What is "fair value" of a minority shareholding?

A recent case, Re Euro Accessories Ltd, provides a useful reminder that when considering allotting or transferring shares to an employee (or anyone else) companies or their owners should bear in mind that employees move on and business relationships break down. A company's constitutional documents should provide for what happens when parties go their separate ways.

What happened?

In 2008 Mr G transferred 24.99% of the shares in his company to an employee, Mr M (retaining the remaining 75.01% himself). Relations between Mr M and Mr G broke down and in 2010, Mr M resigned. Whilst they agreed in principle that Mr M would sell his shares to Mr G, they couldn't agree on a price (Mr G was prepared to pay £175,000 whereas Mr M wanted twice that amount) so there was no sale.

In 2016, Mr G used his majority position to amend the Company's Articles of Association to include new provisions under which (i) Mr M could at any time be required to transfer all of his shares to Mr G at their "fair value" and (ii) if Mr M failed to do so, a director of the Company was deemed to be appointed his agent and attorney to execute all necessary transfers on his behalf. The amended Articles contained no guidance on what was meant by "fair value".

Having unilaterally imposed these compulsory transfer provisions on Mr M, Mr G exercised his new rights and sent Mr M a cheque for £175,000, which he asserted was the fair value of Mr M's shares. When Mr M failed to complete the transfer paperwork, Mr G executed it as director and transferred the shares to himself in accordance with the amended Articles.

The matter came to court because, amongst other things, Mr M disputed Mr G's assessment of the fair value of his shareholding. In his view, the fair value should be calculated pro rata to the value of the Company's entire issued share capital, which an expert accountant had valued at £2.18 million, and accordingly his shares were worth £545,000. Mr G's position was that the fair value should be calculated on the basis of a sale between a willing buyer and a willing seller and should be discounted to reflect the well-established disadvantages of a minority shareholding in a private company (including lack of control and liquidity). The expert opined that the appropriate discount, if one was to be applied, was 55%, meaning that Mr M's shares were worth £245,000.

The court decided, in accordance with existing legal precedent, that the minority shareholding had to be valued as just that, and therefore discounted, in the absence of any "indication to the contrary" in the Articles (or anywhere else). Mr G agreed to pay the £245,000 which the expert said was the proper discounted value.

What should have happened?

Although certain aspects of this decision might, on the face of it, seem unfair (e.g. Mr G wasn’t exposed to the disadvantages of a minority shareholding because he already owned the rest of the shares and, as Mr M pointed out, the "willing seller" assumption was arguably inappropriate in the circumstances), it does reflect the existing state of the law.

Practical lessons

What can be learnt from this decade-long shareholder dispute?

• Before giving shares to Mr M, Mr G could have amended the Company's Articles or entered into a shareholders' agreement with him, to put in place appropriate compulsory transfer or "leaver" provisions obliging Mr M to transfer his shares on leaving and, crucially, specifying the price to be paid or how it was to be calculated.
• Mr M , could have tried insisting on a shareholders' agreement giving him "minority protection" provisions, limiting the scope for amendment of the Company's Articles without his consent and/or containing overriding "leaver" provisions acceptable to both him and Mr G.
• The amendments to the Company's Articles made by Mr M should have been clear about what was meant by "fair value".

On the other hand, Mr G (or his solicitors) had the foresight to include a "self-help remedy" in the amended Articles. Without the power of attorney/ agency provisions, Mr G would have had to go to court to enforce the new compulsory transfer obligations when they were not honoured, leaving the shares in the hands of Mr M. By including that remedy, Mr G put himself in the driving seat.