March 2022
Disputes between shareholders in private companies arise for many reasons. Shareholders may feel, for example, that they have insufficient influence over the company’s management. There may be breaches of shareholders’ agreements or shareholder-directors may be forced off the company’s board and their shares acquired under the terms of its Articles of Association.
Disputes and Remedies
Minority shareholders who consider that they are being unfairly treated have limited options. They may only normally recover by way of a personal action a loss suffered personally as distinct from a loss suffered as members of the company. So if a shareholder suffers a reduction in the value of his or her shares as a result of, say, the diversion of business to another company by the directors, the company suffers the loss and is the entity which would normally take action to recover the loss.
Shareholders who believe that the affairs of a company are being or have been conducted in a manner which is “unfairly prejudicial” to them or to the interests of the members generally can petition the Court under section 994 of the Companies Act 2006. Although the Court has discretion over the remedies which it can order, in our experience the most common remedy sought has been to order the shares of the petitioner to be purchased by those who caused the unfair prejudice. The rest of this article therefore examines some considerations relating to the valuation of shareholdings.
Valuations and Investigations
Independent expertise may be required to value shareholdings which are to be transferred as a result of a dispute between shareholders or to comment on any valuations prepared by the company’s auditors under the terms of its Articles of Association. The valuation of a shareholding will normally start with a valuation of the company as a whole. Most company valuations are based on a multiple of estimated maintainable annual post-tax earnings, which take into account the company’s historical profits. Actions by controlling shareholders may reduce a company’s profits, and hence the value of a shareholder’s stake in the company. Such actions may include:
- excessive directors’ remuneration or management fees paid to shareholder-directors;
- diversion of business from the company to related parties; and
- other transactions which are not at arm’s length.
Expert accountants may need to investigate and adjust for any “funny business” such as that described in the previous paragraph. Similarly, it may be necessary to adjust for legitimate but “one-off” items which are not relevant to a consideration of the company’s maintainable profits.
As far as valuations of individual shareholdings are concerned, in quasi-partnership cases, a discount is generally not applied to reflect the minority status of a petitioner’s holding. For companies not regarded as quasi-partnerships, the Courts have taken conflicting views in recent years. In Re Blue Index Ltd (2014) and Re Addbins Ltd (2015), for example, the Court favoured the valuation of a minority holding on a “pro rata” basis, without applying any discount. But more recently, in Dinglis -v- Dinglis (2019), the Court considered as a “working hypothesis” the view that, outside the quasi-partnership scenario, it will be a very unusual case which calls for no discount to be applied at all.
The date at which the shareholding is to be valued may be important. The Court of Appeal ruled in Profinance Trust SA -v- Gladstone (2001) that the date of the Court’s order to purchase is generally the correct date for a valuation. However, as in the Scottish case of Croly -v- Good (2010), there may be circumstances in which fairness requires that an earlier date be used, e.g. where the business had been controlled solely by one of the parties since the expulsion of the other.
Conclusions
Disputes within private companies often result in the departure of one or more shareholders if the company is to continue trading. Irrespective of whether the matter proceeds to Court, it is likely that a valuation of the shareholding to be transferred will be needed. In these circumstances, it may be necessary for minority shareholders to obtain an independent and objective valuation or to obtain a view on any valuation underpinning an offer to acquire their shares.
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The information contained in our Newsletters is provided as general information only. It does not constitute professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. In addition, since the Newsletters were published in recent years, the information contained in them may not be applicable at the current time.