CHAPTER 31
CASE STUDY IN CREDIT MANAGEMENT: EAST END MARKET

 

 

TABLE OF CONTENTS

31.1 INTRODUCTION
31.1.1 REFERENCE INFORMATION
31.1.2 OVERVIEW

31.2 INITIATION OF THE FACILITY
31.2.1 BACKGROUND
31.2.2 THE PROPOSAL DOCUMENT
31.2.2.1 Submission of the Proposal Document to Beneficial Finance
31.2.2.2 Summary of the Proposal
31.2.2.3 The Urgency of the Proposal
31.2.2.4 The Acquisition Cost
31.2.2.5 The Underlying Value of the Assets to be Acquired
31.2.2.6 The Joint Venture Partner
31.2.2.7 Proposed Development of the Site
31.2.3 SUMMARY

31.3 APPROVAL OF THE FACILITY
31.3.1 REVIEW OF THE PROPOSAL
31.3.2 THE CREDIT SUBMISSION
31.3.2.1 Summary of the Submission
31.3.2.2 Urgency of the Submission
31.3.2.3 The Nature of Beneficial Finance's Participation
31.3.2.4 The Acquisition Cost
31.3.2.5 The Underlying Value of the Assets to be Acquired
31.3.2.6 The Joint Venture Partner
31.3.2.7 Proposed Development of the Site
31.3.2.8 The Nature of the Security to be Taken
31.3.3 APPROVAL OF THE SUBMISSION BY THE BOARD OF DIRECTORS
31.3.4 SUMMARY AND CONCLUSIONS
31.3.4.1 The Preparation of the Credit Submission by Management
31.3.4.2 Approval By the Board of Directors
31.3.4.3 A Review of the Approval of Facility by Beneficial Finance
31.3.4.4 Conflicts of Interest

31.4 MANAGEMENT OF THE FACILITY

31.5 FINDINGS AND CONCLUSIONS

31.6 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
31.6.1 TERM OF APPOINTMENT A
31.6.1.1 Term of Appointment A(b)
31.6.1.2 Term of Appointment A(c)
31.6.1.3 Term of Appointment A(h)
31.6.2 TERM OF APPOINTMENT C

 

 

 

31.1 INTRODUCTION

 

31.1.1 REFERENCE INFORMATION

The following information on the facility for the East End Market Company Ltd is set out for reference purposes:

REFERENCE INFORMATION
Account Name	. The East End Company Ltd (formerly Chepstow Pty Ltd) . East End Market Company Ltd
Group Name	. East End Market
Industry Sector	. Real Estate . Construction and Development
Facility Type	. Equity Investment and Secured Loans
Principal Outstanding at 31 March 1991	. $48.8M
Provision as at 31 March 1991	. $21.06M

 

31.1.2 OVERVIEW

This case study examines the participation by Beneficial Finance in a joint venture with the Emmett Group of Companies, a building and construction group, for the acquisition and proposed re-development of the East End Market.

Beneficial Finance's participation in the venture arose from a proposal presented to it in early May 1988 by Ayers Finniss, the merchant bank subsidiary of the State Bank. Ayers Finniss was acting for the Emmett Group.

The Emmett Group was controlled by its Managing Director, Mr A Emmett. It traded as a builder and developer, mostly of medium-size commercial and industrial projects. In May 1988 the Emmett Group controlled 8.6 per cent of the issued shares in the East End Market Company Limited, a publicly listed company whose principal asset was the East End Market site. Mr Emmett was a director of that company, whose major shareholder was the New Zealand Insurance Group, with control of 67.9 per cent of its shares.

The East End Market site has certain unique features. It is a largely contiguous site in excess of 3.5 hectares, situated on both the north and south sides of Rundle Street in the Central Business District of Adelaide. Its size and locality are such that the site is likely, in time, to be redeveloped as an important part of the City of Adelaide.

During 1987 and early 1988, the East End Market Company prepared concept plans for the redevelopment of the site involving various uses, including carparking, office buildings, hotels, retailing and entertainment.

Mr Emmett became disenchanted with the handling of the development by the East End Market Company. He thought that a public company was an unsuitable vehicle for carrying out the development of the site, and concluded that the best way to bring about the development was to privatise the East End Market Company. The Emmett Group lacked the financial strength to do that, so Mr Emmett engaged Ayers Finniss to assist in procuring finance for the acquisition and development.

A Proposal Document prepared by Ayers Finniss was presented first to the State Bank, on 7 May 1988. The Bank declined, but apparently suggested that Beneficial Finance might be interested. Ayers Finniss then sent the Proposal Document to Beneficial Finance on the 9th or 10th of May.

In essence, the proposal was that Beneficial Finance and the Emmett Group would jointly acquire all of the shares of the East End Market Company. The part ownership of the project by Beneficial Finance would not only provide a potential source of finance for the venture, but would also enable the venture to obtain funds from other financiers who would lend to the venture on the basis that Beneficial Finance, a subsidiary of a State Bank, would ensure that they would be repaid. The Emmett Group would provide the project management and construction expertise to bring the project to fruition. Each would contribute about $1.5M in equity, and Beneficial Finance would provide a subordinated loan of $4.0M. The joint venture would borrow a further $28.1M to fund the acquisition. Ayers Finniss would receive a 2 per cent shareholding in the joint venture company as its fee for acting for the Emmett Group. The Proposal Document stated that the matter was urgent, claiming that there were other unnamed parties interested in acquiring the East End Market Company.

The proposal was well received by the Senior Management of Beneficial Finance, particularly the Managing Director Mr J A Baker, and Mr E P Reichert, General Manager of the Corporate Services division. A credit submission, based almost entirely on the Proposal Document prepared by Ayers Finniss, was circulated to the directors of Beneficial Finance on 11 May 1988 with a covering letter written by Mr Reichert. A Board meeting was convened for the next day to consider the submission. The submission referred to the East End Market Company by the code name "Mousetrap".

The Board meeting was attended by only three Directors - Mr D W Simmons, who acted as Chairman, Mr Baker, and Mr G S Ottaway, an alternate Director. Mr Simmons disclosed to the meeting that he and other partners in his law firm, Thomson Simmons & Co, held shares in the East End Market Company, and that his law firm acted as solicitors for the Emmett Group of Companies. Although Mr Simmons chaired the meeting, he did not vote.

Comments from each of the directors who were not present (other than Mr T M Clark, who was overseas, and Mr K S Matthews), obtained by telephone calls to the directors before the meeting, were reported to the meeting. The meeting resolved to accept the proposal to enter into a joint venture with the Emmett Group.

On 13 May 1988, Beneficial Finance, Ayers Finniss and a subsidiary of the Emmett Group, Nettishall Pty Ltd ("Nettishall"), entered into a Joint Venture Agreement. The three joint venturers agreed to incorporate a new joint venture company, Chepstow Pty Ltd ("Chepstow"), for the purpose of acquiring all of the issued shares of the East End Market Company. On the same day, Chepstow issued a Part C Statement offering to purchase all shares in the East End Market Company at a price equivalent (including rights) of $4.25 per share. Within hours, it had received acceptances of the take-over offer in respect of 86 per cent of the issued shares of the East End Market Company, and shortly after acquired the balance of the shares.

The venture soon encountered problems. Although it had been assumed that development approval would be obtained quickly, the Management of Beneficial Finance did not conduct any independent evaluation of the existing plans for the project before committing to the venture. Subsequent revisions to the plans meant that the development approvals that were obtained had to be abandoned.

The joint venture partner, the Emmett Group, then announced its desire to quit the project, because of a "lack of fit" with its own plans. The East End Market project was more than ten times the size of anything the Emmett Group had undertaken, and yet Beneficial Finance undertook no critical evaluation of the Emmett Group's ability to successfully see the project to fruition before committing to the venture.

Beneficial Finance sought new partners for the venture, but a requirement of the potential partners that were identified was that Beneficial Finance provide the funding for their purchase of Nettishall's interest in the venture. Beneficial Finance's Board of Directors declined to approve the provision of the funding. Eventually, Beneficial Finance purchased Nettishall's interest, and so became the sole owner of the East End Market Company.

Despite much effort and activity, Beneficial Finance was unable to proceed with a viable development of the East End Market site. As at 31 March 1991, the total investment by Beneficial Finance in the venture was $48.8M, with a specific provision for loss of $21.06M. Interest foregone was $12.8M. In June 1992, the South Australian Government acquired the portion of the East End Market site still controlled by Beneficial Finance for $17.4M.

In my opinion, the essential failing of Beneficial Finance was that it became involved in the East End Market joint venture without first undertaking any adequate analysis or evaluation of the project. Beneficial Finance simply accepted at face value the conclusions suggested to it by Ayers Finniss. A reasonable and considered evaluation of the proposal should have made clear the real risks associated with participation in the venture.

 

31.2 INITIATION OF THE FACILITY

 

31.2.1 BACKGROUND

In early 1988, Mr Emmett, who was managing director of the Emmett Group and a director of the East End Market Company, saw an opportunity for the Emmett Group to take over the East End Market Company and develop the East End Market site. In about March or April 1988, Mr Emmett prepared a document titled "Mousetrap", a code name for the East End Market Company, in which he proposed the privatisation of the East End Market Company and the development of the site. Mr Emmett wrote:

"Sometime ago the parcel of properties, bounded by East Terrace, Rundle Street, Union Street and Grenfell Street and the property on the northern side of Rundle Street from East Terrace through to the continuation of Union Street captured my imagination. Problems in respect of amalgamating this site, bearing in mind the variety of ownerships at the time seemed all too difficult. However, approximately two years ago a group of people were able to set a situation whereby all of the land was brought under one ownership in a company called East End Market Company Limited.

This Company is a publicly listed entity with the major shareholder being New Zealand Insurance which has some 68% of the shares. The opportunities with this site are many and varied. By its very location almost all uses that could be attributed for a city development are applicable to this site. Furthermore, the scale of the development is manageable from a staging point of view. I became more intimately involved in this property via the purchase of approximately 9% of the shares in the East End Market Company which had previously been owned by the Adelaide Market Company. These shares were purchased in the third quarter of last year. With that involvement in the Company, it became vividly obvious to me that the development of the site would always be difficult with the owner of the site being a publicly owned Company. By very nature of the publicly listed vehicle, there are a variety of situations that tend to mean that the direction of energies is more related to the share price and dividend structure etc., rather than being directed to the delivery of a well planned and well conceived development solution for the site.

There has always been an enormous amount of enthusiasm shown to the opportunities presented by the site. For some two or three years a team of Architects, Engineers and Planners have worked long and hard to come to grips with the solutions that are applicable. However, during all this time they have not really been under the direction of what I would call entrepreneurial flair where there is a dedication to come up with a solution, agree on it and then deliver it. To this end, I am of the belief that the only way that the reality of this project can be achieved is by a take-over of the Company, its privatisation and getting on with the development scenario.

One may have visions in respect of opportunities like this but visions must be turned into reality at some stage. The visions that we have are deliverable because the opportunities this site provides are what are called multi-use; multi-use in the sense of retail, commercial, hospitality and residential. The total area of the site is in excess of 31,000 sq. m. which in anybody's terms is a significant parcel of land within the confines of the City of Adelaide."

The document described plans for development of the site, including office buildings along the Grenfell Street frontage, commercial and hotel development along East Terrace and retailing along Rundle Street. The development plan was divided into "fourteen packages for development", staged to avoid over-supplying the limited Adelaide property market.

On 23 March 1988 Mr Emmett and a potential partner met with three Ayers Finniss personnel, including the Managing Director Mr J T Hazel, to discuss the engagement of Ayers Finniss to act as their adviser and agent to procure finance to take over 100 per cent of the East End Market Company.

Three aspects of the discussions with Ayers Finniss are significant:

(a) First, Ayers Finniss advised Mr Emmett that he would need a partner that could provide strong financial backing for the project. The Proposal Document subsequently prepared by Ayers Finniss stated that, after reviewing the financial position of the Emmett Group, Ayers Finniss suggested Beneficial Finance as a potential partner.

(b) Second, the Emmett Group would effectively not provide any cash for its interest in the joint venture. Its contribution of $1.5M would come from part of the proceeds of the sale of its shares in the East End Market Company to the joint venture. A letter from the Managing Director of Ayers Finniss, Mr Hazel, stated that the "net cash flow" of the Emmett Group from the sale of its shares in the East End Market Company would be contributed to the joint venture, and that that would "be of the order of $1.5M". That calculation assumed a sale price for the shares of $3.75 per share. The actual sale price was the equivalent of $4.25 per share.

The total amount received by the Emmett Group for the sale of its shares was slightly more than $2.7M. In essence, the Emmett Group acquired its 49 per cent interest in the joint venture by contributing only some of its 8.6 per cent shareholding in the East End Market Company. More than 98.8 per cent of the acquisition cost would be borrowed by the joint venture company.

(c) Third, Ayers Finniss agreed not to require payment of its fee in cash. Instead, it would accept a 2 per cent interest in the joint venture. The Emmett Group would receive fees from the joint venture for acting as project manager and, where appropriate, construction manager for particular stages of the project.

Mr Emmett's proposed partner withdrew from the venture before a proposal document was prepared. Mr Emmett proceeded with the take-over proposal.

31.2.2 THE PROPOSAL DOCUMENT

31.2.2.1 Submission of the Proposal Document to Beneficial Finance

A Proposal Document was submitted by Ayers Finniss to the Bank on 7 May 1988. A copy of the main body of the Proposal, but without a number of supporting appendices, was sent to Mr Clark, Managing Director of the Bank, in London where he was conducting business for the Bank.

Mr Clark declined the proposal on behalf of the Bank, although there is no evidence that any one at Beneficial Finance was aware of that. According to the evidence of Mr Reichert of Beneficial Finance, and of Mr Hazel and Mr G Brigden of Ayers Finniss, Mr Clark suggested to Ayers Finniss that Beneficial Finance might be interested, although Mr Clark said in evidence that he has no recollection of doing so, and the Proposal Document stated that Ayers Finniss had suggested Beneficial Finance as a potential partner. In any event, the proposal was then submitted to Beneficial Finance. Although the precise date is uncertain, it must have been on the 9th or 10th of May.

31.2.2.2 Summary of the Proposal

The Proposal Document, which consisted of seventeen pages supported by ten appendices, invited Beneficial Finance to participate as an "equity partner and lender" in the acquisition of the East End Market Company. It proposed that:

(a) A joint venture company would be formed to make the acquisition. Beneficial Finance would subscribe $1.47M for 48 per cent of the issued shares of the joint venture company. The Emmett Group would hold 50 per cent, and Ayers Finniss 2 per cent as its fee for advising the Emmett Group. The shares issued to Beneficial Finance and the Emmett Group were to be partly paid, with a total uncalled amount of $29.4M.

(b) Beneficial Finance would lend $4.0M to the joint venture company in the form of a sub-ordinated loan, at normal commercial rates.

(c) The joint venture company would borrow a further $28.1M from the State Bank to fund the acquisition.

The Proposal did not relate to the subsequent development of the site, stating that a separate proposal for funding the development would be prepared after the acquisition of the East End Market Company. It did, however, provide some description and financial analysis of a proposed development plan.

31.2.2.3 The Urgency of the Proposal

The Proposal Document stated that there was "a degree of urgency" with the proposal, as "it is apparent from market information and movement in the share price" that there were other parties, "at least two interstate and one local", interested in acquiring the East End Market Company.

In sworn evidence to the Investigation, Mr Hazel was unable to identify the other interested parties.

31.2.2.4 The Acquisition Cost

The Proposal Document stated that the cost of acquiring the shares of the East End Market Company would be $4.25 per share, a total cost of $32.481M. The document stated that:

"Preliminary talks have also been undertaken with the major shareholders who have indicated that they are willing to sell their holdings for a price equivalent of $4.25 per share. Further enquiries have revealed that a prominent Adelaide sharebroker can deliver about 89% of the capital of "Mousetrap" within twenty four hours of a bid being made."

On 28 March 1988 there had been a rights issue on a one for five basis. The "price equivalent" of $4.25 was comprised of $4.12 for each share, plus $0.13 per share representing one-fifth of the value of each right, valued at $0.65.

31.2.2.5 The Underlying Value of the Assets to be Acquired

The Proposal Document stated that the East End Market Company's published accounts for the half year ended 31 December 1987 showed that it had net assets of $20.46M. It was argued, however, that if the land and buildings were revalued to their appraised market value of $31.0M, the actual value of the net assets of the East End Market Company was $34.01M, or about $1.5M more than the acquisition cost.

The appraised market value of the East End Market site of $31.0M had been recently obtained from Mr W Rea, a licensed valuer of Richard Ellis (South Australia) Pty Ltd. The valuation report, addressed to Mr N Calvert at Ayers Finniss, and dated 6 May 1988, was only a brief summary of the valuer's opinion, the report stating that a detailed report would be sent later.

31.2.2.6 The Joint Venture Partner

The Proposal Document described the Emmett Group of Companies as "a leading South Australian based development and construction group", and stated that it had "an excellent reputation in Adelaide as a competent, soundly managed construction and development company with a very good industrial relations record." A history of the Emmett Group was provided, together with a diagram showing its subsidiaries and existing joint venture activities.

The Proposal Document stated that, as well as owning half of the joint venture, the Emmett Group would act as project and construction manager:

"It is proposed that EGC be appointed Manager of the development project once the JV company has control of "Mousetrap" and that where suitable, EGC be appointed construction managers of the various construction projects."

31.2.2.7 Proposed Development of the Site

As noted above, the Proposal Document was not related directly to the re-development of the East End Market site. Nevertheless, the Proposal did provide what it described as "a brief analysis" of the development stage. It stated that work already performed by the East End Market Company in negotiating compromises with the Adelaide City Council, the Market Users Association, and heritage groups would mean a saving of time to bring the development to fruition. The development plan was said to be to establish, on a staged basis, fourteen separately identifiable projects, and that the individual developments could be brought "`on stream' at the most appropriate stages between 1989 and 1992." Twelve of the fourteen packages would be developed initially, with the last two, being premium sites situated on East Terrace, to be retained by the Joint Venture for later development. The options for the Joint Venture were said to be either to hold and develop the project, or to sell land "packages" at a profit.

The Proposal Document assessed the return to the developer as 22.42 per cent of development costs. The Document noted that timing of the release of the developed projects would be important, as an over-supply of office accommodation and retail space in Adelaide between December 1988 and mid-1991 was predicted. The Proposal concluded, however, that:

"... given the location, the flexibility and some entrepreneurial flair, this site offers future developers an opportunity to achieve extremely satisfactory returns on investment."

The Proposal Document predicted that Beneficial Finance would receive a return of $17.64M for its $1.5M equity investment, and recommended that Beneficial Finance participate in the project, stating that:

"If all else fails, BFC has the security of the land and buildings in "Mousetrap", which has a current market value of $31m, as well as cash of approximately $5m in the company."

31.2.3 SUMMARY

There are a number of significant features of the joint venture proposal:

(a) In preparing the Proposal Document, Ayers Finniss was acting for the Emmett Group, not Beneficial Finance. The Document was an invitation to participate in the venture, and not a critical evaluation of the associated risks.

(b) The participation of Beneficial Finance as an equity partner was regarded as important to provide financial strength and credibility to the project. Beneficial Finance was being asked to provide only $5.5M for the project: $1.5M in equity, and a sub-ordinated loan - that is, a loan which ranks last in priority for repayment - of $4.0M. The bulk of the necessary funds - $28.1M - was to be borrowed from a financier other than Beneficial Finance. Part ownership of the joint venture company by Beneficial Finance would, however, encourage other financiers to lend funds to the joint venture company, because it was commercially certain that Beneficial Finance or the State Bank would ensure that the loans would be repaid. Shortly stated, although Beneficial Finance might not provide the funds for the acquisition and development, it nevertheless would bear the credit risk of those loans.

(c) So far as the Emmett Group was concerned, the proposed venture was essentially self-funding. Although it would contribute $1.5M to the joint venture, it was to receive more than $2.7M from the sale of its shares in the East End Market Company to the joint venture. The Emmett Group would receive fees from the joint venture company for acting as project manager, and as construction manager for particular stages of the development.

(d) The Proposal did not relate to the development of the East End Market site. It was concerned only with the acquisition of the East End Market Company, stating that a separate proposal would be submitted in respect of the development.

(e) The proposal was urgent. It raised the spectre of unidentified parties interested in acquiring the East End Market Company.

 

31.3 APPROVAL OF THE FACILITY

 

31.3.1 REVIEW OF THE PROPOSAL

The Proposal Document prepared by Ayers Finniss was reviewed by Management of Beneficial Finance, particularly Mr Baker, Mr Reichert, and Mr G L Martin.

There is absolutely no evidence that Management undertook any independent investigation or critical evaluation of the information provided in the Proposal Document. So far as I have been able to determine, Management simply accepted, without any reasonable inquiry, the information, analyses, and propositions provided by the Emmett Group. The credit submission provided to the directors was, in essence, little more than a precis of the Proposal Document prepared by Ayers Finniss.

31.3.2 THE CREDIT SUBMISSION

31.3.2.1 Summary of the Submission

The submission was sent individually to directors on 11 May 1988, together with a covering letter which stated in part:

"Gentlemen,

Subject: Joint Venture to acquire the shares in a publicly listed company and to subsequently develop a major property in the Adelaide CBD

The attached is a proposal to establish a Joint Venture between Beneficial and the Emmett Group of Companies ("Emmett") to purchase the shares in a publicly listed company, Mousetrap. Subsequently, the Joint Venture intends to develop a major property in the Inner-Adelaide area which is currently owned by Mousetrap.

It is proposed that Beneficial provide $1.5 million equity and $32 million debt, of which $4 million will be subordinated funds. This will provide a 49% shareholding in the company with Emmett also holding 49%. The remaining 2% shareholding will be held by Ayers Finniss Ltd, thus providing the State Bank Group with a majority shareholding in the Venture.

Mousetrap is a long established company which recently listed to acquire a prime group of properties in the Adelaide Central Business District. In the course of the last three years, the Management of this company has been under-performing which has resulted in this opportunity to purchase its shareholding and then develop the site to its full potential."

The letter was signed by Mr Martin above the typed name and title of Mr Reichert.

31.3.2.2 Urgency of the Submission

The credit submission was prepared urgently. At most, there could not have been more than one or two or days to review the proposal and prepare the submission. The covering letter to the directors requested that the directors respond by the next day, stating:

"Details of the Venture are contained in the attached submission. Owing to the time frame associated with this opportunity which requires the joint venture to enter the market on Friday, May 13 1988, a Special Board Meeting to consider this proposal is being called at Beneficial Finance at 33 Franklin Street on Thursday, May 12th at 3.00 p.m. Owing to the sensitivity of the proposal you will be contacted by phone prior to the meeting with details concerning Mousetrap and the property concerned. Should you be unable to attend the meeting, your comments or approval to John Baker, Garry Martin or myself would be appreciated."

31.3.2.3 The Nature of Beneficial Finance's Participation

The credit submission sought approval of the directors for total funding of $32.6M, which included the $28.1M that was proposed to be obtained from the State Bank. The submission stated that after the take-over had been completed, refinance of the $28.1M would be sought from a bank, with the State Bank being offered "first participation subject to a competitive rate".

Beneficial Finance's 49 per cent equity interest would involve it subscribing $1.47M for 14,699,999 ordinary $1.00 shares in the joint venture company, paid up to $0.10, with the balance payable in ten years' time. In relation to the unpaid $0.90 per share, the submission stated that it was "unlikely to ever be paid as the development should be completed and sold within ten years".

The submission proposed that the Board of Directors of the joint venture company would have four directors, two appointed by each of the Emmett Group and Beneficial Finance. Beneficial Finance would take a Power of Attorney over the shares held by Ayers Finniss, thereby providing Beneficial Finance with ultimate control of the joint venture company.

Each shareholder was to have a right of first refusal of shares offered for sale by any other shareholder.

31.3.2.4 The Acquisition Cost

The submission stated that Mr Emmett had made enquiries of the major shareholder, and had ascertained that its shares could be purchased for a price equivalent of $4.25 per share. The submission noted, however, that in the Financial Review of 11 May 1988, the price at which shares in the target company were last traded was shown as $3.20.

31.3.2.5 The Underlying Value of the Assets to be Acquired

The submission advised the directors that although the net assets of East End Market Company shown in its financial statements for the half year ended 31 December 1987 was $20.46M, the valuation by Richard Ellis of the land and buildings at $31.0M meant that the net assets of the company had a value of $33.84M. On that basis, and assuming that all rights were exercised, the submission argued that the net asset backing was $4.31 per share.

Critically, the submission went on to contend that once development approvals had been granted, the land "could be expected" to increase in value to $42.0M, whereupon the East End Market Company's shares would have a net asset backing of $5.39 per share. This estimated valuation had not been included in the Proposal Document prepared by Ayers Finniss, and its origin is a mystery. No evidence was made available to my Investigation to support the opinion that the land value would rise to $42.0M once development approval was obtained.

The overall thrust of the submission to the Board was that the re-development was ready to proceed, that there were no inherent weaknesses other than the inappropriate structure of a public company that had paralysed progress, and that as a result of development approvals which would be obtained very quickly, the East End Market site could be expected to increase in value to $42.0M, almost $10.0M more than the acquisition cost. That the development approvals could be obtained quickly was assumed, rather than established by reliable evidence.

31.3.2.6 The Joint Venture Partner

The credit submission included a review of the experience and expertise of the Emmett Group, which concluded:

"Emmett has demonstrated the capacity and expertise in development and construction which together with the financial strength of Beneficial will ensure the success of the Joint Venture."

31.3.2.7 Proposed Development of the Site

As the rationale for the take-over, the submission stated:

"With his involvement in the company, Emmett has formed the opinion that the development plans of the entity are stifled by a lack of direction from the present Board and share ownership. By the very nature of the publicly listed vehicle, energies have been directed more into the policies of share price, dividends etc. rather than to the well planned development of the site. Emmett believes the only way of achieving the potential of the site and making use of the planning and development work undertaken to date is to takeover the company, obtaining privatisation and under the guidance of a small, more developer-orientated management group, undertake the development on a staged and carefully prepared basis."

The submission stated that if the take-over were successful, Beneficial Finance would be able to exercise complete control of the East End Market Company, and realise its future potential "by way of development or sale of its assets". If the take-over offer should fall short of acquisition of 90 per cent of the shares so that the balance could not be compulsorily acquired, Beneficial Finance would have the option of retaining its interest in the Joint Venture as an investment.

The submission described the East End Market site in these terms:

"The site consisted of fourteen separate projects all subject to development proposals currently before the Council which comprise a mixture of office, retail, hotel accommodation and a carpark. Each project can be developed or sold as deemed appropriate to maximise profit potential.

Panel valuer W. Rea from Richard Ellis has valued the property "as is" subject to existing zoning regulations at $31M. The valuation comprises the total value of several individual sites and the large development site represented by the existing markets. The valuer has analysed recent comparable sales in the area to justify capitalisation rates and the value of the land as a development site. He has also indicated that a lender should allow a sales marketing period of between 6 to 9 months for a parcel of this size. Once development approval for the individual projects are obtained from Council, value for the entire parcel could be expected to be in the vicinity of $42M.

Emmett has already received expressions of interest to package and sell individual parcels of the development on receipt of the approval. Any sales would immediately reduce the gearing on the property.

Ayers Finniss have prepared feasibility studies on each individual development based on parameters (i.e. rental rates, capitalisation rates, etc.) which broadly conform to current market conditions. The analysis indicates a minimum JV development profit of $25M over a period of four years."

31.3.2.8 The Nature of the Security to be Taken

Security for the loans totalling $32.1M from Beneficial Finance was to be a first charge over all of the shares in the East End Market Company to be held by the joint venture company, and over the Emmett Group's shares in the joint venture company. The facility of $28.0M was to be secured by a first mortgage over those shares, with the further $4.0M to be secured by second charges over the same shares. Additionally, joint and several guarantees for 49 per cent of the debt would be obtained from Emmett Holdings Ltd, from the special-purpose subsidiary of Emmett Holdings Ltd that was to hold the Emmett Group's 49 per cent shareholding in the joint venture company, and from Mr Emmett personally.

31.3.3 APPROVAL OF THE SUBMISSION BY THE BOARD OF DIRECTORS

Before the Board meeting at which the submission was to be considered, telephone calls were made by Management to the directors, seeking their responses to the submission. Those responses are very briefly summarised in a handwritten document kept in the records of Beneficial Finance. Although the document may not reflect the range and depth of the directors' responses, it does give some indication of their views as presented to the subsequent meeting of directors:

"DIRECTORS’ RESPONSE - MOUSETRAP
Studdy)	OK. No problem with
Williams)	minority shareholders. Ownership
Malcolmson	Great opportunity.
Barrett	Consider City of Adelaide plan.
Macky	Not read, but must advise Premier
Searcy	OK, however weakness is heritage and therefore Council. SBSA may need to consolidate.
Macky	Will endorse his alternative Director
Barrell	I will go along
Simmons	OK.
Matthews	OK."

The recorded responses indicate that of the nine directors whose reactions were obtained, two, Mr L Barrett and Mr R P Searcy, expressed reservations regarding town planning and heritage considerations; one director, Mr J B Macky, expressed no opinion: and seven directors (including Mr Searcy) were prepared to agree to the submission, though with varying degrees of enthusiasm.

Only three directors, Mr Simmons, Mr Baker, and Mr Ottaway who was present as an alternate director, attended the directors' meeting held at 3:00pm on 12 May 1988. All three were also directors of Ayers Finniss. The meeting was also attended by, among others, Mr Reichert, Mr Martin, Mr J D Blunt and Miss J Zadow of the Management of Beneficial Finance, and by the Acting Company Secretary, Mr J G Graham.

The minutes of the meeting record:

"BUSINESS:

It was noted that the meeting had been convened to consider a submission from Management which recommended approval of:

1. the formation of a Joint Venture company (JVCO) with the following ownership:

Beneficial Finance	49%		$1.5M
Emmett Group of Companies	49%		$1.5M
Ayers Finniss	2%		$0.6M
	100%		$3.6M

2. J.V.Company to seek to acquire 100 per cent of the shares of East End Market Company Ltd. (EEMCo) through the lodgment of a Part C Statement with The Stock Exchange of Adelaide Ltd.;

3. J.V.Company to then proceed with development plan of EEMCo's substantial city land holdings.

Mr. Simmons declared his interest in the transaction in that he and partners in his firm held shares in EEMCo and that the Emmett Group was a client of his firm.

Mr. Baker read a summary of the comments on the Management submission made by Directors not present at the meeting.

It was noted that:

1. the proposed development plans complied with Town Planning Regulations/Requirements and similar plans had been previously approved by the Adelaide City Council;

2. no objections were anticipated from The National Trust;

3. priorities for development should be agreed in advance with The Emmett Group.

It was resolved to approve the proposals contained in the submission and Management was authorised to advise EEMCo accordingly to enable the Part C Statement to be issued following the opening of the Exchange on Friday, 13 May 1988.

CLOSE:

There being no further business, the meeting closed at 4.30 p.m."

That same day, 12 May 1988 Mr Baker wrote to Mr A R Prowse, then the Under Treasurer. The purpose of the letter was to inform Mr Prowse that on the following day a take-over bid for the East End Market Company would be launched. Part of the letter reads:

"The Joint Venture will offer a price of $4.12 per share and 65¢ per option for all of the shares and options which are available in the company. This offer will be made on market by way of a Part C statement. This offer is considered to provide a generous price to the existing shareholders of East End Market Company Ltd., the shares of which have been untraded for some weeks with a 1988 high of $3.20.

Purchase at this price is attractive to the Joint Venture because the skills and intention to rapidly proceed to develop the Rundle Street site in line with the guidelines specified in the City of Adelaide plan and with a sensitivity to enhance the already attractive nature of this part of the City of Adelaide."

31.3.4 SUMMARY AND CONCLUSIONS

There are, in my opinion, a number of highly unsatisfactory features of the preparation of the credit submission by Management and its approval by the directors of Beneficial Finance.

31.3.4.1 The Preparation of the Credit Submission by Management

The most important deficiency with the process was that the Management of Beneficial Finance did not undertake any reasonable independent review or evaluation of the information contained in the Proposal Document. In preparing the credit submission for the Board of Directors, Mr Reichert and Mr Martin did little more than accept and summarise the information, propositions, and analyses provided by Ayers Finniss, which, in turn, relied substantially upon information provided by Mr Emmett. Despite the fact that this was a large scale and potentially complex development, no evaluation of the proposal was undertaken by Beneficial Finance before the Board committed Beneficial Finance to the project.

The consequence of the reliance placed on the Proposal Document was that the risks associated with the project were not identified or properly analysed. Those risks included the risk that the existing proposal for a fourteen stage development might not be viable, that the project could be opposed within the Adelaide City Council, that development approvals could be delayed, that the Emmett Group might not have the experience and expertise to undertake the project, and that the market for the buildings proposed for the site could fall away so that the project would become unprofitable.

A careful and critical evaluation of the project was particularly important given the almost complete responsibility that Beneficial Finance would inevitably bear for the financing risk associated with the project. The Emmett Group essentially contributed no cash to the venture, and it had no demonstrated capacity to do so in the future. Financial statements for the Emmett Group of Companies contained in the Proposal Document showed that in the three years to 30 June 1987, the Emmett Group had made operating losses converted, in two of the three years, to modest profits (the higher of which is $84,003) by extraordinary items of income. In the year ended 30 June 1988, the Emmett Group was expected to have an operating profit of $1.15M on total income of $18.56M.

A considered and detailed review of the Proposal by the Management of Beneficial Finance should have disclosed a range of significant problems that, together, cast doubt upon the viability of the project.

First, there were reasonable grounds to doubt that the Emmett Group had the skills necessary to manage a development of this size and complexity.

The Emmett Group wanted to maximise its involvement in the project. The Proposal Document proposed that the Emmett Group would act as project manager for the duration of the East End Market project, for which a consultancy fee of $0.7M per annum would be paid, and that it would be involved as builder of some, at least, of the buildings in the project. The credit submission proposed that Beneficial Finance place complete reliance on the expertise of the Emmett Group, stating that its "capacity and expertise in development and construction" would, "together with financial strength of Beneficial ... ensure the success of the Joint Venture."

The Proposal Document identified seventeen projects undertaken by the Emmett Group of Companies during the two years before May 1988, the largest of which had values of between $11.0M and $16.0M. The remainder had values below $6.7M. Some of those projects were development projects, while others involved construction only. In contrast, the East End Market development had an expected project value in excess of $200.0M. The project was therefore almost thirteen times larger than any venture previously undertaken by the Emmett Group, and was described in a business plan prepared by the Emmett Group as the most ambitious project ever undertaken privately in South Australia, both because of its size, and the variety of uses to which the site would be put.

Second, there was considerable uncertainty regarding the obtaining of development approval for the project.

The Proposal Document, and even more so the credit submission, were based squarely on the assumption that the existing plans prepared by the East End Market Company would be approved by the Adelaide City Council, and that the project would be implemented in accordance with those plans and the approval obtained. The Proposal Document stated that work already performed by the East End Market Company in negotiating compromises with the Adelaide City Council, the Market Users Association and heritage groups would mean a saving of time in bringing the development to fruition.

The credit submission assumed that as at May 1988, the East End Market project was virtually ready to begin, and that development approvals could be expected almost immediately. The submission described the project as "subject to development proposals currently before the Council ", and stated that the granting of development approval could be expected to increase the value of the site by $11.0M, to $42.0M. The Board Minutes of 13 May 1988 record the Board's belief that the proposals complied with all town planning requirements and that there would be no opposition to approval.

There is a fundamental difficulty associated with those assumptions and expectations. Reliance on the existing plans and applications for development approval essentially involved making a commitment to those plans, since any substantial changes would require new applications. The existing plans, developed by the East End Market Company, had not been subjected to any detailed review or evaluation by Beneficial Finance. Indeed, no decision had been made as to whether the site would be fully developed by the joint venture, or parts of it sold off. The submission stated that one reason for the take-over was the lack of energy devoted by the East End Market Company to a "well planned development of the site."

If the venturers sought to change the plans prepared by the East End Market Company, the development approval process would have to begin again. There were substantial risks associated with that. Although the Adelaide City was legally bound to assess the existing development approval application according to the then existing City of Adelaide Plan, any substantial change to the existing plans could result in the need for new planning approvals which would be subject to the requirements of the new City Plan, which was about to be adopted by the Adelaide City Council. The compromises previously negotiated by the East End Market Company with heritage groups might require renegotiation. Objections to new plans of development of the site could come not only from the National Trust, but also from informal groups and the heritage faction of members of the Adelaide City Council. Proposals for development of the East End Market site were, as at 13 May 1988, a matter of widespread public interest, and there was an element of public opinion, represented by some members of the Adelaide City Council, that too many office towers had been built in the Adelaide Central Business District. There was also a view that the character of Rundle Street East should be preserved.

The risks associated with the new City of Adelaide Plan and the opposition of heritage groups were expressly pointed out in the recorded comments of Mr Barrett and Mr Searcy in respect of the submission.

As Beneficial Finance's Management had not made a full financial and commercial assessment of the existing plans, there was an unacceptable risk that Beneficial Finance might either be "locked into" a commercially unsatisfactory project, or, if it attempted to change the development proposal, be exposed to the risk of needing to obtain new approvals in the face of opposition, based on the requirements of the new City Plan.

Third, there was no reasonable analysis of the real risk that Beneficial Finance was undertaking by participating as a partner in the venture. Together with Ayers Finniss, Beneficial Finance would own 51 per cent of the joint venture company. It was, therefore, commercially unthinkable that Beneficial Finance or the Bank could allow the joint venture company to default in meeting its obligations. The Emmett Group did not have the resources to meet the cost of the project, and there was no analysis by Beneficial Finance of the financial resources of the guarantors. The result was that, in essence, Beneficial Finance bore the entire credit risk of the funding of the venture, even if it did not provide those funds itself. The credit submission stated that the expertise of the Emmett Group and the "financial strength" of Beneficial Finance would together ensure the success of the joint venture. In effect, Beneficial Finance lent its financial backing to the project in exchange for a share of the profits if the project was successful. It would bear practically the entire cost if the project failed.

Fourth, Management did not give any consideration to the implications of the essentially equity investment in a commercial property development in the Central Business District. A substantial number of office developments were coming onto the Adelaide market at the time. In its proposal Ayers Finniss noted an anticipated downturn in the property market, but dismissed that consideration as able to be overcome by the unique qualities of the East End Market site, and by entrepreneurial flair. That was a trite dismissal of an issue that required much more careful consideration by Beneficial Finance, which would bear the cost if the project failed.

There are two matters related to the investment in commercial property that should have been considered.

The first is the level of Beneficial Finance's total exposure to commercial property development. There is no evidence that any analysis was undertaken, at the time that the credit submission was prepared and approved, of the proportion of Beneficial Finance's risk assets that were commercial property related, or of the implications of this further investment. The minutes of the Board of Directors meeting held on 26 August 1988 record that the Board then queried "whether there should be a cap placed on the extent of construction and development business written by" Beneficial Finance. That was three months after the commitment to the East End Market joint venture.

The second is the risk of a fall in property values, and the implications that would have for the value of the site. Property values had been rising for some years, and the Proposal Document noted the predictions of an over-supply of office accommodation and retail space in Adelaide between 1988 and 1991. There should, therefore, have been some analysis of the possibility that there may be a cyclical reversal in property values, and of the effect of such a decline on new property developments. The latter mentioned may be more severely affected by a reduction in values than other property already developed and tenanted. A careful analysis of the maintainable value of the site was particularly necessary given the importance of the value, and anticipated future value, of the site to the decision to participate in the venture.

Further, under the terms of the Joint Venture Agreement between Beneficial Finance, Ayers Finniss and Emmett, Beneficial Finance did not have the legal right to require sale of the land. The land could be sold only by agreement, or by exercise of rights upon default by another Joint Venture partner. That greatly reduced the utility of a calculation of the value of shares in the East End Market Company by net asset value as assurance for Beneficial Finance in relation to its investment.

A further manifestation of Beneficial Finance's failure to undertake any reasonable evaluation of the proposal is its acceptance, without any apparent questioning, of the price of $4.25 set for the shares in the East End Market Company. The credit submission noted that the shares had last traded at only $3.20. Although the Proposal Document cited some "movement in the share price" as grounds for considering that the matter was urgent, Mr Baker wrote in his letter to Mr Prowse dated 12 May 1988 that the shares of the East End Market Company "had been untraded for some weeks with a 1988 high of $3.20". Some investigation of the position was clearly warranted. No such investigation was made by Beneficial Finance.

In my opinion, those officers of Beneficial Finance responsible for reviewing the proposal and preparing the credit submission recommending that the proposal be accepted, namely Mr Baker, Mr Reichert and Mr Martin, failed to exercise proper care and diligence in the performance of their duties.

31.3.4.2 Approval By the Board of Directors

There are a number of unsatisfactory aspects to the approval of the credit submission by the Board of Directors' meeting on 12 May 1988.

First, the directors accepted the credit submission for review even though it had not been subject to the review procedure that required that the submission be recommended by the Credit Committee. In fairness to the directors, it must be noted that:

(a) The directors were told by senior management that the matter was "urgent", which might be regarded as justifying the by-passing of the normal review and approval procedure.

(b) The submission carried the endorsement of senior executives Mr Baker, Mr Reichert and Mr Martin. That endorsement could reasonably be regarded as a representation that the proposed venture had been subject to a thorough and careful analysis, and was supported by senior management. Unfortunately for the directors, the second representation was correct, but the first was not.

Nevertheless, the acceptance of the submission when it had not been through the required approval procedure was a mistake. It was more than probable that it was a mistake that made no difference, since I doubt that the Credit Committee would have rejected the proposal, supported as it was by Mr Baker and Mr Reichert. Still, Beneficial Finance's Management acknowledged in September 1990 that one of the lessons learned from the East End Market problem loan was the danger associated with bypassing the credit risk evaluation process.

Second, the circumstances of the approval of the venture by the Board of Directors was, in my opinion, highly unsatisfactory. The submission was sent individually to directors, with advice from senior management that the matter was both confidential and urgent, and that a meeting was to be convened the next day to consider the submission. The prospect that a significant number of directors would be unable to attend a meeting convened on such short notice is obvious. The directors were contacted by telephone, and at least two directors, Mr Barrett and Mr Searcy, raised issues that were important considerations to the success of the proposed venture. Those directors who gave their comments by telephone could not have known that, effectively, none of the regular non-executive directors would attend the meeting.

Although three directors attended the meeting, one was Mr Simmons, who because of his declared conflict of interest, could not, and did not, vote. Indeed, according to Mr Simmons, no formal vote was taken. Another was Mr Baker, who was sponsoring the submission. The third was Mr Ottaway, an employee of the Bank attending as an alternate director.

The inappropriateness of the means by which the approval of the Board of Directors was sought and granted hardly needs any elaboration by me. The directors had to consider the submission individually, and only those directors who attended the meeting had any real say. In effect, the only directors who approved the venture were Mr Baker, and an employee alternate director.

Third, having regard to the content of the credit submission, in my opinion the directors should have expressly refused to approve the proposal. My opinion is based on two particular facts:

(a) First, the submission contained no analysis of the exposure of Beneficial Finance to commercial property. Given the express prediction in the submission of an imminent over-supply of retail and commercial property in Adelaide, that was critical. The Board of Directors is recorded in the minutes of its meeting held on 24 February 1989 as asking for a report on Beneficial Finance's exposure to central business district property, and the minutes of the August 1989 meeting record the Board as expressing concern about the Bank Group's exposure to central business district commercial property in the course of a discussion of the East End Market venture.

That expression of concern was, in my opinion, far too late. The establishment and observance of prudential policies regarding the loan exposure to particular industries, particular commercial property in the circumstances of 1988, was a crucial responsibility of the Board of Directors.

(b) Second, the only reasonable basis for approval of the submission - that the value of the site "could be expected to be in the vicinity of" $42.0M once development approval was granted - should not have been accepted by the directors. The logical difficulties are outlined above. More importantly, however, the estimate that the site would increase in value to $42.0M was completely unsupported by any valuation or evidence.

In a submission to my Investigation on behalf of certain of the non-executive directors, it was said that because internal procedures required that valuations be supported by expert opinions, the directors believed, and were entitled to believe that the value of $42.0M was based upon a valuation provided either by Richard Ellis, or by qualified valuer on Beneficial Finance's staff.

I have considered that submission carefully. Clearly, the directors were entitled, in the absence of suspicion, to rely on management to adhere to established policies and procedures. On balance however, I cannot accept that the directors were entitled to rely, without question, on the purported $42.0M valuation. There are three reasons for my opinion:

(i) First, the valuation of $42.0M was critical to the proposal. Based on the valuation provided by Richard Elliss of $31.0M, the proposal was, simply stated, wholly unattractive. The absence of detailed development plans that had been analysed by Beneficial Finance upon which to evaluate the project meant that it was critical that the directors should be wholly satisfied that that valuation of $42.0M was reasonable.

(ii) Second, there was no reasonable basis in the submission for an assumption that the valuation of $42.0M was based on any professional assessment. The submission stated only that the value "could be expected to be in the vicinity of $42.0M" once development approval was obtained. A statement that the value "could be expected" to be "in the vicinity of" does not, in my opinion, reasonably allow an assumption that a professional valuation had been obtained, particularly when the details of the valuation of $31.0M were expressly provided.

(iii) Third, for the reasons outlined earlier, the assumption that development approval would be obtained was unsafe.

The Non-Executive directors also submitted that they believed that any project development inexperience of the Emmett Group could be ameliorated by a small scale staged development. In my opinion that belief was not well founded. The Emmett Group had itself described the project as the most ambitious project ever undertaken in South Australia because of its size and variety of uses to which the site would be put. Reliance on a small scale staged project also assumes that such a development plan would be economic. The Directors were not provided with any reasonable basis to ground such an assumption. Indeed, as events transpired, Mr Reichert noted in a memorandum dated 23 May 1989 that the Emmett Group had admitted that it was "not in a position to deliver the project in the macro format which recent events are indicating are appropriate".

Further, the non-executive directors submitted that the Board believed that speed and secrecy were essential to the success of the bid. While I accept that this may have been the Board's belief, that should not have been allowed to take precedence over the need to give adequate consideration to the submission. The urgency of the submission is not a reasonable basis for giving less than careful consideration to it before committing Beneficial Finance to the project.

In my opinion, in accepting the credit submission in the circumstances in which it was prepared and presented to them, the directors of Beneficial Finance failed to adequately and properly supervise, direct, and control the operations, affairs and transactions of Beneficial Finance.

It is probably the case that Beneficial Finance took some comfort from the fact that the Proposal Document had been prepared by Ayers Finniss, a subsidiary of the Bank. They should not have done so. Beneficial Finance should have looked much more critically and sceptically at the proposal from Ayers Finniss, which was acting for the Emmett Group. Ayers Finniss, despite being part of the State Bank Group, were not advisers to Beneficial Finance, and were not independent. They undertook no responsibility to safeguard the interests of Beneficial Finance.

It should be noted that my criticism of Management and of the Directors is not that they decided to participate in the joint venture. If Management had carefully and thoroughly analysed the risks associated with the venture, and if the directors had satisfied themselves that that had been done, then an informed decision to participate in the venture would not attract any criticism. It is not my role to second-guess business judgments which, with the benefit of hindsight, prove to have been unwise.

My criticism is that the decision was made without any reasonable analysis of the risks. The process by which the decision was made was most irregular, and precluded careful consideration of the submission. Management should have analysed the risks, but did not. The directors should have refused to accept the submission in the circumstances that it was presented to them.

31.3.4.3 A Review of the Approval of Facility by Beneficial Finance

In September 1990, the Management of Beneficial Finance presented to the Board of Directors a report titled "Lessons Learned from Problem Loans". The report included the results of a review of ten problem loans, including the East End Market facility. The review identified "the major elements of weakness evident" in the ten problem loans, and stated:

"The indicators, whilst by no means exhaustive, clearly demonstrate where we went wrong in each relationship. Whilst there is a degree of subjectivity in this identification process, it is evident that had we paid greater heed to the fundaments of analysis and critical evaluation, many of these problems may have been avoided."

The review identified as the major weaknesses in the East End Market facility:

(a) an "unquestioning willingness to approve" the facility;

(b) inadequate critical analysis of the project;

(c) the focus on the potentially high rewards from participation in the venture;

(d) Beneficial Finance's attraction to the project as a "big ticket deal";

(e) the by-passing of the credit risk evaluation process;

(f) an over-reliance on the continuation of favourable economic conditions;

(g) a failure to recognise the deterioration in the recoverability of the facility; and

(h) Beneficial Finance's lack of previous experience with transactions of the type involved in the East End Market facility.

31.3.4.4 Conflicts of Interest

Section 228 of the Companies Code requires a Director who is in any way, whether directly or indirectly, interested in a contract with the company of which he was a director, to declare the nature of his interest at a meeting of directors of the company. The section does not, however, preclude the director from voting, provided that the disclosure is made. Section 228(4) provides that a general notice of that nature is deemed to be a sufficient declaration of interest by a director.

Article 23(10)(h) of the Articles of Association of Beneficial Finance requires any director who is personally materially interested in some dealing with it to disclose his interest at a meeting of the Board. Article 23(10)(h) further provides that in those circumstances, the director may not vote on the question in which he was so interested.

Mr Simmons was one of the three directors who attended the meeting at which Beneficial Finance's participation in the East End Market project was approved. He was the only regular non-executive director in attendance, and acted as Chairman of the meeting.

As a shareholder in the East End Market Company, Mr Simmons stood to gain personally from the proposal, which involved the purchase of that company's shares for a price equivalent of $4.25 per share. The most recent price at which the shares had traded was only $3.20. He therefore had a personal and material interest in the matter being considered. Although the minutes of the meeting record that Mr Simmons declared his interest, they do not record that he refrained from voting. Mr Simmons told my investigation that it was not the practice during the time of his membership of the Board of Directors of Beneficial Finance for the minutes to record that a director who had declared an interest did not vote. He also said that he did not vote, and I accept that he did not. In fact, Mr Simmons said that no formal vote was taken at the meeting.

Nevertheless, having regard to all the circumstances, it was in my opinion most unwise of Mr Simmons to have attended the meeting at all. Mr Simmons told me that he would have preferred not to attend the meeting, but was pressed by Mr Baker to do so because, apart from Mr Baker, he was the only director "available at that stage". He said that he took part in the deliberations at the meeting only in the sense of "conducting the traffic of the meeting to get to a position where you could reach a consensus opinion or otherwise", and that he would "direct the nature of the discussion and ask some questions to see whether or not those matters had been attended to."

That was, in my opinion, unsatisfactory. The only other directors in attendance were Mr Baker, who sponsored the submission, and Mr Ottaway, an alternate director and an employee of the Bank. The handwritten record of the directors' responses presented to the meeting recorded Mr Simmons' "OK" of the proposal. No vote was taken at the meeting, with the decision being made on a consensus basis. Having regard to his material and personal interest in the proposal, Mr Simmons' participation in the meeting was imprudent.

The two directors who approved the submission, Mr Baker and Mr Ottaway were also directors of Ayers Finniss, which stood to gain a 2 per cent of the share of the joint venture company valued at $0.6M if the Beneficial Finance Board agreed to the take-over proposal and if the take-over succeeded.

Undoubtedly, however, the appointments of Mr Baker and Mr Ottaway as directors of Ayers Finniss were at some earlier time formally reported to a meeting of the Beneficial Finance Board. Accordingly, a general notice of their appointments as directors of Ayers Finniss was given to the directors of Beneficial Finance in accordance with Section 228(4) of the Companies Code.

I consider that, although Mr Baker and Mr Ottaway may have been materially interested in the business before the Board on 12 May 1988, they were not "personally" interested.

 

31.4 MANAGEMENT OF THE FACILITY

 

After approval of the credit submission by the directors, the joint venture company, Chepstow, was established, owned 49 per cent by Beneficial Finance, 49 per cent by the Emmett Group through a nominee company, Nettishall, and 2 per cent by Ayers Finniss. Beneficial Finance and Nettishall each subscribed $1.47M as paid up capital to Chepstow. Ayers Finniss was issued fully paid shares having a nominal value of $0.6M as its fee for acting for the Emmett Group.

In addition to the paid up capital, Beneficial Finance provided loans of $32.1M to Chepstow, in the form of a $4.0M sub-ordinated loan and $28.1M of other loans. At the time of the take-over it was intended to refinance Beneficial Finance's loans of $28.1M, but not the sub-ordinated loan of $4.0M, by obtaining new advances from a third party financier.

After the take-over, the joint venture company made applications to several financiers for replacement finance, including the State Bank, National Australia Bank and ANZ. State Bank declined to provide finance in excess of $21.7M, being 70 per cent of the site value of $31.0M.

On 24 June 1988, the ANZ agreed to provide a loan facility of $34.4M for a period of two years, subject to the following conditions:

(a) the amount drawn-down under the facility was not to exceed 80 per cent of the value of the site; and

(b) the facility was to be reduced to $20.0M by 31 March 1989.

Security for the ANZ facility included a first registered mortgage over the East End Market site, and letters of comfort from both Emmett Holdings Pty Ltd and Beneficial Finance that included an undertaking not to change the existing shareholding of Chepstow or the East End Market Company.

The initial drawdown of the ANZ facility was limited to $24.8M, being 80 per cent of the site valuation of $31.0M. The loan was in fact made to Manier Pty Ltd ("Manier"), a subsidiary of the East End Market Company. Manier then lent $24.8M to Beneficial Finance's "off-balance sheet company", Kabani Pty Ltd, which lent $24.8M to SBSA Finance Limited which, in turn, lent $24.8M to Beneficial Finance. This arrangement enabled Manier to generate a tax loss in respect of the interest paid on the loan. The tax loss was then transferred to East End Market Company to reduce its taxable income for 1988.

As I noted earlier, the Proposal Document presented to Beneficial Finance did not purport to address in detail the development of the site. On 25 May 1988, a meeting was held at the office of the solicitors for Beneficial Finance, Thomson Simmons, to consider the accounting and taxation implications for the East End Market Company. The meeting was attended by Mr Blunt of Beneficial Finance, Mr P Robinson of the East End Market Company, Mr J Tucker of Thomson Simmons and Mr D Sharpe of Touche Ross, Chartered Accountants. The minutes of the meeting, in part, read:

"To date no intention as to whether to hold or sell individual properties had been formed by EEM (either before or after development) ..."

On 26 May 1988, the first meeting of the directors of the joint venture company resolved that responsibility for obtaining development approvals for the East End Market site would be left to Mr Emmett. On the same day, the Board of Directors of Beneficial Finance received a report from Mr Martin, Business Development Manager of the Corporate division, advising them that:

"... development plans should be lodged with the Adelaide City Council by 30 June 1988 and the Joint Venture company should be in a position to proceed with a staged development early in the new financial year."

The City of Adelaide Planning Commission and the Adelaide City Council approved the original fourteen stage development programme in September 1988. On 5 October 1988, Baillieu Knight Frank provided a valuation of the site in excess of $44.0M, based upon the sale of the land as fourteen individual packages by way of sub-division. The report warned, however, that in the event of a wholesale sell-off, the sale price would be lower.

About that time, however, problems began to emerge.

First, Mr Emmett advised Beneficial Finance that he proposed to sell one half of his interest in the project to interests associated with the Farrugia family. This was done by selling half of the shares of Nettishall, the subsidiary of the Emmett Group that held the Group's shares in Chepstow, the joint venture company.

Second, and more ominously, the Emmett Group, as project manager, sought to "thoroughly rechallenge the existing plans" for development of the site, and in December 1988 asserted that "major amendments were required to be made to the existing planning approvals if the highest economic use is to be achieved for the site".⁽⁾

Meanwhile, the financing arrangements with ANZ were renegotiated in light of changes to the project. On 17 November 1988, ANZ agreed to what it described as "a significant departure" from the terms and conditions of the facility granted in June 1988. The East End Market Company requested ANZ to permit a drawdown of the full amount of the ANZ facility, $34.4M, on the basis of a site valuation of a minimum of $45.0M provided by Colliers International Property Consultants Pty Ltd. It also advised ANZ that, as a result of the company's amended strategy for the development of the site, the required reduction in the ANZ facility to $20.0M by 31 March 1989 might not be achieved.

ANZ agreed to the East End Market Company's request on condition that:

(a) The total facility was to be reviewed before 31 March 1989, with no commitment by ANZ to extend the facility beyond that date.

(b) That the development project was to be formally reviewed by ANZ in mid-February 1990, when the Directors of East End Market Company were to present to ANZ detailed information regarding all aspects of the development.

The ANZ facility was drawn down to the full amount of $34.4M on 30 November 1988.

In January 1989, the East End Market Company decided to re-evaluate the entire East End Market project. The re-evaluation process meant that almost every element of the project was starting again from scratch. In effect, the planning approval granted by the City of Adelaide in September 1988 was abandoned.

In February 1989, Nettishall, which represented the Emmett and Farrugia interests, decided to sell its interest in the project. The Emmett and Farrugia interests told Beneficial Finance that they did not have the financial capacity to participate as a 49 per cent shareholder in the complete development, which had a projected total cost in excess of $200.0M.

The Emmett Group stated that its reason for quitting the project was the project's "lack of fit" with the corporate direction of the Emmett Group. The Emmett Group had anticipated that the development would be undertaken quickly, and that it would receive substantial income as Project and Construction Manager and from the subsequent sale of parts of the development. Delays in the commencement of the development were imposing a financial strain on the Emmett Group.

Beneficial Finance actively sought new Joint Venture participants to replace the Emmett and Farrugia interests. As a result, several parties were identified as prospective Joint Venture participants, including Kinsmen Pty Ltd, Kinhill Engineers Pty Ltd, Parkhill Properties Pty Ltd and Sallmanns International Limited. Beneficial Finance's Board of Directors was not informed of Nettishall's desire to quit the East End Market project until 31 March 1989.

As anticipated, the reduction of the ANZ facility to $20.0M by 31 March 1989 did not occur. Both the development's financing requirements and the proposed joint venture participants had now changed significantly from those contained in the original proposal presented to ANZ. In those circumstances, ANZ was reluctant to extend its loan facility, but agreed on 30 March 1989 to provide additional funds (bringing the total to $41.9M) until 31 May 1989. ANZ required that during the period of the extension, the East End Market Company would provide a proposal for re-payment of ANZ's loan facility in full.

On 28 April 1989 two submissions were presented to the Beneficial Finance Board. One was a credit submission from the East End Market Company for a loan of $5.25M to be used for working capital requirements, with interest to be capitalised for the six month period of the loan. Security for the loan was to be a second Mortgage over the site.

The other submission, prepared by Mr A Bruce of Beneficial Finance's Investment Banking division, requested permission for Beneficial Finance to act as the agent for Nettishall to facilitate the sale of that company's shareholding in the East End Market Company. The submission stated that Beneficial Finance expected to introduce six new participants to purchase the whole of Nettishall's shareholding, and that depending upon final negotiations, Beneficial Finance might be able to reduce its own shareholding to 26 per cent of the East End Market Company.

The proposed sale price of Nettishall's interest was $18.0M, representing about half of the value of the site after deducting borrowings. The site value was based on two valuations - one in late April 1989 from Colliers of between $73.0M and $76.0M, and the other dated 2 May 1989 from Jones Lang Wootton of between $62.0M and $70.0M. The submission proposed that Beneficial Finance would lend up to 70 per cent of the purchase price to the incoming participants. The Beneficial Finance Board approved Mr Bruce's submission for the appointment of Beneficial Finance as Nettishall's agent, and granted permission for further negotiations with all parties. The approval did not, however, extend to the provision of finance to the proposed purchasers of Nettishall's interest.

On 1 May 1989, Nettishall agreed to the appointment of Beneficial Finance as its agent for the sale of its shares to the proposed new Joint Venture participants.

On the same day, ANZ requested repayment of its loan facility within thirty days, having concluded that subsequent to ANZ's original approval there had been substantial changes in both the nature of the project, and the shareholding in the development company. The most obvious source to refinance the ANZ facility was the State Bank. On 19 May 1989, the East End Market Company made application to the Bank for a bridging finance facility of $44.0M.

At the same time, Beneficial Finance in its capacity as the agent of Nettishall, pursued negotiations for the sale of the Nettishall's shareholding in the joint venture company to new participants. On 23 May 1989, Mr Reichert, in a memo to Mr Clark and Mr Baker, reported that Kinhill Engineers, Kinsmen, Sallmanns Limited and Parkhill Properties had each signed a contract to purchase Nettishall's shareholding, and that Nettishall had instructed Beneficial Finance, as its agent, to accept the contracts. The memorandum also noted that as part of the sale arrangements, Nettishall had agreed to reduce its sale price by $2.0M, and to purchase non-strategic land from the East End Market Company at its assessed market value. Mr Reichert's memorandum noted that:

"The Emmett Group and the Farrugia family admit that they are not in a position to deliver the project in the macro format which recent events are indicating are appropriate."

All contracts associated with the proposed sale of Nettishall's shares were signed, and settlement was due on 23 May 1989. The introduction of Kinhills, Kinsmen, Sallmanns and Parkhill Properties was perceived by the Management of Beneficial Finance as adding strength to the East End Market project. The new participants were believed to have greater financial backing, and to be able to contribute professional skills relevant to the development of the project. In particular, it was anticipated that the project and construction management functions previously undertaken by the Emmett Group would be performed by the new participants.

A major impediment to the introduction of the new joint venture participants was their requirement that Beneficial Finance provide the funds for their purchase of Nettishall's interest. The Beneficial Finance Board refused to approve the necessary advances.

The Beneficial Finance Board met to consider the advances on 26 May 1989, and refused to approve them. The transaction was due to settle on that day. The Board expressed concern regarding the level of risk which would be undertaken by Beneficial Finance if it took over ANZ's facility, and funded the new participants' entry into the project.

The decision of Beneficial Finance Board of Directors not to approve finance to allow the purchasers to complete the sale was stated in the Minutes to raise a possibility that Beneficial Finance could be subject to legal action by Nettishall, although the basis of the possible liability is not disclosed in the Minutes. The Board decided to appoint Mr Simmons as a sub-committee of the Board to review the transaction.

On 28 May 1989, Mr G J Yelland, Beneficial Finance Legal Counsel, advised Mr Simmons that based on a limited review of the relevant legal agreements and discussions with Beneficial Finance personnel, he had concluded that Beneficial Finance was vulnerable to legal action for breach of contract, negligence and breaches of Section 52 of the Trade Practices Act, in that Beneficial Finance may have engaged in misleading and deceptive conduct, associated with statements by Beneficial Finance about the timing and success of planning approvals and the availability and cost of accommodation in the completed project.

The decision of the Beneficial Finance Board to decline to approve the financing of the purchase of Nettishall's interest by the proposed new participants was notified to Mr Emmett and Mr Farrugia on 26 May 1989. A meeting between Mr Emmett, Mr D Farrugia, Mr P Farrugia, Mr B Hartwig, Mr Martin and Mr Reichert was held on 29 May 1989 at the office of Thomson Simmons. Reference was made during the meeting to Beneficial Finance's possible legal liability to Nettishall in respect of the agency arrangement.

ANZ's loan facility was due for repayment on 31 May 1989. On 30 May 1989, ANZ agreed to extend its facility until at least 9 June 1989, and possibly until 30 June 1989. The extension by ANZ of the facility until 30 June 1989 was dependent upon the State Bank providing to ANZ, by the next day, 31 May 1989, a letter giving an unqualified and specific undertaking to procure the repayment of the debt due to ANZ.

As at 31 May 1989, the Bank had not completed its review of the East End Market Company's credit application for the $44.0M bridging finance facility. ANZ's demands for repayment and for a "take out" letter from the Bank placed the Bank in a very difficult position. The Bank could not permit a company in which it held a controlling interest through its subsidiaries, Beneficial Finance and Ayers Finniss, to default on repayment of the ANZ loan facility. The consequences of loss as a result of a mortgagee sale of the site were a minor consideration compared with the potential loss of the Bank's credibility and reputation as a banker. Such a default may have harmed the Bank's ability to conduct business on an interbank basis and with other financial institutions. A default in repayment may also have been a breach of Beneficial Finance's Debenture Trust Deed.

On 31 May 1989, Mr Matthews, Chief General Manager of the Bank, wrote to ANZ confirming a commitment to provide finance to Beneficial Finance to enable it to repay the ANZ facility on 30 June 1989. The "take out" letter was issued by Mr Matthews despite the fact that the internal credit review of the East End Market Company's application had not been completed or presented to the Bank's Board of Directors for approval.

As at the beginning of June 1989, Beneficial Finance faced several problems concerning its participation in the East End Market project. The project was still subject to planning and design changes, and had not yet been granted new planning approval. The Emmett Group and Farrugia interests wanted to quit their participation in the East End Market project. Beneficial Finance was subject to a threat of legal action in respect of its performance of its functions as the agent of Nettishall to sell that company's interest to six new participants. ANZ had withdrawn its loan facility.

During late May and early June 1989, Beneficial Finance and Nettishall negotiated a Termination Agreement to dissolve the Joint Venture on 30 June 1989. Pursuant to the Agreement:

(a) Beneficial Finance purchased Nettishall's 49 per cent shareholding in the East End Market Company for $1.7M, making the East End Market Company a wholly owned subsidiary of Beneficial Finance.

(b) A termination fee of $2.1M was paid to the Emmett Group for termination of the Development and Management Contract.

(c) Nettishall purchased that portion of the development site located north of Rundle Street for $20.0M.

During June 1989, the Termination Agreement was the subject of several submissions to the Beneficial Finance Board.

On 13 June 1989, Mr Blunt prepared special Board submission No. 265, which requested approval from the Beneficial Finance Board for purchase of Nettishall's shareholding in the East End Market Company, sale of the northern portion of the site to Nettishall, and refinancing of the ANZ loan facility by the Bank. This submission was signed as approved by the Chairman of Beneficial Finance Board, Mr Barrett, on 14 June 1989.

A second submission dated 20 June 1989 was prepared by Mr Blunt for the Beneficial Finance Board sub-committee responsible for the development. Mr Blunt's submission reviewed the terms and conditions of the Agreement made between Beneficial Finance and Nettishall for the dissolution of the Joint Venture, and requested ratification of the Agreement which had been executed on Monday, 19 June 1989, and which had been approved by the Beneficial Finance Board sub-committee prior to execution. The full Beneficial Finance Board was informed of the transaction by a Board Paper dated 22 June 1989. The sub-committee proposal was ratified by the Beneficial Finance Board on 30 June 1989.

The Termination Agreement was also the subject of submissions within the Bank. On 20 June 1989, a credit application was prepared for submission to the Bank Lending Credit Committee. The credit application, prepared by Mr M Shipp, Manager Corporate Finance, proposed that the Lending Credit Committee recommend to the Board of Directors approval of a $41.9M bridging finance facility for the East End Market Company. The submission stated that the purpose of the facility was to repay the ANZ loan facility, which was due for repayment on 30 June 1989, and to permit the termination of the existing Joint Venture arrangements on the terms referred to above.

The State Bank documents that have been examined by me indicate a realisation that the credit application would not normally have been accepted by the Bank. Under the topic of "Risk Assessment", Mr Shipp stated as follows:

"RISK ASSESSMENT

Under normal circumstances, corporate banking could not support a recommendation to approve funding to the East End Market redevelopment until many of the issues presently outstanding have been determined, e.g.

. final form of project concept and feasibility;

. independent valuations concerning security cover on an "as is" basis and with development approvals in place;

. project participants, e.g. JV participants, financial strength, project consultants, etc.;

. pre-commitments;

. end take out prospects;

. the opportunity to undertake full assessment of the project's viability.

This proposal is only being submitted for consideration by the Lending Credit Committee on the basis of the "group's" involvement and the undertaking given by the Bank to ANZ to provide funding to enable the East End Market Company Ltd. to pay out the ANZ loan by 30 June 1989.

CONCLUSION

As a full and thorough assessment of the project's feasibility and debt servicing capability has not been possible at this time, no recommendation on approval based on credit assessment is offered by Corporate Banking. It is suggested that the Lending Credit Committee may consider approval of funding as outlined above as being prudent given the State Bank group consideration." (Emphasis added)

Another submission also prepared on 20 June 1989 by Mr P F Mullins, Chief Manager Corporate Banking, expressed similar concerns. Although Mr Mullins recommended that the Bank Board approve the facility to Beneficial Finance, his report clearly stated that the recommendation was based upon strategic reasons. Mr Mullins stated, under the topic of "General Comments":

"Approval of the liquidity scheme by alliance facility is considered strategically important to ensure BFC's liquidity in the short term and to allow the company to continue to borrow from the market on favourable terms without being totally dependent upon liquidity lines external to the group. It should be noted that the acceptability of this increase as a credit risk is predicated solely upon the Bank's ownership of BFC. Should BFC have been an external borrower, we should not have been looking to increase our exposure at this time."

On 21 June 1989, Mr Clark is reported to have expressed concern about the proposal by the Bank to refinance the ANZ loan facility. In a file note prepared by Mr Blunt and distributed to Mr Baker, Mr Reichert and Mr Martin, Mr Clark is reported to have stated that:

"... State Bank are over-exposed to Beneficial and that no new or additional facilities for Beneficial will be approved."

On 30 June 1989, the Bank provided $41.9M to repay ANZ. $15.8M of that facility was to be repaid from the proceeds of sale of the northern site from East End Market Company to Nettishall, which was completed on 27 December 1989.

On 25 January 1990, Beneficial Finance paid to the Bank the remaining $26.1M. Approval for repayment of the Bank was provided by Mr Baker on 11 January 1990 without reference to the Beneficial Finance Board.

 

31.5 FINDINGS AND CONCLUSIONS

 

Management of Beneficial Finance, particularly Mr Baker, Mr Reichert and Mr Martin, failed to make proper, reasonable and necessary enquiries into the contents of the proposal received from Ayers Finniss, in that they did not subject to scrutiny the statements, assumptions and analyses contained in the Proposal Document. Management adopted without adequate enquiry, and recommended to the Board, the proposal received from Ayers Finniss. The proposal had been prepared by Ayers Finniss to advance the interests of its client, the Emmett Group of companies. The Proposal Document minimised the difficulties of the project, and risks attaching to the project were ignored or minimised. The consequence was that the credit submission presented to the directors failed to point out the risks inherent in the proposal.

No effort was made by Beneficial Finance Management to determine whether the price at which the shares were offered was the lowest price at which the existing shareholders would sell. Inadequate consideration was given to the various risks associated with the project that, in the event, imposed lengthy delay on the development. No adequate consideration was given to a cyclical reduction in property values, or to Beneficial Finance's total property exposure.

The directors of Beneficial Finance (with the exception of Mr Baker) had a difficult decision forced upon them at little more than twenty four hours notice. The timing of the submission to the Board, linked to the threat of competitive bids from other unidentified interested parties, forced the Board to deal with the proposal urgently. The Board meeting at which the decision to participate in the Joint Venture for the take-over was approved, was attended by only three directors; the Managing Director, the Chairman who did not participate in the decision, and an alternate director. Eight other directors expressed opinions about the proposal; two warned of the risks associated with planning requirements and opposition from heritage groups; seven were prepared to endorse the proposal.

The Directors failed to adequately assess the submission from Management. A careful assessment by the directors was particularly important, because the submission had not been reviewed and recommended by the credit committee as required by Beneficial Finance's internal procedures. It was incumbent upon the directors to ensure that adequate time was made available for their examination of the matter. If they had considered that further time was required then consideration of the submission should have been deferred or the submission refused.

 

31.6 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT

 

I have investigated and inquired into matters relating to the East End Market Joint Venture in accordance with my Terms of Appointment. Having regard to all the available evidence and for the reasons indicated in this Chapter, I hereby report as follows:

31.6.1 TERM OF APPOINTMENT A

31.6.1.1 Term of Appointment A(b)

The processes described in this Chapter in relation to the initiation, assessment, approval and establishment of Beneficial Finance's interest in the East End Market joint venture led Beneficial Finance to engage in operations which resulted in material losses and in Beneficial Finance holding significant assets that were non-performing were inappropriate.

31.6.1.2 Term of Appointment A(c)

For the reasons described in this Chapter, those processes were not appropriate.

31.6.1.3 Term of Appointment A(h)

I am of the opinion, for the reasons stated in this Chapter, that Mr Baker, Mr Reichert and Mr Martin failed to exercise proper care and diligence in the performance of their duties as officers of Beneficial Finance in that they failed to subject the proposal to any adequate independent assessment or review before recommending that it was approved by the directors of the company.

31.6.2 TERM OF APPOINTMENT C

As to my Term of Appointment C, I am of the opinion that, for the reasons detailed in this Chapter, the operations, affairs and transactions involved in the participation of Beneficial Finance in the East End Market Joint Venture were not adequately and properly supervised, directed, and controlled by:

(a) the directors of Beneficial Finance; and

(b) the officers of Beneficial Finance, particularly Mr Baker, Mr Reichert and Mr Martin.