“Lush” shareholder dispute on fair value

A recent case involving Lush Cosmetics (“Lush”) highlights the importance of carefully drafted corporate documentation when a company is formed. The dispute concerned the value of a shareholder’s shares when they wished to exit, and whether a minority discount should apply.

Background to the Lush shareholder dispute

Lush’s articles of association contained pre-emption provisions requiring shares to be offered to existing shareholders at a “prescribed price”. If the price could not be agreed, it was to be determined by independent accountants.

The selling shareholders held a minority interest. The articles contained certain assumptions and disregards for the valuation but did not expressly provide for a minority discount.

The Court's decision

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.

The Court of Appeal held that the shares should be valued on a pro-rata basis by reference to the value of the company as a whole, rather than applying a discount to reflect the minority nature of the shareholding. The Court focused on the wording of the articles and did not accept that a different valuation approach should be implied..

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.

Why bespoke documentation matters

The case demonstrates the importance of ensuring that articles of association and shareholders’ agreements properly reflect the commercial agreement between shareholders.

Where shares may be transferred on an exit, the documentation should clearly address how “fair value” is calculated and whether discounts or premiums can be applied. This can be particularly important where there are employee shareholders, good and bad leaver provisions or compulsory transfer arrangements.

Without clear wording, a dispute can arise over the valuation methodology and the parties may be left relying on the Court to interpret documentation that does not fully reflect their intended commercial position.

Wider shareholder dispute ramifications

Fair value provisions commonly arise where:

• a shareholder wishes to sell their shares and existing shareholders have pre-emption rights;
• an employee shareholder leaves the business and must transfer their shares; or
• good and bad leaver provisions determine the amount payable for departing shareholders’ shares.

Bespoke articles and shareholders’ agreements can help establish the valuation mechanism from the outset and reduce the risk of costly shareholder disputes later.