High Court gives further clarity on “fair value” for shares
In the recent case of Re Euro Accessories Ltd  EWHC 47, the High Court considered how a company’s articles of association should be interpreted where they permitted a majority shareholder to acquire a minority shareholder’s shares for “fair value”.
In 2008, Euro Accessories’ founder, Mr Gilsenan (‘G’), voluntarily transferred 24.99% of the then issued share capital of the company to company secretary Mr Monaghan (‘M’), while retaining the majority 75.01% of the shares. In 2010, the relationship between the two individuals broke down, and M resigned.
They then discussed the purchase of M’s shares by G. M valued the shares in the region of £350,000, taking the view that he was entitled to a proportionate part of the controlling stake in the company. However, G was only prepared to offer a discounted consideration of £175,000, as M’s shares represented a minority holding. As a result, the discussions failed.
G then used his powers as majority holder of the voting rights to propose special resolutions to amend Euro Accessories’ articles of association. G inserted new articles which gave him the option to acquire M’s shares on demand “at a fair value”. G acquired the shares and attempted several times to send M a cheque for £175,000, but M did not cash any of them and refused to comply.
Several years later, M presented a petition that the discounted consideration for his minority shareholding was unfairly prejudicial.
Perhaps surprisingly, there was no disagreement over G’s single-handed amendments to the articles of association or the acquisition of M’s shares in principle. The issue to be decided was the price to be paid for them. The court was asked to determine the meaning of “fair value” in the amended articles. It was M’s view that “fair value” should represent an equivalent proportion of the total shareholding in Euro Accessories, and that no discount should apply.
In his judgment, Snowden J made some useful clarifications, referring to previous case law on the interpretation of “fair value”. He also reminded the court of the important distinction between a private contract and a company’s articles of association: articles are not the product of a ‘meeting of minds’ in a commercial negotiation process between two parties, but a creature of statute. Further, as articles of association are required to be registered as a public document at Companies House, they must be understood by anybody who inspects them.
Consequently, Snowden J’s analysis was that the proper method of interpretation of a company’s articles of association must focus on three elements:
- The natural and ordinary meaning of the words used
- Any extrinsic facts about the company which any reader of the articles would reasonably be expected to know
- Commercial common sense
The extent of the court’s interpretation of “fair value” was the consideration for the sale shares only. Therefore, the focus was solely on the value of the property being transferred, rather than M’s position as a minority shareholder. Importantly, the court also stated the general principle that M could not insist on being paid by G for something he was not entitled to (a proportionate part of the controlling stake in the company, or a pro rata part of the company’s business undertaking and net assets) as this had not been made clear in the articles.
On the basis of the above, Snowden J dismissed M’s petition and held in favour of G. On a proper interpretation of the articles as they were drafted, a discount should be applied to the consideration for M’s minority shares.
What should we take away from this case?
This case demonstrates that a reference to “fair value” and nothing more in a company’s articles of association can be problematic on a future interpretation. It's vital to elaborate beyond this subjective phrase and make it clear how the value of shares is to be calculated. There are several ways to achieve this in the articles, including by:
- Using a common accounting or auditing standard definition of ‘value’ which is understood by financial experts and applies objective metrics.
- Including a calculation to demonstrate how certain situations and factors could affect a share valuation.
- Drafting bespoke provisions which clearly set out the treatment of a sale and purchase of a minority stake, including whether a discount will be applied.
- Drafting adequate ‘good’ and ‘bad’ leaver provisions, which make clear to a shareholder from the outset of their membership what will happen when they exit the company, and how this might differ depending on the circumstances.
- Drafting expert determination mechanisms to use in the event of disagreements over value. As court proceedings are expensive and time-consuming, an effective way to avoid this is by appointing an independent accountant or valuer to value the shares or other assets in question. A robust determination mechanism will state that the decision of the expert is binding on the parties.
Get in touch
This article was prepared by Tom Revitt.