Court clarifies valuation of shares for pre-emptive offer

In Cosmetic Warriors Limited and another v Gerrie [2017], the Court of Appeal decided that shares in a company that were offered to the other shareholders under a pre-emption procedure were to be valued on an individual “per share” basis, and not as a single block.

Background

Mr Gerrie and his wife were minority shareholders in two companies - Lush Cosmetics Limited (which owns the Lush high-street retail chain) and Cosmetic Warriors Limited (which owns the intellectual property used by that business). Their combined holding in each company was 22 per cent.

Mr Gerrie was a director of both companies. When relations between him and the companies’ other main shareholder and director deteriorated, Mr Gerrie and his wife served notice under the transfer provisions of the companies’ articles of association stating that they wished to sell their shares.

Both companies’ articles of association contain relatively standard pre-emption provisions stating that, if a shareholder wished to sell his shares in the company, he first had to offer them to the other shareholders at a price agreed between the shareholder and the company.

If the shareholder and company could not agree the price, the articles required them to appoint two independent accountants to calculate it and to take the median average of their valuations.

What was the dispute?

Although several issues arose, both originally before the High Court and subsequently before the Court of Appeal, the key dispute centred around how the price for the shares was to be calculated.

Mr Gerrie argued that the price should be calculated based on the value of each company, with each individual share then ascribed a proportionate value based on that calculation. This would result in each share demanding a price referable to the pure value of the company in question, with no discount or premium to reflect whether the selling shareholder held a minority or majority stake in the company.

The companies, on the other hand, argued that Mr Gerrie’s and his wife’s shares should be valued as a single block. This would mean that a discount should be applied to reflect the fact that their combined holding of 22 per cent represented a minority stake in the company (and, indeed, a stake that could not block key decisions taken by special resolution).

Mr Gerrie’s approach would have resulted in a higher price for his shares.

In essence, this became a question of how the companies’ articles should be interpreted.

What did the articles say?

The key provision of the articles, which defined the sum payable for the shares, was as follows:

“. . . such sum per share as shall be agreed between the Vendor and the Company failing which it shall be the median price of the price as determined and certified in writing by two independent chartered accountants as being in their opinion the fair value thereof as between a willing buyer and a willing seller valuing the Company on a going concern basis . . 

The High Court judge had fixed on the words “per share” and “fair value thereof” in the article, saying that these words pointed towards a valuation of each share on an individual basis. It therefore ordered that the shares be valued on a per share basis; not on the basis they were a single block.

On appeal, the companies argued that the court should start with a presumption that the shares should carry a value that they would have “in the real world”. This would naturally take into account the fact that the shares represent a minority holding in the company. This, they said, was the “common sense” approach and fitted more naturally with the concept that the accountants were to value the shares on the basis of a “willing buyer and a willing seller”.

What did the court decide?

The Court of Appeal upheld the original decision.

In giving his judgment, Lord Justice Henderson said it was not appropriate to start with any presumption as to how shares should be valued in this context. This is particularly the case for a closely-held private company, where the relationship between the members is more like that between partners. Rather, the appropriate place to start was the article that stated how the price was to be calculated.

In his view, it was “unambiguous” that the shares were to be calculated on a per share basis, and that the accountants were to value the companies as a going concern for that purpose. The valuation had to be carried out on the basis of a valuation of the company “as a whole”. It then followed that the price per share had to be ascertained on a “pro rata basis” (i.e. apportioned proportionately across the shares being sold).

In addition, the judge emphasised that it would be illogical to require the accountants to value the shares as a single block when, at the time of the valuation, it could not be known who the ultimate buyer or buyers would be (whether shareholders or third parties).

It was also impossible to know when valuing the shares to what extent a buyer may be prepared to pay a special price in order (for example) to acquire a blocking stake in the companies, or to prevent the shares from falling into the hands of particular persons.

The judge felt that the parties were unlikely to have intended for the accountants to apply a substantial discount or premium to the value of a block of shares, without regard to the size of the lots in which the shares might be sold or to any special value they may have to the ultimate buyer.

It therefore only made sense to value each share individually, rather than the block as a whole.

Practical implications

In many respects, the judgment reflects the specific facts and circumstances of the case. Every company’s articles will be different, if only subtly, and so it can be hard to draw generalisations. However, the decision does emphasise certain points to bear in mind when including a pre-emption mechanism in articles and when triggering it:

  • The courts will approach each case with an open mind. They will not assume that a valuation is to be conducted on any particular basis. Rather, they will look at the wording of the company’s constitution to decide what the shareholders intended should happen.
  • For this reason, it is important to set out explicitly any factors which an independent expert is to take into account when valuing shares. For example, it is common to include provisions stating that no discount is to be applied on the basis that the shares represent a minority holding, or to reflect the selling shareholder’s financial standing.
  • However, it would seem that the courts may be reluctant to uphold an approach to valuation that does not sit comfortably with the information available to the person conducting the valuation. For example, as in this case, it is hard to reach a valuation that reflects the strategic importance of a block of shares without understanding whether and in what proportions that block may be split up.
  • As always, it is important to use unambiguous language and to structure the company’s articles appropriately to ensure that it is clear whether the parties intend shares to be valued individually or in blocks.

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