Fair Value defined in forced share sale
Shareholder dispute over share valuation.
It’s a fairly common scenario. The two shareholders in a small company agree that they can no longer work together and that one must buy out the other. However, they cannot agree on the value to be attributed to the shares that are to change hands and there is no shareholders’ agreement, nor anything in the company’s articles of association that resolves the matter.
Unless the parties can somehow find a way to bridge the gap, or unless circumstances exist that enable one or other party to bring legal action such as a petition alleging unfair prejudice or perhaps a petition seeking the just and equitable winding up of the company, indefinite stalemate can be the result.
In the case of Re Euro Accessories Limited, which was the subject of a judgment in High Court proceedings in January 2021, the majority shareholder, G, (who held 75.01% of the company’s issued shares) addressed the position by passing a special resolution which, whilst its mechanics involved re-classification of the shares as A and B shares, had the practical effect of enabling him to force a sale of the minority shareholder’s shares “for fair value”. Having passed such a resolution, G served notice on the minority shareholder, M, requiring the latter to transfer his shares to G for what G believed to be their fair value, being £175,000. M considered, however, that his shares were worth £350,000, so he refused to sign the stock transfer form presented by G and did not cash G’s cheque for £175,000. Faced with this refusal, G signed the stock transfer form himself, as a director, as the amended articles permitted.
M then presented a petition under section 994 of the Companies Act 2006, contending that G had acted in a manner that was unfairly prejudicial to M’s interests as a minority shareholder. He contended that “fair value” in the amended articles meant that he was entitled to be paid an amount for his 24.99% minority shareholding which was calculated pro rata to the value of the entire issued share capital in the company and that by expropriating his shares for a discounted sum, G had acted in just such an unfairly prejudicial manner. He had secured a windfall, in the form of the pro rata value of the shares at a discounted price. M’s main contention was that the articles had to be construed in light of the fact that they gave G an unrestricted option to take M’s shares at will, exercisable without cause and at any time of his choosing. He argued that this meant that no reasonable businessman, viewing the matter from the outside, would think that the shares could be acquired on the fictional basis that M would be a willing seller and hence be subject to the sort of discount that might normally apply in such a situation: an adjustment had to be made to mitigate the consequences of such an unrestricted right of expropriation.
M did not challenge G’s right to pass the special resolution requiring him to transfer his shares for their fair value at the transfer date.
The parties jointly instructed an expert Chartered Accountant to value the company as at the agreed transfer date and to report on the appropriate discount to be applied, if it was appropriate to value M’s shares on a discounted basis to reflect a minority holding, assuming a sale in the open market on the transfer date. Her conclusion was that the company was worth £2.18 million, so that on a pro-rata basis, M’s 24.99% shareholding was worth £545,000. But if it were appropriate to apply a minority discount, she thought that a 55% discount should be applied, resulting in a value of £245,000.
G submitted that the natural reading of “fair value” is the fair value for the thing that is being bought and sold, and that once it is identified that the subject matter of the sale is a minority shareholding, it follows that a discount is appropriate to reflect the well-established disadvantages of a minority shareholding in a private company. There was nothing in the wording of the articles, nor any other admissible factual background, to justify any restriction on the ability of G to exercise the option according to its terms, or to require him to pay anything more than a discounted basis for M’s shares.
The court observed that the articles are a statutory contract between the members, and between each member and the company. They must therefore be construed in accordance with the ordinary principles that apply to the interpretation of any written contract. When interpreting a written contract, the court has to identify the intention of the parties by reference to what a reasonable person, having all the background knowledge which would have been available to the parties, would have understood them to be using the language in the contract to mean. That meaning has to be assessed in the light of the natural and ordinary meaning of the words in the clause, any other relevant provision of the contract (or articles, in this instance), the overall purpose of the clause, the facts and circumstances known or assumed by the parties at the time that the document was executed, and commercial common sense. But it should disregard subjective evidence of any party’s true intentions.
It also observed that the articles of association of a company are generally not the product of a process of negotiation between all of the shareholders. They have to be registered as a public document at Companies House. So, unlike a private contract, the articles have to be understood by anyone who inspects the register at Companies House. Because the articles are addressed to anyone who wishes to inspect them, the admissible background for the purposes of construction must be limited to what any ordinary reader would reasonably be supposed to know based upon public filings at Companies House and commercial common sense. It cannot include other facts which were known only to some of the people involved in the formation of the company
Here, it would have been apparent to any third party that the company was a private company, that it had originally been wholly owned by G, that M had become the company secretary in 2007 and a second shareholder in 2008, and that he had resigned as secretary in 2010. It would also be apparent that at the time that the relevant special resolutions were passed altering the share capital and adopting the new articles, the right to exercise the option was introduced by G as the 75.01% shareholder in respect of the shares held by M as the 24.99% shareholder. It was obvious from the terms of the amended article that its purpose was to give the majority shareholder an option to require the minority shareholder to sell his shares to him.
On the basis of past case law, there was a clear statement of general principle that unless there are indications to the contrary in the relevant instrument establishing the right of acquisition, the general principle of share valuation is that what must be given a “fair value” is what is being compulsorily transferred. This has the result that unless there is a contrary indication, the transferor cannot insist on being paid by the transferee for something to which his shares do not entitle him and that he does not own. He therefore cannot insist on payment for a proportionate part of the controlling stake, or a pro rata part of the value of the company’s net assets or business undertaking, as M sought here.
Here, there were no indications to the contrary in the articles. In the court’s view, M’s argument essentially boiled down to whether the fact that the option was exercisable at any time by the majority shareholder, together with the fact that M had not agreed to the amendment of the articles, was sufficient “indication to the contrary” to take this case out of the general principle of valuation. And in the court’s view, the answer to that question was that it could not.
The court did go on to consider whether the unfair prejudice jurisdiction could assist M, particularly under section 996(2)(e) of the Companies Act 2006. A court could, in theory, order G to purchase M’s shares, but this only applies where there has been a finding of unfairly prejudicial conduct. The court commented that such a finding is not generally available where the conduct of the majority is in accordance with the company’s articles, and that it is not available simply because the relationship between shareholders has broken down. In such cases, the petitioner must establish some unfairness based on established equitable principles. In any event, it is a matter for the court’s discretion and there is no statutory requirement that any purchase of shares ordered under section 996(2)(e) must be on a non-discounted basis: only that the order made must be fair in all the circumstances in order to provide a remedy that is proportionate to the unfair prejudice that has been suffered.
Amongst the ways of avoiding costly litigation over share valuations are firstly, to define valuation terms clearly and precisely so as, ideally, to leave no room for argument: secondly, to include a suitable clause that provides for binding expert determination to resolve any disputes.
Disclaimer: this article is not to be relied upon as legal advice. The circumstances of each case differ and legal advice specific to the individual case should always be sought.