Court File and Parties
COURT FILE NO.: 15-66562 DATE: October 24, 2018
ONTARIO SUPERIOR COURT OF JUSTICE
BETWEEN: Thomas Scullion and Thomas Scullion Holdings Inc., Plaintiffs – and – Paul Munro, Paul Munro Holdings Inc., Munro & Scullion Contracting Inc., John Sweeping (2014) Inc., 1561987 Ontario Inc., and 1823059 Ontario Inc., Defendants
AND BETWEEN Paul Munro, Paul Munro Holdings Inc. Plaintiffs by Counterclaim -and- Thomas Scullion, Thomas Scullion Holdings Inc. Munro & Scullion Contracting Inc., John Sweeping (2014) Inc., 1561987 Ontario Inc. and 1823059 Ontario Inc., Defendants by Counterclaim
COUNSEL: Benoit M. Duchesne, for the Plaintiffs and Defendants by counterclaim K. Scott Mclean and James Wishart, for the Defendants and Plaintiffs by counterclaim Lisa Langevin, for Bank of Montreal, (creditor)
HEARD: September 12, 13 and 25, 2018
REASONS FOR DECISION
C.T. HACKLAND J.
OVERVIEW
[1] This is a ruling on the valuation of Thomas Scullion’s 50% shareholding interest in the Munro & Scullion group of companies. Specifically, the court is to set the valuation of Mr. Scullion’s shares in Munro & Scullion Contracting Inc., John Sweeping (2014) Inc., 1823059 Ontario Inc., and 1561987 Ontario Inc., (the companies). The valuation date for the companies is November 30th, 2017.
[2] The two principals of the companies are Thomas Scullion and Paul Munro and they have been engaged in litigation under the oppression sections of the Canada Business Corporations Act and the similar provisions in the Ontario Business Corporations Act.
[3] Importantly, Mr. Scullion and Mr. Munro are in agreement that their conflicting positions and mutual lack of trust have created a deadlock in the companies and they have agreed that pursuant to the relevant provisions of the Canada Business Corporations Act and the Ontario Business Corporations Act, the appropriate remedy is that Mr. Munro will purchase Mr. Scullion’s 50% shareholding in the companies at fair market value, which is to be established by the court.
[4] A valuation report has been undertaken by a court appointed business valuator, with the agreement of the parties, being Stephen R. Pittman, CPA, CA, CBV. Mr. Pittman provided a report to the court (the Pittman report) dated June 14, 2018 which, as noted, valued the companies as of the valuation date November 30 2017. The Pittman report valued the companies at a mid-range value of $4,348,800. This would suggest that Mr. Scullion’s 50% shareholding interest would have a market value of $2,192,400.
[5] It was hoped that the Pittman report would suffice to provide a valuation of the companies, and Mr. Scullion’s 50% shareholding interest, which the court would then use to establish the appropriate buy-out price. The parties have advised the court that they are in general agreement with the Pittman report as providing a careful and fair neutral valuation of the companies. Mr. Munro is content to accept the valuations in the Pittman report. However, Mr. Scullion wishes to raise 3 discreet issues which he contends would increase the valuation in the Pittman report and which the court should recognize in fixing the value of his interest in the companies. I will discuss these issues below.
[6] By way of background, I would note that the principals of the companies, Mr. Munro and Mr. Scullion have been in a deadlock position for at least the last 3 years. Unfortunately, there is no shareholders agreement to determine the terms of departure of either of the principals. Mr. Munro has had the operational direction of the companies, whereas Mr. Scullion was in charge of financial and administrative functions.
[7] In August of 2015, Mr. Munro excluded Mr. Scullion from the business premises and cut off his remuneration. Justice Corthorn, pursuant to an endorsement dated December 18, 2015, ordered the reinstatement of Mr. Scullion into the business. Her Honour’s reasons are reported at 2016 ONSC 116. This was intended as a temporary arrangement to allow the parties to negotiate a buy-out. In June of 2017, the Bank of Montreal, the companies’ principal secured creditor, brought a receivership application due to their concerns with the deteriorating cash flow position of the companies and the continuing deadlock between the principals. Pursuant to my order dated June 26 2017 a monitor was appointed to provide stability and bank reporting and was given the mandate of providing a report to the court within 60 days on the state of the companies’ assets and operations.
[8] Pursuant to my subsequent endorsement dated October 30, 2017, reported at 2017 ONSC 6506, I accepted the monitor’s report and, in particular, accepted “option 2” recommended in the report which was the following:
After many months of deliberation and analysis, it is our opinion this matter demands some form of equitable process that will allow the parties to financially resolve matters. That is why we believe that some sort of Court sanctioned buyout sale may very well work in favor of all parties. In our view, it will accomplish all of that which the other three (3) options cannot:
- It resolves the ongoing dispute;
- Jobs are protected as the business continues;
- Creditors are protected by the going concern of the business;
- Shareholders maximize their return whether continuing with the business or not; and
- Ongoing professional fees are mitigated.
[9] The October 30, 2017 endorsement reflects the parties’ agreement that Mr. Munro would buy-out Mr. Scullion’s shareholding in the companies. At that point Mr. Munro sought to pursue a shotgun buy-out arrangement whereas Mr. Scullion wished to be bought out at fair market value. His expressed concern was that he could be the victim of a “low bid windfall”, given that he was not, he said, in a position to buy-out Mr. Munro’s interest.
[10] As set out in the October 30, 2017 endorsement, I established a buy-out procedure. This provided for Mr. Scullion to withdraw from any continuing operational role in the company, with the companies continuing his salary and benefits, by way of severance, for a period of 24 months. The endorsement also contemplated an exchange of offers, which subsequently occurred, but no agreement was reached. This necessitated the current hearing. Relevant to this hearing are sections (e) and (f) of the endorsement which provided:
(e) In the event of disagreement this Court will schedule a hearing to fix the buyout price and associated terms for Mr. Scullion’s shares. At such hearing the court will consider any relevant evidence as to the fair market value of Mr. Scullion’s shareholding;
(f) Should a hearing be required a fair market valuation of the company shall be carried out for the Court. It shall be paid for initially by the company and carried out by Surgeson Carson Associates Inc. in as timely a way as possible. The purpose of this valuation will be to assist the Court in establishing a fair and equitable buyout price for Mr. Scullion’s shares in the companies.
ISSUE
[11] As noted, this hearing was held to determine the fair market value of Mr. Scullion’s 50% shareholding interest in the companies. Both parties agreed to accept the Pittman reports mid-range valuation as a starting point, with the specific questions before the court to be whether this valuation should be increased to account for;
(a) The bonding issue; (b) The catch basin revenues; (c) The property valuations.
Mr. Munroe was content to accept the valuations in the Pittman report, whereas Mr. Scullion sought increases in the mid-range Pittman valuation, based on these 3 aspects of the companies’ business.
ANALYSIS
[12] At the hearing in this matter the Pittman report was filed in evidence and Mr. Pittman testified in support of his analysis and conclusions. As noted, Mr. Pittman was the court appointed neutral valuation expert. Apart from providing background to support his overall valuation, Mr. Pittman was asked to specifically respond to the 3 “discrete” issues raised by Mr. Scullion. In support of Mr. Scullion’s issues, in reference to the bonding issue and the catch basin revenues issue, a report was filed by KPMG, authored by Glen Smith CPA, CA, CBV. Mr. Smith also testified in support of his analysis. Mr. Smith explained that the KPMG report was a “limited critique” of the Pittman report. In preparing his analysis, Mr. Smith explained that he relied on the Pittman report itself and conversations that he had with Mr. Scullion, but he did not speak with Mr. Munro. As Mr. Smith acknowledged at the conclusion of the KPMG report, a limited critique report is not allowed (under accepted accounting practices), to contain a valuation conclusion or indeed any conclusion of a financial nature in the context of litigation. Mr. Smith explained that he was offering the court an alternative analysis of the 2 noted issues, which the court may or may not choose to accept.
a) Bonding Issue
[13] The operating company, Munro & Scullion Contracting Inc., was unable to obtain bonding for the fiscal year 2017. This resulted from the disagreement of the 2 principals as to a specific issue in the company’s draft financial statements. Specifically Mr. Scullion, who did not testify in this hearing, was in disagreement with the advice of the company’s accountants, Collins Barrow Inc., on certain expense allocation issues. The effect of a lack of bonding (resulting from the companies’ 2017 financial statements not being available) was, among other things, that the companies could not bid on certain municipal contracts, which require bonding. The Pittman report did not adjust the revenue projections for any loss of revenue due to the lack of bonding in 2017. Mr. Pittman acknowledged that Mr. Munro had asserted that the company suffered an estimated loss of revenue of $1,000,000 because of the inability to bid on certain contracts due to a lack of bonding.
[14] Mr. Pittman explained why he did not adjust for any loss of revenue due to a lack of bonding in 2017. He considered the $1,000,000 loss of revenue to be an unsupported estimate on Mr. Munro’s part. In effect, he found that any such loss was speculative and would not represent the type of temporary non-recurring loss that would require an adjustment or normalization of ongoing revenue projections. In Mr. Munro’s testimony, he clarified that he was not suggesting that there was a net loss of company revenues of $1,000,000 arising from the bonding problem. Rather, the company sought and obtained other work to replace revenues that otherwise would have been earned from contracts the company was unable to bid.
[15] In his evidence, Mr. Smith of KPMG started from the proposition that there was $1,000,000 in lost revenue arising from the lack of bonding and lack of completed financial statements and the companies’ resultant ineligibility to bid on certain contracts. He noted that the Pittman report arrived at fair value estimates employing the capitalized cash flow approach. He said that the lost revenue due to the bonding problem, which was a temporary and non-recurring problem, should have resulted in a normalizing (increase) of income for the 2015-2017 period, so as to arrive at a fair valuation. However, Mr. Smith conceded that normally a valuator would have to perform a review of the foregone contracts themselves to determine what the lost revenues would have been, as well as ascertaining the profit to be earned on such contracts and to look at other revenues achieved by the companies to assess whether there was in fact any loss from the inability to bid on certain contracts due to a lack of bonding. He conceded that due to his inability to do so he was not able to properly calculate the impact of the bonding issue on fiscal 2017 revenues however, he postulated that approximately one half of the claimed revenue loss of $1,000,000 occurred in fiscal 2017, (being $500,000), and lost profits would be estimated at $100,000.
[16] Mr. Scullion argues based on the KPMG analysis that the under valuation of the companies due to the Pittman reports treatment of the bonding issue, was approximately $200,000. I do not accept that argument. I regard this line of argument as speculative and would prefer the opinion in the Pittman report that there is no need to adjust or normalize the companies’ earnings arising from the bonding problems. I accept Mr. Munroe’s testimony that the companies largely replaced the revenue losses by securing alternative work that did not require bonding and that he was not claiming that the company suffered an actual loss of revenues of $1.0 million dollars after factoring in the revenue from other sources. Mr. Pittman was of the opinion that there was no loss, beyond a speculative possibility, arising from the companies’ inability to obtain bonding. I accept his opinion on this issue.
b) Catch Basin Revenues
[17] Mr. Scullion argues that an amount of $204,102 should be added to the Pittman valuation to represent the appropriate treatment of cash basin revenues. Catch basin revenues are earned by the companies under a municipal Standing Order that pays fixed amounts for servicing catch basins as required and directed by the municipality from time to time. Mr. Smith’s analysis postulates that different assumptions about revenues for this type of work should be made that would affect the Pittman report’s approach to estimating the capitalized cash flow.
[18] In particular, Mr. Smith is of the view that profits from fiscal 2015 and 2016 should be normalized to reflect the expected continuation of this work going forward. Assumptions are also made by Mr. Smith about the maximization of nighttime catch basin work and the effect this could have on the companies’ valuation. The companies secured a contract from the city in February 2016 for this type of work for $2.3 million, of which $236,000 was earned in fiscal 2016 and $1.76 million in fiscal 2017. Mr. Smith’s opinion is that “for the purpose of the valuation, we believe that profits from fiscal 2017 are more reflective of future expected profits, and as a result, 2015 and 2016 should be normalized to include catch basin profits comparable to 2017.” In contrast the Pittman report utilizes the actual revenue figures ie. the 2015 and 2016 earnings from catch basin work are not adjusted (normalized) to the 2017 levels.
[19] I prefer the analysis in the Pittman report, particularly in conjunction with Mr. Munroe’s evidence. The companies are now doing catch basin work under a call-up arrangement in a Standing Offer. This is a considerably more tenuous arrangement than the 2016 contract which was not renewed. I accept Mr. Munroe’s testimony that the nighttime catch basin work is not profitable for the company and at the end of the Standing Order arrangement in two years’ time, he will not re-bid the work at the current rates, so there exists a real risk that this type of work may not continue in the longer term.
[20] I also prefer the Pittman report analysis because Mr. Pittman interviewed both Mr. Munroe and Mr. Scullion as well as the municipal purchasing officer who administers the Standing Order. In contrast Mr. Smith interviewed only Mr. Scullion (who did not testify) and does not disclose what information he received from Mr. Scullion. Finally, Mr. Smith’s written report concludes with the observation his report is a “limited critique report”, not a valuation, and that he is precluded from offering valuation conclusions. The case law supports the preposition that valuations based on “limited critique” reports should not be relied on by a court in such circumstances, see Glass v 618717 Ontario Inc., 2012 ONSC 535, at paras 247-249 (Brown J.)
c) The Property Valuations
[21] Mr. Scullion’s final point is that the real property owned by the companies should attract a higher valuation thereby increasing the companies’ valuation by approximately $51,551. The Pittman report did not undertake a property valuation and instead, (pursuant to paragraphs 2(a) and (b) of my Order dated October 30, 2017), relied on real estate appraisals prepared by Don Edey of Rivington Commercial Appraisers in April 2017, seven months prior to the valuation date of the companies. The 4100 Belgreen property, where the companies’ building is situated was valued at $2.4 million and vacant land at 4090 Belgreen Drive was appraised at $270,000. The Rivington appraisals were filed in evidence.
[22] Mr. Scullion filed property appraisals prepared by Juteau Johnson Comba Inc., dated July 11, 2018 and supported by Mr. Juteau’s oral testimony. The Juteau appraisal valued the main property (4100 Belgreen) on which the building is located at $2.87 million and the one acre parcel to the rear at $550,000.
[23] In short, Mr. Juteau values the properties about $750,000 higher than the Rivington appraisals relied on in the Pittman report and would increase the value of the business by a median figure of $290,000.
[24] Both appraisals utilized the direct comparison approach, identifying similar properties and making appropriate adjustments to facilitate the comparisons. I found both appraisals to be credible and carefully prepared. In the normal course I might have considered adopting a mid-point evaluation between these appraisals.
[25] It is to be noted that it is the companies’ valuation, (not the land values), that is the focus of this hearing. It is accepted by valuators that the value of the business is impacted by the market rent that the business would have to pay to the owner of the real estate. Essentially the higher the value of the land, the higher the rent charged to the business and the lower the value of the business. Stated otherwise, one must deduct the rental income from the operating income of the business. Mr. Comba’s report summarizes the calculation in this way:
In summary, the market value of the two properties was estimated by JJC to be $3,420,000 which is $750,000 higher than the market value estimated by Rivington. However, based on a review of the Andrews & Co valuation of the business, the higher market value estimate by JJC should result in a lower value for the business of between $440,778 and $477,719. Therefore, the net increase in market value for the real estate and the business would be $272,281 to $309,222 if based on the JJC market value estimates and the methodology used in the Andrews & Co report.
[26] The Rivington appraisal put the market rent at $10.50 per square foot and the Juteau appraisal at $9.00 per square foot. There was evidence that a parcel of vacant land consisting of one acre, at the rear of a nearby business sold in June of 2016 for $120,000. Mr. Monroe’s opinion was that he paid too much for his 1 acre parcel of land in 2013. The valuators did not factor this transaction into their comparables and it is unknown if this was an arm’s length transaction. Nevertheless this comparator suggests that the Rivington appraisal of $270,000 for this one acre parcel is high enough.
[27] Mr. Jutra candidly admitted that land valuations are a matter of opinion and are not issues of right or wrong, they are matters of judgment.
[28] A very significant difference in approach between the two appraisals related to the parcel of land being valued. The Rivington appraisal relied on by Mr. Pittman, focused on the 3 acre site at 4100 Belgreen which included the parcel on which the building was located as well as the adjacent land to the rear of the lot on which the company parks its heavy equipment.
[29] This, in my view was appropriate because this 3 acre parcel is a unified site which would obviously be sold as one parcel to a prospective purchaser of the business. In contrast the Juteau appraisal purports to value the 1.36 acres on which the building is situate, separately from the 1.63 acres of “excess land” to the rear on which the companies’ heavy equipment is parked.
[30] In my view, the Juteau approach artificially inflates the value of the Belgreen properties. An appraisal filed on behalf of Mr. Munroe by Shore-Tanner and Associates describes this arbitrary division of the property for valuation purposes as “fundamentally flawed”. The author states: “this division of land is counter-intuitive to the fundamental nature of the property whereby a user operating this or a similar business would require a large land component zoned heavy industrial, to profitably operate the business”. I accept this observation.
[31] For these reasons I prefer the Rivington appraisal of the Belgreen properties where the companies’ operations are located and I accept that the Pittman report appropriately relied on such appraisal.
d) Current Cash Flow Issues
[32] The court heard evidence, which I accept, from Mr. Munroe and from the court appointed monitor as to the acute cash flow problems being experienced by the companies. They are operating under a forbearance agreement with Bank of Montreal, they have $1.7 million in accounts payable, $1.1 million of which is over 60 days. They are maxing out their $750,000 line of credit to meet payroll and urgently need a cash infusion of $500,000 for equipment replacement to ready their operations for winter snow removal. The heavy professional fees associated with the court appointment monitor and the current litigation are eroding the value of the companies.
[33] I accept Mr. Scullion’s submission that current circumstances should not influence the valuation of his shareholding interest in the companies and indeed the Pittman report does not consider these issues. However the current circumstances do highlight the need to complete this buyout of Mr. Scullion’s interests as soon as reasonably possible. I am also cognizant of the fact that Mr. Scullion’s shareholding interest will be bought out in cash, leaving Mr. Munroe to take on the borrowing and other long term risks of operating the business.
[34] In all the circumstances I find that the valuation of Mr. Scullion’s 50% shareholding interest in the companies is $2,192,400, which is in accordance with the valuation prepared by the court appointed valuator Stephen Pittman. This amount is to be paid to Mr. Scullion in cash in accordance with an offer put forward by Mr. Munroe (contained in exhibit 2). If and to the extent this valuation exceeds Mr. Munroe’s offer I may be spoken to (in the absence of agreement), as to the terms and conditions of payment for such excess amount.
[35] I am prepared to consider the matter of costs of this 3 day valuation hearing and of the Pittman report, as contemplated by paragraph 8(g) of my endorsement dated October 30, 2017. Any such submission should be received within 30 days of the release of these reasons and either party shall be entitled to reply to any such submission with 14 days of receipt.
Mr. Justice Charles T. Hackland