In this article Matthew Moy, Associate in our Litigation team, looks at minority discounts in relation to instances of unfair prejudice; explains the rationale for and against a discount and considers the circumstances in which it may be applied.
A petitioner can seek a range of remedies when pursuing an unfair prejudice petition however, the most common is often for the Court to order a minority shareholder’s shares to be purchased by the majority shareholders or by the company itself.
This requires the Court to determine the value of those shares and whether a minority discount should be applied. It is an important point as the discount can be substantial and can mean that minority shareholders receive less than the value their shares might otherwise generate at the point a company is sold.
The law on whether a discount should be applied was reasonably settled depending on whether the company was considered to be a quasi-partnership or not. However, in recent years there have been a number of decisions in which this point has been reconsidered.
Background
Section 994 of the Companies Act 2006 provides that a minority shareholder may petition to the Court for relief where the affairs of the company are being, or have been, conducted in a manner that is unfairly prejudicial to the interests of some or all of the shareholders. A failure to comply with the company’s articles of association or shareholders’ agreement may justify the bringing of an unfair prejudice petition.
A quasi-partnership is a form of private company akin to a partnership which usually involves one or more of the following aspects: (i) a relationship of mutual confidence between shareholders; (ii) an understanding that all or some of the shareholders will participate in the conduct of the business; and (iii) restrictions on the transfer of shares. Examples of quasi-partnerships often include small family run businesses and long-term business associates operating through limited companies.
Purchase Order
As mentioned above, the remedy that is often ordered in unfair prejudice petitions is for the minority shareholders’ shares to be purchased by the majority or by the company itself. The Courts will seek to achieve a fair result between the parties. The starting point is that the shares should be valued on a pro-rata basis, representing a proportion of the total value of the company.
Minority Discount
Once a full market value is arrived at for the shares, as a percentage of the value of the company, the Court may adjust it by reference to a number of factors including whether a minority discount should be applied. The justification for a discount is often that a reduction should be applied to minority shareholders’ shares to reflect the lack of control, voting rights and marketability of those shares when compared against the shares of a majority shareholder.
There are, however, arguments against a discount including that if a discount is applied, a minority shareholder is effectively relinquishing the value that would have been received upon the sale of the company. This value is then added to the existing shareholding of the majority which arguably rewards them for their own unfairly prejudicial conduct.
When will a minority discount be applied?
Until reasonably recently, the circumstances in which a minority discount would be applied were relatively settled:
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In a quasi-partnership company, a discount will generally not be applied due to it being akin to a partnership and including the features outlined above. That said, as was explained in O’Neill v Phillips [1999] 1 WLR 1092, this general rule can be departed from in “special circumstances”, a typical example of which being where the minority shareholder deserved to be excluded from the running of the company; and
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In a company without quasi-partnership features, it had been established that a minority discount should be applied. In Irvine v Irvine [2006] EWHC 583 (Ch), it was held that “Short of a quasi-partnership or some other exceptional circumstance, there is no reason to accord it a quality which it lacks. [The company] is not a quasi-partnership. There are no exceptional circumstances. The shareholdings must therefore be valued for what they are: less than 50% of [the company’s] issued share capital.”
Non-Quasi Partnership Companies
As mentioned above, the position with non-quasi partnership companies remained relatively clear until it began to be questioned in a number of cases beginning with the decision in Re Sunrise Radio Ltd [2010] 1 BCLC 367 in which it was held that “there is no inflexible rule” that a minority shareholder should see their shares subjected to a discount in a non-quasi partnership context.
It was further doubted in Re Blue Index Ltd [2014] EWHC 2680 (Ch) in which it was held that the “default position” should be that there is no minority discount for all companies. To order otherwise would be to reward the oppressing majority and improperly treat the petitioner as if they were a willing seller. An exception to this would be if the shares were originally acquired at a discount.
The point was considered again in Re Edwardian Group Ltd [2019] EWHC 873 (Ch) in which it was held that the Court did not only have a binary choice between discount and no discount. Instead, it emphasised that the task of the Court is to find what is considered to be a fair outcome in all of the circumstances which may involve a more nuanced approach.
In Re Dinglis Properties Ltd [2020] 1 BCLC 107, the Court held that it must: "try to arrive at a valuation method which is fair in light of the facts of the case, including the nature of the unfair prejudice identified” but also acknowledged that, “outside the quasi-partnership scenario, it will be a very unusual case which calls for no discount to be applied."
Conclusion
The decisions since Re Blue Index have sought to express something of a middle ground and that in reality, a degree of flexibility both exists and is necessary to achieve fairness in claims concerning non-quasi partnership companies. As such, advising what to expect in terms of share price upon a successful petition is more uncertain than it once was.
The valuation of a successful petitioner’s shares calls for consideration of all of the specific facts and circumstances of the case, rather than the application of a general rule. However, it is evident that minority shareholders in non-quasi partnership companies will continue to run the risk of a minority discount being applied.
If you require any advice on shareholder disputes (including unfair prejudice petitions and minority discount), please do not hesitate to contact a member of our commercial litigation department.
