationship as shareholders of the corporation and the orderly completion of the Forest Creek Subdivision". I agree with the defendant that this is the touchstone by which the provisions of the agreement are to be interpreted. The brothers intended that they would disentangle their business affairs, Robert would take over the company and Ronald would share in the profits of Forest Creek in addition to the other payments and adjustments set out in the agreement. Pursuant to his duty of good faith, Robert would have been required to proceed with reasonable diligence to sell and complete the remaining portion of Forest Creek. There is no reason to think that he did not do so. It is common ground that the work on Forest Creek was completed in 2013.
[25] What Robert failed to do of course is to pay out the purchase price 30 days after the completion of the subdivision. Westerra had provided an estimate of profits in 2012. The estimated amount for 50 per cent of the profits was said to be $450,000 which was far below what Ronald believed them to be. By that time, Robert had been operating the company on his own for a year and he had initiated work on additional projects. Ronald was deeply unsatisfied and suspicious about the estimate and it appears the difference could not be resolved.
[26] In May of 2013, he commenced this action which was originally for damages for anticipated breach of contract, an accounting and oppression remedies. After the litigation had proceeded for approximately two years, the parties and their counsel agreed to distill the questions in dispute to the four issues listed above plus interest and costs. A consent judgment of reference was signed by Mr. Justice Beaudoin on June 10, 2015. I addressed the reasons for setting aside that order and the mode of trial at the beginning of these reasons. As set out therein, a summary trial of the defined issues took place in November.
Analysis -- Questions B & C -- Articles 16 and 17 of the Agreement
[27] These are the simplest of the issues. Article 16 deals with a payment by Ronald to Robert of $14,500, which was said to be 50 per cent of the net profit earned by Ronald on the sale of a home built on lot 32. He concedes this amount is owing.
[28] Article 17 is very similar. In that paragraph, Robert agrees that he will "cause to be paid to Ronald the sum of $30,000, being 50% of the net profit earned by Robert on the sale of such property" within five days of the sale of the former Weedmark property. It appears that the actual profit from the sale of the Weedmark property was $141,388 and if the intent of the provision is to share 50 per cent of the net profits from the sale of Weedmark then Robert would owe Ronald $70,694 rather than $30,000.
[29] This is a very good example of context informing interpretation. The wording and general intent of the two articles is similar. These provisions require sharing of profits from two side projects. The context is slightly different. In the case of art. 16 the profit had already been calculated but in the case of art. 17 it was estimated. I therefore agree with the plaintiff that the proper interpretation of the latter is to share the actual profits and that $30,000 was an estimate. In this case, I also agree that any ambiguity should be interpreted in favour of Ronald. Accordingly, while I find that art. 16 requires Ronald to pay the fixed amount of $14,500 to Robert (an obligation he recognizes), I find that art. 17 requires Robert to pay the higher amount of $70,694 to Ronald which is 50 per cent of the actual profit on Weedmark.
[30] If the intent was to fix the debt at $30,000 regardless of what was actually realized, then it would have been easy to say so. Rather than describing the amount as 50 per cent of the net proceeds of sale and deferring the payment until after the sale had occurred, for example, the clause could have recited that Ronald accepted $30,000 as a reasonable estimate and waived any right to future profits. On the other hand, art. 16 was a fixed obligation for an amount that was known.
Analysis -- Question D-- The Shareholder Loan
[31] The agreement fixes the amounts of shareholder loans owing to Ronald by Westerra at $241,196.49 and to Robert at $121,205.14. These shareholder loans represent adjusted amounts of contributed capital by each shareholder. From time to time when they were operating Westerra together contributions, drawings or personal expenses paid by the corporation were reflected in adjustments to the shareholder loan accounts. Corporate expenses paid by either Robert or Ronald were similarly recorded as loans.
[32] The amounts reflected in the agreement were drawn directly from the company shareholder loan ledgers. In agreeing to these amounts in the contract, they were agreeing to accept those ledgers as accurate. That is made clear by art. 14, which acknowledges that all contributions of capital or transfer or use of personal assets made by either shareholder to the corporation and the Forest Creek subdivision are fully reflected in the shareholder loans.
[33] The agreement then provides that both loans are to be paid by Westerra as soon as possible and it provides that Robert cannot pay down his own loan without repaying an equal amount to Ronald. It is further provided that Ronald was entitled to retain a corporate credit card until August 31, 2011 but if he charged any personal expenses to the card for which he did not reimburse the corporation, there would be an adjustment to his shareholder loan.
[34] It is clear from the shareholder ledger that Ronald incurred expenses for the Prescott subdivision and when he did so, the amounts were recorded as loan repayments. In addition, there were direct payments. The ledger shows that Ronald was fully repaid as of November 2, 2011, but then purports to show by means of further adjustments that Ronald was overpaid by $138,591.28.
[35] The major adjustment was because of the cost of upgrades to Ronald's "spec house" in the Forest Creek subdivision. The agreement specified that each of the brothers would be able to purchase a house at cost but they were to be finished to the same specifications. Ronald apparently selected more expensive features and upgrades. When the lot was transferred to Ronald, Westerra received funds from Ronald's lawyers towards the purchase price. Westerra charged the balance including the cost of the upgrades to Ronald's shareholder account. Mr. McEvoy determined that some of the upgrades had been charged twice so that the $59,052.89 adjustment to the shareholder account should only have been $39,991.35. This adjustment would reduce the overpayment to $119,529.
[36] Ronald acknowledges the amounts paid out to him and through Mr. Durand he agrees he owes $117,623. The difference is not more than a quibble in the overall calculation but it arises because Ronald now seeks to raise certain expenses he says he incurred on behalf of Westerra and also he disputes a much earlier charge to his shareholder loan account for money Ronald lent to Robert's son, David.
[37] It is quite clear from the evidence that Ronald agreed to lend David $8,300 to buy a car in 2007. It is also clear that the funds were advanced by Westerra and charged to Ronald's shareholder account. This charge is included in the totals acknowledged as accurate in the agreement. It is not open to either Ronald or Robert to revisit those amounts now in the absence of a dramatic error that could not have been realized at the time. In any event, the evidence also demonstrates that David has been dealing with Ronald and making loan repayments which were not paid by Ronald to Westerra. As for the other alleged payments on behalf of Westerra, they have not been proven. Accordingly, I accept the adjusted amount of $119,529 as the amount of the overpayment of the shareholder loan.
Analysis -- Question A -- Article 18 -- Calculation of Net Profits for Forest Creek
[38] This is the most complex question. The issue is what the contract means when it defines the share purchase price as 50 per cent of the net after tax profit from the Forest Creek subdivision and how the calculation is to be done. The accountants reach substantially different numbers because they have made different assumptions and approached the calculation in different ways. They have in some cases included items that may be justifiable on the basis of accounting principles or in the name of fairness.
[39] There is agreement on the gross revenue. The parties agree that the total income from the sale of homes in Forest Creek was $23,576,406. To calculate the share purchase price it is necessary to determine what costs can legitimately be charged against this revenue in order to calculate net profit.
[40] Expert evidence is admitted to assist the court to reach a decision. The court is not obliged to accept the opinion of either expert, particularly when it comes to whether to recognize certain expenses. Of course, factual findings of the court must be grounded in all of the evidence including that of the experts and the accountant's respective review of the financial records has been invaluable. The accountants, however, are not experts in contractual interpretation. That is the very issue to be decided and I can readily dispose of some of the questions that separate the calculations.
[41] The purpose and intent of a share purchase is that the corporate vehicle continues with all of its assets and liabilities intact. In this case, the agreement provides for Ronald to receive specific payments and benefits plus 50 per cent of the Forest Creek profits (past, present and future). At the time the agreement was signed, this was the principal activity of the business but there remained revenue and expenditures relating to other projects. It was entirely predictable that Robert would carry out further development projects through Westerra just as Ronald would be continuing to build houses on his own account. There is no reasonable way to construe the agreement as entitling Ronald to share in any other revenues, profits or benefits accruing to Westerra besides those contracted for. Nor would he be liable for any liabilities, losses or costs arising from Westerra's operations. There is no room in my view to expand the concept of profits for the Forest Creek subdivision to include other revenues (or non Forest Creek expenses). The brothers intended a buy out of the corporation as of the date of the agreement but they also intended to provide for completion of the Forest Creek subdivision and division of the profits.
[42] One issue that accounts for a difference in the numbers was the inclusion by Mr. Durand of certain residual income relating to the Massie Drive development. That this should form part of the calculation of profit for Forest Creek is disputed. I agree with the defendants' argument on this point. The Massie Drive income (and offsetting expenses) are not part of the contract and should not be included in the calculation. This is also consistent with Ronald's own evidence that the profits from Massie Drive "remained in the company to finance the next project". In other words, the revenues from Massie Drive were included in the working capital of Westerra.
[43] Conversely, since the agreement provided that Ronald would exit the corporation and be released from his guarantee with Tarion, it appears to me there was no intention for Ronald to have any residual financial obligation for claims which might be made against Westerra many years in the future. In any event, there is no evidence supporting any significant risk of liability for the corporation for breach of the seven-year major structural defect warranties and I do not consider it appropriate to take a charge for such claims against the calculation of profits. It is otherwise for the one and two-year warranties or the cost of servicing and repairing short term construction deficiencies.
[44] I agree that a reasonable allowance for the cost of servicing warranty claims or remedying construction defects during the two years after closing would have been a proper charge and on that point, I agree with Mr. Durand that the past experience is the best evidence of the likely cost. The 0.5 per cent allowance he proposes for such claims is reasonable. Of course, now that more than two years has passed since the construction was completed, it has been possible to actually determine the costs incurred to the date of the trial. I agree with the methodology shown at p. 104 of the record. That is to deduct the $23,665 actually incurred from the figure of $43,600 generated by applying 0.5 per cent to the 2012 and 2103 sales. This produces a net figure of $19,935 for short term future warranty claims or deficiencies.
[45] Another issue was Robert's salary. The agreement provided that Robert was to continue to receive his regular salary but he significantly increased it after Ronald's departure. It is entirely reasonable for him to have done so since he was taking over functions previously carried out by Ronald. Moreover, as the sole owner of Westerra within limits he would be free to set his own compensation. But however reasonable the increased salary may have been from the point of view of Robert and Westerra, I do not believe the contract contemplated him taking an increased salary and charging it to the Forest Creek project as a cost of sales. The salary that should be used for that purpose is the regular salary he was receiving at the time the contract was signed. On this point, I accept the Durand position.
[46] There was also a difference of opinion on the allocation of promotion and marketing efforts including redesign of the corporate visual identity. This was done at a time when Forest Creek was still being marketed but was almost sold out and was arguably an expense that had more to do with the new Westerra projects that were just being launched. In my view, Robert was under a duty to use reasonable efforts to close out Forest Creek so that Ronald's share of profits could be calculated and paid. It would have been within the contemplation of the parties that reasonable sales efforts would continue so this is a legitimate expense. On the other hand, I agree that the marketing expenses in 2012 and 2013 were primarily for the benefit of the new projects and the business of Westerra. I consider that allocating 25 per cent of those expenses to Forest Creek would be appropriate. That is consistent with the manner it was allocated by Mr. McEvoy.
[47] The remaining difference is primarily a question of how to allocate head office or overhead costs and whether or not they can legitimately be charged against the Forest Creek revenues. Generally, construction projects may be visualized as involving direct and indirect costs of construction. Direct costs might be items such as roof trusses, lumber, drywall or concrete utilized for a particular building. Indirect costs might be such things as toilet rental, equipment rental, security and clean up that relate to all of the buildings under construction. These costs may be thought of as the cost of building and in new home construction they are frequently measured in cost per square foot of construction. They are a principal concern in estimating and in pricing new homes. But a construction company must also cover its costs of operation. These are head office costs such as telephones, office space, secretarial and administrative staff and accounting.
[48] In the financial statements of the company the construction costs (both direct and indirect) will show up under "cost of sales" resulting in a "gross profit" number. General office expenses show up as "expenses" and are deducted from gross profit to generate a number for "income before taxes". The financial statements are helpful and they bear some relationship to the question at hand but they do not answer it for two main reasons. First, the statement of income is a consolidated number and is not broken out by projects. Second, the income statements are compiled for the fiscal year which will not match the temporal scope of the project in question.
[49] Before delving into the evidence in more depth, it is important to observe that the question of allocating head office overhead to individual construction projects is frequently problematic and it is one that courts are frequently called upon to determine. In most construction projects, the builder or contractor must calculate a price to the end user or customer based on the direct and indirect costs of carrying out the construction but they must also fix a price that covers overhead and profit. This frequently comes before the court in claims for damages arising from extras or delay claims. The question is how to allocate general business expenses such as administration, payroll, and accounting that are legitimately impacted by the extra work or the extra time spent on a project.
[50] It is not always possible to calculate the impact of a particular project on the overall operations of a construction company with precision. Nevertheless, the courts have been prepared to recognize that these are legitimate costs of servicing the contract. For example, see Crownwood Construction Ltd. v. Omartech Construction Inc. in which a markup of 25 per cent for overhead and profit was allowed. There are even formulas which have been developed to deal with this such as the "Eichleay formula" widely used in the United States and the "Hudson formula" developed in the United Kingdom. See Bianchi Grading Ltd. v. University of Guelph. Canadian courts have been reluctant to adopt a formulaic approach and generally require proof of increased overhead costs causally related to the project in question. See Ramex Systems Ltd. v. Ottawa (City).
[51] Of course we are not concerned here with assessing damages but with the calculation of net profit for Forest Creek. I make this point simply to illustrate that it is no easy task to appropriately allocate overhead to construction projects and reasonable parties can disagree. For example, during a period of time when the only project under construction was Forest Creek it is possible to argue that in a small construction company all of the overhead cost is attributable to that development but that assumes the company would not be operating and would have no overhead if it was not actively building. Yet there is a base cost of operations that would continue in any event and is necessary simply to maintain the corporate structure and an office. Even a company completing one project at a time would not be justified in charging all of its overhead to "cost of sales".
[52] The question before the court is not the correct method of calculating net profit in any absolute sense. The question is, what is intended by the provision in the contract? As the evidence discloses, at the time the contract was signed, the brothers had a method of calculating profit for each home they built. It is evident that they had little difficulty in agreeing on the net profit from individual lots and we see several instances in which this is the case. In fact, job cost reports were maintained on a running basis for each home constructed.
[53] In my view, the past practice is important as it informs what would have been understood by the profits from the Forest Creek subdivision. It is reasonable to suppose that the amount would be derived by taking the cumulative net profit from all of the homes in the subdivision subject to some unallocated costs which might be charged to the project as a whole. The job cost reports do contain a certain allocation of general office expenses to each new home. As Mr. Durand pointed out when that kind of allocation is made, it is important that it be booked as either cost of sales or as a corporate expense but not double counted.
[54] Ultimately, Mr. McEvoy conducted an analysis of all of the individual job cost reports for the Forest Creek subdivision. He came up with an adjusted cost of sales of $19,435,251, which I accept as the correct number. Using the job cost reports is consistent with the manner in which profit per job had been calculated by Robert and Ronald in the past and it is a consistent way to deal with each home comprising the subdivision.
[55] This leaves the question of general operating expenses allocated to Forest Creek, which Mr. Durand found to be $754,642 and Mr. McEvoy found to be $901,630. I will accept the Durand number for salaries as the difference is Robert's increased salary which I have excluded. Much of the remaining difference relates to 2013, when there were other subdivisions under construction. For that year, the Durand analysis allocates the cost based on a percentage calculated by comparing the number of units sold whereas Mr. McEvoy did so on the basis of price. For two reasons I accept the Durand approach. First, it is consistent with using the job cost reports; and second, it is likely that more of the company's efforts were directed at Pinehill in 2013.
[56] I also accept the Durand calculation of advertising and promotion costs for 2012, but the McEvoy total (with the Durand allocation of 5/9) for 2013. I accept that most of the promotion incurred in those years would not have related to the closing out of Forest Creek but the McEvoy number also includes the Avenue Designs number which I have allowed at 25 per cent.
[57] I have accepted Mr. McEvoy's calculation of vehicle expense for 2012. There was disagreement about whether meals and entertainment were a legitimate cost. Mr. McEvoy included it because it was consistent with earlier years whereas Mr. Durand excluded it because it was only incurred by Robert after Ronald's departure. I have allowed a reduced number at 50 per cent because this is an ordinary expense but I have reduced it to reflect the fact that it was an expense purely controlled by Robert in those years. In addition, in 2013 this expense is much higher than was historically the case as recognized by Mr. McEvoy. I have taken a similar approach with travel. In 2012, I have recognized the expense as it was to attend the Canadian Home Builder's Association. In 2013, the expense is much higher and there is no evidence that the travel was for the benefit of Forest Creek.
[58] My calculation of the general expenses allocated to Forest Creek would therefore be as follows:
[59] This totals $797,339 for the two years in question. For 2009, 2010 and 2011, there is agreement that the general expenses to be deducted total $1,754,058. This makes the total general expenses allocated to Forest Creek $2,551,397.
[60] It is possible some of my rulings may affect these numbers in ways I have not recognized or there may be adjustments that were agreed upon which I have not included. I expect the accountants will have to agree on the calculation of taxes which may require adjustment. I have used the same 21.5 per cent tax rate found in the schedules. If there are calculation errors which cause any disagreement or confusion, I may be spoken to.
Conclusion
[61] Subject to adjustment if my arithmetic is in error of there is any calculation flowing from this decision that I have not recognized, it appears the net profit on the Forest Creek subdivision may be calculated as follows:
The total amount due may then be calculated as follows:
[62] The apparent result is that Ronald is owed $552,820. I say apparent because there were numerous schedules and adjustments contained in the accountant's reports that I have certainly not done justice to in these relatively brief reasons. While I believe I have dealt with all of the issues in dispute, it remains possible that there are adjustments I have not accounted for. As noted above, counsel may arrange to speak to this matter and if necessary may have the experts reattend.
[63] There also remain the issues of pre-judgment interest and costs. I will hear submissions on both of these matters.
[64] Accordingly, counsel should arrange to reattend before me to deal with any arithmetical errors, further adjustments, interest and costs.
Action allowed.