Timing is everything when valuing shares of a start-up company: ILS Rehab Pty Ltd v Josephine Borg (as administrator of the estate of the late Damien Robert Borg) [2017] NSWSC 442

This case emphasises the importance of taking all potential scenarios (including, in this case, the early and unexpected death of a shareholder) into account when drafting exit and valuation provisions for a shareholders’ agreement for a start-up company that may take a few years to generate value.

ILS Rehab Pty Ltd (Company) had 3 directors who also each held one share in the Company. When one of the directors (Mr Borg) died on 6 March 2015, a dispute arose as to the construction of the provisions in the shareholders’ agreement relating to the price to be paid by the surviving shareholders for Mr Borg’s share.

The shareholders’ agreement provided as follows:

  • clause 13.1 - If a Director should die during the Shareholding Period, then the Shareholders that are not the Respective Shareholders of that Director shall purchase the shares held by the Respective Shareholder of that Director (‘the outgoing Shareholder’);
  • clause 13.1.1 - The purchase price shall be equal to 3 x EBITDA; and
  • clause 1.1 – EBITDA was relevantly defined as “the earnings before interest, tax, depreciation and amortisation of the Company in the immediately preceding financial year, excluding any unusual or non-recurring items.

White J in the Supreme Court of New South Wales firstly ordered rectification of clause 13.1.1 to read: The purchase price shall be equal to the percentage shareholding of the outgoing Shareholder in the Company multiplied by 3 x EBITDA.

The key question was then whether the reference in the definition of EBITDA to “immediately preceding financial year’ was to the financial year immediately preceding the death of Mr Borg (in which case the purchase price would be nil or only nominal consideration as EBITDA in that year was negative), or the financial year immediately preceding the time for completion of the purchase of Mr Borg’s share under clause 13.1.

White J found that it was the date of death that determines which financial year is the immediately preceding financial year, and that the purchase price for Mr Borg’s was therefore only nominal. White J rejected the argument that if the event of death was the trigger date (as opposed to the date on which a notice of sale was given under the general sale process for shareholders wishing to sell shares under the shareholders’ agreement), there would be no contractual mechanism to determine when the purchase was to take place, finding that:

  • in circumstances where no time is fixed, then it is to be implied that it is to be done within a reasonable time; and
  • if such construction was correct, Mr Borg’s administrator could, but is not required to give a notice that she had decided to sell Mr Borg’s share. However, the clear intent of clause 13 is that purchase of Mr Borg’s share by the surviving shareholders is mandatory given the clause states that the surviving shareholders “shall purchase” Mr Borg’s share.

White J was not persuaded by the complaint that this caused hardship because the Company was a start-up that was only just becoming profitable. Rather, White J emphasised that the parties had contracted for relative certainty (as opposed to applying a potentially complex valuation exercise if the goodwill or future prospects of the Company were to be taken into account) and Mr Borg’s administrators did not rely upon hardship as a separate defence to a claim for specific performance (nor was there evidence that would support any such defence).