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  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.
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 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 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.
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.