English Court Determines Meaning of ‘Fair Value’ in a Private Company Shareholder Buy-Out

In a recent ruling, the High Court has provided useful guidance on an issue common to many joint ventures and similar shareholder arrangements:  when one shareholder is forced to sell its shares to the other shareholder(s), how is ‘fair value’ to be determined?

In Re Euro Accessories Ltd [2021] EWHC 47 (Ch), the minority shareholder of a company (Mr Monaghan) brought an unfair prejudice claim to determine the ‘fair value’ to be paid to him by the majority shareholder (Mr Gilsenan) for his minority shareholding in the company. The key issue was whether the value of Mr Monaghan’s shares, absent any specific contractual agreement, should be discounted to reflect the fact it was a minority shareholding. The court held that a discount should be applied in the circumstances. 

Summary of the Facts

The company was incorporated by Mr Gilsenan, who initially held 100% of the shares. Mr Monaghan joined the company subsequently as an employee and was later given 24.99% of the shares. After their relationship broke down, the parties tried to negotiate a deal for Mr Gilsenan to buy Mr Monaghan’s minority stake, but they were unable to agree a price. Mr Gilsenan then used his majority control to amend the articles of association of the company to enable him to purchase the shares held by Mr Monaghan at ‘fair value’. The revised articles did not define ‘fair value’ or otherwise provide guidance as to how it should be calculated.

Following adoption of the new articles, Mr Gilsenan sent Mr Monaghan a notice requiring Mr Monaghan to sell his shares to Mr Gilsenan for a total price of £175,000 - in his calculation of the price, Mr Gilsenan had discounted the value of Mr Monaghan’s shares to reflect the fact that it was a minority shareholding. Mr Monaghan did not comply. 

Mr Gilsenan ultimately effected the share transfer himself using a power under the amended articles to do so. However, several years later, Mr Monaghan commenced legal proceedings under section 994 of Companies Act 2006 on the grounds that the company had been run in such a way that his interests had been unfairly prejudiced.

High Court’s Decision

The court agreed with Mr Gilsenan that a ‘minority discount’ should be applied.

An independent appraiser found that the value of Mr. Monaghan’s shares would have been £545,000 if no discount were applied, but only £245,000 if the value was discounted, a difference of 55%.

In reaching its decision, the court referred to the ordinary principles that apply to the interpretation of any written contract. While noting that a company’s articles of association are a contract between it and its members, they do have certain distinguishing features that require some modification to the usual principles of contract interpretation. Such features include:

• the articles of association are generally not the product of a process of negotiation leading to a meeting of minds or consensus between all the shareholders, and there was certainly no such process or meeting of minds in this case given that the amended articles were introduced by Mr. Gilsenan alone; and
• the articles of association are public documents, and as such, they must be capable of being understood by anyone who inspects them.

The court stated that, unlike the case in interpreting a normal contract, it is not necessary to take into account all of the factual background when interpreting articles of association. Specifically, the background to the relationship between Mr Gilsenan and Mr Monaghan, or the circumstances surrounding the breakdown of their relationship, were not relevant as it would not have been apparent to a general reader of the articles. Instead, the court concentrated on the natural and ordinary meaning of the words used, any extrinsic facts about the company or its membership that would reasonably be ascertainable by any reader of the company's articles, and commercial common sense.

The court followed previous cases where it had been held that, in the absence of some indication to the contrary, the minority shareholder's shares should be valued as a minority shareholding and not on a pro rata basis. The court found that there was not a sufficient ‘indication to the contrary’ to take the case out of the general principle of valuation. It also rejected Mr Monaghan’s argument that the 2013 International Valuation Standards Council (IVSC) definition of ‘fair value’ should apply, as the articles did not refer to such standards and no general reader would know of the IVSC definition.

Also important to the court’s decision was the wording of the articles, which stated that ‘the consideration payable for the Sale Shares which shall be for fair value’. The court noted that this strongly suggested that the focus was on the property, i.e. the Sale Shares, not the shareholders. The court also found that the language of the articles did not in any way suggest that when specifying the consideration payable, the transferee was required to exercise any subjective discretion, or in some way to take into account the personal relationship between himself and the transferor.

Practical Pointers

Mandatory sales clauses are commonly used in joint ventures and similar arrangements. The Euro Accessories case reveals critical potential pitfalls, but which can be avoided through careful legal drafting.  Below are key takeaways:

• Clearly state how valuation is to be determined and whether certain factors (such as a minority discount) should be taken into account. 
• Use clear, unambiguous terms – factors should be clearly defined or refer to commonly accepted accounting standards. 
• To avoid expensive court proceedings in case of a dispute, ultimate resolution should be determined by a binding independent valuation.   

We have assisted numerous clients through these issues, so please get in touch if we can be of any help.