Rebecca Birkby Tim Brown May 30 2017 A fair approach to share valuations RPC | Litigation - United Kingdom Rebecca Birkby, Tim Brown Litigation FactsFirst-instance decisionCourt of Appeal decisionCommentIn a case involving the shareholders of Lush Cosmetics,(1) the Court of Appeal dismissed an appeal relating to the correct interpretation of two companies' articles of association in respect of the valuation of shares which were subject to pre-emption rights, applying the well-known judgment on contractual interpretation in Arnold v Britton.(2)FactsAndrew Gerrie and his wife Alison Hawksley (the respondents) were minority shareholders of the appellant companies, Cosmetic Warriors Limited and Lush Cosmetics Limited. The other main shareholders in the companies were Mark Constantine and his wife Margaret Constantine, who founded the Lush cosmetics business in 1994. Gerrie initially joined them as an investor in 1994, but within a few months became a full-time executive.In 2014 relations between Mr Constantine and Gerrie deteriorated and Gerrie decided to leave the group. In October 2014 the respondents served transfer notices in respect of their shareholdings in the companies, which triggered pre-emption provisions contained within Article 5 of the companies' respective articles of association. Article 5 stated that no shares in the companies were to be transferred unless other shareholders were given the opportunity to purchase the shares at a "prescribed price" which, if not agreed, was to be determined by two independent chartered accountants. To the extent that the shares were not taken up at that price by the other shareholders or sold at that price by the companies to external purchasers, the vendor then had a 90-day period during which he or she could transfer them "to any person at any price (not being less than the prescribed price)".The parties were unable to agree the prescribed price for the shares or the basis on which that price was to be determined by the accountants pursuant to Article 5. As a result, the companies issued a Part 8 claim for clarification of the correct method of valuation of the shares.First-instance decision The first-instance court found in favour of the respondents and agreed that valuation should be based on a pro rata proportion per share of the value of the whole equity of each company. The companies appealed the following issues:whether the share valuation should be based on a pro rata proportion of the value of the whole equity of each company or (as the companies submitted) the price that might be achieved for the shares as between a willing buyer and a willing seller of that block of shares, having particular regard to its status as a minority shareholding;if the answer to the first question was the latter, whether the shares owned by the respondents should be valued separately, together or in accordance with such basis of valuation as the accountants considered appropriate; andwhether the "any person" to whom the vendor could transfer shares, if they were not taken up by the other shareholders, was restricted to natural persons (so as to exclude a corporate transferee).Court of Appeal decisionThe Court of Appeal found in favour of the respondents on the first and third issues. The second issue did not arise because the correct valuation of shares in respect of the first issue was a pro rata proportion of the value of the whole equity of each company.In determining that the court at first instance had chosen the correct basis of valuation, the Court of Appeal construed the articles in accordance with the general principles of contractual interpretation established in Arnold v Britton, Wood v Capita Insurance Services Limited(3) and Rainy Sky SA v Kookmin Bank.(4)In Arnold v Britton Lord Neuberger held that when interpreting a written contract, the court is concerned with identifying 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". The court does this by focusing on the meaning of the relevant words in their documentary, factual and commercial context, disregarding subjective evidence of any party's intentions. The factual background was important in this case, as the company's constitution was akin to a quasi-partnership.While the Court of Appeal considered case law on interpreting similar wording on share valuations in articles of association, Lord Justice Henderson, giving the Court of Appeal judgment, did not ultimately rely on them and observed that:"there is in my judgment no substitute for looking at the language which the parties have actually used, in accordance with the principles of construction which are common ground, in order to ascertain what they objectively intended. As the cases show, the issue is one which frequently arises and is often difficult to answer, but the guidance which the authorities can give is limited because ultimately everything turns on the wording of the articles in question."The companies submitted that the court should favour a construction of the articles which put a value on the shareholding that it would have in the real world (ie, a value which took into account its status as a minority shareholding) over a construction which put an artificial value on it based solely on the value of the company as whole. The companies argued that the prescribed price may differ depending on whether it was calculated on a pro rata or block basis. For example, if the shares comprised a minority shareholding, calculation of the prescribed price on a pro rata basis of the whole company might be higher than if it were calculated on a block basis which would take into account the status of the shares as a minority holding. Conversely, if the shares comprised a majority shareholding, the opposite may be true.The Court of Appeal found that counsel for the companies had "developed his submissions attractively", but in the end there was "no substitute for looking at the language which the parties have actually used, in accordance with the principles of construction which are common ground, in order to ascertain what they objectively intended".The Court of Appeal therefore upheld the lower court's reasoning that the definition of the prescribed price in Article 5 was concerned unambiguously with fixing a price per share on the basis of valuing the companies as a whole on a going-concern basis. The articles referenced "the fair value thereof"; the court found that the use of 'thereof' referred to an individual share, not any block of shares to be transferred as a whole. The Court of Appeal found that a strong indicator in favour of the pro rata construction was that the parties were unlikely to have intended the accountants to apply a potentially substantial discount or premium depending on the size of the block of shares, without knowledge of the sizes of the lots in which the shares may in fact end up being transferred or of any special value that they may have in the hands of any transferee.Finally, the Court of Appeal determined that, despite some ambiguity in the articles regarding the definition of 'person', the normal legal meaning of the word should apply in accordance with Section 61 of the Law of Property Act 1925 and Section 5 of the Interpretation Act 1978, and would include a corporate body. The court found that there was no compelling commercial justification for construing the word 'person' restrictively.CommentThe court reached a fair outcome taking into consideration the quasi-partnership relationship of the shareholders and looking objectively at the language used in the articles. The case highlights that parties should be careful to ensure that the wording of any contractual document is clear as to their intentions; otherwise, the court will interpret what is there in a way that best serves the objective meaning given the factual background.For further information on this topic please contact Rebecca Birkby or Tim Brown at RPC by telephone (+44 20 3060 6000) or email ([email protected] or [email protected]). The RPC website can be accessed at www.rpc.co.uk.Endnotes(1) Cosmetic Warriors Ltd v Gerrie  EWCA Civ 324.(2)  UKSC 36.(3)  UKSC 24.(4)  UKSC 50.