Summary

In this article, we consider the recent judgment of Mr Justice Snowden In the matter of Euro Accessories Ltd [1], which concerned the interpretation of a provision in the articles of association of a private limited company giving the majority shareholder an option to acquire the shares of the minority shareholder on terms that the consideration payable for the sale shares shall be for “fair value”.

Background

Euro Accessories Ltd (the “Company”) was incorporated by Mr Gilsenan (“Mr Gilsenan”) in December 2000, and carried on business as a supplier of construction concrete related accessories.  Mr Gilsenan was the sole shareholder of the Company.

In 2003, Mr Monaghan (“Mr Monaghan”) joined the Company as a sales representative and, in order to satisfy the desire to remunerate Mr Monaghan in a more tax efficient way, Mr Gilsenan transferred 24.99% of his shares in the capital of the Company to Mr Monaghan in 2008.

In 2010, the relationship between Mr Gilsenan and Mr Monaghan broke down and Mr Monaghan subsequently resigned from his role in the Company.

Negotiations, offers and counteroffers ensued for the purchase of Mr Monaghan’s shares by Mr Gilsenan. However, no agreement could be reached on price.

This impasse endured for several years until Mr Gilsenan decided to use his majority control to impose a solution.  After warning Mr Monaghan of his intentions, Mr Gilsenan  proposed and passed special resolutions in 2016, which had the effect of amending the articles of association of the Company (the “Articles”) to facilitate the redesignation of Mr Gilsenan’s shares into ‘A’ shares and Mr Monaghan’s shares into ‘B’ shares, and the right to acquire all of the shares held by Mr Monaghan for fair value through the insertion of an option (the “Call Option”) in favour of Mr Gilsenan relating to the ‘B’ shares.

Mr Gilsenan subsequently wrote to Mr Monaghan giving notice that he was exercising the Call Option and that the consideration for Mr Monaghan’s shares was £175,000.  The notice was accompanied by a cheque for the consideration and a stock transfer form for Mr Monaghan to sign.

Mr Monaghan did not sign the stock transfer form.  Mr Gilsenan, acting in his capacity as a director of the Company, proceeded to sign the stock transfer form under a signing power of attorney granted to the Company under the Articles.

Mr Monaghan did not cash the cheque (or, after its expiry, any further cheques) sent by Mr Gilsenan.

The arguments

In 2019, Mr Monaghan complained of unfair prejudice and petitioned the court under s. 994 of the Companies Act 2006.

Mr Monaghan did not dispute that Mr Gilsenan could force him to sell his shares.  Instead, Mr Monaghan complained that the amount paid was less than fair value such that the affairs of the Company have been conducted in a manner which was unfairly prejudicial to his interests. Mr Monaghan argued that “fair value” should have been calculated without any discount so as to represent its equivalent proportion of the entire issued share capital of the Company (i.e., the pro rata value).

Mr Monaghan argued that no discount should have been applied for the following reasons:

  • the right granted to Mr Gilsenan by the Articles as majority shareholder should be construed in light of the fact that it confers “an unrestricted right in the majority to expropriate the shares of the minority at will”. As this power was exercisable without cause and at any time, no reasonable businessperson would think that Mr Monaghan would be a willing shareholder and be subject to the discount that would normally apply in that situation;
  • “fair value” should be defined by reference to the International Valuation Standards of the International Valuation Standard Council (“IVSC”) which defined fair value as “the estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties”. On this basis, the price of the shares should have been the median point between the pro rata value and the discounted value of Mr Monaghan’s shares. It was argued that this was necessary to reflect the benefit obtained by Mr Gilsenan acquiring full control of the Company; and
  • the “fair value” of the shares is a value that is “just and equitable in all the circumstances” and, where the shareholders have an agreement of mutual trust, it followed that it would be unfairly prejudicial to Mr Monaghan to impose a discount.

Mr Gilsenan argued that a natural reading of the words in the Articles was required.  Once it was identified that the subject matter was a minority holding, it followed that a discount is appropriate to reflect the disadvantages of a minority shareholding in a private limited company.

To put these arguments in context, one must consider the valuations of the jointly instructed expert. At the agreed transfer date in 2016, the Company was valued at £2.18 million. On a pro-rata basis, Mr Monaghan’s 24.99% shareholding was worth £545,000. On a discounted basis (the expert considered that a 55% discount should apply), Mr Monaghan’s shareholding was worth £245,000.

Decision

Mr Justice Snowden held that the phrase “fair value” required a discount to be applied (agreeing with Mr Gilsenan) and made an order to that effect.

Having considered relevant case law, Mr Justice Snowden noted that “the process of interpretation to arrive at the true meaning of a provision in a company’s articles of association must concentrate on the natural and ordinary meaning of the words used, when viewed in light of the scheme and purpose of the articles in general, any extrinsic facts about the company or its membership that would reasonably be ascertainable by any reader of the company’s constitution and public filings at Companies House, and commercial common sense” [2].

Applying this to the present case, Mr Justice Snowden noted that:

  • a third party who viewed the Articles would not be aware of the breakdown in the relationship between Mr Gilsenan and Mr Monaghan and, therefore, this breakdown should not be considered when interpreting the Articles;
  • it would be apparent to a third party that Mr Gilsenan, as the holder of 75.01% of the shares, instigated the purchase of Mr Monaghan’s shares. The most a third party could deduce from the information publicly available is that Mr Monaghan did not agree to the introduction of the right for Mr Gilsenan to buy Party’s B shares, as Mr Monaghan had not signed the written resolution; and
  • nothing in the Articles pointed the reader to the meaning of “fair value”. The Articles simply required “the consideration payable for the Sale Shares [to] be for fair value“.

Mr Justice Snowden noted that “fair value” is the consideration payable “for the Sale Shares”, and that the focus is, therefore, on the value of the identified “property owned by the minority shareholder which is to be transferred under the option” (emphasis added) [3]. This was also consistent with case law relating to compulsory acquisitions where the general principle is that what must be given a “fair value” is what is being compulsorily transferred. Unless there is a contrary indication, the transferor cannot insist on being paid by the transferee for something to which his shares do not entitle him and that he does not own. Therefore, a transferor cannot insist on payment for a proportionate part of the controlling stake which the acquirer thereby builds up, or a pro rata part of the value of the company’s net assets or business undertaking.

Mr Justice Snowden did not consider it right to import the IVSC definition for “fair value” because it would not be reasonable to suppose that any general reader of the Articles would know of the IVSC definition so as to make the connection with it.  In any case, the IVSC definition has been replaced by a new definition of “equity value” to avoid confusion between different concepts of “fair value”.

Finally, Mr Justice Snowden dismissed the “just and equitable” argument.  Even if inserting and exercising the call option amounted to unfair prejudice (Mr Justice Snowden did not think it did), there was no reason why a discount should not nonetheless be applied.  A discount had been applied in previous, similar cases.

Comment

This case highlights and should serve as a reminder that:

  • as a principle, when interpreting a company’s articles of association, the natural and ordinary meaning of words used in the context of the articles is key. The intentions of the parties during negotiations (if any) leading to the adoption or amendment of articles of association will unlikely be considered by a court;
  • when drafting articles of association, references to “fair value” or “value” in a different form (e.g., “market value”), must be considered carefully. They can and do mean different things. The articles of association should be clear as to how that value is to be calculated and should be readily understood by an expert valuer;
  • as part of the drafting exercise, it should be considered whether a premium or discount should be applied, particularly if a controlling stake is to be acquired or disposed of. As this case highlights, in the absence of such clarity, a court will consider the shares in question and, if such shares constitute a minority shareholding, apply a discount;
  • other relevant accounting and valuation-based assumptions may be incorporated into the valuation calculation in the articles of association;
  • if you wish to avoid (costly) litigation, a mechanism for escalating and independently determining the “fair value” or “value” should be specified in the company’s articles of association. Such determination should be binding on the parties (in the absence of manifest error); and
  • while not a point of contention in this case, there are generally few limits on the exercise of a shareholder’s right to cast votes at a general meeting or by way of written resolution. As such, majority control can be used to impose a desired action (e.g., amending the articles of association to facilitate the exit of a minority shareholder), even if it is potentially to the detriment of a minority shareholder.

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[1] [2021] EWHC 47 (Ch)

[2] [2021] EWHC 47 (Ch), paragraph 34.

[3] [2021] EWHC 47 (Ch), paragraph 39.

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