“Lush” shareholder dispute on fair value

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A recent case has again highlighted the importance of bespoke corporate documentation upon a company’s formation. Lush Cosmetics (“Lush”) is a high street cosmetics retailer. A commercial dispute arose amongst the shareholder base. The central issue in the shareholder dispute concerned the value of a shareholder’s shares upon an intended exit. The Court would not imply wording into the articles of Lush to save the existing shareholders from paying allegedly over the odds for a departing shareholder’s shares.

Background to the Lush shareholder dispute

Lush’s articles of association included a right of first refusal process in the event that a shareholder sought to sell shares. By this, the shares would first be offered pro rata to the existing Lush members at a price equal to “fair value”. If the shareholders refused the right of first refusal, the selling shareholder was then permitted to sell their shares on to a third party at a price no less than fair value.

The share valuation problem giving rise to the shareholder dispute

The case centred on the meaning of fair value. The selling shareholder held a minority of Lush’s voting rights (i.e. no more than 50%). The articles of Lush included certain assumptions and disregards that the professional valuer was entitled to make when arriving at the fair value. However, the articles did not include specific wording entitling the valuer to apply a discount on the basis that the selling shareholder did not have “control” of Lush.

Common practice

It is advised for every company to have bespoke articles and or a shareholders’ agreement. The documents are known as the company’s “constitution” on the basis that the documents regulate management decision making, sale proceeds, voting rights, and procedures upon a transfer of shares. When preparing documentation of this kind, it is common for a clause similar to the following to be included for determining fair value:

“The Valuer may…. apply a discount or premium on the value attached to any share(s) proposed to be transferred taking into account the size of the holding of shares in comparison to the company’s entire issued share capital…”.

The commercial rationale for this is that a holding in excess of 50% has more value than one equal to 50%. The former will have a premium applied whereas the latter a discount. A shareholder owning in excess of 50% of a company’s voting rights can pass an ordinary resolution, one such resolution being the right to remove a director under the Companies Act 2006. In practice this right is often invaluable.

The Lush dispute

The Lush articles did not include a clause akin to the above. The selling shareholder argued that no discount applied as the articles did not provide for one. The shareholders entitled to purchase the shares argued that a discount did apply on the basis that custom implied one. The “buying” shareholders argued that without a discount, a precedent would be set for over inflated share prices in the event any further shareholders sought to sell shares in the future.

Minority discounts vary in size but can range from 20% through to 60%. So, if 50% of a company’s shares were valued at £100,000.00, a 60% discount would see the shares hypothetically devalued by as much as £60,000.00.

The Court’s decision on the Lush shareholder dispute

The Court did not permit the valuer to apply a discount. The shares attracted full market value with no discount applicable. The Court emphasised the fact that had a discount been intended, then it should have been included in the articles. As often is the case, the Court was not willing to depart from the ordinary language included in the articles of Lush. To do so would override the parties’ free negotiating power.

The Court also took the view that the shareholders of Lush were astute business professionals and had ample time and opportunity to consider and if thought fit amend the articles if they did not reflect the apparent agreed commercial position.

Wider shareholder dispute ramifications

Fair value provisions often apply to situations whereby:

  1. A shareholder wishes to sell shares and they first have to be offered to the existing members;
  2. A service providing shareholder (e.g. employee holding shares) ceases employment and is forced to sell their shares back to the company or to the remaining shareholders. This often includes a distinction between a good and bad leaver, with a bad leaver receiving a reduced percentage of fair value.

Without bespoke documentation, the Courts are not usually willing to imply commercial terms with potentially wide ramifications. Here, the selling shareholder reaped the benefit of terms omitted from the Lush articles. No doubt the existing shareholders will seek to amend the articles of Lush to prevent future issue.

John Deane is a partner in the Corporate team and assists companies with shareholders’ agreements, company articles, and shareholder exits. John can be contacted on 02074381060.