M Yovich & Sons Ltd v Yovich
[2001] NZCA 32
•22 February 2001
| IN THE COURT OF APPEAL OF NEW ZEALAND | CA187/00 |
| BETWEEN | M YOVICH & SONS LIMITED |
| Appellant |
| AND | JOHN ZALTO YOVICH |
| Respondent |
| Hearing: | 22 November 2000 |
| Coram: | McGrath J Doogue J Young J |
| Appearances: | G P Denholm for the Appellant J D Sadler for the Respondent |
| Judgment: | 22 February 2001 |
| JUDGMENT OF THE COURT DELIVERED BY MCGRATH J |
Table of Contents ....................................................................................... Paragraph Number
Introduction..................................................................................... [1]
The Statute...................................................................................... [2]
Facts................................................................................................ [3]
High Court Proceeding.................................................................... [9]
High Court Judgment...................................................................... [18]
Submissions on Appeal............................................................................................... [25]
Prejudicial conduct under s174....................................................... [29]
Fixing the price:.............................................................................. [35]
(a) Notional costs of liquidation........................................................................... [37]
(b) Contingent claim for wages............................................................................ [39]
(c) Discount for minority shareholding............................................................. [40]
(d) The Windfall Issue............................................................................................ [60]
Costs in the High Court.............................................................................................. [61]
Conclusion...................................................................................................................... [62]
Introduction
This is an appeal against the basis on which the High Court fixed the price at which it ordered a company to acquire the minority shareholding of a member under s174 of the Companies Act 1993. The appeal is against a judgment of Laurenson J delivered in the High Court at Whangarei on 31 July 2000, in which the Court ordered the appellant, M Yovich & Sons Limited, to acquire for $140,000 a parcel of 2027 ordinary shares in the appellant held by the respondent Mr John Yovich. Before the Judge the parties had accepted that by reason of their inability to work together, the affairs of the appellant were likely to be conducted in a manner unfairly prejudicial to the respondent as a shareholder. The substantial issue in this case was accordingly the price to be paid for the shares.
The Statute
Insofar as it is relevant to the issues in this appeal s174 of the 1993 Act provides as follows:
174. Prejudiced shareholders-(1) A shareholder or former shareholder of a company, or any other entitled person, who considers that the affairs of a company have been, or are being, or are likely to be, conducted in a manner that is, or any act or acts of the company have been, or are, or are likely to be, oppressive, unfairly discriminatory, or unfairly prejudicial to him or her in that capacity or in any other capacity, may apply to the Court for an order under this section.
(2) If, on an application under this section, the Court considers that it is just and equitable to do so, it may make such order as it thinks fit including, without limiting the generality of this subsection, an order-
(a)Requiring the company or any other person to acquire the shareholder’s shares; or
…
(3) No order may be made against the company or any other person under subsection (2) of this section unless the company or that person is a party to the proceedings in which the application is made.
Facts
On its formation in 1953 the appellant acquired a farm at Mata from the founder of the company Mr Mick Yovich. He had come to New Zealand in his youth and had purchased the farm in the late 1920s. Mick Yovich and his wife had four sons: George, Milan, Mate and the respondent. Each worked on the farm although the respondent ceased to do so when he left home at the age of 20 years in 1950. Thereafter the respondent’s brothers ran the farm with their father until he retired. Mick Yovich died in 1964 and Mate in 1969. At the time this proceeding was brought the farm was being worked by George and Milan Yovich. Milan died early in 2000 leaving George Yovich as the sole surviving working shareholder of the brothers.
At its formation the capital of the company comprised 2000 ordinary and 12,000 preference shares. Initially Mick Yovich and each of George, Milan and Mate held 500 ordinary shares; Mick Yovich held 10,936 of the 12,000 preference shares and Mate the remaining 1064. However, because all 14,000 shares had equal voting rights Mick Yovich retained full voting control. When Mick Yovich died in 1964 he held 500 ordinary shares and 7606 preference shares.
In his will Mick Yovich provided for a life interest in his residuary estate in favour of his widow, and on her death that all his shares in the appellant should pass to his sons equally. Accordingly, on his mother’s death in 1982, the respondent became entitled to be registered as the holder of 125 ordinary shares and 1902 preference shares in the appellant. There was a delay in completion of the administration of the estate of Mick Yovich which had the consequence that the shareholding of the respondent was not registered until 1997 but, in our view, in this proceeding nothing turns on that.
It was common ground before Laurenson J, and in this Court, that by operation of the Companies Act 1993 the preference shares in the appellant were, in effect converted into ordinary shares. The parties have accordingly proceeded on the basis that the respondent now holds 2027 shares which are subject to the same rights in terms of ss28 and 36 of the 1993 Act. The appellant characterises this situation as a windfall benefit, which enhanced the respondent’s interest in the equity of the appellant company from 125 of 2000 ordinary shares to 2027 of 14,000 shares, an increase of from 6.25% to 14.48% in his ownership interest. By January 2000 all other shares were owned by Milan and George Yovich, who had acquired the shareholding of Mate Yovich from his widow following his death in 1969.
From the limited financial information about its affairs that was given in evidence it is clear that the appellant has been and is a conservatively managed but profitable company. Its income has been derived from its farming and contracting businesses, the latter involving haybaling, bulldozing and cartage contracts carried out over the years for the company by its working shareholders. The evidence of Mr Halse, who has been the company’s accountant since 1972, was that annual decisions as to allocation of company profit were always left to him and made with the objective of minimising tax. Wages were drawn by the working shareholders until the 1992-1993 year. No provision at all for remuneration for working shareholders was made thereafter because of the impact of the tax surcharge on income over and above national superannuation payments to the working shareholders. In consequence drawings from the appellant thereafter were charged to the shareholders’ current accounts. At 31 March 1999 these were overdrawn to the extent of $111,421.
In its accounts the accumulated profits of the appellant over the years are substantially reflected in investments of $284,825 as at 31 March 1999. No dividends have been paid by the appellant for at least 20 years, which covers the period in which the respondent has been entitled to be registered as a shareholder. Accordingly the respondent has at no stage received any tangible benefit from his shareholding.
High Court Proceeding
Initial steps taken by the respondent in 1996 to have the appellant wound up could not proceed because the administration of his father’s estate had not been completed. Once registration of his shareholding was achieved, and following unsuccessful attempts to negotiate a sale of the shares to George and Milan Yovich, the respondent in September 1999 brought this proceeding against the appellant, under s174 of the 1993 Act, alleging that the affairs of the appellant had been , and were in future likely to be, conducted in a manner unfairly prejudicial to the respondent’s interest as a shareholder. The respondent sought by way of relief either that the appellant be liquidated or that it acquire the respondent’s shares at a proper valuation. In its statement of defence the appellant asserted that it continued to trade profitably and maintain its asset value. It denied that its affairs were being conducted in any manner that was oppressive to the respondent. It also pleaded by way of answer to the claim that the appellant was providing a living wage for the working majority shareholders, with surplus profits being reinvested to preserve and improve the asset base.
In the introductory section of his judgment Laurenson J said:
The background to the application arose from a long‑standing family dispute. The pleadings and affidavits reflected this in the form of accusations and counter‑accusations as to the conduct of the plaintiff and the shareholders of the defendant. Whatever may have been the rights and wrongs of what had gone on in the past, it was quite clear that the situation had been reached where, if the existing situation was allowed to continue, the affairs of the defendant were likely to be conducted in a manner which would be unfairly prejudicial to the plaintiff.
At the outset of the hearing he accordingly invited the parties to consider whether they might each accept that two preconditions to the Court exercising jurisdiction under s174 were met. They were first that the conduct of the company fell within the description “oppressive, unfairly discriminatory or unfairly prejudicial” to the respondent and secondly that it was “just and equitable to make an order”. In response to His Honour’s suggestion a memorandum signed by the parties was filed which stated:
The parties agree:
1.That by reason of the inability of the parties to work together, the affairs of the defendant are likely to be conducted in a manner unfairly prejudicial to the plaintiff as a shareholder.
2.This being the case they further agree that it is just and equitable that the Court should make an order pursuant to s174(2)(a) that the defendant should acquire the plaintiff’s shares.
3.That the Court is thus required to determine an appropriate valuation to be placed on the plaintiff’s shares.
So far as matters of past history are concerned the Court shall not be concerned to evaluate the past dealings between the parties beyond recognising-
(a)The plaintiff has not, to this point, had the benefit of his
shareholding; and
(b)The company’s present situation has come about as a result
of the efforts of the remaining shareholders.
As a result the High Court hearing proceeded on the assumption an order would be made under s174 for the purchase of the respondent’s shares by the appellant the only issue in dispute being the amount to be paid for them. The hearing then became a contest as to the price to be paid for the respondent’s parcel of shares.
Each party called valuation evidence in the form of an affidavit from a chartered accountant, which was supplemented by oral evidence at the hearing. Each witness agreed in his evidence that the appropriate basis of valuation was that of a notional liquidation. Both also adopted a market valuation by a registered public valuer of the farm land, buildings, stock, plant and machinery as at 25 November 1999.
The respondent’s valuer, Mr McLoughlin, calculated the net amount available for distribution to shareholders in the company, in the event of a notional liquidation as at 25 November 1999, as follows:
Current Assets $32,641.00
Livestock 92,513.00
Investments 284,825.00
Fixed Assets (as per Valuation of
25 November 1999) 810,500.00
Shareholders’ current accounts 120,101.00
Total Assets 1,340,580.00
Less
Current liabilities $23,043.00
Estimated disposal and
liquidation costs 32,100.00
Estimated income tax
liability 10,566.00 65,709.00
Net Assets $1,274,871.00
This valued each share at $91.06 and the respondent’s holding of 2,027 shares at $184,583.
Approaching the valuation on the same premise of a notional liquidation and having made the same adjustment for the fixed assets of the appellant Mr Ross, the valuer for the appellant, made three further adjustments. The first reflected Mr Ross’s view of the higher notional costs of liquidation. He allowed $46,971 rather than $32,100. Secondly he made a deduction of $252,000 to reflect a notional claim by the working shareholders George and Milan Yovich who, for reasons already outlined, had not been paid wages for the past seven years. A tax benefit for the company of $10,000 correlative to recognising the notional claim for wages was added back. Thirdly Mr Ross made an adjustment of 40% for the minority nature of the respondent’s holding to reflect his general disadvantageous position in the company and in particular lack of voting control.
The effect of these adjustments on Mr McLoughlin’s net asset valuation was as follows:
McLoughlin Valuation of Net Assets $1,274,871
Adjustment for increased disposal and
liquidation costs (14,871)
Adjustment for undrawn wages claim (252,000)
Adjustment for correlative tax benefit 10,000Ross’s valuation of net assets $1,018,000
This valued each share at $72.71 and the parcel of 2027 shares at $147,392 pro rata; but after applying the 40% discount of $58,956 the value of the parcel became $88,435 or $43.63 per share.
High Court Judgment
Laurenson J said his responsibility in fixing the price was to determine a value of the shares which was fair in the particular circumstances. He addressed four issues in his judgment. The first concerned the differing views of the valuers as to the deduction for the notional cost of realisation of the assets. Here the Judge differed from both, concluding that there was no reason in this case to make any allowance at all for the notional cost of realisation as none would actually be incurred.
The second issue was whether there should be a deduction for a notional claim to undrawn wages by the company’s working shareholders George and Milan Yovich. The Judge decided that there should also be no adjustment to reflect that factor. The decision to make no provision for wages after the year ended 31 March 1992 was one deliberately taken, on the advice of the company’s accountant, and for tax reasons. Although those reasons largely disappeared with the lifting of the tax surcharge in 1997 the accountant had decided not to alter the practice in case it was seen as a device to reduce the company’s net worth to the detriment of the respondent who by that time was in dispute with the company.
As indicated, one consequence of the failure to make adjustments for wages of the working shareholders during the 1990s was that the drawings which George and Milan Yovich continued to make on the appellant were directly reflected in the shareholders current accounts which were overdrawn by $120,101 as at the date of the valuation. In Laurenson J’s view it would be neither fair nor equitable to reflect in the notional valuation of the appellant’s net assets sums which, for practical purposes, had been taken in place of salary over those years. Accordingly he decided to reduce the net assets of the appellant by the amount of the overdrawn current accounts, that is by $120,101;
The third issue concerned whether there should be a discount in the proportionate capital value to reflect the minority nature of the shareholding of the respondent. Here Laurenson J decided it was not appropriate to discount asset value at all to reflect this factor. He saw as significant that the respondent had inherited his holding and could not in the circumstances be regarded as having acquired it voluntarily at a discounted price. Similarly whether there were rights of sale subject to pre‑emption was also of little weight. No difficulty would be caused to the company in being required to buy out the respondent’s shares at a value that was not discounted as it held readily realisable investments sufficient to cover the cost. Finally the respondent had received no actual benefit from his inheritance since becoming entitled to hold the shares in 1982 whereas the shareholders had, in the Judge’s view, benefited from the respondent’s holding. For those reasons it would be unfair to the respondent if he were to exit the company at a discounted price.
The fourth issue was whether there should be a deduction because the respondent’s original holding of 125 ordinary shares and 1902 preference shares had effectively been converted into 2027 shares having equal rights to all other shares in the company by operation of the 1993 Act. Here the Judge accepted that this enhancement of the respondent’s ownership interest in the appellant from 6.25% to 14.48% was a windfall. He dealt with this factor by discounting the value of the respondent’s parcel of shares by one third of the difference between the value of a holding of 6.25% and one of 14.48% of the appellant.
In a summary set out in his judgment Laurenson J valued the respondent’s parcel as follows:
A. Value of 14,000 Ordinary Shares after 1993
1. Mr McLoughlin’s original net asset value $1,266,191.00 2. Add adjustment for overdrawn shareholders’ accounts 8,680.00 $1,274.871.00 3. Less adjusted total overdrawn shareholders’ accounts 120,101.00 $1,154,770.00 4. Add back estimated disposal costs 32,100.00 5. Adjusted net asset value $1,186,870.00 6. Value for each of the 14,00 ordinary shares $84.776
B. Value of 24,000 $1 Preference Shares pre 1993 Act
1. Paid up value $24,000.00 2. Accumulation 5% preference dividends for 18 years 21,600.00 3. Total value of preference shares $45,600.00 4. Value of each share $1.875
C. Value of 2000 Ordinary Shares Pre 1993 Act
1. Adjusted net asset value (A5 above) $1,186,870.00 2. Less value of preference shares (B3 above) 45,600.00 3. Net amount available for distribution to ordinary shareholders $1,141,270.00 4. Value for each ordinary share $570.64
D. Calculation of Nature of Plaintiff’s Shareholding pre 1993 Act
1. 1902 preference shares @ $1.875 $3,566.00 2. 125 ordinary shares @ $570.64 71,330.00 $74,896.00
E. Calculation of Value of Plaintiffs 2027
Ordinary shares post 1993 @ $84.776 each 171.841.00
F. Difference between D & E $96,945.00
G. Calculation of Value of Plaintiff’s Shareholding
For purposes of this proceeding
1. Calculation for 2027 ordinary shares (E above) $171,841.00 2. Less one-third of difference (F above) 32,315.00 $139,526.00
He determined accordingly that the fair value of the respondent’s shareholding was $140,000 and ordered pursuant to s174(2)(a), that the appellant should acquire for that sum the plaintiff’s 2027 shares. In addition he allowed interest on that sum from 25 November 1999 (being the date of the valuation of the fixed assets) until the date of judgment at 5.25% on $62,000 and 7.5% on $78,000. The difference in interest rates reflected the split of returns in the fixed interest investments of the company.
Submissions on Appeal
The written and oral submissions of Mr Denholm for the appellant addressed each of the issues decided by the High Court. Mr Denholm contended that making provision for notional costs of realisation was fundamental to the concept of a net assets valuation. Mr Sadler, for the respondent, on the other hand argued that the Judge had exercised his discretion in order to reach an overall fair value. In that context he was entitled in a notional liquidation valuation to recognise that no liquidation costs would actually be incurred.
On the question of a deduction reflecting a notional liability for unpaid wages Mr Denholm argued there should have been an adjustment to reflect the element of under-recognised value of the contribution of Milan and George Yovich to the company. He referred to the calculation of Mr Ross of a net figure of $252,000 (which was based on an annual salary of $45,000 for each working shareholder over the seven year period, discounted by 20%). Mr Denholm’s submission was that an adjustment of $120,101, simply cancelling the indebtedness occasioned by the working shareholders’ drawings, was inadequate recognition of their working contribution to the company and the enhancement in the value of its net assets over that time. Mr Sadler’s argument supported the approach of the Judge and contended there was no support in the authorities for any principle allowing recognition of the claim.
Much of the appellant’s written submissions were devoted to whether there should have been a discount in the price to reflect the minority nature of the holding. Mr Denholm contended that the Judge’s perception was that the working shareholders had the benefit of the use of the respondent’s capital as well as their own, and that the respondent had not to date had any benefit from his shareholding. This he said resulted in the Judge’s failure to give any weight to the fact that the company’s present strong situation, as reflected in the value of its assets, had come about as a result of the efforts of the remaining shareholders. The parties’ agreement that the Court should proceed directly to determine the appropriate valuation of the shares required that this element would be recognised. Mr Denholm argued there was little advantage to the appellant or its shareholders other than the respondent in the acquisition of the respondent’s shares. Mr Sadler again emphasised the discretionary nature of the Judge’s decision and that the Court’s responsibility was to ascertain a fair and equitable valuation in circumstances in which the company would be operated to the prejudice of the respondent. He supported the Judge’s view that the working shareholders’ earning of their living through the farm entailed the use of the respondent’s capital.
On the “windfall” issue Mr Denholm argued that the present net asset value should be apportioned on the basis of the respondent’s shareholding prior to 1993 rather than as a trial. This would reflect the share of the equity the respondent received under his father’s will rather than that he presently held.
Prejudicial conduct under s174
Given that in both Courts it was common ground between the parties that there was jurisdiction to make an order to buy-out the respondent’s shares, and that such an order should be made, the consideration in this judgment of the principles underlying s174 need not be lengthy. It is however necessary to identify the nature of the unfair prejudice in the case as that is relevant in fixing the price to be paid for the shares. Section 174 closely follows provisions included in clause 136(1) and (2) of the draft Bill included in the report of the Law Commission: Company Law Reform and Restatement (1989 NZLC R9). There are minor syntactical changes that are, for present purposes at least, not of significance. In its commentary on the draft the Law Commission makes plain it did not seek to make major changes to the scheme of the current statute law:
573 The remedy for unfair prejudice contained in the current section 209 is retained in the draft Act in section 135. This section modifies section 209 in two ways
•it removes the present ability of a shareholder to seek relief for prejudice suffered other than as a shareholder. We consider this undesirable because it does not relate to abuses arising from separation of ownership and management.
•it emphasis the diversity of orders available to the Court where it finds that shareholders have been prejudiced.
Subject to these modifications, which are not in point in the present appeal, the concept of unfair prejudice in s174 of the 1993 Act is in substance unchanged from that of s209 of the 1955 Act as amended in 1980. This was considered in detail in Thomas v H W Thomas Ltd [1984] 1 NZLR 686, 690-695, 697-698 C.A. in particular in the judgments of Richardson J and Sir Thaddeus McCarthy.
The concern reflected in s174 is whether there has been, or is likely to be, conduct unjustly detrimental to the interests of a member of the company, it being unnecessary to show a breach of legal rights or an absence of good faith. Assessment of whether a detrimental effect is unjust or unfair will generally require a balancing of the interests of the parties in light of the policies of the Act which of course include the underlying contractual nature of the relationship of members with a company and the rights generally enjoyed by a majority of shareholders (Cf Thomas pp 693 and 694 per Richardson J). As that case demonstrates not every exercise of majority power against the interests of a minority will be caught. The statutory protection for prejudiced shareholders is not intended to facilitate exit from the company in all cases where minority shareholders differ from the majority on the policy and direction of a company which they see as being to their disadvantage. As the English Law Commission has said:
In our view there are strong economic arguments against allowing shareholders to exit at will. Also, as a matter of principle, such a right would fundamentally contravene the sanctity of the contract binding the members and the company which we considered should guide our approach to shareholder remedies.
(Shareholders’ Remedies, Law Commission No.246 page 39 para 3.66)
Those who become shareholders in a family company operating a specialist business will often do so appreciating that a central and continuing objective of the company may be to employ one or more members of the family in the conduct of that business. That may be especially so in New Zealand when the company conducts a farming business. It will often also be the case that this objective reasonably subordinates for quite lengthy periods the interests of a minority who are not so employed. However particular circumstances can come to outweigh such understandings with the result that there is unjust detriment to shareholders who are not engaged in the company’s operations of a kind that s174 is intended to address.
As already indicated the appellant at trial expressly accepted that by reason of the inability of the parties to work together the appellant’s affairs would be likely to be conducted in a manner that will be unfairly prejudicial to the respondent. We consider that concession to have been realistic and indeed even without it, in the circumstances of the company, such a finding was inevitable. We respect the wish of the parties that the Court should avoid evaluating the detail of past dealings between them. We acknowledge also that the appellant is a tightly held family farming and contracting company which as a result of the efforts of its working shareholders over the years has been able to apply accumulated profits towards investments which are surplus to the needs of its core business activities. It is with no disrespect to those efforts that we say the stage was plainly reached some time ago where the company was readily able to pay dividends without affecting the drawings of its working shareholders or putting any strain on the core business. In the circumstances the unwillingness of those in control of the company to facilitate the payment of dividends or some form of return to the respondent, who has been entitled to be registered as a shareholder since 1982, is clearly indicative of unfair prejudice.
It is true, as Mr Denholm emphasised, that the benefit of the company’s policy can be seen in the present financial situation of the appellant, but it would nevertheless plainly be unfair for the policy to continue when the respondent can be bought out without disruption to the appellant’s business by realising liquid investments themselves built up from accumulated profits over the years. It would be unjust to expect the respondent to wait any longer when he has waited so long already. Furthermore the fact that the value of the company has been enhanced over the period of delay in our view provides no reason for the Court to depart from general principles of valuation of the shares of a prejudiced shareholder when fixing the price to be paid for a buy-out under s174. On that basis we turn to address the appellant’s submissions as to what were said to be errors by the Judge in fixing the price to be paid for the respondent’s shareholding.
Fixing the price
As already noted Laurenson J approached the matter on the basis that he was required to exercise a discretion in order to produce a result that was fair in the particular circumstances. This approach accords with that taken in England under the equivalent provision of the 1948 Companies Act (U.K.) by Nourse J and the Court of Appeal in re Bird Precision Bellows Ltd [1984] Ch 419 (Ch.D) and [1986] Ch 658 (C.A.). Nourse J, after observing that the Act was silent on the point, said: “it is axiomatic that a price fixed by the Court must be fair”. His judgment as to the manner in which the price was to be assessed was upheld on appeal as being within the Court’s statutory discretion, but it is plain from the judgments of Oliver LJ and Purchas LJ that they were in full agreement with it. Together the judgments support the proposition that there is an overriding principle that the price to be fixed by the Court on an order for the acquisition of shares under what is now s174 is to be a fair price in all the circumstances of the case.
This principle has been recognised in New Zealand by the High Court in Vujnovich v Vujnovich [1988] 2 NZLR 129,148 Henry J, in Holden v Architectural Finishes Ltd [1996] 7 NZCLC 260976, 261,007 by McGechan J and now of course by Laurenson J in the judgment under appeal. It was not challenged in this case. In that context we turn to consider the four criticisms of the judgment raised on appeal.
(a) Notional Costs of Liquidation
Laurenson J held that, when determining the value of the appellant’s shares on a net assets value basis, it was inappropriate to make a deduction for the costs that would be incurred in a liquidation of the company. His reason, in essence, was that an actual liquidation was neither intended nor likely. We however accept that there is a strong argument that in a notional liquidation valuation whether liquidation is actually proposed or likely is irrelevant. On this view to recognise that there would be costs on a liquidation and to allow for them in making a valuation is simply to carry through the valuation concept to its logical conclusion and to do otherwise is to give it only partial application. As Cooke J observed in NZ Insurance Company Limited v Commissioner of Inland Revenue [1956] NZLR 501: “I think that underlying the assets‑value method is always a notional liquidation, and that, in principle, the assets‑value method is directed to the ascertainment of what would be the net result to the shareholder if liquidation were carried out.” (at p503). To the same effect see Hatrick v Commissioner of Inland Revenue [1963] NZLR 641, 662 (C.A.) (per Turner and McCarthy JJ ).
It is also true that in the present case the evidence of both valuers made provision for the notional costs of liquidation of the appellant. One allowed a deduction of $32,100 and the other $46,971 in assessing the net value of the appellant’s assets. Nevertheless we do not regard the Judge’s view that because the company is a going concern there should be no deduction of the notional costs of liquidation as a sufficient breach of a rule or principle that we should interfere on this appeal. Others might well have seen this matter differently. We would certainly have preferred that before the Judge departed from established practice he tested his view with the valuers when they gave evidence. In the end, however, it was open to Laurenson J in the circumstances to apply the notional liquidation principle of valuation in the way he chose, that is without allowing for liquidation costs. Particularly when the overall result achieved is within the bounds more orthodox approaches might have achieved we see no reason to intervene.
(b) Contingent claim for wages
This issue concerned whether the deduction made by the Judge from the net assets value of the amounts shown as owing on the shareholders’ current account adequately reflected the absence of any provision for wages following the year ended 31 March 1992. The Judge said the decision to make no provision for wages in the years in question was deliberately taken with a view to minimising taxation. As Mr Sadler said it was a conscious rational decision taken on professional advice from which a benefit was obtained. It was also a decision controlled by the majority. The Judge’s deduction takes into account what was actually drawn instead of wages. No doubt he had in mind that inactive shareholders are entitled, after such provision as the company decides is appropriate for remuneration of working shareholders, to share equally with them in proportion to their shareholding any increase in value of a company. There is in our view no basis for an appellate court to make additional provision.
(c) Discount for Minority Shareholding
The issue here is whether there should be a discount in the value of a minority shareholding when the Court is determining a fair price for shares to be acquired by order of court from a prejudiced shareholder. It is of course general practice in share valuation to incorporate such a discount to reflect such a shareholder’s lack of control over the affairs of a company. Whether that practice should, as a matter of principle, apply where the vendor is a prejudiced shareholder whose shares are to be purchased at a fair valuation has been considered in a number of jurisdictions, usually in situations in which a working shareholder has been excluded by the majority from participation in the affairs of a company. In England in Re Bird Precision Bellows Ltd Nourse J said that there was no universal rule that the value of a minority shareholding either should or should not be discounted. However, in the case of a company which was an incorporated ‘quasi partnership’, and where the purchase order related to the shares of a ‘quasi partner’, such a shareholder should be regarded as an unwilling vendor. That was because it was the prejudicial manner in which the majority had conducted the company’s affairs which made retention of the shares intolerable and forced on the vendor the wish to sell them. In such circumstances the fairness criteria would require a price fixed according to the value of a holding on a pro rata basis (pp426 E-G, 430 D-F).
Conversely, where the shareholding had been acquired as an investment a discount to reflect its minority nature might be appropriate, even in the case of a quasi partnership, where particular circumstances in the Court’s opinion warranted exclusion of the minority shareholder. Nourse J spoke of the fair basis of valuation in a quasi partnership case being generally applicable “unless the respondents have established that the petitioners acted in such a way as to deserve their exclusion from the company” (p431G).
The treatment of a prejudicially affected minority shareholder as an unwilling vendor when fixing the price under a buy-out order, was however questioned by Hoffman J in Re a Company ex parte Kremer [1989] BLCL 365. Hoffman J pointed out that a majority shareholder ordered to purchase shares in a company generally would gain little or no benefit from the compulsory acquisition. The purchase could accordingly equally be categorised as involuntary. This logic would of course apply equally to cases such as the present where a company has been ordered to acquire the shareholding. Hoffman J’s view was that in an appropriate case the price fixed by the Court should reflect the involuntariness of the purchase as well as that of the sale (p369h).
Mr Denholm for the appellant naturally relied on this decision but, overall, English cases over the years under statutory provisions equivalent to s174 have followed the Re Bird Precision Bellows Ltd line treating them as “showing a general inclination to a pro rata basis of valuation”: per Balcombe LJ in Virdi v Abbey Leisure Ltd [1990] BCLC 342 at p350. In Virdi the Court of Appeal allowed an appeal against a judgment of Hoffman J who had held that a minority shareholder was acting unreasonably in refusing to purchase shares in a cashed up company at a valuation made pursuant to the provisions of the Company’s Articles of Association, that is at a discount. The shareholder’s proceedings under the unfair prejudice provisions were struck out as an abuse of process. The Court of Appeal held there was nothing unreasonable in refusing to accept the risk of a discount being applied in a valuation on the basis of the company’s articles and reinstated the petition for trial.
Recently in O’Neill & another v Phillips and others [1999] 1 WLR 1092; [1999] 2 All ER 96) the House of Lords addressed the scope of the provisions in relation to prejudiced shareholders in the Companies Act 1985 (UK) as amended. In its form considered in that case s459 provides:
A member of a company may apply to the court by petition for an order under this Part on the ground that the company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself) or that any actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.
The Court is empowered by s461(1), if satisfied that a petition is well founded, to make such order as it thinks fit for giving relief in relation to matters complained of in the petition. Under s461(2) relief may provide for the purchase of any shares of members by other members of the company or the company itself. Accordingly the English legislation considered in 1999 by the House of Lords continues to take the same general form as that of New Zealand.
In a unanimous opinion, delivered by Lord Hoffman, the House of Lords reiterated that fairness is the criterion by which the Court decides if it has jurisdiction to grant relief. The concept of fairness also gave the Court a wide power to do what appeared just and equitable but, he added, it had to be applied judicially and rationally (p1098D; 966f). There was no right generally to exit at will. Instances of conduct for the purposes of s459, making it unfair for any shareholder to insist on continuance of the association, included a breach of some promise or undertaking, or an event which putting an end to the basis on which the parties entered into an association with each other. In elaboration of the latter point Lord Hoffman drew an analogy with contractual frustration and added:
The unfairness may arise not from what the parties have positively agreed but from a majority using its legal powers to maintain the association in circumstances to which the minority can reasonably say it did not agree (pp1101-1102; p970b).
The House of Lords held that form of unfairness did not arise in the circumstances of that case.
Finally, in O’Neill v Phillips, consideration was given by the House of Lords, obiter, to the effect of an offer to buy the prejudiced member’s shares as an answer to a claim of prejudicial conduct. Speaking of cases of prejudice arising from the exclusion of the minority shareholder from continuing a working association with the company, and in the context of English Law Commission proposals in Shareholder’s Remedies: (The Law Commission (England): Report 246 para 3.26-3.56), for a more expeditious exit route in such situations, Lord Hoffman said:
But the unfairness does not lie in the exclusion alone but in exclusion without a reasonable offer. If the respondent to a petition has plainly made a reasonable offer, then the exclusion as such will not be unfairly prejudicial and he will be entitled to have the petition struck out. It is therefore very important that participants in such companies should be able to know what counts as a reasonable offer.
In the first place, the offer must be to purchase the shares at a fair value. This will ordinarily be a value representing an equivalent proportion of the total issued share capital, that is, without a discount for its being a minority holding. (p1107C to E; p975b to d).
In policy terms, as Lord Hoffman said, “parties ought to be encouraged, where at all possible, to avoid the expense of money and spirit inevitably involved in such litigation by making an offer to purchase at an early stage” (p1106H; p975j). We agree with that statement. Equally valuable in the New Zealand context are the observations about the unfairness lying in prejudicial conduct without making a reasonable offer to buy the member’s shares. That policy can be said to be equally applicable to all forms of conduct that are unfairly prejudicial and not merely those concerned with exclusion of a shareholder from participation in a company’s affairs.
Lord Hoffman added that if value for the purposes of buying‑out were not agreed it should be determined by a competent expert, acting as such, with both parties having the same full right of access to information about the company bearing on the value and the right to make submissions to the valuer (p1107F to G; p975e to g).
In Australia the approach in Re Bird Precision Bellows has in general been applied. The Full Court of the Federal Court of Australia considered the issue on appeal in Dynasty v Coombs (1995) 138 ALR 64, 86-87, and upheld a trial judge’s decision not to apply a minority discount to the share value. The Full Court held that while there was a discretion to discount, in order to come to a fair value there was also an inclination against doing so (citing both Re Bird Precision Bellows and Virdi v Abbey Leisure Ltd). The Court treated the minority shareholder as not being a willing seller but one who had been forced to sell due to oppressive conduct. There was no discussion of the alternative analysis advanced in re Kremer.
In Canada there is a helpful discussion of the issue in Re Mason and Intercity Properties Ltd (1987) 38 DLR (4th) 681 where the Ontario Court of Appeal allowed an appeal against the decision of a divisional court which had upheld a minority discount on the ground that the minority shareholder’s conduct had contributed to the company’s difficulties. The context was a dispute amongst members of a family owned company concerning the manner of its administration. In delivering the judgment of the Court Blair JA discussed and applied Re Bird Precision Bellows. He said:
…I am of the view that majority shareholders, who have created an intolerable situation for a minority shareholder sufficient to justify the invocation of s247, must, except in unusual circumstances, expect to pay for the shares of the minority shareholder at their fair value without minority discount. (p696).
Leave to appeal to the Supreme Court of Canada was refused (62.O.R. (2d) ix) and the issue does not appear ever to have been addressed in that Court.
On the basis of this and subsequent Canadian decisions the New Zealand text Morison’s Company and Securities Law has observed:
In Canada, the weight of judicial opinion is against a minority discount in buy-out orders except in limited and unusual circumstances. It is considered there that as no “established market” exists, the Court must arrive at a fair value for the shares, not at a fair market value. The forced sale itself is contrary to the application of market value. The value should incorporate no minority discount and must reflect the existing state of the company at the date of valuation… (Chapter 37.10).
In New Zealand in Vujnovich v Vujnovich [1988] 2 NZLR 129 Henry J, sitting at first instance, held on the facts that there was no element of oppression that would found an order under s209 of the 1955 Act. He went on to indicate that had he found otherwise he would not have been disposed to allow a discount factor. He referred to Nourse J’s judgment in Re Bird Precision Bellows although commenting that the matter was not free from difficulty. As Henry J saw the question, in theory, a valuation reached on a notional liquidation basis should accord all shares an equal value because on a distribution no differentiation would be made (p149). In Holden v Architectural Finishes (1996) 7 NZCLC 260,976 McGechan J spoke of “a marked tendency, even referred to as a ‘general rule’, toward valuation pro rata in a so called “quasi partnership when the oppressed party is to be regarded as forced to sell by the oppressor’s intolerable conduct”.
In our view nothing in the House of Lords’ recent decision in O’Neill v Phillips contradicts the principles for determining price originally stated in Re Bird Precision Bellows Ltd even though neither the Court of Appeal nor the Chancery Division decisions in that case are referred to by the House of Lords. In any event, and having in mind the well established acceptance in both Australian and Canadian authority of those principles, we are of the view Re Bird Precision Bellows Ltd continues to apply in New Zealand. The House of Lords’ decision does, however, helpfully reiterate or establish a number of principles including that for conduct in relation to the affairs of a company to be unfairly prejudicial under s174 of the 1993 Act it must be of a kind that is in breach of a claiming shareholder’s legal rights or of recognised equitable principles restraining the exercise of majority powers.
These authorities clearly demonstrate the general reluctance of the Courts of the various jurisdictions to any discounting the proportionate value of a minority shareholding in the case of a buy‑out order under s174. On the other hand the restricted position of a minority shareholder is readily acknowledged by the Courts when the Court is required to set a market valuation for such a holding (Holt v Holt [1987] 1 NZLR 87,90 per Cooke P). The reason for the difference of approach is the overriding criterion of fairness, which the Courts see as an implicit requirement in fixing the price.
To apply a discount to the proportionate value of a minority holding would of course often be to reduce the price for a parcel of shares on account of the weakness in the shareholder’s position which the unfairly prejudicial conduct exploited. It would indeed provide continuing incentives for such conduct. This is apparent in the present case where any discount would largely reflect the respondent’s lack of influence over the dividend policy of the appellant and the appellant’s insistence on continuing its longstanding policy of not paying dividends despite plainly having the means to do so.
In this context the fairness of the policy of treating the respondent as an unwilling vendor when fixing the price for the shares is plain. The appellant may be an unwilling purchaser but because it is conducting its affairs to the unfair prejudice of the respondent that is not in point. There are in the present case, in any event, no factors in our view indicating the appellant’s continuing insistence on excluding the respondent from an immediate return on his asset is warranted. A shareholding arising from an inheritance or from internal family arrangements is not to be equated with that from an independent investment. In these circumstances the criteria of fairness overrides general principles of market valuation of shares reflecting that fixing the price under a buy‑out order under s174 differs from other situations involving valuation by the Court.
In the present case, shortly before trial, the respondent made an offer to sell his shares to the company for $150,000 inclusive of costs. No response was received from the respondent. On the principles discussed it was incumbent on the appellant (and those who controlled it) if they wished to continue their policies to offer to buy out the respondent on reasonable terms. In the present context reasonable terms could not have provided for any discount to reflect the minority nature of his holding.
For these reason, which are in substance similar to those which persuaded Laurenson J, we take the view that his conclusion that it was inappropriate to discount the value of the shares in this case was entirely in accordance with the applicable principles. This head of appeal also fails.
(d) The Windfall Issue
Laurenson J made an adjustment to the valuation to reflect the fact that by operation of law the respondent’s shareholding, which in terms of his father’s will represented 6.25% in the capital of the appellant, became one of 14.48%. He made a deduction of one third of the difference between what the plaintiff would have received had he continued to hold shares in two classes. Whether or not a greater deduction should have been made is not so much an issue of valuation rather but does go to the overriding requirement that the price is fair. This issue was presented to us as concerning the appropriate date of valuation but we do not see it in those terms. The date the change occurred has no relationship with the conduct complained of or proceeding seeking a remedy. The argument is in our view rather that the Judge should in fairness have made a more substantial adjustment so that the price more closely reflected the historic proportionate ownership position. However, as in the case of the Judge’s failure to make deduction for notional liquidation costs and wage claims, the extent of the appropriate adjustment was in the end a matter of discretion and judgment and had to be made in the context that the ownership rights the subject of the purchase order were not in dispute. In our view nothing indicates an error of approach by the Judge in exercising his discretion by discounting the value of the shares by one third of the difference between a holding of 6.25% and one of 14.48% in the capital of the appellant.
Costs in the High Court
The appellant invited us, whatever the outcome of the appeal, to revisit the trial Judge’s decision to award costs in favour of the respondent calculated in accordance with the 2B formula under Rules 48 and 48A together with disbursements. The ground was the late withdrawal of the claim for a winding up order after preparation of argument was completed. However in the circumstances in particular given the lack of a reasonable offer to purchase by the appellant, it was not unreasonable for the respondent to seek that relief until a late stage. The order for costs made by the High Court will accordingly stand.
Conclusion
This appeal is largely an attempt to challenge the manner in which Laurenson J applied a method of valuation of shares which method both parties agreed was appropriate. To that extent many of the criticisms of Laurenson J’s approach raised no issue justifying the reappraisal of this Court. Only the minority discount question raised an issue of principle as opposed to valuation practice and for the reasons we have outlined Laurenson J’s decision on this point was entirely in accordance with applicable principles correctly understood.
As the Privy Council has pointed out the making of an order under s174 “is essentially a discretionary exercise in respect of which an appellate Court will not interfere unless it can be demonstrated the discretion has been plainly wrongly exercised or has been exercised on some wrong principle of law Vujnovich v Vujnovich [1989] 3 NZLR 513,517 P.C. It is also perhaps worth restating the longstanding general reluctance of this Court to embark on an initial consideration of valuation processes or the manner they are applied: (See for example Wellington City v National Bank of New Zealand Properties Ltd [1970] NZLR 660,669,679 (CA) and Allison v K.P.M.G. Peat Marwick [2000] 1 NZLR 560,578 (CA)).
Overall we are satisfied that Laurenson J’s approach fixing the price for the shares that were the subject of the purchase order was a sound exercise of his discretion concerning which we have made only minor criticisms. Accordingly the appeal is dismissed. The respondent is entitled to costs in this Court which we fix in the sum of $5000 together with disbursements and reasonable travel and accommodation costs of counsel to be fixed if necessary by the Registrar.
Solicitors
Foy & Halse, Auckland, for appellant
Connell Rishworth, Whangarei, for respondent
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