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.