Shareholder Disputes: Unfair Prejudice Petitions and The Art of Share Valuation

August 3, 2022

Lisa Linklater QC

Lisa Linklater QC’s article on Shareholder Disputes for the Solicitors Journal.

The tensions created by the uncertainty and disruption of the last two years have led to a significant number of disputes between shareholders in privately owned companies.  Tensions that have been bubbling under the surface have reached breaking point, leading to an irreconcilable breakdown in the relationships between shareholders.  Minority shareholders may feel driven by boardroom feuds to sell their shares.  How can we, as advisors and advocates, best advance our clients’ case on the price payable or to be received for shares in privately owned companies?

It has often been said that share valuation in such companies is an art not an exact science.  Unlike companies that are listed on a stock exchange, there is a very limited market for shares in privately owned companies.  Unless the company or its business is being sold to a third party, the primary marketplace for shares in such companies is usually the other shareholders.  The lack of voting control that a minority shareholder has in a company and the very limited market for such shares is usually reflected in price by a very significant minority shareholder discount.  This is to be contrasted with a “pro rata” valuation of a shareholding, where the shareholding is valued as an equivalent percentage of the value of the company or companies in question with no discount.

There may be little appetite amongst other shareholders to purchase a minority shareholder’s shares for a variety of reasons, some of which may stem from financing the purchase.  How can a shareholder force the other shareholders or the company to purchase their shares?  If there is no satisfactory solution under either the articles of association or any shareholder agreement, the focus for advisors is likely to be on the prospects of success of an unfair prejudice petition under s994 Companies Act 2006 (previously s459 of the Companies Act 1985).  There are a number of reasons for this.

First, as emphasised by Lord Hoffmann in the leading House of Lords’ case of O’Neill v Phillips, unfairly prejudicial conduct has to be established in order for a petition to succeed under s994 of the Act; this is not “no fault divorce”.  The breadth of allegations that are likely to succeed in establishing unfair prejudice are wider where a quasi-partnership can be established because unfairness can include equitable restraints stemming from agreements and understandings between the quasi-partners.  For those who frequently act for family-owned businesses, many such companies are often quasi-partnerships, although this is not always the case.  Equally, quasi-partnerships are not limited to family-owned businesses and may be established in other situations.

The leading case and guidance on what is a quasi-partnership remains Lord Wilberforce’s judgment in the House of Lords in Ebrahimi v Westbourne Galleries Ltd in 1973 in which he identified three factors, not of all which need be present, when equitable considerations will be imposed: (1) An association formed or continued on the basis of a personal relationship, involving mutual confidence, which will often be found where a pre-existing partnership has been converted into a limited company; (2) An agreement, or understanding that all, or some, of the shareholders shall participate in the conduct of the business; (3) Restriction upon the transfer of the members’ interest in the company so that if confidence is lost, or a member removed from the management of company, he cannot take out his stake and go elsewhere.

The availability of and likely success in an unfair prejudice petition by a shareholder is also important because a petition by a shareholder to wind up a company on the just and equitable ground under s124 of the Insolvency Act 1986 is available on relatively limited grounds and does not lead to a purchase of shares but to the winding up of the company.

If unfair prejudice in the conduct of the company’s affairs is proven, the court has a very wide discretion to do what is considered fair and equitable on the facts of the case.  In exercising its discretion on remedy, the court is seeking to put right and cure for the future the unfair prejudice which the petitioning shareholder has suffered at the hands of the other shareholders: see per Oliver LJ in Re Bird Precision Bellows Ltd (1986).  This broad discretion gives the court considerable flexibility in the remedy that it may order in any particular case and also as to how it fixes the price of shares that it orders to be purchased.

An order that the shares of the petitioning shareholder be purchased by the majority or the company is the remedy most often sought by Petitioners and ordered by the court under s996(2)(e) Companies Act 2006 (“the Act”).  The reason for such an approach was explained by Patten J in Grace v Biagioli (2005) where he stated that “nothing less than a clean break is likely in most cases of proven fault to satisfy the objectives of the court’s power to intervene.”

However, a recent example of the court using its wide discretion and deciding not to make a purchase order is Re Macom GmBH (UK) Ltd (2021).  HHJ Hodge QC sitting as a High Court Judge held that it was disproportionate to the unfair prejudice established to order the director to buy out the Petitioner’s shares because no financial loss was suffered by the Petitioner.  Instead, he made orders regulating the future conduct of the company’s affairs.  This case underlines the importance of being clear as to what is the unfairly prejudicial conduct that is likely to be established in any particular case and how that may be reflected in the remedy that the court orders.

The Act does not give any guidance to the court or include any presumptions as to the calculation of price in making an order under s996(2)(e) of the Act and the court has a broad discretion.  Instead, the court, guided by expert forensic accountancy evidence, determines the purchase price of the petitioning shareholder’s shares.

Aside from the merits of any unfair prejudice petition, the time when forensic accountants value the shareholding and the information that they are given to value the shareholding is likely to have a significant impact on price.  This is not just because of how the forensic accountant values the business but wider factors that may influence both seller and purchaser and may be of a commercial and personal nature.  These may include the cost of legal proceedings and the plans for the business.

Therefore, thinking through the strategy on when to instruct forensic accountants to value the shareholding, the instructions to experts and the questions to experts is important for the legal team.  However, it is also important to keep in mind whether a forensic accountant is being instructed as advisor or to give expert evidence in court proceedings (or may be so instructed in due course).  When the forensic accountant is instructed to give or prepare expert evidence for the purpose of legal proceedings, it is to be recalled that their duty is to help the court on matters within their expertise, which overrides any obligation to the person from whom they have received instructions or by whom they are paid (under CPR 35.3).

Moreover, whether or not a minority shareholder discount is to be applied is a matter for judicial discretion.  The draftsmen of the Act did not adopt the recommendation of the Law Commission in its report on Shareholder Remedies in 1997 that there should be a statutory presumption that shares were to be purchased on a pro rata basis in certain circumstances.  Since Re Bird Precision Bellows Ltd and more recently Lady Justice Arden’s judgment in Strahan v Wilcock in 2006, there has been broad judicial consensus that where there is a quasi-partnership, there should be no minority shareholder discount.  Therefore, understanding the strength of the case on whether or not there is a quasi-partnership and advancing that case is important for advisors and advocates not just in establishing unfair prejudice but also in the fixing of the amount payable for shares.

However, courts are also focussing not just upon the seller but also the purchaser. A notable and influential decision is Re Edwardian Group Ltd (2018).  Fancourt J having held that there was no quasi-partnership, applied a minority shareholder discount and then provided that the valuation was to take into account the marriage value of the seller’s and purchaser’s shares.

The valuation of shares in privately owned companies and the route to achieving a purchase will continue to present many key junctures for both sellers and purchasers of shares and those who advise and advocate for them.

This article first appeared on https://www.solicitorsjournal.com/sjarticle/shareholder-disputes-unfair-prejudice-petitions/650169