High Court grants unfair prejudice petition on grounds of auditor's flawed valuation of claimant's shares in contractual exit process

The High Court has broadly interpreted what amounts to a "company's affairs" for the purposes of an unfair prejudice petition under s.994 of the Companies Act 2006, and also considered the impact on such a petition of an exit mechanism in a shareholders' agreement: Wells v Hornshaw [2024] EWHC 330 (Ch).

This case is relatively unusual since s.994 petitions are typically brought by minority shareholders who have no means of exiting a company that is being managed in an unfairly prejudicial way. Here, however, the claimant had an exit mechanism available to him under the shareholders' agreement. Consistent with previous cases involving similar scenarios (eg O'Neill v Phillips [1999] 1 WLR 1092), the court found that the existence of such a mechanism will usually provide a bar to relief from unfair prejudice.

However, the decision shows that where there is a contractual process for valuing shares on exit, a claim for unfair prejudice may still succeed if that process is not followed. In such circumstances, the court may grant relief comprising an order for a revaluation based on proper adherence to the contractual process.

The case is also notable for the court's broad interpretation of what amounts to the conduct of the "company's affairs" for the purposes of s.994. In this case, it extended beyond the conduct of the Company's officers and employees to a valuation carried out by a third-party auditor.

Background

The claimant was the minority shareholder of the third defendant (the "Company"), holding 14.3% of the issued shares. The remaining 85.7% was held equally by the first two defendants (the "Co-Shareholders"). Each shareholder had entered into a shareholders' agreement ("SHA") with the Company. The SHA contained an exit mechanism, at clause 7, outlining the process that should be followed when a shareholder intended to exit and the procedure for valuing the shares of the exiting shareholder. Each shareholder was also a director of the Company.

As a result of various events during September 2015, including a raid of the Company's premises by HMRC, the claimant emailed the Co-Shareholders on 26 September 2015 stating that he wished to sell his shares in the Company by the end of November 2015. The Company's auditor was therefore instructed to carry out a valuation of the shares. Despite the existence of the Company's audited accounts for the 18 month period to the end of June 2015, the auditor based the valuation on financial information up to the end of 2014.

The claimant disagreed with the auditor's valuation and did not exit. Instead, he remained as a shareholder of the Company, all the while continuing to express a desire to exit.

In July 2019, the claimant issued an unfair prejudice petition under section 994, complaining that he had been unfairly prejudiced as a result of:

• how the Company was managed before 26 September 2015;
• how the Company was managed after 26 September 2015; and
• how the auditor had valued the claimant's shares, namely by using out-of-date financial information.

Decision

The High Court (Adam Johnson J) upheld the claim for unfair prejudice in respect of the share valuation but not the management of the Company.

Management of the Company

Although the High Court held that the Company had been mismanaged during the periods both before and after 26 September 2015, it found that the claimant had not suffered unfair prejudice.

In relation to the period before 26 September 2015, the court found that the mismanagement of the Company had been prejudicial to the claimant because of the negative impact it had on the value of his shares. However, while prejudicial, it was found not to be unfair for two reasons:

• First, the claimant had an exit route available via the SHA. This enabled him to obtain fair value for his shares, as it outlined: (1) the process to be followed once the claimant had given written notice of his intention to exit; and (2) a procedure for valuing the shares.
• Second, the methodology prescribed by the SHA for valuing the shares already had built into it an allowance for instances of prejudice.

With regard to the period after 26 September 2015, the court found that the mismanagement had not been prejudicial or unfair.

The claimant's email to the Co-Shareholders on 26 September 2015 expressing his desire to exit the Company amounted to an intention to effect a clean break from the Company. This meant that the exit mechanism had been triggered on this date, which was also therefore the relevant date for the purposes of valuing the claimant's shares.

Given that the claimant's only remaining interest related to realising the value attributable to his shares as at 26 September 2015, how the Company was managed after that date could not be prejudicial or unfair to the claimant as it would not affect the valuation of his shareholding.

The valuation

The valuation of the claimant's shares was held to be unfairly prejudicial. This was primarily due to the auditor's use of outdated financial information. Despite: (1) the shares needing to be valued based on their value as at 26 September 2015; and (2) financial information being available for the period up to June 2015, the auditor only used financial information up to the end of 2014.

The court found that the failure to use up-to-date financial information in the valuation process likely had an unfair impact on the valuation of the claimant's shares. By only considering financial information up until the end of 2014, the auditor had departed from his instructions and had failed to ascertain the fair market value of the Company as at September 2015.

In this context, the court noted that section 994 is engaged where the "company's affairs" are conducted in a manner that is unfairly prejudicial to a member's interests. There was therefore a question as to whether a valuation conducted by an auditor (as an independent third party) could properly constitute the company's affairs in this context.

The court noted that the affairs of a company is a broad concept. Despite the fact that the auditor was a third party, the court was prepared to accept that his valuation could nevertheless be characterised as comprising conduct of the Company's affairs. Ultimately the Company would have to acquire the claimant's shares at the price determined by the valuation and the Company therefore had a direct interest in the valuation process.

Under the SHA, the claimant had the right to insist that the share valuation be completed accurately and carried out according to instructions. The instructions given to the auditor had been to obtain a fair value for the claimant's shares. However, because the instructions had not been followed and the share valuation had not been properly completed, the valuation process was found to be unfairly prejudicial.

The court therefore held that the valuation was not binding on the claimant and ordered that the claimant's shares be revalued in accordance with the SHA and using up-to-date financial information. Further, since the process for valuing the claimant's shares should have been properly completed long ago, the court also held that interest should be awarded to the claimant (with the rate of interest and period the interest is to run to be decided at a later date).