Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.11.3:3.3.11.3 Discount or no discount

Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.11.3

3.3.11.3 Discount or no discount

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In Re Bird Precision Bellows, Nourse J considered that when shares representing a minority holding are sold on the market, a discount is applied, because of their minority character.1 The question was raised whether in case of a buy-out order a minority discount has to be applied or whether the shares have to be valued pro rata parte to the total value of the company. Nourse J observed the common case of a buy-out order on the ground that unfürly prejudicial conduct has occurred in a quasi-partnership. He put that the minority shareholder is unwilling to sell his shares in these circumstances, in the sense that the sale is forced upon him. Assuming that it can no longer be expected from him to remain a shareholder, the sale of his shares is his only way out of the company. Therefore, it would be unfür to use the same pricing basis as one would use in the situation of a voluntary sale of the shares.

According to Nourse J, when a shareholder is unfürly prejudiced, a für valuation entails that shares are valued pro rata parte to the total value of the company and, thus, without any discount. As can be derived from the authoritive case Re Bird Precision Bellows, usually there will be no discount applied when a buy-out is ordered in case of exclusion from management in a quasi-partnership:

"In my judgment the correct course would be to fix the price pro rata according to the value of the shares as a whole and without any discount, as being the only für method of compensating an unwilling vendor of the equivalent of a partnership share."2

The view taken by Nourse J is now widely adhered to by the courts.3Nourse J added that it would not be für to reward the majority with a majority premium for their shares, in the reverse situation that the court would provide that the majority has to be bought out.

Prentice puts forward three justifications for the stance taken by Nourse J. Prentice submits that with respect to quasi-partnerships it is difficult to assess the petitioner's contribution to the value of the company and holds that courts should, therefore, perhaps err in favour of the petitioner. Secondly, he puts forward that the no discount rule creates an incentive for the majority shareholder to seek an agreed sale with the minority, as perhaps an agreement could be more favourable to the majority shareholder than a court ordered buy-out applying no discount.4 Thirdly, he contends that application of a discount by the court may "provide the majority with a perverse incentive to oppress the minority."5

Nevertheless, as also follows from Re Bird Precision Bellows, situations may occur in which a discount can be für. In the first place, a discount is regarded to be für if the minority shareholder has not operated with clean hands and deserved his exclusion as a director in a quasi-partnership. According to Nourse J, under those circumstances it cannot be said that the minority shareholder is an unwilling seller:

"A shareholder who deserves his exclusion has, if you like, made a constructive election to sever his connection with the company and thus to sell his shares".6

Secondly, a discount may also be applied when the shares were originally acquired for a price to which a minority discount is applied and the shares are merely held as an investment. A discount may be für when the shares are acquired as an investment and where the intention to participate in the management is absent. If the existence of a quasi-partnership is not proven, a discount may thus be appropriate.7 When a shareholder is removed from management, he may choose to keep his stake in the company for some years. However, this shareholder will run the risk that a discount will be applied, while he may no longer be regarded as a quasi-partner, but as an investor.8

As appears from case law, there is even a middle course between applying a full discount and no discount.

In Richards v Lundy, Nicholas Strauss QC held that the choice between a discount or no discount on occasion may not lead to a für result.9 He stated that a minority discount can be very substantial, in the case concerned between 65% and 90%, and thus quite drastic. In his opinion, taking the width of Section 996 into consideration, he thought it open for the court to find a middle course between a discount and no discount, if the court concludes that this is more appropriate.

In Re Planet Organic Ltd, the holders of preference shares started a petition under S. 994.10 The preference shareholders did not participate in the management of the company. The preference shares entitled their holders to a 9% interest plus an entitlement to dividends. In the year 2000, the preference shares were convertible into ordinary shares for a rate of one ordinary share for two preference shares. The preference shares did not entitle to voting rights, except in the situation of non-payment of dividends. Jacob J found that the preference shareholders were merely investors and not quasi-partners. Moreover, Jacob J took into consideration that the preference shareholders did not come to the court with clean hands. The valuer of the respondent held that an appropriate minority discount would amount to 50%. Nonetheless, Jacob J held that the appropriate discount was 30%.

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