Saputo Inc. et al. v. Dare Holdings Limited et al. [Indexed as: Saputo Inc. v. Dare Holdings Ltd.]
111 O.R. (3d) 733
2012 ONSC 4981
Ontario Superior Court of Justice
Newbould J.
September 4, 2012
Corporations -- Shares -- Valuation -- Share valuation conducted pursuant to unanimous shareholders' agreement -- Definition of fair market value in agreement directing valuator to apply generally accepted valuation principles -- Valuator failing to meet generally accepted valuation standards in its dealing with working capital -- Setting aside entire valuation report not appropriate -- Analysis to determine appropriate working capital adjustment being ordered.
The applicants applied to set aside the valuation of the issued and outstanding common shares of the respondent D Ltd., conducted pursuant to unanimous shareholders' agreement ("USA") as part of an acquisition of the applicants' interest in D Ltd. by the respondent S Ltd. The applicants argued that the valuator failed to follow the requirements of the USA, resulting in a significant undervaluation of D Ltd.
Held, the application should be allowed in part.
A court should not intervene where a valuation was made in accordance with the terms of an agreement, even if the valuation proceeded on the basis of error or resulted in a gross over- or undervalue. Rule 1 in the definition of fair market value in the USA directed the valuator to apply generally accepted valuation principles. In the engagement letter negotiated by the parties, the valuator agreed to prepare a comprehensive valuation report in accordance with the standards defined by the Canadian Institute of Chartered Business Valuators. The valuator failed to meet generally accepted valuation standards in its dealing with working capital, and thus failed to meet the requirements of the USA. The appropriate remedy was not to set aside the entire valuation report, as sought by the applicants. Rather, the appropriate remedy was to order an analysis to determine the appropriate working capital adjustment.
APPLICATION to set aside the share valuation.
Cases referred to
Legal & General Life of Australia Ltd. v. A. Hudson Pty Ltd. (1985), 1 NSWLR 314, apld
Other cases referred to
Glaister v. Amalgamated Dairies Ltd., [2002] NZLR LEXIS 84 (Auk. H.C.); Ivaco Inc. (Re) (2007), 87 O.R. (3d) 561, [2007] O.J. No. 4236, 2007 ONCA 746 , 161 A.C.W.S. (3d) 525, 39 C.B.R. (5th) 182, 41 B.L.R. (4th) 223; Jones v. Sherwood Computer Service Plc, [1992] 1 W.L.R. 277, [1992] 2 All E.R. 170 (C.A.)
Eliot N. Kolers and Ellen M. Snow, for applicants.
M. Philip Tunley, for respondents.
[ 1 ] NEWBOULD J.: -- The applicants ("Saputo") bring this application to set aside the valuation of the issued and outstanding common shares of Dare Holdings Limited performed by BDO. The valuation was conducted pursuant to a unanimous shareholders' agreement ("USA") as part of an acquisition of Saputo's 21 per cent interest in Dare by Serad Holdings Limited, which held 79 per cent of Dare. The applicants contend that BDO failed to follow the requirements of the USA, resulting in a significant undervaluation of Dare.
[ 2 ] In 2001, Saputo purchased 21 per cent of the common shares of Dare. In connection with the purchase, the Dare [page735] shareholders entered into the USA. Saputo was given the right to put its shares to Serad, which it did on June 30, 2010, to be acquired at the fair market value of the shares. The USA defined fair market value as follows:
"fair market value of the Common Shares" means the fair market value for all the Common Shares in the capital of the Corporation as a class determined by an independent business valuator . . . who shall be appointed as an expert and not as an arbitrator to determine the fair market value of the Common Shares of the Corporation as a class in accordance with the following rules:
The valuator shall take into account and apply generally accepted accounting and valuation principles.
The valuator shall determine the fair market value of the Common Shares by establishing the highest price for the Common Shares in an open and unrestricted market between informed prudent parties, under no compulsion to act and acting at arm's length, expressed in terms of cash or cash equivalent payable in full at the closing of the purchase and sale transaction determined on a consolidated earnings basis. . . . . .
The fair market value of the Common Shares shall not be diminished because (i) the Common Shares are not publicly traded, or (ii) [Saputo] or any of its Affiliates owns a minority interest in the Corporation.
The valuation arrived at by the valuer, made as an expert and not as an umpire arbitrator, shall be final and binding and no appeal shall lie therefrom.
[ 3 ] BDO was chosen as the expert to determine the fair market value of the Saputo shares. Saputo contends that BDO failed to follow rules 1 and 4. Dare says that BDO followed the agreement and that the complaints of Saputo, even if valid, are as to the merits of the valuation from which no appeal lies.
Test for Court Intervention
[ 4 ] Saputo relies on the decision of McHugh J.A. in Legal & General Life of Australia Ltd. v. A. Hudson Pty Ltd (1985), 1 NSWLR 314, at p. 335, to support court intervention. Dare agrees with the test articulated in that case. McHugh J.A. stated:
By referring the decision to a valuer, the parties agree to accept his honest and impartial decision as to the appropriate amount of the valuation. They rely on his skill and judgment and agree to be bound by his decision. . . . While mistake or error on the part of the valuer is not by itself sufficient to invalidate the decision or the certificate of valuation, nevertheless, the mistake may be of a kind which shows that the valuation is not in accordance with the contract. A mistake concerning the identity of the premises to be [page736] valued could seldom, if ever, comply with the terms of the agreement between the parties.
But a valuation which is the result of a mistaken application of the principles of valuation may still be made in accordance with the terms of the agreement. In each case the critical question must always be: Was the valuation made in accordance with the terms of a contract? If it is, it is nothing to the point that the valuation may have proceeded on the basis of error or that it constitutes a gross over or under value. Nor is it relevant that the valuer has taken into consideration matters which should not have been taken into account or has failed to take into account matters which he should have taken into account. The question is not whether there is an error in the discretionary judgment of the valuer. It is whether the valuation complies with the terms of the contract. (Underlining added)
[ 5 ] I have underlined parts of this passage as, in my view, which I will explain, much of what Saputo complains of falls within the underlined passage.
[ 6 ] Thus, there is a two-part test, being first what was agreed in the contract, being a question of law, and second, what was the nature of the mistake. In Jones v. Sherwood Computer Service Plc, [1992] 1 W.L.R. 277, [1992] 2 All E.R. 170 (C.A.) , Dillon L.J. stated this in the following terms:
On principle, the first step must be to see what the parties have agreed to remit to the expert, this being, as Lord Denning M.R. said in Campbell v. Edwards, a matter of contract. The next step must be to see what the nature of the mistake was, if there is evidence to show that. If the mistake was that the expert departed from his instructions in a material respect -- e.g., if he valued the wrong number of shares, or valued shares in the wrong company, or if, as in Jones (M.) v. Jones (R.R.) . . . , the expert had valued machinery himself whereas his instructions were to employ an expert valuator of his choice to do that -- either party would be able to say that the certificate was not binding because the expert had not done what he was appointed to do.
[ 7 ] Our Court of Appeal has accepted these principles. In Ivaco Inc. (Re) (2007), 2007 ONCA 746 () , 87 O.R. (3d) 561, [2007] O.J. No. 4236 (C.A.), the court stated [at para. 3]:
By the end of argument, it was clear to us that there was no real dispute about the underlying legal principles. If the expert (KPMG) went beyond the mandate given to it in the agreements, the report prepared by the expert cannot stand. Equally, if the expert stayed within its mandate, its report is final and binding and not subject to judicial review: Jones v. Sherwood Computer Services, [1992] 1 W.L.R. 277 (C.A.); Glaister v. Amalgamated Dairies Ltd., [2002] NZLR LEXIS 84 (Auk. H.C.); Shinkaruk Enterprises Ltd. v. Commonwealth Insurance Co. (1990), 1990 7738 (SK CA) , 71 D.L.R. (4th) 681 (C.A.).
[ 8 ] In Glaister v. Amalgamated Dairies Ltd., [2002] NZLR LEXIS 84 (AUK. H.C.), referred to in Ivaco, it was stated that a court could not intervene with the exercise of judgment by a [page737] valuer where that judgment had been authorized by the parties, but could intervene where there had been an error in the interpretation of a valuation instruction because that was a question of law rather than an issue to be resolved on valuation principles. The court followed Legal & General Life of Australia Ltd. v. A. Hudson Pty Ltd.
Analysis of Saputo Complaints
(i) Special purchasers
[ 9 ] The parties and their experts agree that in order to find the highest price payable for the shares, the valuator is required to consider the presence of special purchasers in the marketplace. A special interest purchaser, according to the expert Farley Cohen retained by Saputo, is an acquirer who believes that it can enjoy post-acquisition economies of scale, synergies or strategic advantages by combining the acquired business interest with its own. The experts differ as to whether BDO dealt with this issue appropriately.
[ 10 ] BDO obtained a representation from management of Saputo that there were no special purchasers that they were aware of and no offers to purchase the company. BDO stated in its report that it assumed there were no special purchasers evident in the marketplace who might pay a premium to purchase the operations of Dare. In its report, BDO stated that unless there is a high probability that special interest purchasers do exist, and that the net economic value-added can be quantified with reasonable certainty, to date in a notional market context such purchasers tend to be noted by valuers as a possibility but are otherwise disregarded. BDO referred to an inability to identify special interest purchasers in actual transactions and quantify the net-economic value added that the purchaser was willing to pay for.
[ 11 ] BDO prepared a draft report and sent it to the parties. Saputo was critical of the report, including the section dealing with special purchasers. Although requested by BDO for any information it might have, Saputo did not provide BDO with the names of any potential special purchaser.
[ 12 ] In his expert report filed by Saputo, Mr. Cohen stated that he believed there were special interest purchasers active in the marketplace and the BDO assumption that there were none was "inappropriate" and understated the value of the Dare shares. He did not identify any particular purchaser, other than to say that Kellogg had expressed an interest in acquiring Dare [page738] in 2007, or give any information to support his statement that the BDO report thus understated value.
[ 13 ] Mr. Cochran of Ernst & Young, another expert retained by Saputo, said nothing in his report on the subject of special purchasers. On his cross-examination, he said there was overwhelming evidence that synergies should have been considered.
[ 14 ] Mr. Howard Johnson, the managing director of Campbell Valuation Partners Limited, was retained by Dare as an expert witness. He stated in his report that with respect to special purchasers, BDO's consideration was in accordance with generally accepted valuation standards and the USA. He stated that in the absence of either open market negotiations involving Dare at or near the valuation date (July 17, 2010) or a sufficient number of industry transactions near the valuation date evidencing an active market involving businesses highly comparable to Dare and where synergies that were paid for could be meaningfully quantified, it is speculative to assume that a hypothetical special purchaser could have been negotiated into paying for any synergy. He considered the Kellogg approach to Dare in 2007. He stated that as Dare was not interested in selling and there were no discussions of price, given the preliminary nature of the discussions and the fact it was several years prior to the valuation date, it was not identified by Dare to BDO in their discussion of any special interest purchasers that might exist. He said it would not be possible to speculate what price and terms might have been struck.
[ 15 ] Saputo's point as to what BDO should have done, as summarized in para. 60 of its factum, is that BDO failed to take a number of things into account. In my view, however, even if the criticism is correct, it amounts to an assertion that BDO failed to take into account things that it should have, which according to McHugh J.A. in Legal & General Life of Australia Ltd. v. A. Hudson Pty Ltd. is not relevant or grounds for an appeal. It is very clear that BDO considered the issue of special purchasers and used its judgment in coming to the conclusion that it did. Moreover, the fact that Saputo's experts are of the view that BDO did not properly exercise its judgment in the matter, even if their view were to be preferred over the view of Dare's expert, does not mean that BDO failed to carry out its mandate under the USA. The exercise of judgment by BDO is not capable of being the subject of an appeal.
[ 16 ] In my view, what BDO did or did not do regarding special interest purchasers does not give grounds for an appeal under the USA. [page739]
(ii) Minority discount
[ 17 ] Rule 4 of the definition of fair market value required BDO not to diminish the fair market value (i) because the Dare shares were not publicly traded or (ii) because Saputo owned a minority interest in Dare. I do not see condition (ii) adding anything to the definition because what was to be valued were all of the shares of Dare en bloc, in which case there could be no minority discount. In any case, it was a contractual requirement to follow rule 4 (i) and (ii).
[ 18 ] Saputo contends that BDO effectively breached rule 4 by the use of public trading multiples that it says reflected a minority discount. It contends that BDO should have made an upward adjustment to these multiples, but did not.
[ 19 ] BDO used a capitalized cash flow ("CCF") method of valuation as its primary valuation method. That involved the capitalization of, or application of a multiple to, future expected cash flows to determine a going concern value. To assess the reasonableness of its conclusions under the CCF method, BDO (i) considered a discounted cash flow ("DCF") method of valuation and (ii) considered the implied valuation multiples from public companies and industry transactions. It is with this second reasonableness test that Saputo and its experts take issue. BDO stated in its report that the public company multiples should not be used as a primary valuation approach for a number of reasons, including the fact that the wide variety of multiples it observed rendered them of little use.
[ 20 ] Mr. Cohen stated in his report that BDO failed to take into consideration that public company share trading prices reflect the price of a minority interest in any particular company as it is the price for one share, which is a non- controlling interest. Accordingly, when analyzing public company trading multiples for the purpose of determining en bloc value, trading prices must be adjusted upwards to eliminate any minority discount implicit in the prices. Such upward adjustment is often referred to a control premium. Mr. Cohen stated that the comparable company trading multiples used by BDO were understated, and that had BDO adjusted them, it would have concluded that its value reached by its CCF method was not reasonable and that it ought to have reconsidered its value conclusions.
[ 21 ] Mr. Cochran in his report expressed the same view as Mr. Cohen. It was expressed in a section in which Mr. Cochran disagreed with the use of the CCF method of valuation used by BDO and expressed the view that a discounted cash flow ("DCF") method should have been used. Mr. Cohen did not [page740] express a view that the CCF method should not have been used. Mr. Johnson disagreed with Mr. Cochran and expressed the view that using a DCF method of valuation would have been a meaningless exercise and that it was appropriate for BDO to use a CCF methodology as its primary valuation method. Saputo does not raise this issue in this application.
[ 22 ] Mr. Johnson in his report stated that BDO's analysis of public company trading comparables was consistent with generally accepted valuation standards. His view is that while public equity market trading prices typically represent small lots of shares that constitute minority ownership positions, such shares are highly liquid and the ability for public equity market investors to readily liquidate their investments negates any disadvantage of a non-controlling equity interest. His view is that shares of public companies do not trade at prices that reflect an embedded minority discount. He stated that BDO did not apply a minority discount in its determination of the fair market value of Saputo's 21 per cent interest and this effectively conferred on Saputo's interest the benefit of liquidity that is available to publicly traded shares.
[ 23 ] On cross-examination, Mr. Johnson referred to other qualified valuation experts who held the view that he expressed in his report and said that one would be hard pressed to find any stock market analyst who has ever thought of a minority discount in the context of public share prices. Mr. Johnson, like Mr. Cochran but unlike Mr. Cohen, is a chartered financial analyst. He acknowledged that there are some differences of opinion in academic debate whether there is a minority discount in publicly traded share prices. Regarding transaction multiples (not trading prices on a stock market), he agreed that typically takeover prices are often higher than trading prices prior to the takeover but his view is that this is due to perceived synergies rather than a premium for control.
[ 24 ] In his reply report, Mr. Cochran acknowledged that there has been debate on the issue and that there is not unanimous agreement among valuation professionals and academics. He stated his own view that the hypotheses that most public companies trade at or near their controlling interest values and that the existence of liquidity would tend to eliminate worries about lack of control was theoretically flawed.
[ 25 ] In my view, what is taking place here is a debate over valuation principles to be applied by a valuer and the judgment exercised by BDO in using the public trading multiples that it did in its reasonableness check on its primary CCF valuation. If Mr. Farley and Mr. Cohen are right and BDO failed to make an [page741] appropriate adjustment to the public trading multiples, that does not mean that BDO failed to carry out its contractual mandate. As stated by McHugh J.A. in Legal & General Life of Australia Ltd. v. A. Hudson Pty Ltd., it matters not that the valuer has proceeded on the basis of error or has failed to take into account matters which he should have taken into account. That is a matter of judgment left to the valuer.
[ 26 ] In my view, what BDO did or did not do in its review of public trading multiples gives no grounds for appeal under the USA.
(iii) Valuation standards
[ 27 ] Rule 1 in the definition of fair market value directed BDO to apply generally accepted valuation principles. In the engagement letter negotiated by the parties, BDO agreed to prepare a comprehensive valuation report in accordance with the standards defined by the Canadian Institute of Chartered Business Valuators ("CICBV"). Although Mr. Cochran expressed the view that valuation standards were not met in many respect, Saputo raises only two of them. It contends that by not meeting generally accepted valuation standards, BDO failed to follow the direction in rule 1.
(a) Working capital
[ 28 ] When a business interest is valued using a CCF approach, it is necessary to establish whether there are any surplus or redundant assets to the operation of the business. Net redundant assets are added to the value of the business to arrive at an overall fair market value for the business. In its report, BDO identified redundant assets of $19.8 million in cash and $25.5 million in real estate.
[ 29 ] Mr. Cochran in his report was critical of BDO's analysis, saying that it was not reasonable and understated value. Mr. Cochran made a calculation of what he considered to be a proper valuation of working capital and concluded that a further adjustment should have been made that would result in $3.3 million more being paid to Saputo. In his reply report, Mr. Cochran stated that the work performed by BDO was not consistent with the level of review and analysis required by the CICBV standard for a comprehensive valuation report.
[ 30 ] Mr. Johnson in his report disagreed with the method by which Mr. Cochran arrived at his adjustment but was unable to provide any other calculation as he had not been retained to do one. He did say that while a company's working capital requirements are a matter of professional judgment, he understood that [page742] BDO conducted a limited amount of independent analysis to assess the reasonableness of management's stated position and that if BDO had conducted further independent analysis, it may or may not have found that Dare's working capital requirements were greater or less than the amount estimated by management. On cross-examination, Mr. Johnson agreed that BDO did not adequately address the working capital issue and that it failed to satisfy valuation standards.
[ 31 ] By failing to meet generally accepted valuation standards in its dealing with working capital, BDO thus failed to meet the requirements of rule 1 as required in the USA. What remedy flows from that will have to be addressed.
(b) Unprofitable plants
[ 32 ] Two of Dare's plants were unprofitable. One was in Toronto and the other in Denver. The chairman of Dare had said that the primary solution to [this] problem must be through increased sales in those plants.
[ 33 ] In his report, Mr. Cochran was critical of the use of the CCF method used by BDO as the primary valuation method. In that part of his report, he said that the chairman's remarks were not as readily dealt with under a CCF valuation as they could be under a DCF valuation. He stated that by not reflecting the projected revenue growth or, alternatively, not considering any savings from restructuring the plants in the event that revenue growth could not be achieved, the use of the CCF method by BDO has likely understated the value of the business. Contrary to the argument of Saputo, Mr. Cochran did not say that BDO had failed to meet valuation standards.
[ 34 ] On his cross-examination, Mr. Johnson disagreed with the assertion in Mr. Cochran's report that there ought necessarily to have been an adjustment for the losing plants. He said that one would have to analyze the reasons for the losses, including the basis on which they were accounted for. If there were general overhead expenses allocated to the plants, those expenses would not go away with closure. Other factors and strategic elements would come to light in a valuation. He did not say, as Mr. Cochran asserted on his cross-examination, that he has acknowledged that there was no analysis done by BDO on the fact that there were underutilized plants. Mr. Johnson said that he had no idea if BDO had considered these issues or to what extent, as he had not discussed this issue with BDO. He said he did not recall seeing anything in the working papers, although he would have to go back and examine them more carefully. [page743]
[ 35 ] Mr. Jason Kwiatkowski, who co-signed the BDO report and was instrumental in the work done by BDO, was examined under rule 39 by counsel for Saputo. I have not been referred to any part of his examination in which he was questioned about this issue. If he had acknowledged in any way that BDO had not considered the issue of the two plants in question, I would have thought that such acknowledgment would have been pointed out in argument. It was not. If he was not questioned on the issue, it would be unfair to now assert BDO did nothing or too little to meet standards.
[ 36 ] Whether a CCF or DCF method of valuation was the preferred method is obviously a matter of professional judgment and not one for a court to get into in an appeal such as this. As stated earlier, Mr. Johnson thought that a CCF valuation method was appropriate. Whether BDO ought to have made adjustments to cash flows in carrying out its CCF valuation is a matter of professional judgment. If Mr. Cochran is right, BDO improperly exercised its judgment and failed to take into account matters which it should have. But that gives no grounds for an appeal on the principles of Legal & General Life of Australia Ltd. v. A. Hudson Pty Ltd.
[ 37 ] I also think there is merit to the argument of Dare that any error of BDO, if in fact there was an error, would unlikely not rise to the level of materiality required to review a report by a valuer. Although Saputo was sent a draft of the BDO report and asked for its views and any information that it wanted BDO to know, Saputo did not raise any issue regarding these closed plants. One may question, therefore, whether Saputo thought the issue material. I also think there is something to the argument that Mr. Cochran was speculating in his conclusion that BDO likely understated the value of the business.
[ 38 ] In my view, what BDO did or did not do regarding the two money-losing plants gives no grounds for appeal under the USA.
(c) Remedy for working capital analysis
[ 39 ] Saputo contends that the entire BDO report must be set aside because of the failure of BDO to meet the appropriate standards in dealing with working capital. Dare contends that the entire report should not be set aside, but rather steps be ordered to remedy the working capital analysis. Saputo says that what Dare asks for is a minimum that the court should order if the entire report is not set aside.
[ 40 ] Mr. Johnson stated in his report that working capital is an isolated issue and that if an adjustment on working capital is warranted, such an adjustment can be made to BDO's en bloc [page744] equity value conclusion as any working capital adjustment does not otherwise impair the valuation conclusions in its report. Mr. Cochran in his reply report said that he generally agreed with Mr. Johnson that working capital is an isolated issue, although in certain circumstances he would adjust the discount rate. He did not state that this case was such a case.
[ 41 ] As stated, any working capital adjustment is made after the CCF valuation of the en bloc shares is made. It is separate from the CCF valuation of equity. If the entire BDO report were set aside because of the working capital issue, it would mean that Saputo would be obtaining what I have held it is not entitled to. In the circumstances, it appears reasonable to deal only with the analysis required to determine the appropriate working capital adjustment and to leave the rest of the BDO report intact.
[ 42 ] This result is similar to the result in Glaister v. Amalgamated Dairies Ltd., referred to in Ivaco by the Court of Appeal. In Glaister, a valuation of shares was reduced by a valuer to reflect a minority discount as the seller did not have a majority of the shares. It was held that the agreement referring the valuation to a valuer did not permit a minority discount. The court did not set aside the valuation, but directed that the amount of the minority discount set by the valuer be paid to the seller.
[ 43 ] In my view, it is appropriate that the relief requested by Dare in the event that relief is to be given is appropriate, subject to slight modification, in an order as follows: (a) a valuer is to be engaged by the company to prepare an opinion and report (the "Working Capital Adjustment Report") as follows; (b) the scope of Working Capital Adjustment Report shall be limited to the following question: within the context of the other findings and conclusions of the BDO final report, was the assessment by management of the company's working capital requirements (including cash, accounts receivable, inventories, prepaids, accounts payable and other components) at the valuation date, as referred to and relied upon in the BDO final report, reasonable, and if not, what adjustment or adjustments to that assessment should be made; (c) the terms of engagement of the valuer, the standards applicable to the Working Capital Adjustment Report and the effect of that report shall be in all respects the same as are specified in the USA, and in the BDO retainer; [page745] (d) any opinion or conclusion with respect to adjustment of the company's working capital requirements in the Working Capital Adjustment Report shall be applied directly to the midpoint equity value conclusion in the BDO final report, without any other adjustment to that value conclusion; and (e) Serad shall pay to Saputo 21 per cent or, as the case may be, Saputo shall pay to Serad 79 per cent, of the adjustment amount referred to in paragraph (d), above, within 10 business days of the parties' receipt of the Working Capital Adjustment Report.
[ 44 ] There was no argument as to whether BDO or some other valuer should be the valuer to carry out this task. A number of issues arise, including cost. If either party wishes to contend that a valuer other than BDO should do the work, and no agreement is reached, this may be raised with me. If it is not to be BDO, it should be agreed by the parties who such an independent valuer should be, failing which it can be the subject of further order.
[ 45 ] Success being divided, there is no order as to costs.
Application granted in part.