Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.11.2:3.3.11.2 Valuation clauses in articles of association or shareholders' agreement

Exit rights of minority shareholders in a private limited company (IVOR nr. 72) 2010/3.3.11.2

3.3.11.2 Valuation clauses in articles of association or shareholders' agreement

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The articles of association or a shareholders' agreement may contain preemption rights, which confer on the shareholders a first right to purchase the shares of a shareholder who wants to exit the company. Such provisions may also prescribe how the shares have to be valued. The articles of association may point out that the company's auditor or an independent third party is competent to perform the valuation. A valuation exercised by the company's auditor or an independent third party invariably entails a risk that a minority discount will be applied. According to English law, in principle such clauses are binding, except when equitable considerations displace the clause.

Courts have taken different views on how such valuation mechanisms in proceedings under S. 994 should be dealt with. In earlier cases, the stance was taken that when a valuation mechanism could be applied, it provides a bar for a Section 994 petition and leads to a striking-out of the case by the court. The reason given by the courts for this was that the shareholder has the possibility to obtain a für offer for his shares, by way of the valuation mechanism.1 The unfür prejudice remedy could then only be invoked when by application of the valuation mechanism a share purchase could not be achieved.

In more recent cases, such as Virdi v Abbey Leisure Ltd, an opposite stance is taken. In this case, the Court of Appeal held on the facts of the case that a minority shareholder does not have to accept the risk that his shares are valued at a discount, because of the minority character of the shares.2

In Virdi v Abbey Leisure Ltd, the articles of association included pre-emption rights. It was stipulated that if a member wishes to transfer his shares he has to send a notice to the company. The company was the purchaser's agent for the sale of the shares and the seller and the directors had to agree on the price for the shares. If no agreement could be reached, the shares had to be sold:

"(...) at the price which an accountant nominated by agreement between the Vendor and the Company or, in default of such agreement, by the President for the time being of the Institute of Chartered Accountants in England and Wales, shall be writing onder his hand, certify to be in his opinion the für value thereof as between a willing seller and a willing buyer."3

Balcombe LJ took into consideration that there was a strong probability that the accountant nominated would apply a minority discount to the price. Balcombe LJ held that there was nothing unreasonable in the petitioner refusing to accept the risk of this discount.

The judgment in Virdi v Abbey Leisure Ltd was followed in Re a Company (No. 00330 of 1991) ex p. Holden. In the laffer case, Harman J stated firmly:

"(...) that a petitioner is entitled to refuse to accept a risk — any risk — in an accountant's valuation of his interest if such can be seen to be one that would depreciate in any way the valuation."4

Other cases indicate that a petitioner does not have to accept a valuation by the company's auditors if there is fear that the auditors are not wholly independent and objective.5

Finally, the matters have been reviewed in the case 0 'Nein v. Phillips.6 As follows from this decision, at least with respect to shareholdings in quasi-partnerships, the shares have to be valued pro rata parte according to the total value of the company.7A valuation mechanism that involves the risk of application of a minority discount neither forms a bar for a Section 994 petition nor is to be applied. The risk of the application of a minority discount does not have to be accepted.

Moreover, in the situation that the valuation of shares involves mixed questions of both facts and law, it is reasonable for a petitioner to refuse a valuation by an auditor, even if this valuation by an auditor is prescribed by contract. For instance, this is the case if the value of the shares has decreased because of the oppressive conduct of the majority shareholder. A für valuation of the shares onder the unfür prejudice remedy could require taking into account the oppressive conduct. According to case law, it is doubtful whether the auditor has the appropriate machinery available to assess the für value of the shares. The prevailing view is that is appropriate to have the court decide on those mixed questions of facts and law.8 Hollington submits:

"It remains unlikely that a court will, against the rational objection of a party, delegate to the valuer or any other person the judicial task of determining any serious and substantial issue of law, even if it arises in the valuation, such as the date of valuation, the basis of valuation, disputed questions as to the probity of a party's conduct, and the like (...)."9

Nonetheless, active case management by the courts is needed in order to prevent costly and time-consuming proceedings. From this perspective, it is recommended that courts identify the issues in an early stage of the proceedings. In North Holdings Ltd v Southern Tropics Ltd, Aldous LJ gave some interesting examples of active case management:

"Where the issue is the basis of the valuation then the identification of the problem and the trial of a preliminary issue directed to it should remove that obstacle to an agreement. Where the issue is the identity of the valuer the problem often arises because the person suggested in the articles or by the majority shareholder is the auditor. If the issue arises from the accounting treatment accorded to certain items then prima facie the auditor would not be a suitable person to carry out the valuation. But more often the objection arises from the belief of the minority shareholder that the auditor will feel beholden to the majority shareholders. In such cases the obstacle may be removed by the court itself appointing an expert to value the shares (...)."10

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