Misleading financials: cheating the ATO or deceiving his buyers?

A business owner who provided potential buyers with impressive financial accounts that differed from the loss-making figures he had filed with the ATO has been ordered to refund the purchaser $2,150,000 of the buy price as a consequence of the misleading financials.

In early 2018 Bing Hu and Cindy Qiu were investigating the potential purchase of the café business at Melbourne’s Royal Children’s Hospital that was on the market for sale for $2.5 million.

They received financial statements from the seller recording annual profits of $502k in 2016 and $542k in 2017 and a projected profit of $530k for 2018.

John Zhang of seller Melbourne Café Pty Ltd was firm on his price but agreed to sell the business in April 2018 to Hu and Qiu’s company H & Q Café Pty Ltd, for $2.4 million.

Settlement occurred in November 2018 with the purchaser funding the buy with a loan from CBA bank.

In February 2019, Qiu discovered “hidden” records on a computer that had been acquired as part of the sale indicating losses of $174k and $265k for 2016 and 2017 and a projected profit for the 2018 year of around $150,000.

The “hidden” records – which had never been disclosed to the buyer – were consistent with the information provided by the Seller to be ATO.

The business traded poorly and in December 2019 when it was put up for sale through a broker, the only purchase offer received was at $250,000.

H & Q commenced proceedings in the Victorian County Court seeking a refund of the purchase price for the business, together with lost profits, trading losses and interest on the CBA loan.

It argued that had it been informed of the true financial position of the business, it would not have entered into the deal.

Zhang unsuccessfully contended that the “represented” financials depicted the correct financial position of the business and that the lodged tax returns for 2016 and 2017 were inaccurate.

He was found to have destroyed documents relevant to the business’ performance pre-acquisition and to have otherwise behaved deceitfully.

Zhang ultimately accepted in cross-examination the falsity of the information provided to the buyer.

The trial judge also took Ms Qiu to be an untruthful and unreliable witnesses. H & Q had concealed the poor trading performance from the CBA – in fear of its reaction – and supplied them with false information indicating a net profit of $175k for the period October 2018 to June 2019.

Against that background, the judge was required to assess what damage the buyer had suffered.

H&Q relied on expert evidence from CFAS chartered accountant Michael Smith who arrived at a value as at the date of sale – based on the “represented” misleading financials – of between $1.75 and $2 million. Victoria Wheeler of Munday Wilkinson – for Zhang arrived at a range between $2.28 and $2.57 million.

Smith valued the business on the “hidden” financials at the date of sale at nil. He also returned a nil value based on post- acquisition trading and an operating loss during H&Q’s tenure of $623k.

Wheeler was not asked to provide a figure based on the “hidden” financials but her value for the café business post- acquisition came in at between $92,000 and $103,500 with an operating loss over the period of $401k.

The judge was not convinced that the losses were attributable to the seller’s misleading representations.

“There seems to be a myriad of reasons why the business was not operating as successfully as it had been hoped.

Based on the same observations, she ruled there was insufficient evidence to assess true value of the business as at the date of acquisition. She therefore awarded only nominal damages for the buyer’s reliance on the misleading financials.

On appeal, the court did not disturb the judge’s conclusions as to Qiu’ lack of credibility as they were “neither glaringly improbable nor contrary to compelling inferences”.

It noted that Zhang’s evidence was “breathtakingly disingenuous”.

“One is left with the distinct impression after reading the transcript that he would say anything regardless of its veracity if he perceived that it improved his position,” the court’s judgment reads. “To the ATO in 2017 the business was a loser; to the prospective purchaser it was a winner. His evidence was in exactly that vein”.

Neither did they disturb the nil damages ruling in relation to operational losses since acquisition, holding that the trial judge was entitled to have concluded that those losses could have arisen for a “myriad of reasons”.

The position in respect of loss on the purchase of the business was though – they ruled – “considerably different”.

They had no hesitation in deciding that the true value of the business at the time that it was purchased by H & Q was either nil – based on accountant Smith’s evidence which ought to have been accepted – or $250,000 (based on the offer to purchase the business).

“Doing the best it could on the evidence adduced at trial”, the court – in adopting “a common sense approach” – the value of the business at the time of acquisition was $250,000.

The appeal judges assessed damages at $2,150,000, being the difference between that sum and the purchase price.

H & Q Cafe Pty Ltd v Melbourne Cafe Pty Ltd & Anor [2023] VSCA 200 Niall, Kennedy JJA and J Forrest AJA, 25 August 2023

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Asset lending can be unjust; compounding interest unconscionable

“Asset loans” – at very high interest rates – are particularly attractive to financially distressed borrowers who are not eligible to obtain a bank loan.

Those borrowers are often over-optimistic about their own capacity to make high repayments and the lender is rarely interested in that capacity as long as the asset they are putting up as security will cover what will have to be paid in the event of a default.

Once the lender increases the rate – in response to Reserve Bank rises – and other ordinary living costs sharply increase, borrowers can find themselves in an inescapable trap.

In August 2018, Thuc Tran Huynh and Chau Quach borrowed $140,000 from a private lender on second mortgage security over a house in Fairfield.

The loan – which was to finish construction of their own home, also in Fairfield – was subject to interest at 4% per month, compounding monthly and escalating to 6% per month in the event of default.

Unsurprisingly, the borrowers did not repay the principal on the due date in November 2018.

Demands were issued but the mortgage was not registered until September 2019 and recovery proceedings were not filed until September 2022.

Those proceedings claimed an amount which by September 2023 had escalated to almost $1.4 million of which $1.119 million was interest.

In their defence, the borrowers claimed the transaction terms were absent from the documents they signed; that the interest at the higher rate of 6% per month was a penalty and unenforceable; and that the delay in enforcing the mortgage was itself unconscionable given interest was still compounding at 72% p.a.

They also counterclaimed to the effect that the lender’s conduct was unconscionable pursuant to ACL s 21 on the basis that what was said to be an “Asset Lend”, was unfairly designed to increase the borrowers’ debt.

Justice David Davies  sitting in the NSW Supreme Court rejected the contentions that a high rate of interest of itself made the transaction unconscionable or that asset lending per se, fall into that category.

“The system of asset-based lending could have been attractive to financially distressed borrowers who were not eligible to obtain a loan in the ordinary way,” he observed.

Such loans, he noted are likely to be “paid off by sale or, far more likely, refinancing”. And if interest is paid upfront, “an enquiry about whether the borrower had sufficient income to service the loan would be pointless”.

He observed though that asset lending may have features that were unjust.

High rates in combination with monthly compounding was a feature that in this case – he concluded – supported a finding of unconscionability, that left it open to the court to grant relief.

The court altered the terms to prevent monthly compounding but allowed the lender to recover the principal plus simple interest at 6% per month, ie 72% per annum for 5 years, $504,000. This was some $600,000 less them the interest the lender claimed but still a whopping amount in comparison to the sum borrowed.

The judge dismissed the argument that the interest rate particulars were missing from the mortgage documents at the time they were signed by the borrowers and the submission that the delay in instituting the recovery proceedings – thereby allowing the lender to continue to charge interest at 6% per month – was unconscionable.

Ledinh Sovereign Super Pty Ltd v CT Stone Pty Ltd [2023] NSWSC 1079 Davies J, 15 September 2023 Read Case

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Encroachment of neighbours garage: court orders land transfer

Agnieszka and Pawel Wardanski’s home at 10 Cynthia Crescent, Springwood that they acquired in 2003, adjoined that of Karen Mawby and Scott Marks who acquired their residence in 2014.

Neither conducted a survey to confirm the boundary line between the properties or that the boundary fence – constructed decades earlier – was in the correct position.

For several years, they lived happily next door to each other, each in the mistaken belief that the fence sat precisely on the boundary.

When Mawby/Marks began renovations on their property in July 2017 it was discovered in the course of a survey that the Wardanski property extended beyond the fence line and includes part of the land former believed was theirs.

They kept the matter to themselves for about 12 months until they met with their neighbours to seek consent for boundary works  purportedly at the request of their builder.

What they proposed was an easement that would have allowed the encroaching structures to remain but withheld the survey plan from the Wardanskis so as not to reveal the extent of the problem.

Realising what was afoot, Wardanski demanded the removal of the encroaching structures – a retaining wall, garden shed, gardens and part of a garage – and for the area of land of about 9 m2 extending along the entire 30m common boundary to be surrendered.

Mawby/Marks on the other hand – because of the huge costs they would incur in removing the encroachment – proposed a boundary realignment, which would allow them to acquire that part of the Wardanski land on which the encroachments stood so that those structures – and further improvements that continued to conduct – could be retained.

Project manager Beverly Hollands estimated the removal cost on their behalf, at $221,013, plus GST.

Wardanski then set about designing improvements – a garage – to take advantage of their newly-discovered land holding. They requested builder Kent Jenner identify the costs of that renovation as well as the estimated costs their neighbours would incur to remove the encroachment.

In August 2019 with no agreement in sight, Wardanski’s lawyers demanded the neighbours ‘cease and desist’ carrying out any repairs and refurbishments to the encroaching structures.

When that was largely ignored, they applied to Queensland’s Supreme Court for an order pursuant to s 185(1)(c) of the Property Law Act for the encroachments to be removed and in the alternative $185,000 for the costs of modifications to the design and construction of their garage and other losses.

It was not in dispute that Mawby/Marks were liable for the encroachment notwithstanding it had been “inherited”.

They contented that Wardanski never held any intentions to build a garage or deck extension and that it was simply a ‘device’ to justify removal of the encroachment.

While rejecting that submission, Justice Lincoln Crowley was of the view that the plaintiffs’ insistence on the removal of the encroachment so they could build their proposed garage and their unwillingness to consider potential alternative solutions that did not involve demolishing or moving the neighbour’s garage, to have been unreasonable.

He accepted the evidence of civil engineer and project manager Bradley Schaper that it is feasible for the Plaintiffs to construct an adequately sized, enclosed double car garage on their property – albeit absent the storage they desired – without removal of the neighbour’s garage.

While their rejection of the neighbour’s settlement offers was a continuation of their unreasonable conduct, the judge noted the matter was not to be determined, “by deciding whose conduct has been the most virtuous”.

“Whilst I am mindful that the Plaintiffs are the owners of the land and that their property rights ought not be lightly interfered with,” he ruled “it is abundantly clear in this case that the prejudice that to the Defendants – as ‘largely innocent encroachers’ – by an order for removal of the encroachment outweighs the prejudice that to the Plaintiffs if no such order were made”.

He ordered that Mawby/Marks pay Wardinski $16,087.50, being three times the unimproved capital value of the land burdened by the encroachment which was to be transferred to them and $5,000, for the resulting diminution in the value of their property.

There was also a retaining wall that a builder had constructed negligently on part of the Wardinski land. The court considered that to be de minimus, ie so trivial that it was of no concern.

Wardinski requested in relation to any land transfer, that it be of the total 19m2 piece of land, being the area between the existing fence and the true boundary.

Justice Crowley rejected that submission holding that the Court’s power under s 185(1)(b) is limited to ordering the transfer of the land over which an encroachment extends.

Wardanski & Anor v Mawby & Anor [2023] QSC 136 Crowley J 18 August 2023

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Gold coast unit owner battles for long standing exclusive use

Can the owner of a community title lot – in the absence of a formal exclusive use resolution – justify improvements constructed on adjacent common property by demonstrating they were sufficiently authorised as part of the original scheme?

“Malibu” is an iconic community titles scheme in Aquila Court, Mermaid Waters on the Gold Coast established by way of a group titles plan in 1978.

It is comprised by eight adjoining two-storey townhouses that each back onto a spectacular canal outlook.

Over the years various lot owners made improvements in the form of decks and extensions that encroach onto common property.

In mid-2018 Nicholas Hronis – who acquired his lot one year earlier – installed a security gate and an enclosed sundeck that were later ordered to be removed because of such an encroachment.

After removing his additions as per the order, he retaliated  by complaining about those made by most other owners and in particular those of his immediate neighbours Stuart Tume and Talia Marques, the owners of lot 8.

He argued that their rear deck backed onto the common property and their upper deck encroached into common property airspace.

Moreover, the railings and balustrades associated with those structures essentially cut of all of the common property at the rear such that it was ‘exclusively occupied’ by lot 8.

On Hronis’s application, the couple were ordered in June 2021 – at the height of Covid restrictions when they were stuck in New Zealand – by a Body Corporate and Community Management adjudicator to remove the patio and upper deck and to reinstate the affected rear common area lawn.

They appealed the adjudicator’s decision pursuant to s 289 of the BCCM Act to the QCAT appeals tribunal.

They argued that they had been denied the opportunity to provide additional material to the adjudicator for his consideration by reason of the delay they had encountered in receiving it due to the COVID lockdown.

The lot 8 owners argued before Senior Member Graham Traves that the patio and upper deck were built by the original owner in about 1980 as “original components of the scheme” in accordance with the original group titles plan, architects’ drawings and a 1999 general meeting approval for the construction of the sundeck.

Ms Marques also appeared in QCATA on behalf of the Body Corporate in her capacity as chairperson and presented minutes of its March 2023 AGM as submissions.

Member Traves concluded that in the absence of evidence to the contrary, the adjudicator was entitled to find that the encroachments must have been made after the original construction and were not protected by any approval granted on inception of the scheme.

He declined to allow the introduction of the plans etc as “fresh evidence” but agreed Tume and Marques had been denied procedural fairness by reason of the adjudicator’s “failure to circulate evidence to the parties that he had gathered and submissions he had received.

Observing that QCATA is strictly required to determine the appeal on the material that was before the adjudicator, he observed it could – pursuant to s 294 of the BCCM Act – also “exercise all the jurisdiction and powers of an adjudicator under the BCCM Act” and has power under QCAT Act s 146 to set aside an adjudicator’s decision and require it to be reconsidered.

With that in mind he resolved that the denial of procedural fairness constituted an error of law warranting the June 2021 decision to be set aside and the remitting of the dispute for re-consideration.

Given the critical records were not accessible to the lot 8 owners at the time of the BCCM adjudication despite their reasonable effort to obtain them, he directed a re-hearing of the dispute.

Member Traves also rules the adjudicator was required to consider the additional and “apparently credible” evidence that Mr Tume and Ms Marques had produced that they believe will save their patio and deck from destruction.

Hronis v Body Corporate for Malibu CTS 22174 & Anor [2023] QCATA 101, Senior Member Traves

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