Unfair Prejudice Caused By Out-of-Date Financial Information
Company directors are urged to be cautious when relying on financial information in making decisions around exiting shareholders, and ensure it is up-to-date, or risk an unfair prejudice claim if shareholders suffer loss.
The question of the appropriate valuation date of shares is routinely disputed in unfair prejudice petitions, for obvious reasons. In a recent case1, a company auditor failed to use up-to-date financial information when valuing the shareholder’s shares under a shareholders’ agreement
What is ‘unfair prejudice’?
Unfair prejudice arises in circumstances where the majority shareholders (who are also frequently directors of the company) abuse their powers to further their own interests to the detriment of the other shareholders. This often leads directly to the devaluation of their shares.
The aggrieved shareholders then have the legal right to bring an unfair prejudice claim under section 994 of the Companies Act 2006. Typically, in a successful claim, the majority shareholders will be ordered to buy out the petitioner’s shares for value – but not always.
Out-of-date financial information
The three shareholders of a waste management company were also its directors. One shareholder (P) owned 14.3% of the share capital and the other two, who were brothers, owned the remaining share in equal shares.
The shareholders’ agreement set out a procedure for valuation of an existing shareholder’s shares. In September 2015 P expressed his intention to leave and sell his shares and the company auditor was duly appointed.
Unfortunately, there was a delay – for genuine reasons - in the auditor completing his valuation and it was finally produced in June 2016. The valuation was, however, based on figures up to 31 December 2014 and it also included a 75% discount to reflect that it was a minority shareholding. The auditor valued his shareholding at the net figure of £550,191.
P was not happy. He challenged the discounting on the basis the company was a quasi-partnership company; and particularly, the figures relied on by the auditor were out-of-date – a fact the auditor himself had acknowledged.
Matters could not be resolved and, in July 2019, P brought an unfair prejudice claim on the basis of the way the auditor had valued his holding.
The High Court concluded that the auditor had not properly complied with the instructions given to him. Those instructions were to estimate "the fair market value of the business enterprise of [the company] as at 30 September 2015”.
P, as the exiting shareholder, had suffered unfair prejudice because of the auditor’s use of outdated financial information. The auditor’s failure likely to have an impact on the proper calculation of the sale price to be paid for his shares.
The appropriate relief in this case was a fresh valuation by a jointly appointed valuer (as an expert). The judge said that fairness required P’s shareholding to be valued as at the end of September 2015.
What does this mean?
Companies should make sure the management and conduct of arrangements for the valuation of the company and an exiting shareholder’s shares are carried out correctly, fairly and in accordance with any contractual agreements.
If in doubt, seek specialist advice from corporate and commercial solicitors to avoid the risk of an unfair prejudice claim.
1Wells v Hornshaw and others [2024] EWHC 330
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