IN THE SUPREME COURT OF BRITISH COLUMBIA
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Citation: |
Asian Concepts Franchising Corporation (Re), |
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2017 BCSC 1452 |
Date: 20170817
Docket: B131424
Registry: Vancouver
In Bankruptcy and Insolvency
In the Matter of the Proposal of
Asian Concepts Franchising Corporation
Before:
Master Muir
(as Registrar)
Reasons for Decision
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Counsel for the applicant, Grant Thornton Limited, Trustee in the Proposal of Asian Concepts Franchising Corporation: |
K.A. Robertson |
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Counsel for a creditor, Adrenaline Drive Inc.: |
J.H.H. Hockin, Q.C.
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Counsel for Asian Concepts Franchising Corporation: |
G.G. Plottel
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Place and Dates of Hearing: |
Vancouver, B.C. July 25–26, 2017 |
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Place and Date of Judgment: |
Vancouver, B.C. August 17, 2017 |
[1] There are two applications before me, the first is that of a creditor, Adrenaline Drive Inc. (“Adrenaline”), and the second is that of the debtor, Asian Concepts Franchising Corporation (“Asian Concepts”).
[2] Both applications are appeals from the Trustee’s Notice of Valuation of the Adrenaline claim dated January 15, 2015, pursuant to s. 135(4) of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 as amended [BIA].
[3] Asian Concepts was the franchisor of the Wok Box Fresh Asian Kitchen franchise. It had the right to develop Wok Box restaurants under licence from the trademark holder, 0839297 B.C. Ltd. (the “Trademark Holder”).
[4] Adrenaline entered into a master development agreement with Asian Concepts dated September 9, 2008 (the “MDA”), which appointed Adrenaline a master developer to assist in the development and operation of franchised Wok Box restaurants within Alberta, Saskatchewan, and Manitoba.
[5] Adrenaline has brought an action in the Court of Queen’s Bench of Alberta in Edmonton against, amongst others, Asian Concepts, WB Franchising Limited (“WB Franchising”), the Trademark Holder, and Brandman Holdings Ltd. (the “Alberta Action”).
[6] In that action, Adrenaline alleges that the defendants conspired, amongst other things, to deprive it of the benefit of the MDA for which it had paid Asian Concepts $600,000 and which generated approximately $35,000 per month in gross revenue.
[7] As background to that claim, Adrenaline alleges that, in 2011, Asian Concepts was a defendant in certain actions or otherwise faced claims totalling in excess of $1.7 million. To deal with this potential liability, it is alleged that Scott Bender, a directing mind of Asian Concepts, WB Franchising, and the Trademark Holder, developed a plan, the first step of which was terminating the master development agreements, including Adrenaline’s, and having that income stream revert to Asian Concepts.
[8] Adrenaline alleges that the second step in Mr. Bender’s plan was to transfer the trademarks, the franchise agreements, and the other assets required to operate the Wok Box franchise to WB Franchising.
[9] As a result, it is said that on November 1, 2011, Asian Concepts was given notice that its licence to the trademarks was terminated effective May 31, 2012.
[10] On November 14, 2011, Adrenaline was notified by Asian Concepts that it considered Adrenaline to be in breach of its MDA. The MDA was subsequently terminated by Asian Concepts on February 27, 2012.
[11] On May 18, 2012, Asian Concepts was found liable to a former shareholder in one of the actions that is alleged to have precipitated Mr. Bender’s plans. Asian Concepts was valued by the court at $2.4 million and the plaintiff was granted judgment of $624,000.
[12] Two days later, Asian Concepts and WB Franchising notified all franchisees in Adrenaline’s former territory that the franchises had been assigned to WB Franchising.
[13] It is alleged that although WB Franchising paid a small amount for the tangible assets, it paid nothing for the transfer of the franchise agreements or the intellectual property.
[14] On November 20, 2013, Asian Concepts filed a notice of intention to make a proposal pursuant to Division 1 of Part III of the BIA (the “Proposal”).
[15] The Proposal provides that WB Franchising and the Trademark Holder will put up a pool of money of not less than $325,000 to fund the payments set out in the Proposal and to pay the expenses of the Trustee. In return, the unsecured creditors, including Adrenaline, would accept payment under the Proposal in full satisfaction of their claims against Asian Concepts, WB Franchising, and the Trademark Holder.
[16] Thus, acceptance of the Proposal would defeat Adrenaline’s claims against WB Franchising and the Trademark Holder in the Alberta Action.
[17] The potential loss of the Alberta Action is a force behind Adrenaline’s appeal of the Trustee’s valuation.
[18] Adrenaline filed its proof of claim with the Trustee on January 10, 2014 and an amended proof of claim on February 25, 2014 in the amount of $8,166,774.82.
[19] The Trustee disallowed the claim but for $65,720.25. That determination has been appealed. The appeal came on but was adjourned generally by my order of October 7, 2014 to allow the Trustee to further evaluate the quantum of Adrenaline’s claim based on a more expansive definition of what constituted, or should have constituted, the record before the Trustee.
[20] At a provisional vote taken on the Proposal in March 2014, claims totalling $3,090,011.40 were voted in favour of the Proposal. Adrenaline voted against the Proposal.
[21] By my order of December 16, 2014, the Trustee was granted leave to value the Adrenaline claim for voting purposes only, without determining liability. The Trustee valued the Adrenaline claim at $754,720.25 on January 15, 2015 (the “Valuation”).
[22] The Valuation is broken down as follows:
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Liquidated claim: |
$65,720.25 |
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Unliquidated claim: |
$689,000.00 |
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Total claim for voting purposes: |
$754,720.25 |
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[23] Proposals have to be approved by 50% of creditors having two-thirds of the debt, thus, Adrenaline cannot affect the outcome of the vote on the Proposal unless either its claims are valued significantly higher or other creditors’ claims are valued lower or a combination of the two.
[24] There is no dispute as to the law applicable. All counsel referred to the decision in Galaxy Sports Inc. (Re), 2004 BCCA 284. In that decision the court discussed the nature of an appeal under s. 135(4) of the BIA as follows:
[39] On a consideration of all the “contextual” factors mandated by the “pragmatic and functional” approach, I see no reason to disagree with the long-standing principle enunciated in Re McCoubrey, [(1924), 5 C.B.R. 248 (Alta. S.C.)], which requires the application of a “correctness” standard where compliance with a "mandatory" provision (which I would equate to a question of law or statutory compliance) is involved, and the application of a “reasonableness” standard where the determination of a factual matter or an exercise of true discretion is called for. In the former category, I would place the chair’s decision under s. 108 rejecting a proof of claim for voting purposes and the trustee’s decision disallowing a proof of claim under ss. 124 and 135(2). In the latter category, I would place the trustee’s role in valuing contingent and unliquidated claims under s. 135(1.1). This general approach conforms with the objective, which I see as implicit in the BIA, of enabling debtors to have their proposals voted upon expeditiously and permitting creditors to have their rights and claims determined in a business-like manner, while at the same time providing a meaningful appeal to a court of law on questions that clearly affect legal rights, engage the relative expertise of judges, and set precedents for other cases.
[40] I am also of the view that the Supreme Court’s hearing of an appeal under s. 135(4) of the BIA is not intended to be a trial de novo but a true appeal. …
…
[43] … Obviously, valuation is a matter of discretion in the sense that the Trustee could bring many factors, unspecified in the BIA, to bear on it, and in the sense that there is no one “correct” answer. (See S. Waddams, “Judicial Discretion”, (2001) 1 Cwth. L.J. 59.) Obviously, such a determination would call upon the Trustee’s expertise in commercial insolvency matters. For these reasons and the reasons given above at paras. 27–39, the Trustee’s decision in this regard would normally be scrutinized on a “reasonableness” standard.
[25] In addition, the Trustee relied on the decision in Johnson v. Erdman, 2006 SKQB 280 at paras. 28–31:
[28] The Supreme Court of Canada in Law Society of New Brunswick v. Ryan, [2003] 1 S.C.R. 247 and Dr. Q. v. College of Physicians and Surgeons of British Columbia, [2003] 1 S.C.R. 226 elaborated on the application of the reasonableness standard.
[29] Deference is a definite factor to be considered. In Ryan, Iacobucci, J. at paras. 46 and 51 summarized deference in the context of judicial review and the reasonable standard:
Judicial review of administrative action on a standard of reasonableness involves deferential self-discipline. A court will often be forced to accept that a decision is reasonable even if it is unlikely that the court would have reasoned or decided as the tribunal did. …
[C]ourts testing for unreasonableness must avoid asking the question of whether the decision is correct. Unlike a review for correctness, there will often be no single right answer to the questions that are under review against the standard of reasonableness.
[30] At para. 47 Iacobucci, J. formulates the legal question that a reviewing court must ask when applying the reasonableness standard:
The context of a standard of review is essentially the question that a court must ask when reviewing an administrative decision. The standard of reasonableness basically involves asking “After a somewhat probing examination, can the reasons given, when taken as a whole, support the decision?”
[31] And at para. 55, Iacobucci, J. states:
A decision will be unreasonable only if there is no line of analysis within the given reasons that could reasonably lead the tribunal from the evidence before it to the conclusion at which it arrived. If any of the reasons that are sufficient to support the conclusion are tenable in the sense that they can stand up to a somewhat probing examination, then the decision will not be unreasonable and a reviewing court must not interfere. …
[26] The Trustee also referenced Transglobal Communications Group Inc., 2009 ABQB 195. In that decision, the court notes at para. 73:
[73] On an appeal based on the standard of reasonableness, the court recognizes that certain questions may give rise to a number of possible, reasonable conclusions. As indicated the Dunsmuir [v. New Brunswick, 2008 SCC 9] court at para. 47, “reasonableness is concerned mostly with the existence of justification, transparency and intelligibility within the decision‑making process. But it is also concerned with whether the decision falls within a range of possible, acceptable outcomes which are defensible in respect of the facts and law.”
[27] The Trustee’s approach to valuing the unliquidated claim was, in concept, relatively simple.
[28] To estimate a likely level of earnings subsequent to 2012, the Trustee normalized the earnings for fiscal years 2009 through 2012.
[29] The 2009 and 2012 earnings had to be annualized, as they were both partial years of operation.
[30] The Trustee determined that fiscal year 2012 was the least affected by other complicating factors and decided to use it as a base year from which to form projections.
[31] The Trustee was of the view that this was a conservative approach and in the Notice of Valuation, stated:
In our view, these are conservative assumptions. In respect of Recurring Revenue, average same store revenue declined in nominal terms by over 4% annually between 2008 and 2013 or by over 20% in absolute terms (the decline in real terms was even larger). The trend in 2012 was a decline of nine percent versus 2011. Similarly, we would expect overhead costs to increase with inflation over time. Finally, we have assumed a net increase of one store per year with associated Franchise Fees, whereas we understand there is some evidence the market for franchises was saturated.
[32] The Trustee then applied a discount rate:
We have discounted the normalized cash flows, initially, at a rate of 22.5%. This discount rate is a relatively standard equity rate of return for a small business in Western Canada (i.e., a typical rate of return that would be required by investors in a business like this - rates of between 20% and 33% are not atypical).
The discount rate applied to a set of future cash flows should reflect the risk inherent in those cash flows relative to other investments, as an investor would require an appropriate return for assuming those risks as opposed to making some other investment.
We have increased the discount rate at renewal points by 5% to reflect the additional risk of renewal, (or the fact there is some doubt about whether renewal would occur). We have also assumed a renewal charge of $25,000.
[33] Adrenaline does not take issue with the valuation of the liquidated claim.
[34] Adrenaline’s position regarding the unliquidated claim was founded on several opinions provided by Randy Popik. Mr. Popik is, amongst other professional designations, a Chartered Accountant and a Certified Business Valuator. He has extensive qualifications in business valuation, litigation support, and forensic accounting.
[35] Two opinions by Mr. Popik, dated November 6, 2014 and November 19, 2014 were provided to the Trustee in advance of the Valuation.
[36] After the Valuation was issued, Adrenaline provided an opinion dated April 8, 2015, marked “Draft”, which was a critique of the Trustee’s valuation of the liquidated claim.
[37] In that critique, Mr. Popik identified what he called errors in mathematics or application of methodology, which are, firstly, computational errors and, secondly, errors said to have been made in the application of discounts.
[38] In addition, Mr. Popik provided what were referred to as comments on matters of professional judgment.
[39] The latter comments were directed at the Trustee’s selection of the initial discount rate of 22.5% on the predicted future cash flows to account for contingencies or the inherent risks of the business. Mr. Popik was also critical of the Trustee’s use of the additional premium to that discount rate of 5% for each of the two predicted renewals to account for the risk that such renewals might not occur.
[40] In the course of subsequent negotiations to attempt to come to agreement on the valuation of Adrenaline’s claim, the Trustee considered the April 8, 2015 opinion and concluded that it had made certain errors in calculation but did not agree that there were errors in applying the discount rate or that the discount rate or the additional discount on renewal were unreasonable.
[41] Negotiations could not resolve the impasse and directions were sought for the hearing of this appeal. One of the directions sought was that the report of Mr. Popik be finalized. That was ordered and the final report was produced dated June 30, 2017 (the “Final Popik Report”).
[42] The Trustee was able to review the Final Popik Report and provide its comments in the affidavit of Michelle Madrigga, Vice President of the Trustee, sworn July 20, 2017.
[43] Asian Concepts asserts that the Valuation is too high.
[44] Asian Concepts took the position that the Trustee had not given full effect to contingencies and had made errors of law.
[45] In particular, Asian Concepts was of the view that the MDA did not give Adrenaline an automatic right to renew, but was so uncertain regarding renewal as to amount to only an agreement to agree. Further, even if Adrenaline did have a right to renew, it had to do so in accordance with the “then current form of Master Development Agreement”. Thus, Asian Concepts argues that it should have been presumed that no renewal would have occurred or a more significant discount for the risk of non-renewal should have been used.
[46] In addition, Asian Concepts argues that the MDA was frustrated due to the termination of the licence agreement for the franchise in June of 2012. Thus, it would argue that there were no losses after 2012.
[47] In the alternative, Asian Concepts says that the Valuation was within reasonable bounds and should not be varied. In submissions it noted:
… the real issue in assessing the reasonableness of the Valuation is whether the Proposal Trustee took into account the various evidence and factors each side submitted in the court-mandated process. It appears that the Proposal Trustee did so.
[48] As to the discount rates applied by the Trustee, Asian Concepts points out that in an Alberta action by the shareholders of Asian Concepts, 1115038 Alberta Ltd. v 1163256 Alberta Ltd., 2012 ABQB 334 (the “Shareholder Action”), an expert provided a valuation of Asian Concepts and, in doing so, used discount rates of between 19–21%. Although those were argued to be too low, they were accepted by the trial judge in that action.
[49] At the outset of the hearing of these appeals, counsel for Asian Concepts and for the Trustee took issue with admitting the Final Popik Report as an expert report.
[50] Those counsel had previously requested and received, with some redactions, Mr. Popik’s file, and considerable portions of that were in evidence before me.
[51] Counsel for the Trustee and Asian Concepts agreed that the Final Popik Report was part of the record the Trustee reviewed and responded to, but submitted that it was more equivalent to argument than an expert report.
[52] Various arguments were advanced, including:
a) the certification of the Final Popik Report as required by the B.C. Supreme Court Civil Rules was lacking;
b) the Final Popik Report was provided for the assistance of counsel for Adrenaline, not for the court;
c) the Final Popik Report fails to define clearly what was relied upon, including referring to discussions with the management of Adrenaline;
d) the relationship of Adrenaline as Mr. Popik’s client for these purposes undermined the required impartiality; and
e) Mr. Popik took instructions from counsel for Adrenaline and that violated the requirement that he not be an advocate.
[53] Mr. Popik’s curriculum vitae is appended to his Final Popik Report . He is clearly an expert in accounting and valuation matters and his credentials to advance the opinions contained in his Final Popik Report are not questioned.
[54] Evidence of expert opinions in civil proceedings requires notice in the form of a report produced in accordance with the requirements of Rule 11-2 of the B.C. Supreme Court Civil Rules regarding certification by the expert, and Rule 11-6 regarding what must be included in any such report.
[55] The application of Part 11 of the Supreme Court Civil Rules is limited by Rule 11-1 and, in particular, the rules regarding expert reports do not apply to summary trials under Rule 9-7, except as provided in that rule, which, in turn, provides that a court may order that a report that does not conform to Rule 11-6(1) is admissible.
[56] Counsel for Adrenaline argued that this hearing was a summary proceeding in accordance with the provisions of the BIA and, as such, more closely resembled a summary trial. Adrenaline’s position is, first, that the Final Popik Report is in compliance with the Supreme Court Civil Rules and, second, that the Final Popik Report should be admitted even if there are any formal defects and that they should be considered in the weight given to the opinions.
[57] In an earlier decision in this matter, Re Asian Concepts Franchising Corporation, 2016 BCSC 1581, I considered the applicability of the Rules to BIA proceedings and noted:
[25] A registrar has certain powers and jurisdiction provided for in the BIA, and the parties rely, in part, on s. 192(1)(k):
192 (1) The registrars of the courts have power and jurisdiction, without limiting the powers otherwise conferred by this Act or the General Rules,
…
(k) to hear and determine any matter relating to practice and procedure in the courts;
[26] Pursuant to Rule 3 of the Bankruptcy and Insolvency General Rules, C.R.C., c. 368 (“Bankruptcy Rules”):
3. In cases not provided for in the Act or these Rules, the courts shall apply, within their respective jurisdictions, their ordinary procedure to the extent that that procedure is not inconsistent with the Act or these Rules.
[58] Given the summary nature of these proceedings, I consider that I would have jurisdiction to admit the Final Popik Report even if it did not comply with the requirements of the Supreme Court Civil Rules.
[59] Although the Final Popik Report does acknowledge that it was prepared in accordance with the duty of an expert under the Supreme Court Civil Rules, it does not contain the certification required by the Supreme Court Civil Rules. Mr. Popik did, however, provide that certification in a second document dated July 19, 2017, less than three weeks following the production of the Final Popik Report.
[60] In my view, to refuse the Final Popik Report due to this discrepancy would be a triumph of form over substance.
[61] There is not sufficient evidence of bias in the Final Popik Report or file materials to convince me that there was bias sufficient to totally undermine the opinions advanced by Mr. Popik. Thus, the balance of the objections properly go to weight, not admissibility. The Final Popik Report is, therefore, admissible.
[62] I note that no one has taken the position that as this is a true appeal, I should not have reference to any of Mr. Popik’s opinions unless they were before the Trustee prior to the Valuation. I have considered that question, however, and conclude that as no factual evidence is being presented that was not considered by the Trustee it is appropriate to consider Mr. Popik’s critique of the Valuation.
[63] The Trustee’s position is that, as the valuation of the unliquidated amount is within a range of reasonable values, the Valuation should stand, despite the admitted errors in calculation. The Trustee argues that the standard of review is not correctness.
[64] Adrenaline’s position is that, given the Trustee has admitted that there were significant calculation errors in the valuation of the unliquidated amount, the Valuation is inherently unreasonable and should be set aside.
[65] Adrenaline does not take issue with the basis for the Trustee’s analysis, other than with respect to the discount rate. It is not the approach of the Trustee that is in issue. The question is, where a Trustee proceeds to a valuation based on a certain approach but makes admitted errors in its application, is the result still reasonable if the value attributed is within a range that it could have come to using another approach?
[66] Specifically, the Trustee argues that it could have acceded to the arguments of Asian Concepts and proceeded on the basis that the MDA would not have been renewed. In that case, correcting for the admitted errors, the valuation would have been less than the present Valuation, which was based on two renewals of the MDA.
[67] The Trustee could not provide me with authority in support of its proposition that, where a Trustee embarks on a valuation based on a certain set of assumptions but gets the calculation wrong, the valuation is nonetheless reasonable as it was within a range that could have been calculated using different assumptions.
[68] In other words, relying on Transglobal Communications at para. 73, the Trustee argues the Valuation:
… falls within a range of possible, acceptable outcomes which are defensible in respect of the facts and law.
[69] The Trustee considered it reasonable to proceed on the basis that the MDA would be renewed twice with the earnings further discounted at each renewal date to account for the risk of non-renewal.
[70] If I am to give deference to the Trustee’s decision in that regard, it seems contradictory to then say, that because of the errors in calculation, I should conclude that the valuation would still be reasonable because it is greater than the value if one corrects for the admitted errors but assumes that there are no renewals of the MDA.
[71] I accept that deference should be given to the Trustee’s decision on the methodology for the valuation, provided it is reasonable. There is, however, nothing in the rationale for deference to the decision of the Trustee that requires me to turn a blind-eye to admitted calculation errors.
[72] In addition, in my view a valuation that is based on incorrect calculations cannot be said to be defensible in respect of the facts, as referred to above from Transglobal Communications.
[73] That, however, does not mandate the conclusion that the entire Valuation should be set aside and replaced with my determinations of value.
[74] It does require a more in-depth view of the alleged calculation errors contained in the Final Popik Report as there is some dispute as to their effect.
[75] The Trustee admits that it erred in prorating 2012 for a two-month period instead of a ten-month period.
[76] Mr. Popik calculates that correcting that error results in a $79,000 increase in the calculation of prorated 2012 earnings from $19,000 to $98,000.
[77] The Trustee, in its recalculation, concludes that correcting the error results in prorated 2012 earnings of $82,667 per its revised Schedule 3.
[78] The sole difference appears to be that in its recalculation, the Trustee has revisited its earlier methodology and disallowed two items of revenue in Adrenaline’s 2012 general ledger which were alleged to be recorded sales for which no invoices were provided. The two disallowed items were amounts of $12,857.14 and $4,761.90 (the “Disallowed Revenue”).
[79] Adrenaline submits that the Trustee has no right to revisit these amounts at this stage of the proceeding. All parties have proceeded in their analyses to date on the basis of reported fiscal year 2012 income of $349,043.
[80] Adrenaline was not given the opportunity, prior to the completion of the record on which the Trustee was to base its valuation, to address these alleged deficiencies. There was no request from the Trustee with respect to the Disallowed Revenue, despite a process order requiring the Trustee to request further information by a certain date.
[81] Given that the Trustee was content to value the Adrenaline claim relying on the general ledger in support of this revenue, it appears to me to be unjust to allow that to be revisited at this juncture.
[82] Thus, I conclude that the correction of this error properly results in prorated 2012 earnings of $98,000.
[83] The Trustee concedes that the annualization of revenues for 2012 should have been for nine months instead of the ten months used by the Trustee.
[84] Using the same adjustments as the Trustee, but for the Disallowed Revenue, Mr. Popik concludes that the correct normalized earnings before taxes for fiscal 2012 would be $148,000.
[85] The Trustee’s calculation of the impact of this error results in normalized earnings before taxes for fiscal year 2012 of $124,000, but, as noted above, this is based on removing the Disallowed Revenue from the calculation.
[86] I, therefore, accept that the correction of this error results in normalized earnings before taxes for fiscal 2012 of $148,000.
[87] The incremental impact of this is to increase the past loss calculated by the Trustee by $88,000 and the future loss by $117,000, for a total of $205,000.
[88] The Trustee concedes the error and says it results in an increase of $1,000 to the figures used by it.
[89] Applying the corrected calculation to the increased amounts set out above, however, results in a $3,000 increase to the loss calculated.
[90] The Trustee used an end-of-year discounting convention in the Valuation. The Trustee concedes that a mid-year valuation is more appropriate. This results in an increase in the unliquidated damages calculation of $61,000.
[91] Adrenaline was required to pay $25,000 to Asian Concepts for each renewal of the MDA. Accounting for the value of money over time, the cost of renewals expressed in real dollars should have been $23,100 and $18,900 for the first and second renewals respectively.
[92] This is accepted by the Trustee and results in an increase to the liquidated damages calculation of $1,000.
[93] As a result of the calculation errors dealt with above, the unliquidated amounts increase as follows:
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a) 2012 Proration: |
$98,000 |
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b) 2012 Annualization: |
$205,000 |
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c) Prejudgment Interest: |
$3,000 |
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d) Mid-Year Discounting: |
$61,000 |
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e) Payment on Renewal: |
$1,000 |
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Total: |
$368,000 |
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[94] There were a number of issues raised by Mr. Popik regarding the Trustee’s selection and application of discounts in calculating the Valuation.
[95] As noted above, the Trustee applied an initial discount rate of 22.5% to future loss to account for contingencies and added an increment of 5% on each of the two renewals of the MDA to account for the risk that the MDA might not be renewed.
[96] Adrenaline takes the position that this is inappropriate and the Trustee should have used only the discount rate of 2% mandated by s. 56 of the Law and Equity Act, R.S.B.C. 1996, c. 253:
“discount rate” means the rate, expressed as a percentage, used in calculating the present value of future damages;
“future damages” means damages to compensate for pecuniary losses to be incurred, or expenditures to be made, after the date of the trial judgment in a proceeding.
(2) The Chief Justice of the Supreme Court may make regulations prescribing
(a) a discount rate that is deemed to be the future difference between the investment rate of interest and the rate of increase of earnings due to inflation and general increases in productivity, and
(b) a discount rate that is deemed to be the future difference between the investment rate of interest and the rate of general price inflation.
(3) In a proceeding, the discount rate prescribed under subsection (2) (a) must be used in calculating the present value of future damages that are intended to compensate for or are determined with reference to
(a) loss of future earnings because of partial or total loss of income earning capacity, or
(b) loss of dependency under the Family Compensation Act.
(4) The discount rate prescribed under subsection (2) (b) must be used in calculating the present value of all future damages other than those referred to in subsection (3).
[97] The present discount rate is set by the Chief Justice in Law and Equity Regulation, B.C. Reg. 352/81 as follows:
1 Pursuant to section 56 of the Law and Equity Act, I hereby prescribe:
(a) a discount rate of 1.5% per annum compound which shall be deemed to be the future difference between the investment rate of interest and the rate of increase of earnings due to inflation and general increases in productivity, and
(b) a discount rate of 2% per annum compound which shall be deemed to be the future difference between the investment rate of interest and the rate of general price inflation.
[98] This discount rate, however, is only to present value future loss. It has no component for contingencies or risk.
[99] Counsel for Adrenaline argued that there should have been no discounting for risk, as:
… Adrenaline’s return during this period was to accrue in a risk free context such that Adrenaline’s future loss over the remaining term of the MDA ought to be more intelligibly discounted upon a risk free rate return net of inflation.
[100] Further, Adrenaline submits that the Trustee was unreasonable in embarking on a business valuation of Adrenaline rather than a quantification of damages. Mr. Popik says this:
However, we assert that the Trustee Valuation is not a business valuation, but rather a quantification of damages. A quantification of damages is the present value of a specific stream of cash flows related to a particular event, in this case, the purported breach of contract. Any discussion of risk should be specific to the contract rather that the required rate of return on equity. We assert that the objective is to determine the present value of the loss of the contract rather than the fair market value of the equity of Adrenaline.
[101] In the Final Popik Report, Mr. Popik notes that a change from the discount rate used by the Trustee to the 2% rate in the Law and Equity Act would result in an increase in the unliquidated damages of Adrenaline of $842,000, without change to the 5% increase upon renewal.
[102] Mr. Popik does not opine that it is inappropriate to consider contingencies or risk in a valuation. In fact, his letter of November 19, 2014, which was a response to the submission of Asian Concepts to the Trustee, deals specifically with contingencies in para. iii. There Mr. Popik notes that he accounted for contingencies for business exits and shareholder mortality in his November 6, 2014 valuation report.
[103] Allowance for contingencies can undoubtedly be dealt with in various ways. As noted above, a discount rate of between 19–21% was used in the Shareholder Action to value Asian Concepts.
[104] The court in the Shareholder Action discussed and considered discount rates, including as follows:
[19] In his valuation analysis, Mr. Sharpe used a discounted cash flow to calculate the value. Future cash flows were discounted to present value to reflect the time value and the risk involved. As November 30, 2010 was the agreed upon valuation date, all prospective cash flow in the future were discounted back to that date. He looked at historical forecasts and achievements and built in a growth factor.
…
[88] Mr. Mynett also disagreed with the discount rates used by Mr. Sharpe. He used the same discount rates in all three scenarios. Scenario 3 is much riskier and he should have used a higher discounted rate. He also has a problem with the level of debt financing used by Mr. Sharpe. The company could not get the level of debt financing assumed by Mr. Sharpe because it did not have positive cash flow. No prudent lender would lend, therefore an assumption of debt was not appropriate. Mr. Sharpe should have removed the debt financing from his calculations and assumed 100% equity financing. Further, the cost of finance used by Mr. Sharpe was too low. Start up companies such as ACFC would require much higher rates of return than he assumed. This resulted in the discount rates he used being too low.
…
[130] Mr. Mynett was critical of the of use of three weighted scenarios. I find this criticism to be without merit. The approach taken by Mr.Sharpe is recognized as appropriate in a leading textbook on valuation, The Valuation of Business Interests, by R. Campbell and Howard E. Joh[n]son (Canadian Institute of Chartered Accountants, 2001) at p. 183:
It is often useful to conduct sensitivity analysis on the forecast. Frequently several scenarios may be prepared reflecting pessimistic, most likely, and optimistic assumptions with respect to key economic drivers. These sensitivity tests not only may assist in meaningful forecast development, but also may contribute significantly to risk assessment, and hence to the determination of appropriate discount rates.
[105] Courts routinely take contingencies into account when calculating damages. Counsel for the Trustee referred me to several such decisions, including Johnson v. Clark (1998), 61 B.C.L.R. (3d) 303 (C.A.), where the Court noted the application of the Law and Equity Act discount rate and considered an argument that no appropriate consideration of negative contingencies had been made. The Court concluded that the base income amount reflected periods of unemployment and a pre-existing disability, and held at para. 11:
… Thus, the negative contingencies of that history were embedded in the base amount. …
[106] That the Trustee chose to use a specific percentage based on equity rate of return, rather than analyzing each potential risk to this contract and attributing a specific discount to each is not a decision that can be characterized as unreasonable.
[107] I am bolstered in that view, as in the Final Popik Report the use of the equity rate of return as opposed to the statutory rate is considered under the heading, “Comments on Matters of Professional Judgment”.
[108] It is clear that in such questions of judgment, deference is to be accorded to the Trustee.
[109] This applies equally to Asian Concepts’ submission that the inherent risks were much larger and a greater discount rate should have been used to account for them.
[110] Adrenaline then submits that the 5% additional contingency on each contract renewal was unreasonable. Mr. Popik states that the 5% increase to the discount rate for each renewal of the MDA was arbitrary and that no rationale was provided for it.
[111] There was certainly force behind the argument that renewal of the MDA was not a foregone conclusion.
[112] Asian Concepts argued the valuation should have proceeded on the basis that the MDA would not be renewed. There were issues raised about the enforceability of the renewal provisions in the MDA as well as uncertainty as to the terms of any renewal agreement.
[113] The Trustee concluded that this was best accounted for by an additional 5% contingency discount. I cannot conclude that the Trustee’s position was unreasonable in the circumstances.
[114] Adrenaline argues that the discount for risk should not have been applied at all to the term of the then existing Adrenaline MDA, as it would be operating under a known contract until August 31, 2018. It is argued that a risk-free rate of return should have been used.
[115] In addition, Mr. Popik comments that the discount rate was only applied after December 31, 2014, which, for some reason having no relationship to the contract, was chosen by the Trustee as a valuation division between past and future losses.
[116] It was reasonable for the Trustee to conclude that there was risk to the MDA even before the termination date of the existing contract. Asian Concepts certainly took the position that the MDA was frustrated and at an end as of May 31, 2012. There were also other issues such as market saturation that the Trustee was properly cognizant of.
[117] As to the choice of December 31, 2014 as the date to begin applying the discount rate, the short answer appears to be that the valuation date was chosen to reflect the date of the valuation order of December 16, 2014.
[118] Even if I concluded that that was not the correct date, or not the date that I would have chosen, that is not the test. It was well within the Trustee’s exercise of judgment to determine when to begin applying the discount rate to the revenue stream.
[119] Adrenaline further asserts that there was an error in applying the discount rates to the revenue stream upon contract renewal. In the Final Popik Report, this is described as follows:
We note a mathematical error in the calculation of the net discount factors beginning with the First Renewal of the Trustee Valuation. The annual discount factor should be calculated on an incremental basis, that is, the discount rate for the last four months of 2018 should not utilize the rate of 27.5% rate for the entire duration. For greater clarity, the Trustee Valuation calculates the 2018 discount factor (after the first renewal) to be 0.3784, which equals 1/(1+27.5%)^4 years.
[120] I take this to mean that Mr. Popik feels that the discount factor is too high as it does not take into account that the rate was to be 22.5% for the first eight months of 2018, and 27.5% for the last four months. The Trustee appears to have calculated the discount factor using 27.5% for a full year.
[121] I note that this is a new comment that was not included in the Draft Report. The Trustee does not deal with it specifically, simply commenting that it does not agree that any of the issues raised regarding the discount rate have any substance.
[122] I cannot conclude that this is an error on the part of the Trustee. It is certainly not the type of error dealt with earlier in these reasons. In my view, this falls on the side of a judgment call and therefore within the province of the Trustee and its decision in that regard is entitled to deference.
[123] As a result of the above, the valuation of the unliquidated claim is increased by $368,000.00. Thus, the Adrenaline appeal is allowed and the Valuation varied as follows:
|
Liquidated claim: |
$65,720.25 |
|
Unliquidated claim: |
$1,057,000.00 |
|
Total claim for voting purposes: |
$1,122,720.25 |
|
|
|
[124] The appeal of Asian Concepts is dismissed.
[125] The parties sought to make submissions regarding costs once my decision was known. Thus, I will reserve judgment regarding costs and receive written submissions.
[126] All parties may file and serve written submissions limited to ten pages by September 8, 2017. Response submissions limited to ten pages are to be filed and served by September 22, 2017.
“Master Muir”