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24 Feb 2021

Compulsory Share Acquisitions: What is a “fair value”?

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Where a Company’s Articles of Association confer a right to compulsorily buy out a shareholder’s shares for “fair value”, how should that value to be determined?

That was the question recently determined by Mr Justice Snowden in In the matter of Euro Accessories Ltd [2021] EWHC 47 (Ch). In summary, he held that where a minority shareholding was being compulsorily acquired for “fair value”, the value of those shares should be discounted to reflect the fact that the shares comprised only a minority shareholding (and were not to be valued as a pro rata share of the Company’s overall value or given some other hypothetical value).

This reflects a general principle of share valuation that the “fair value” of shares being compulsorily acquired is the actual value of those shares. Unless the relevant contract conferring the right to compulsorily acquire those shares (in this case the Articles of Association) indicates that a different interpretation applies, such shares fall to be valued in accordance with this general principle.  

The facts

Euro Accessories Limited (the “Company”) had two individual shareholders: one with a 24.99% stake (the “Minority Shareholder”) and one with a 75.01% stake (the “Majority Shareholder”). 

After the relationship between the two shareholders broke down, the Minority Shareholder, who was employed by the Company, resigned. Negotiations then began for the Majority Shareholder to purchase the Minority Shareholder’s stake. However, no agreement could be reached on the price. The Minority Shareholder valued his shares at £350,000 whereas the Majority Shareholder’s final offer was for £175,000.

The Majority Shareholder subsequently used his majority control in the Company to impose a solution: he proposed and passed a series of special resolutions which had the effect of amending the Articles of Association by inserting a new Article1 conferring a right on him to forcibly acquire the Minority Shareholder’s shares at any time for “fair value” (the “Buy-Out Option”). The Majority Shareholder then purported to exercise the Buy-Out Option and sent the Minority Shareholder a series of cheques of £175,000 for payment of the shares, presumably representing what he considered to be the “fair value” for those shares, along with a stock transfer form for his execution. Those cheques were not cashed, and the Minority Shareholder refused to execute the stock transfer form.

The claim

The Minority Shareholder issued an unfair prejudice petition (under section 994 of the Companies Act 2006) alleging that the expropriation of his shares was at less than “fair value”. However, he did not challenge the right of the Majority Shareholder to amend the Articles of Association by inserting the Buy-Out Option.

The question for Snowden J was whether the Minority Shareholder’s shares should be valued on the basis of the following: (i) a pro rata proportion of the total value of the issued share capital of the Company (which, on the basis of the evidence of the parties' jointly appointed valuer, would result in a share valuation of £545,000) as the Minority Shareholder submitted; (ii) with a discount applied to reflect the fact that the shares comprised only a minority shareholding (which, on that same valuation, would result in a significantly reduced share valuation of £245,000) as the Majority Shareholder submitted; or (iii) some other hypothetical value.

The decision

The Court held that the “fair value” of the Minority Shareholder’s shares was the value that reflected the fact that the shares were a minority shareholding; the Minority Shareholder had no entitlement to a pro rata proportion of the Company’s overall value. The effect of this was that the Minority Shareholder was entitled to receive the value of what he possessed (and was not entitled to a valuation which would otherwise attribute any part of the ‘control’ value which belonged to the Majority Shareholder).

Snowden J’s reasoning was, in essence, as follows.

The principles of interpretation applicable to Articles of Association

A company’s Articles of Association should be construed in accordance with the ordinary principles that apply to the interpretation of any written contract (which, in broad terms entitle a Court to consider what was intended by the parties to the contract by reference to certain background information), save that a company’s Articles of Association cannot be treated in quite the same way as a private contract and there is a limit to the extent to which background information can be taken into account in construing the true meaning of the words in question2.

Accordingly, the interpretation of a company’s Articles of Association involved looking at the natural meaning of the words in question, any readily ascertainable facts about the company (including from documents filed on Companies House) and commercial common sense3.

Here, there was limited background information which could assist Snowden J in interpreting the meaning of “fair value”. In particular, the breakdown in the relationship between the two shareholders was not admissible background information (since that would not be apparent from any of the documents on the public register). The most that an astute and assiduous reader would be able to deduce from any readily ascertainable documents was that the Minority Shareholder might not have agreed to the inclusion of a right by the Majority Shareholder to acquire his shares (given that the Minority Shareholder’s signature did not appear on the relevant special resolutions).

Construing the words used in the Buy-Out Option

Against this background, Snowden J turned to the words used in the Buy-Out Option. This stated that what had to be “fair value” was the price payable for the shares to be compulsorily acquired. In other words, the wording of the Buy-Out Option focussed on the value of the Minority Shareholder’s shares.

This construction was consistent with the general principle of share valuation that what must be given a “fair value” is what is being compulsorily acquired, unless there are indications to the contrary in the relevant document or instrument4. In this case: (i) what was being compulsorily acquired was a minority shareholding (and not a controlling stake); and (ii) there were no indications to the contrary which would displace that general principle. To that end:

  • The fact that the right to compulsorily acquire the Minority Shareholder’s shares was exercisable at any time, and that the Minority Shareholder did not agree to the amendment of the Articles of Association by inserting the Buy-Out Option, were not indications to the contrary; and
  • There was no indication in the words used in the Buy-Out Option of an intention to incorporate an alternative definition: in particular, there was no indication that the 2013 definition of “fair value” in the International Valuation Standards published by the International Valuation Standards Council (the "IVSC") was intended to apply (such that Snowden J should take into account the alleged advantage secured by the Majority Shareholder in obtaining full control of the Company)5. Moreover, even if that definition could be treated as relevant background evidence, “it would [not] be reasonable to suppose that any general reader… would know of the 2013 IVS Definition so as to make the connection with it”. In any event, the Majority Shareholder already had a 75.1% share in the company with substantial control of the Company; he had not, therefore, secured a windfall in the form of the pro rata value of the shares by exercising the Buy-Out Option (as was alleged)6.

It was also commercially implausible that in exercising the Buy-Out Option, the Majority Shareholder was required to take into account certain equitable factors when specifying the consideration payable for those shares7.

Comment

This decision brings welcome clarification on how the value of shares, which are to be acquired for “fair value” pursuant to a contractual right of compulsory acquisition (including in a company’s Articles of Association), is to be determined.

It is now clear that, unless the contract which confers the right to acquire the shares for “fair value” indicates otherwise, the value to be attributed to those shares is no more than their actual value. There is no basis for seeking to attribute to such shares a pro rata share of the company’s overall value or some other hypothetical value by reference to equitable or other factors. Further, where the right to compulsorily acquire the shares in question is contained in a company’s Articles of Association, it is unlikely that the circumstances in which that provision came to exist will amount to relevant background information for the purposes of construing that provision.

Nevertheless, the ordinary reader would be forgiven for assuming that the word “fair” does in some way qualify the actual value of those shares, particularly in circumstances where the acquiror of those shares would thereby acquire a controlling stake in the company at a discounted price. Given that the compulsory acquisition of shares can come as unwelcome news to the shareholder whose shares are being acquired (and/or be perceived with hostility), the risk of challenge to the valuation of those shares should be readily anticipated.

It would therefore be prudent, as this decision underlines, to clearly specify in the relevant contract how the shares are to be valued in the event of any compulsory acquisition in order to seek to limit the scope for any dispute. For example, this may include:

  • Specifying how the value of such shares is to be determined by reference to specific industry standards (e.g. the IVSC's current standards or other prevailing accounting standards) or to a clearly laid out formula or metric (which sets out any special accounting treatment required such as discounts or an uplift to be applied to minority stakes), along with worked examples where necessary8; and/or
  • Stipulating that the valuation of the shares to be acquired is to be determined by an independent expert whose decision is to be binding on the parties (in the absence of manifest error).

The inclusion of such provisions is likely to remove any appearance of bias that would otherwise exist where the acquiring shareholder purports to determine the value of those shares, and more fundamentally, minimises the risk of the parties having to resort to costly and time-consuming litigation in resolving a valuation dispute, as was necessary in the instant case.

Finally, it is also worth noting that it is unclear why the Minority Shareholder elected not to challenge the amendments made to the Articles of Association by which the Buy-Out Clause was inserted (which, on the face of it, could have been challenged as unfairly prejudicial on the basis that these amendments were made for the benefit of the Majority Shareholder and not for the benefit of the Company). Had such a claim succeeded, it could, in principle, have resulted in the Court ordering valuation of the Minority Shareholder's shares on an alternative basis without regard to the express wording of the Buy-Out Clause.

 


1 The relevant provision provided (emphasis added):

"6A The B Shareholder may at anytime be required to transfer all their shares ("Sale Shares") to the A Shareholders ("Sale Option").

6A 1 The A Shareholder may only have the right to acquire the Sale Shares by giving written notice to the B Shareholder ("Option Notice") at any time before the transfer of the Sale Shares to the A Shareholder. The Option Notice shall specify

(a) that the B Shareholder is required to transfer all his Shares pursuant to this Article 6A,

(b) the consideration payable for the Sale Shares which shall be for fair value, and

(c) the proposed date of transfer ("Transfer Date") which shall be such date as the A Shareholder may specify.

6A 2 On the Transfer Date the B Shareholder shall deliver a stock transfer form for the Sale Shares, together with the relevant Share Certificates (or a suitable indemnity for any lost Share Certificates) to the A Shareholder against payment of the amounts that are due for the Sale Shares pursuant to Article 6A 1(b).

6A 3 If any B Shareholder does not on the Transfer Date execute the stock transfer form in respect of the Sale Shares held by it, the defaulting B Shareholder shall be deemed to have irrevocably appointed any Director to be his agent and attorney to execute all necessary transfer(s) on his behalf, against receipt by the Company (on trust for such B Shareholder) of the consideration payable for the Sale Shares, to deliver such transfer(s) to the A Shareholder (or as they may direct) as the holder thereof. After the A Shareholder (or its nominee) has been registered as the holder, the validity of such proceedings shall not be questioned by any such person. Failure to produce a share certificate shall not impede the registration of the Sale Shares under this Article."

2 This is because a company’s Articles of Association: (i) are not generally the product of negotiation between the shareholders; and (ii) are required to be registered as a public document at Companies House (in other words, they are addressed to the world and not just to a specific counterparty or counterparties and have to be understood by anybody who inspects the Companies House register).

3 Snowden J cited with approval the analysis in Cosmetic Warriors Ltd v Gerrie [2015] EWHC 3718 (Ch).

4 To that end, Snowden J relied on the decisions in Shanda Games Ltd v Maso Capital Investments Ltd [2020] UKPC 2 and Short v Treasury Commissioners [1948] 1 KB 116 which concerned the meaning of “fair value” (albeit in the context of statutory provisions which conferred a right of compulsory share acquisition), in which it was held in each case that a minority shareholder's shares should be valued as a minority shareholding and not on a pro rata basis.

5 The Minority Shareholder argued that this definition indicated that their shares should be valued as the median between a fully discounted value and the pro rata value of the shares on the basis that the IVSC’s guidance states that “Fair value requires the assessment of the price that is fair between two identified parties taking into account the respective advantages or disadvantages that each will gain from the transaction”. (Emphasis added.)

6 Snowden J did seem to accept, however, that the Majority Shareholder could potentially have derived an advantage (or a more significant advantage) from exercising the Buy-Out Option if he had done so just before a sale of the Company to a third party (such that he would have been able to deliver the entire shareholding of the Company to a buyer without the Minority Shareholder’s consent). Since there was no such planned sale, the question of whether such a sale would have justified a non-discounted share valuation did not arise for determination. Nevertheless, based on Snowden J’s primary findings, it does not appear that it would have resulted in a different outcome.

7 It having been argued by the Minority Shareholder that the Majority Shareholder was required to make some allowance for the types of ‘equitable’ factors that come into play under the unfair prejudice regime in sections 994 – 996 of the Companies Act 2006 or which fall to be considered on a petition for a winding-up order on the just and equitable ground in section 112(1)(g) of the Insolvency Act 1986. Such a conclusion would have meant that the Majority Shareholder was required to undertake an assessment of (among other matters) his own conduct.

See in this regard Altera Voyageur Production Ltd v Premier Oil E&P UK Ltd [2020] EWHC 1891 (Comm) in which it was held that worked examples included in an appendix to a contract took precedence in the event of a conflict with the narrative for the calculation set out in the main body of the agreement.

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