Minority Shareholders’ Discount: Meaning of Fair Value

Minority shareholders’ discount is a controversial topic. In the recent High Court case, Re Euro Accessories Ltd [2021] EWHC 47, it was held that a minority shareholder should receive less than the shareholding pro rata to the value of the entire issued share capital. Taken at face value this is an unsurprising conclusion given that it is a well enshrined principle that a minority shareholding, due to its lack of control over a company, cannot expect to receive a buyout amounting to a pro rata valuation of the entire issued share capital. Many view this as prejudicial against minority shareholders. The important thing to take away from this case is that minority shareholders should pay close attention to articles of association and shareholders agreements, with a view to defining what exactly ‘fair value’ of their shares will be when it comes to their transfer, so that they do not fall foul of the minority shareholders’ discount.

Minority shareholders’ discount – Re Euro Accessories

The facts of this recent case are as follows. The company was incorporated by the majority shareholder (MAJ) on 15 December 2000. The minority shareholder to be (MIN) joined the company in 2003 as a sales representative. On 22^nd February 2008 MAJ voluntarily transferred 24.99% of the then issued share capital of the company to MIN. This is significant because by retaining 75% or more of the shareholding, MAJ would still be able to pass special resolutions. A special resolution can, among other things, alter the articles of association. Articles of association regulate the internal affairs of a company including the issue and transfer of shares and therefore, if worded accordingly, have the capacity to take advantage of a minority shareholders’ discount.

In early 2010, the relationship between MAJ and MIN came to an end and on 31 January 2010, MIN resigned from the company. MAJ wanted to purchase MIN’s 24.99% shares which MIN was also happy to sell. Issues arose around the value of such shares, with offer and counteroffer being consistently rejected.

Minority shareholders’ discount – ‘fair value’

MAJ finally decided to use his majority control of the company to pass three special resolutions on 9 March 2016 under his sole signature and hence take advantage of the minority shareholders’ discount. One resolution had the effect of amending the articles by inserting several new articles. New article 6A provided:

• “6A The MIN Shareholder may at any time be required to transfer all their shares (“Sale Shares”) to the MAJ Shareholder (“Sale Option”).
• 6A 1 The MAJ Shareholder may only have the right to acquire the Sale Shares by giving written notice to the MIN Shareholder (“Option Notice”) at any time before the transfer of the Sales Shares to the MAJ Shareholder. The Option Notice shall specify:
• that the MIN Shareholder is required to transfer all Shares pursuant to this Article 6A,
• the consideration payable for the Sale Shares which shall be for fair value, and
• the proposed date of transfer (“Transfer Date”) which shall be such date as the MAJ Shareholder may specify.”

After article 6A was adopted, MAJ wrote to MIN saying that he wished to exercise the option to acquire all of MIN’s shares. MAJ valued consideration for the shares at £175,000. MIN did not sign or return the stock transfer form. MAJ, however, with 75% of shares could still execute the transfer form, and did so on 30 August 2016.

The parties eventually used a third party, a chartered accountant, to value the Company and report on the appropriate minority shareholders’ discount to be applied, based on a sale in the open market on the transfer date. The chartered accountant concluded that the company was worth £2.18 million, so that on a pro-rata basis MIN’s 24.99% shareholding was worth £545,000. Applying the minority shareholders’ discount was deemed to mean a 55% discount and so it was calculated that MIN should receive £245,000.

Re Euro Accessories – High Court decision

The court dismissed MIN’s petition against the chartered accountant’s assessment and therefore deemed £245,000 to represent ‘fair value’. It gave a number of reasons for this. Most importantly the court highlighted the importance of interpreting articles of association on the “natural and ordinary meaning of the words used” and any facts about the company that would be reasonably ascertainable by any reader of the company’s constitution or public filings at Companies House. Therefore, the background to the relationship between MAJ and MIN including the breakdown in their relationship were irrelevant. All the court could do was interpret the wording in the updated articles of association and conclude what ‘fair value’ would mean. Even though the circumstances around which MAJ passed the special resolution to amend the articles was, given the background, clearly prejudicial against MIN.

The courts relied upon the principle established in Short v Treasury Commissioners [1948] 1 KB 116 and recently reaffirmed in Shanda Games Ltd v Maso Capital Investments Ltd [2020] UKPC 2 that MIN could not insist on being paid something to which his shares did not entitle him to and that he did not own. Therefore, MIN could not insist on payment for a proportionate part of the controlling stake which MAJ thereby built up, or a pro rata part of the value of the company’s net assets or business undertakings. The economic concept of minority shareholders’ discount applied because nothing in the articles of association suggested it would be otherwise.

Interpretation of articles of association

In Cosmetic Warriors Ltd v Gerrie [2017] EWCA Civ 324 it was mentioned that articles of association need to be interpreted in accordance with the ordinary principles of contract law. This was why it was hard for MIN to argue that the High Court should imply any other principles outside of the wording in the articles, given that English contract law is predicated on the concept of contractual certainty. With contracts, and therefore articles of association, the court is looking at:

• “what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean”, which it does by focusing on the meaning of the relevant words in their documentary, factual and commercial context;
• meaning must be accessed considering (as set out in Arnold v Britton [2015] AC 1619, by Lord Neuberger PSC at paragraph 15):
• “the natural and ordinary meaning of the clause,
• any other relevant provision of the contract,
• the overall purpose of the clause and the contract,
• the facts and circumstances known or assumed by the parties at the time that the document was executed, and
• commercial common sense, but
• disregarding subjective evidence of any party’s intentions.”

It was on this point (f) that MIN failed to convince the court that MAJ’s prejudicial reason for changing the articles of association was an admissible piece of evidence. All the court could do was look at the less subjective elements of the dispute. However, it is also important to highlight the difference between articles of association and contracts. This includes:

• Articles of association can be altered by a special resolution without the consent of all the contracting parties.
• Articles of association are not undermined (defeasible) on the grounds of misrepresentation, common law mistake in equity, undue influence or duress or rectification on the grounds of mistake. Therefore, it could be argued, minority shareholders have less principles (than in contract law) beyond the scope of the wording of the articles to rely on.
• It is not permissible to imply into articles of association a term based on extrinsic evidence of surrounding circumstances. This is because, as stated in Bratton Seymour Service Co Ltd v Oxborough [1992] B.C.C. 471, ‘the consequence would be prejudicial to third parties, namely, potential shareholders who are entitled to look to and rely on articles of association as registered’.

Minority shareholders’ discount – valuation of shares on sale

In Short v Treasury Commissioners [1948] (referred to above) the issue was whether the Crown could acquire individual minority share tranches of the company it was acquiring at a discount. The Court of Appeal held the individual shareholders were not entitled to the pro rata value of their shareholdings. This became the precedent upon which minority shareholder’s discount was based. It was reaffirmed recently in Bratton Seymour v Oxborough (mentioned above) when Lady Arden stated:

“In the opinion of the Board, it is a general principle of share valuation that (unless there is some indication to the contrary) the court should value the actual shareholding which the shareholder has to sell and not some hypothetical share. This is because in a merger, the offeror does not acquire control from any individual minority shareholder. Accordingly, in the absence of some indication to the contrary, or special circumstances, the minority shareholder’s shares should be valued as a minority shareholding and not on a pro rata basis.”

Here to help

The ruling in Re Euro Accessories confirms the principle of minority shareholders’ discount and so where articles of association allow for the acquisition of shares at fair value, a minority shareholder should expect to be treated the same way. The case hinged on the fact that ‘fair value’ was not defined in the articles and so it is in the interest of minority shareholders to try and define it. They should also aim to include a provision, as is widely practised, which states that there will be no discount for transfer of minority holdings. Getting legal advice around any articles of association you sign up to or any shareholders agreement you agree to, is going to be important.

EM law specialises in corporate law. Get in touch if you need advice on articles of association, shareholders agreements or have any questions about minority shareholders’ discount.