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A recent High Court case has demonstrated the importance of adopting well-drafted articles of association

Posted on 12th April 2021 in Company & Commercial

Posted by

Oliver Kent

Trainee Solicitor
A recent High Court case has demonstrated the importance of adopting well-drafted articles of association

The case of Re Euro Accessories Ltd [2021] EWHC 47 (Ch) involved a claimant who had originally joined the company as an employee and was subsequently given a 24.99% shareholding. A couple of years later the relationship between the shareholders had deteriorated and it was agreed that the claimant would sell his shares to the majority shareholder, but they couldn’t agree a price.

The majority shareholder then used his control over the company to amend its articles of association so that he could force a sale of the claimant’s shares to him “for fair value”. The option was then exercised and the fair value was calculated to be £175,000, when the claimant had wanted around £350,000.

A “minority discount” was applied in calculating the value of the claimant’s shares (to reflect the fact that the claimant only had a minority shareholding, which carried fewer voting rights). The claimant argued that he was not a willing seller in this instance and so a minority discount should not be applied. The High Court held that, in this instance, “fair value” did permit the application of a minority discount. The background to the relationship between the shareholders would not be apparent to anyone reading the information publicly available at Companies House and therefore could not be taken into account in interpreting the articles of association.

There is a lesson to be learnt here. When a company owner wants to introduce an employee into the ownership of a company, they should think carefully about the provisions that apply on that shareholder ceasing to be an employee. Ideally, in this situation, the company should have adopted articles of association setting out a clear and pre-agreed valuation process on a compulsory share transfer, before the claimant became a shareholder. Therefore, the delay and expense of going to court could have been avoided altogether. Although there is a cost associated with putting in place a specific set of new articles (and potentially a shareholders’ agreement), it helps to avoid disputes later on since the difficult conversations are had up front, whilst the parties are on good terms. Therefore the parties agree the position and know where they stand before any relationship turns sour.

For more help and advice, then our Company and Commercial team will be happy to help. Please visit their dedicated hub page for starting a business, or content them directly.

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