The 26 February 2018 appeal decision by the Federal Court of Australia in Chowder Bay Pty Ltd v Paganin resulted in the valuer and the developer dodging a bullet by the skin of their teeth. Six investors had sued the valuer on the basis his valuation of the project at $67.8 million was misleading and deceptive, this resulted in the bank advancing money to the developer, which in turn resulted in a loss to the investors. They argued if the valuation was accurate (about $45.5 million), the bank would not have financed the development and they would have sold the undeveloped land and recovered their money.
The argument failed because the valuers had qualified their valuation and the bank was a sophisticated user of valuations. The outcome may have been different had the end user of the valuation not been as sophisticated as the bank.
Twenty-three investors had each invested $500,000 into a project involving the development of a former caravan park in Western Australia into a residential resort. The investors were to receive one residential apartment each on sale of the remaining development and the developer was to receive several apartments. The bank was to finance about 45% of the sale price of all of the apartments. When arranging the valuation the developer gave the valuer a list showing the sale prices of the apartments and the 23 apartments to be given to the investors as “sold”. The valuer seemed to be unaware of the true consideration for those “sales” but ultimately was aware they were to investors and inserted appropriate qualifications into the valuation.
The developer defaulted when sales of the remaining apartments were not sufficient to repay the loan before it expired. The bank appointed a receiver to the development and sold the apartments.
When assessing the merits of the claim, the trial judge examined all of the circumstances surrounding the valuation and found that the bank was not mislead or deceived as the assumptions and qualification by the valuer were clearly expressed. The bank’s knowledge of the transaction and its sophistication as a user of valuations were factors in this decision as was the qualification in the second valuation to the effect that the valuer had not seen the presale contracts and that the bank should confirm them.
The Court of Appeal supported the Judge’s reasoning in this regard and upheld the decision that the valuation did not mislead the bank. As a result, the case failed from an investor perspective.
Lessons from the case
Valuers need to consider to whom they are addressing their valuation and where appropriate to include sufficient explanation of unusual features and qualifications relevant to the degree of sophistication of the recipient.
Financiers should be aware of the basis for assumptions made by a valuer and specifically check matters raised by the valuer in any qualifications to the valuation.
In this instance the argument was narrow and focussed on the valuation. A similar argument could have been raised by the investors to the effect that “they made a loss because the bank was negligent in making the loan. Had the bank been diligent and acted on the qualification they would not have made the loan and the investors would have recovered their money from sale of the undeveloped land.” Unfortunately the argument that “the bank should not have lent me the money” arises too frequently for financiers to ignore this point.
Developers, directors and their management must make sure that they fully and frankly advise valuers when instructing them. They should also ensure their financiers are fully and frankly advised of the nature of any special arrangements.
Here the bank’s risk was that the sale of the remaining units did not occur in time to repay the loan. Although there was sufficient equity to protect the bank, had the developer been diligent, the issue could have been dealt with before the loan was drawn and the outcome for the developer and investors would have been different.
The developer and one of its directors misled the valuer by not advising the nature of the arrangements with investors described in the valuation as “pre-sales”. They were aware of the issue by the time of the second valuation.
It’s possible they also mislead the bank as to the nature of the “pre-sales” to investors. This was not argued and nothing turned on the finding against the director and developer as the link with the loss claimed by the investors was broken (the valuer had not misled the bank). Had the outcome been different, the directors would have been liable for at least part of the loss.
This scheme had more than 20 investors. If the investors each had paid less than $500,000 it would be a managed investment scheme requiring registration with ASIC. This was not relevant to the case above but we recommend that developers and others raising funds using trusts or other forms of investment vehicle check that their activities comply with the laws regarding managed investments.