Skip to content

How business risks affect compensation for compulsory acquisition.

23/11/2016

Mr Taylor owned a small blueberry farm with 4 acres of vines. It was very profitable.  In FY15, it yielded 65 tonnes of blueberries for a gross profit of $10.36 per kilogramme.  The farm was acquired by  the NSW Government to accommodate an upgrade of the Pacific Highway near Ballina.  Market value was agreed, but his business losses fell to be determined by the Land and Environment Court.

Following the compulsory acquisition, Mr Taylor bought another property and replanted his vines.  It would take four years for the new plantation to reach the same level of production.

The problem was that blueberry production is cyclical.  Vines have a productive life of Image result for blueberry farmten years.  They bear more fruit in the middle of that period than in the early or late years.   However, the compulsory acquisition legislation does not specify any particular time frame for assessment of lost profits. Mr Taylor calculated his lost profit over the four years it would take to re-establish production at the same level.  That  period coincided with the most productive and profitable period in the lifecycle of his vines.

In contrast, RMS took a long term view and analysed a twenty  year projection, reflecting two growth cycles and the point when the present value of the cash flow became nominal.  But Pain J thought that was too distant from the applicant’s immediate loss resulting from the acquisition.  She preferred to analyse the profit lost until production returned to pre-acquisition levels.

The Court only has power to order payment of a lump sum as compensation for those lost future profits.   Those profits had to be discounted to bring them back to their present value.   It adopted a discount rate of just 2.5% p.a, which was the rate that Mr Taylor would have earned if the compensation money had been invested in a CBA term deposit at the date of the compulsory acquisition.    That was more appropriate than a rate reflecting the cost of borrowing money (such as the Australian Government bond 10Y rate).

RMS also argued that the future profits should be further discounted by 25% p.a.post-tax to reflect the risk that they might not be realised.

That partly reflected the specific hazards facing Mr Taylor’s business, such as hailstorms, pest infestations, the cost of itinerant labour, market oversupply or collapse in demand. An investor will demand a greater return to reflect the chance that those events will affect profits.

Investors in business enterprises also demand higher returns  in comparison to risk-free alternatives because their capital is in greater jeopardy.  That market risk premium can be derived from benchmark indices which reflect the additional returns achieved over the long term from  investment in a balanced portfolio of equities.  There are even greater risks attaching to investment in small businesses, compared to  large, diversified widely-held, listed companies.  That greater risk demands an additional premium on return.

But, in the Court’s view, those risk premiums should not be applied in this case.  It was unlikely that any of those risks would materialise in the short period during which profits were projected.  In fact, none of the specific hazards had adversely impacted the farming enterprise prior to the trial.  A size premium was not warranted for a business as profitable as blueberry farming with limited apparent risks.  In any event, the applicant had plans to manage all the risks.  Pain J declined to discount Mr Taylor’s expected future profits because she treated his business as essentially risk-free.
This case provides some insight for other small businesses displaced by Government infrastructure projects.  It is unusually unproductive to be portrayed as financially challenged in an  effort to gain the sympathy of  an acquiring authority.  That approach may lead to significant discounting of the amount of compensation.  This decision illustrates the benefit of presenting as a strong, stable, well-managed, risk-free enterprise assured of future profitability.
Read all the reasons for judgement in Taylor v RMS [2016] NSWLEC 138.
Advertisements

Comments are closed.