Corporate Law Update
- A fair value determination mechanism in a company’s articles of association took precedence over a different procedure in a shareholders’ agreement
- A shareholder did not lose the right to continue proceedings for unfair prejudice when they ceased to hold shares
- The Chancery Lane Project publishes its new Net Zero Toolkit
Fair value determination mechanism in articles of association took precedence over shareholders’ agreement
The High Court has held that the fair value of shares to be sold by departing directors under a compulsory transfer mechanism could not be calculated using a mechanism in a private contract, even though the articles defined “fair value” by reference to that contract.
Lord v Maven Wealth Group Ltd  EWHC 2544 (Comm) concerned the holding company of a financial advisory services group.
In August 2019, the group’s founders sold certain of their shares in the holding company to another wealth management business (IWP). However, they retained some ordinary shares in the company and continued to serve as directors of the company and directors and employees of a subsidiary.
On the sale, the company adopted new articles of association, and the company and its shareholders (that is, IWP and the sellers) entered into a separate private contract described as a “call option and shareholders’ agreement” (COSA).
In April 2020, two of the founders were dismissed as directors and suspended from their employment on the grounds of gross misconduct. On ceasing to be directors and employees, they became required, under a compulsory transfer mechanism in the company’s articles of association, to offer to sell their shares to the other shareholders in a prescribed order.
The price for the two individuals’ shares depended on whether they had in fact committed gross misconduct, which remained in dispute. However, either way, the price was to be calculated by reference to the “Fair Value” of their shares.
The articles set out a procedure for determining the Fair Value. This required the relevant founder and the company’s directors to agree the value. If they failed to do so, they would appoint the company’s auditors to determine it. If the auditors were unable or unwilling to do this, they would appoint an independent chartered accountant nominated by a shareholder majority. The decision of the auditors or the accountant would be final and binding.
The articles defined “Fair Value” by reference to the COSA, which used that term for a separate purpose (to value the founders’ shares in connection with the exercise of certain put and call options).
The COSA defined “Fair Value” as an amount to be determined in accordance with Schedule 2 to the COSA. Schedule 2 in turn referred to Schedule 3 to the COSA, which contained a mechanism for determining the Fair Value. That mechanism differed from the mechanism in the articles in three principal respects.
- The COSA mechanism required the company to instruct the auditors to determine the Fair Value immediately. It did not envisage the parties attempting to agreeing it between themselves.
- There was no “back-up procedure” if the auditors refused or were unable to act.
- Each party was entitled to dispute the auditors’ determination. If any of them did, IWP and the founders were required to try and resolve the dispute by agreement. If they could not, any party could ask the President of the Institute of Chartered Accountants in England and Wales to determine the Fair Value. That determination would be final and binding.
The COSA contained a “prevail clause” stating that, if there were a conflict between the terms of the company’s articles and the terms of the COSA, the COSA would apply.
A dispute arose over which valuation mechanism applied. IWP purported to appoint an independent accountant under the company’s articles. The leavers claimed that the procedure in the COSA applied, in particular because the articles defined “Fair Value” by reference to the COSA, and the COSA defined that term specifically by reference to the valuation methodology and determination procedure set out in the COSA.
What did the court say?
The procedure in the company’s articles applied.
The definition of “Fair Value” in the COSA incorporated both a calculation methodology and a determination mechanism, whereas the articles incorporated only a determination mechanism. However, requiring the parties to use the determination mechanism in the COSA would have explicitly contradicted the specific mechanism in the articles, which could not be right.
The court therefore interpreted the articles as requiring the calculation of “Fair Value” to be carried out according to the COSA, but the determination of that calculation to be carried out under the articles.
The judge also noted that the mechanism in the COSA dealt with determining the Fair Value for the purposes of the put and call options, not a compulsory transfer under the articles.
Because the articles, properly read, did not incorporate the determination mechanism in the COSA, there was no conflict and the prevail clause did not apply.
What does this mean for me?
The judge clearly considered this a straightforward case, describing the litigation as “unfortunate and unnecessary” and noting that, in the time dedicated to the litigation, the parties could have reached an outcome on the Fair Value.
However, these matters are not always so clear-cut. It is common for different documents in a single transaction to cross-refer to and “borrow” definitions from each other. This usually makes sense, as it can create clarity of meaning across a suite of documents and ensures that there is harmony and consistency in the way the arrangements operate.
However, it is important to ensure that any borrowed terms fit properly with the relevant document and do not contradict any express terms and not to resort to “lazy” cross-referencing. This is particularly important because the courts will interpret a term or phrase in one contract in a particular way that may not be appropriate when used in another document.
One reason parties may wish to include a valuation mechanism in a separate document outside of the articles is to ensure it remains private and out of public view. A company’s articles are a publicly available document, whereas a shareholders’ agreement is almost always a private document. However, again it is important to take care. If it is necessary to read a shareholders’ agreement to understand the articles properly, the company may be required to file the shareholders’ agreement itself publicly, in turn defeating the objective of keeping the valuation mechanism private.
The High Court has held that a shareholder of a company who commenced a petition for unfair prejudice was entitled to continue that petition when he ceased to be a shareholder.
Clarence v Nayar  EWHC 2504 (Ch) concerned a film and television series development and production services company.
In January 2019, one of the company’s shareholders – Mr Clarence – brought court proceedings in unfair prejudice, claiming that the company had acted in several respects in a way that was unfairly prejudicial to him as a shareholder. (These circumstances are set out in the judgment.)
Around 17 months earlier, in August 2017, Mr Clarence had granted a charge over his shares in favour of the company itself as security for amounts owed by a limited liability partnership of which he was a member. The share charge contained a power of attorney allowing the company to transfer Mr Clarence’s shares to satisfy the outstanding debt.
In January 2018, the company obtained a court order for payment of those sums. At the time of the petition, however, the sums remained unpaid.
In November 2020, the company used its powers under the share charge to force a transfer of Mr Clarence’s shares to two nominees. The company then claimed the following.
- Under section 994(1) of the Companies Act 2006, a petition for unfair prejudice is available only to shareholders (strictly, members) of a company. Section 994(2) made it clear that this included a person to whom shares had been transferred but who was not yet listed as a member, but it did not include persons who no longer held shares. Mr Clarence was now no longer a shareholder and so was not entitled to continue his petition.
- Even if Mr Clarence was entitled to continue his petition, he was no longer able to pursue the remedy he was seeking, which was a buy-out of his shares. The court should therefore dismiss his petition.
What did the court say?
The court disagreed on both counts.
It was clear that section 994(1) and (2) are directed at commencing proceedings and so deal with whether the petitioner is a shareholder at the time they bring an unfair prejudice petition. They did not require a petitioner to continue to hold shares throughout proceedings.
The court acknowledged that, if Mr Clarence had voluntarily sold his shares during the proceedings, the remedy he sought would no longer apply and his petition would need to be dismissed. The same would hold if the company had exercised its powers under the share charge for a valid purpose.
However, in this case, the company had used its powers to acquire the shares without any intention of selling them on and realising their value. It had not, therefore, appropriated them to satisfy the outstanding monies which the share charge secured. In doing so, it had not exercised its powers under the share charge properly and there was a real prospect of showing that its directors had breached their duties. These were matters which themselves could amount to unfair prejudice against Mr Clarence. The court therefore allowed him to continue his petition.
What does this mean for me?
The decision in this case is quite straightforward and makes complete sense. If a shareholder were to lose all grounds for complaint against unfair prejudice merely because they no longer hold shares, it might be possible to do precisely what the company here was attempting: to force a sale of the shareholder’s shares simply to defeat the petition. That could not be right.
This case involved forcing a transfer of the petitioner’s shares, but it might equally apply where a company forfeits a petitioner’s shares because the petitioner has not paid them up fully, or where the members carry out a capital reduction and cancel the petitioner’s shares.
A company responding to an unfair prejudice petition or its shareholders should not take action, such as appropriating shares, merely to block the petition.
The facts of the case are important. Here, the company clearly acted improperly when forcing the share transfer. But the outcome may have been different if the shares had been sold on in the market for value. That would have been an appropriate use of the company’s powers in the share charge and may well have brought the petition to an end.
A person who is considering bringing a petition for unfair prejudice should consider their own liabilities to the company before launching proceedings and assess the possibility that launching proceedings might prompt the company to take action that defeats the claim.
Ahead of the COP26 summit, the Chancery Lane Project (TCLP) has launched its Net Zero Toolkit. The toolkit is designed to help lawyers (whether in-house or in private practice) to amend their contracts to meet net zero goals.
The Toolkit builds on TCLP’s previous Climate Contract Playbook, a suite of climate-conscious clauses designed to be inserted into various types of commercial contact or document. As part of the Toolkit launch, TCLP has:
- added 20 new clauses, each of which (with the existing clauses) bears a child’s name to remind users of the importance of climate awareness to future generations; and
- revised 24 of its existing clauses to create a suite of “best-in-class high-ambition clauses aligned with the Paris Agreement.
New clauses added by TCLP include the following:
- Pasfield’s clause. A net-zero variation of TCLP’s existing Arlo's Clause, which contains ESG-aligned clauses for company articles of association.
- Ragnar’s clause. Green articles of association for a company containing a framework for decision-making and reporting.
- Eddie’s recitals. Recitals to frame a contract and the parties’ intentions in terms that are aligned with achieving net zero or net negative emissions and Paris Agreement goals.
- Lagatha’s clause. A clause designed to reduce the use and wastage of water throughout a company's supply chain by requiring suppliers to provide audit results.
- Javier’s clause. A stakeholder company climate questionnaire to explore an organisation’s climate position and net zero ambition.
- Emilio’s clause. A checklist that requests one-off or repeated disclosure of a company’s climate-related lobbying, financing, sponsoring and climate leadership activities.
- Sebastian’s clause. A menu of climate-aligned practical steps organisations can require their counterparties to take to transition to net zero.
- Griff’s clause. Template drafting for board papers with detailed prompts to consider the climate impacts of a significant transaction and the associated climate risks to the business.
- Lila’s clause. A board paper for building net zero objectives and targets into corporate strategy and for ongoing monitoring and evaluation of a company’s progress against its net zero targets.
- Elsie’s resolutions. A template shareholder resolution setting out obligations relating to a company's climate change commitments.
- Tilly’s clause. A checklist to help issuers of debt securities with drafting risk factors for prospectuses.
The Toolkit also contains a collection of tools to align contract drafting with net zero. These include:
- a net zero suite, containing an explainer, dashboard, drafting checklist, a series of definitions and a prototype transition map; and
- a clause timeline, which illustrates how TCLP’s model clauses align with contractual cycles (including pre-contractual work, procurement and supply chains, performance, breach and dispute resolution); and
- a series of case studies designed to show a range of applications of TCLP’s model clauses.