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The former CFO of failed technology retailer Dick Smith, Michael Potts, has been ordered by the NSW Supreme Court to fork out A$43 million plus interest to National Australia Bank (NAB) following allegations of misleading and deceptive conduct.
Potts was the retailer’s CFO from 2013 until its spectacular demise in 2016.
Initially, Dick Smith Holdings (DSH) receivers, Ferrier Hodgson, pursued eight former directors and executives of the collapsed electronics retailer with a damages claim worth millions in March 2017, alleging that the former directors and executives breached their duties by failing to implement an “adequate system” related to rebates and inventory management.
The legal action alleges that Dick Smith’s earnings in 2015 were inflated thanks to the use of a “rebate maximising” strategy that compelled managers to make stock purchasing decisions based on rebates instead of customer demand.
The initial statement of claim took aim at former executives Nick Abboud, who was CEO, and Potts, as well as former directors Bill Wavish, Jamie Tomlinson, Rob Murray and Phil Cave.
Two banks associated with DSH — NAB and HSBC — decided to pursue Potts along with Abboud in relation to the misleading and deceptive conduct in which they were alleged to have engaged, in connection with the syndicated facility and extension agreement, which is said to have "induced the banks to enter those agreements", according to court documents.
In June 2015, the retailer replaced its Westpac facility with a syndicated facility agreement and associated agreements with NAB and HSBC, where NAB agreed to provide working capital facilities to DSH up to a total commitment of A$75 million and HSBC agreed to provide an overdraft financing facility to DSH up to a total commitment of A$60 million. On 16 November 2015, HSBC agreed to increase its total commitment from A$60 million to A$80 million until January 2016.
Accordingly, Justice Michael Ball found that NAB advanced money as a result of misleading and deceptive conduct in exchange for a promise to repay that money and security, and that Potts did engage in misleading conduct when he said that the increase in the overdraft with HSBC was to fund the acquisition of additional stock for the Boxing Day sales.
“Even if that was literally true, that state of affairs had come about because DSH was facing serious problems with its liquidity. DSH was overstocked and sales had declined substantially. If it required additional stock that was because it was overstocked with product that was selling poorly,” Justice Ball said.
“To say that DSH needed a temporary increase in its facility to buy additional stock for the Boxing Day sales suggested that the business was otherwise performing satisfactorily and DSH wanted additional funds to capitalise on an opportunity. The true position was that it needed additional funds because it was in financial difficulties.”
Justice Ball said at the time DSH requested an increase in the facility limit, it was facing serious liquidity problems.
“In my opinion, if Potts had disclosed that the reason DSH wanted an increase in its facility was because it was facing serious liquidity problems, HSBC would not have entered into the Extension Agreement on the terms that it did. But it may well still have granted an extension on some terms,” Justice Ball said.
“Support for that conclusion can be found in the reaction of the banks when DSH announced that it was taking a provision of A$60 million and Potts asked for an extension of the temporary increase in the facility limit.
“The banks did not refuse that extension. Instead, they placed tight restrictions on DSH and monitored DSH’s financial position closely. It is true that by that stage the money had been advanced. It is one thing for a lender to agree to an extension of a loan already made. It is quite another for it to agree to lend additional money.”
As NAB agreed to extend its overdraft facility to the retailer of A$20 million, one of the conditions was that no draws could be used to repay or reduce finance debt including unsecured lines of credit provided by Macquarie Bank.
In December 2015, Dick Smith drew down the HSBC overdraft facility to pay A$9.961 million and a further A$1.195 million to pay Macquarie Bank. NAB then notified Dick Smith that it had breached the terms of its syndicated facility by making payments to Macquarie and requested to remedy the breach in 10 business days.
Unable to remedy the breach or reach an agreement with the banks, the board resolved to place Dick Smith and its subsidiaries into voluntary administration on 4 January 2016, appointing Ferrier Hodgson at the time.
Both banks claimed the total amount owing to them at the time Dick Smith went into voluntary administration was A$124.89 million, less the amounts recovered during receivership which, depending how those amounts were held by the receivers and treatment of legal costs, was between A$50 million to A$92 million.
In the most recent receiver's report dated 7 November 2018, it estimated a deficit in the return to the banks of between A$72.70 million and A$75.52 million.
The retailer’s auditor, Deloitte, was also dragged into the proceedings, but the case was dismissed, along with HSBC as the retailer did manager to reduce its debt from A$77.8 million to A$50 million as receivers were appointed.
The conduct that the banks claimed was misleading and deceptive involved the misstatements of Dick Smith’s financial position and failure to disclose its dependence on ‘over and above’ (O&A) rebates and the effect those rebates had on the retailer’s quality and level of stock.
The rebates scheme unravels
Justice Ball claimed that both Abboud and Potts breached their duties under section 180 of the Corporations Act and their duties at Common Law by adopting the scheme to maximise rebates, particularly O&A rebates, without putting adequate procedures in place.
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