The importance of ‘fair value’ in a forced share buyout

We often use the term ‘fair value’ in our documents when determining how shares are to be valued in the future, and recently the High Court interpreted the meaning of these words in the case of Euro Accessories Limited (2021). The court heard from Gerard Gilsenan (Gilsenan) and Aiden Monaghan (Monaghan) regarding a dispute over the sale price of shares in a forced share buy-out.

The facts of this case are interesting and worth looking at the detail. Gilsenan incorporated Euro Accessories Ltd (Company) in December 2000 and held all of the shares in the Company. In 2008, Gilsenan transferred 24.99% of his shares to Monaghan making him a minority shareholder in the Company. As it can happen, Gilsenan and Monaghan’s relationship deteriorated in 2010 ending with Monaghan’s resignation. Gilsenan attempted to buy back Monaghan’s share in the Company, however, the two shareholders were unable to agree on a price. The argument between the two shareholders was such that Monaghan was a minority shareholder and therefore had no controlling influence over the Company, and that Gilsenan had the right to apply a discount to his shares. Monaghan though, insisted that he was entitled to 24.99% of the total value of the Company’s shares.

Gilsenan, as majority shareholder, had controlling influence over the Company and the authority to make controlling decisions in relation to the Company without Monaghan’s permission. In 2016, Gilsenan passed a number of special resolutions, amending the Company’s articles of association and redesignating the Company entire share capital from ordinary to alphabet shares and varying the rights attached to those shares. Gilsenan’s shares were redesignated from ordinary to B shares and Monaghan’s shares from ordinary to A shares. The articles were amended to give Gilsenan the right to force the A shareholder, Monaghan, to sell his A shares to the B shareholder, Gilsenan, for “fair value” on receipt of written notice. Gilsenan served written notice on Monaghan who then filed court proceedings. Monaghan did not dispute the authority for Gilsenan to force him to sell his shares but rather that the shares should not be discounted because they would not then be sold for “fair value”.

The court therefore had to consider and rule on the meaning of “fair value”. Firstly, Monaghan argued that his shares should not be discounted on the grounds that the amended articles gave Gilsenan, as majority shareholder, the unrestricted right to force the Monaghan to sell his shares without notice or cause. Furthermore, that no reasonable businessman would think that he was willing to sell his shares at a discounted price. Secondly, Gilsenan’s actions went against the meaning of “fair value” as set out in the International Valuation Standards Council (2013) which defines 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”. Lastly, “fair value” of the shares was one that was “just and equitable in the circumstances”, discounting Monaghan’s shares would be unfairly prejudicial.

The court ruled in favor of Gilsenan agreeing that as the shares held no controlling influence over the Company they should be sold at a discounted price. The key question was, what was the meaning of “fair value” in a company’s articles of association. A company’s articles of association are a contract between the company and its members, i.e. Gilsenan and Monaghan. Case law states that the court is able to consider both the literal meaning and factual context in which a contract is made to determine the meaning of its contents. However, the High Court stated that as a company’s articles of association is a public document it would not take all of the factual background into account as a public reader would not be aware of the background and therefore would not be able to draw further understanding from the articles other than its literal meaning. The High Court also stated that articles of association are not like a commercial contract where negotiation leads to a meeting of the minds. As a result, when interpreting a company’s articles, a court will look at the natural meaning of the words, how they are used in the articles, any readily ascertainable facts about the company and apply commercial common sense.

The judge noted the following:

1. A third party would see that Gilsenan introduced the buy-out right as majority shareholder and an “astute and assiduous” reader might conclude that Monaghan had not agreed to the right, given he had not signed the documents.
2. That the breakdown between Gilsenan and Monaghan’s relationship would not be evident to a third party.
3. The articles did not provide a definition of “fair value” but did state “the consideration payable for the Sale Shares … shall be … fair value”, which suggested that the focus was on the property, not the identity, of the shareholder.
4. The articles did not reference the International Valuation Standards Council 2013 and there is no reason for its definition to be chosen over that of another. Indeed, the 2013 Standards had been superseded by new standards in 2017 precisely to avoid confusion between different concepts of “fair value”.
5. Previous case law suggests that, unless the articles state otherwise, a discount should be applied to a minority stake on the basis that the consideration paid should take account of the “control value”. Although, Gilsenan could exercise the option to force Monaghan to sell his shares at any time and without limit in time, the High Court did not think that a different approach should be taken. Monaghan’s shares were minority shares which conferred no control.
6. Even if inserting and exercising the buy-out right amounted to unfair prejudice (and the court 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.

The case of Euro Accessories Limited (2021) reinforces the approach to be taken when interpreting articles of association in comparison to that taken with commercial contracts. The two main points to be taken from the ruling in this case is: Firstly, the court is unlikely to take into account background information when determining the meaning conferred by a company’s articles of association. Secondly, when drafting articles the definition of value and how it is to be calculated should be clear. The meaning of value can be made more transparent in a number of ways:

• Define the meaning of “value”. This could be done by referencing a particular definition i.e. International Valuation Standards 2017.
• State how the “value” is to be calculated.
• Use terminology that is commonly recognised and their meanings professionally agreed upon.
• Account for any matters specific to your company, for example, a discount being applied to shares belonging to a minority shareholder.
• Include a determination mechanism. Courts can be expensive, it may be in everyone’s best interests to agree that an independent expert such as an accountant or valuer be appointed in case of a dispute and their opinion be binding.

These simple measures can help protect parties from disputes born from misunderstanding and miscommunication.

The Ramsdens Corporate Team would be more than happy to assist you and your fellow shareholders by reviewing your current articles of association and shareholders agreement in light of the above.

For advice on all aspects of company and commercial law, please call our specialist team on 01484 821 500 or fill out our online enquiry form and we will be in touch at a convenient time for you.