The articles of association of private companies commonly confer power on majority shareholders to acquire minority interests for ‘fair value’ – but what exactly does that mean? The High Court addressed the issue in a case which clarified the law.
The sole owner of a private company transferred 24.99 per cent of his shares to a lynchpin employee as a means of remunerating him in a more tax-efficient manner. After they fell out and the employee resigned, a dispute developed over how much the owner should be required to pay to buy back the employee’s shares.
The impasse continued for some years until the owner exerted his power as majority shareholder to unilaterally change the company’s articles of association. The new articles conferred on the owner an unfettered right to require the employee to sell back his shares at a fair value. The owner transferred the employee’s shares to himself, but disagreement as to the price payable for them continued.
The employee argued that the ‘fair value’ provision required the owner to pay him a sum calculated pro rata to the value of the company’s entire issued share capital. The owner countered that ‘fair value’ meant the value of the shares on a sale between a willing buyer and a willing seller. He argued that the value of the employee’s shares should be discounted to reflect his minority holding.
The company had been independently valued at £2.18 million as at the date on which the employee’s shares were transferred to the owner. If the minority shareholding were valued in accordance with the method put forward by the employee, it was agreed that it was then worth £545,000. If valued on the basis favoured by the owner, however, it was worth £245,000.
Considering the matter, the Court noted that its role was to discern the natural and ordinary meaning of the articles of association. The background to the relationship between the two men, and the circumstances surrounding the breakdown of that relationship, were irrelevant and inadmissible in evidence.
Ruling in favour of the owner’s valuation method, the Court noted that he owned over 75 per cent of the shares and was in substantial control of the company. The only obvious practical benefit to him in acquiring the minority shareholding might have been to enable him to deliver the entire company to a third-party buyer without the employee’s consent.
His acquisition of the employee’s shares made little difference in practice in that any buyer of the company would itself have been able to exercise the ‘fair value’ purchase option. There was no suggestion that, at the time of the transfer, the owner intended to sell the company. The Court declared that a payment of £245,000 would represent fair value for the employee’s shares, a sum that the owner was willing to pay with interest.