England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
LEEDS DISTRICT REGISTRY, CHANCERY DIVISION
HHJ Kaye QC (sitting as a Deputy Judge of the High Court)
2LS60661

		Royal Courts of Justice Strand, London, WC2A 2LL
		21 February 2017

DAVID RICHARDS LJ :

1. This appeal concerns the valuation of shares in a private company pursuant to an order for their purchase made in proceedings under section 994 of the Companies Act 2006.
2. Quarry Walk Park Limited (the company) owns and operates a lodge park providing self-catering holiday accommodation close to Alton Towers leisure park in Staffordshire. It has four shareholders, the three appellants and the respondent, each of whom holds 25% of the issued shares. Each was a director until August 2009 when the respondent was removed by the appellants.
3. In May 2012, the respondent presented a petition under section 994 of the Companies Act 2006, alleging unfairly prejudicial conduct of the affairs of the company. He complained of his exclusion from participation in the management of the company and other matters.
4. In December 2012 and January 2013, the petition was tried before Mr J. M Holmes, sitting as a Recorder in the Leeds County Court. In a judgment delivered in April 2013, the Recorder held in favour of the respondent and made an order for the purchase of the respondent's shares by the appellants.
5. The order for the purchase of the respondent's shares provided as follows:

"2. The First, Second and Third Respondents ("the Respondents") shall purchase the Petitioner's shares in the Company between them at a fair value, being a rateable proportion of the total value of the Company as at 10 April 2013, on the following assumptions;

(1) That the Company is a going concern, and,

(2) That they are respectively a willing vendor and willing purchasers operating at arms' length, and,

(3) Without any discount to the value of those shares because they are a minority shareholding, and,

(4) Without any discount to the value of those shares resulting from the terms of either clause 8, or 9, of the 1 March 2006 agreement referred to in the judgment herein, and,

(5) Without any discount arising from the fact that the Petitioner's loan account is to be repaid, and that he is to be released from his personal guarantees he has provided the [sic] Barclays Bank plc ("the Bank") in respect of the Company, and,

(6) That payments of bonuses and management fees to the Respondents and companies controlled by them after 31 October 2008 had not occurred."

6. Paragraph 3 of the order provided that, unless agreed between the parties, the "precise means by which the said value of the shares in the Company shall be determined…shall be determined by the court".
7. The order further provided that a timetable annexed to it would apply for the future conduct of the proceedings. A single joint expert would be appointed, and a draft letter of instructions in an agreed form was annexed to the timetable. The draft letter required the expert to produce "a full, detailed, objective and unbiased valuation of the Company as at 10 April 2013 and the Petitioner's shares without a discount for minority within your expertise." The letter set out the assumptions for the valuation contained in paragraph 2 of the order.
8. The draft letter continued:

"Please produce a valuation based on the assumptions set out above on each of the following criteria:

1. Multiple of earnings

2. Discounted cash flow

3. Net asset value

4. Comparables

5. Entry cost

As part of your report you are also required to ascertain the price which a buyer with knowledge of all material facts would pay to the existing shareholders for 100% of the issued share capital."

9. The timetable and the draft letter made provision for the supply of documents, evidence and information to the expert and for the expert to answer "proportionate questions" put to him by the parties.
10. Philip Alan Handley, a chartered accountant and accredited forensic accountant with 28 years of experience in advising and assisting small and medium-sized enterprises, was appointed as the joint expert on the terms of a letter in substantially the terms of the draft letter.
11. In view of the specialist nature of the company's business, Mr Handley instructed property valuers, Colliers International and Consulting UK LLP (Colliers), to assist with the valuation.
12. Colliers prepared a report dated 31 July 2014. Paragraph 2 states that "The subject of the valuation is Quarry Walk Park, a lodge park providing self-catering holiday accommodation." It described Quarry Walk Park as a 17.7 hectare freehold site, with 26 timber lodges and planning permission for a further 14 lodges.
13. Colliers valued Quarry Walk Park on each of the bases set out in Mr Handley's letter of instruction, other than net assets. However, it was the clear view of Colliers that the appropriate basis of valuation was on the basis of profits (which they used instead of "multiple of earnings", a term or basis which they explained was not known to them as property valuers, although it appears to amount to the same thing). As they explained in paragraph 57 of their report:

"Owner-occupied operational entities such as this are normally bought and sold on the basis of their trading potential. This type of property has been designed or adapted for a specific use, and the resulting lack of flexibility usually means that the value of the property interest is intrinsically linked to the returns that an owner can generate from that use. The value therefore reflects the trading potential of the property. This type of property is usually sold as a fully operational business including trading potential and all trade furniture, fixtures, fittings, plant and equipment, but excluding trading stock and it is on that basis that we have valued the property."

14. Significant difficulties were encountered in arriving at reliable figures for the revenue and profits of the company for the four years ended 31 October 2012. It was Mr Handley's opinion that profits were understated due to unrecorded income, because various elements of sales had not been recorded at all or had been accounted for incorrectly. He had not found it possible to quantify accurately the understatement. Accordingly, adjusted net profit figures determined by Colliers, using their extensive knowledge of the industry sector and comparable operations, were adopted.
15. The profits method involved first ascertaining the Fair Maintainable Operating Profit (FMOP), defined as "the level of profit, stated prior to depreciation and finance costs relating to the asset itself that [a reasonably efficient operator] would expect to derive from the [fair maintainable turnover] based on an assessment of the market's perception of the potential earnings of the property." The valuation is arrived at by applying an appropriate multiple to the FMOP. At paragraph 64, Colliers stated:

"To assess the market value of the property the FMOP is capitalised at an appropriate yield reflecting the risk and rewards of the property and its trading potential. Evidence of relevant comparable market transactions should be analysed and applied."

16. Based on comparable transactions, Colliers capitalised their estimate of FMOP of £270,000 by a multiplier of 10 to arrive at a valuation of £2.7 million. They added a further £140,000 for the potential to develop an additional 14 lodges, resulting in a total value on this basis of £2.85 million. Their conclusion, stated in paragraph 106, was:

"In our opinion, the value of the freehold interest in Quarry Walk Park as at 10 April 2013 on a "Multiple of Earnings" approach is £2,850,000."

17. It is important to note that, as clearly stated in their conclusion and elsewhere in their report, Colliers were not valuing the share capital of the company, but its property on the basis that it was used profitably as a lodge park.
18. Mr Handley annexed Colliers' report to his own report, dated 12 August 2014. He reviewed the valuations prepared by Colliers on the alternative bases and considered each of them to be fair. He also himself prepared a net asset valuation, which arrived at a significantly lower figure than the other valuations. He considered that the multiple of earnings or profits valuation was the most appropriate for the company, reflecting the trading potential of the business, as confirmed by Colliers. His overall conclusion was that the most appropriate valuation of the company at 10 April 2013 was £2.85 million, with the respondent's shareholding having a value of £712,500.
19. On 9 September 2014, Mr Handley provided answers to questions raised by the parties. In view of the issue which is central to this appeal, it is relevant to note that in answer to a question put by the appellants, "If the company's borrowings were nil, would this affect your share valuation?", Mr Handley responded that "The only valuation methodology that would be directly affected by a reduction in borrowings is the net asset value." He added that the multiple of earnings methodology reflected the trading potential and trading assets of Quarry Walk Park, excluding stock, cash, debtors and creditors, and therefore, by definition, did not take borrowings into account in arriving at a valuation. In answer to a further question from the appellants, Mr Handley responded that the comparables detailed by Colliers in their report were asset sales, rather than sales of the shares of companies, and it was not known whether liabilities were deducted in order to arrive at the prices, this being a matter for negotiation between buyer and seller.
20. In section 4 of his responses, Mr Handley considered further the relevance of the company's borrowings as at 10 April 2013. He reiterated that the only valuation method directly affected by such borrowings was the net asset value and that all other valuations were not affected by borrowings. He continued:

"However, if a buyer were looking to buy 100% of the issued share capital of QWP, it would not be unusual for the buyer to look to reduce the price he would be willing to pay (i.e. the original valuation figure) by the amount of any borrowings, excluding director/shareholder loan accounts which would remain payable regardless of ownership. Conversely, QWP would also be looking to increase the price for any non-trading assets that were to be acquired, e.g stock, debtors, prepayments, etc.

This arrangement is often known as a "cash free, debt free" sale and the specific details of such an arrangement would be finalised by negotiation between the buyer and seller(s)."

21. In his summary of conclusions, Mr Handley stated that it remained his overall conclusion that the most appropriate valuation of the company as at 10 April 2013 was £2.85 million, giving a value of £712,500 for the respondent's shareholding. He added:

"Furthermore, in my opinion, a buyer with knowledge of all material facts wishing to purchase 100% of the issued share capital from the existing shareholders would potentially look to reduce the valuation of QWP by £1,400,000 to £1,450,000, but any "realisation price" would obviously be negotiated between buyer and seller(s)."

22. A hearing to determine the value of the respondent's shares and hence the price at which they were to be purchased by the appellants was fixed before HH Judge Kaye QC on 14 April 2015.
23. Before Judge Kaye, the respondent submitted that the court should accept the opinion of Mr Handley that the most appropriate valuation of the company was £2.85 million and should therefore order the price at which the appellants were to purchase his shares as £712,500. The appellants submitted that Mr Handley had failed properly to distinguish between a valuation of the property and business, which had been the subject of the valuation report prepared by Colliers, and a valuation of the issued share capital of the company. The former would properly exclude all liabilities, but the latter would take into account the company's net borrowings of approximately

£1.4 million, being debts that were not integral to its trading activities. A purchaser of the company's share capital would be buying not simply the benefit of the property and business but also the burden of its net borrowings. In these circumstances, the appellants submitted that the appropriate approach was to deduct the net borrowings from the valuation based on maintainable profits. These points were put to Mr Handley in cross-examination and I refer to his evidence when dealing with the merits of this appeal.

24. In an ex tempore judgment, the judge accepted the submissions made on behalf of the respondent and fixed the price for his shares at £712,500.
25. The judge recorded that Mr Handley had said in evidence that his understanding of the letter of instructions was that "he was asked to value the total value of the company and that he was secondly asked to value the shares", by which was meant the entire issued share capital of the company. The judge continued at [8]:

"Mr Handley has reduced his task to two essential valuation exercises. If one wanted to be a pedant one might say, in fact, he had three: the first was to value the company, then ascertain a rateable portion of the total value of the company being the price for the petitioner's shares in accordance with paragraph 2; and, secondly, ascertain the price at which a buyer with knowledge of all material facts would pay to the existing shareholders for 100% of the issued share capital."

26. The judge emphasised that the second part of this exercise, arriving at a price that would be paid for 100% of the issued share capital, was not part of the court's order but was included by the parties in the letter of instruction to Mr Handley.
27. The judge summarised the approach taken by Mr Handley and by Colliers, and referred to the reservations that Mr Handley had set out in his report to the use of a net asset value. The judge recorded that as against a net asset value, "a multiple of earnings basis was a much more careful and long-term view as to what is the real earnings potential of the business carried on by the company."
28. As regards the price which a buyer would pay to the existing shareholders for 100% of the issued share capital, the judge recorded at [20] that Mr Handley came to the conclusion that on that basis the company's borrowings would have to be deducted. He referred to Mr Handley's responses to the questions posed by the parties, in which Mr Handley had said that it would not be unusual for a buyer to look to reduce the price by the amount of any borrowings, but any price would be negotiated between the buyer and seller.
29. In dealing with this evidence and the submissions made on behalf of the appellants, the judge said at [23]:

"I come back to the point that I made at the outset of my judgment, Mr Recorder Holmes did not specify that what was to be valued was the 100% of the issued share capital. What was to be valued was the total value of the company and then Mr Birkinshaw's shareholding was to be arrived at as a 25% rateable portion of that on certain assumptions and ignoring certain factors, such as a discount for a minority shareholding."

30. Later, at [29] the judge said:

"Mr Shaw [counsel for appellants] submits that Mr Handley accepted that reaching a fair value of the shares one would deduct the liabilities. He therefore submits it would be in those circumstances fair to deduct the liabilities in arriving at the value of the shares. In my judgment, in fairness to Mr Shaw, that was more focussed at the second task that Mr Handley was being asked to do, rather than the first."

31. In reaching his conclusion that the fair price to be paid for the respondent's shareholding was the figure of £712,500 put forward by Mr Handley, the judge said at [27]:

"Mr Handley, with all his experience, clearly, as he said, reached the view that the earnings potential is the important position here and that is why he has taken a multiple of earnings approach. He agreed that the level of borrowing in this case does not threaten the future potential income stream. A purchaser would not have to pay off the debt, as far as he can see from the figures, but the income stream provided by this business was going to be good enough. Accordingly, the multiple of earnings approach is concerned with the future, as I understand it, long-term business potential and profitability of the company and on that basis capital borrowings were to be ignored; bearing in mind the factors that I have mentioned."

32. The judge refused permission to appeal but permission was granted on the papers by Lewison LJ on the grounds that it was clearly arguable that the judge was wrong to value the company as being the gross value of its principal asset without deducting the borrowings secured on that asset, in order to arrive at the true market value of the asset, and hence of the company.
33. On this appeal, the principal submissions made on behalf of the appellants are as follows. First, the judge drew an artificial and unwarranted distinction between a valuation of "the company" and the price which a purchaser would be willing to pay for the entire issued share capital of the company. This distinction is not justified in principle or by the terms of the order made in May 2013 (the Order). It is submitted that, on an ordinary and natural reading, the Order required the fair value of the respondent's shares to be determined by reference to the fair value of the entire issued share capital. Second, the judge's determination of the price to be paid for the respondent's shares in effect treated him not as the holder of shares in the company but as a co-owner of Quarry Walk Park, the company's principal asset. Third, the judge failed to attach any, or adequate, weight to the oral evidence given by Mr Handley. It is submitted, by reference to the transcript of his evidence, that Mr Handley agreed that in order to arrive at the value of the issued share capital of the company, it was necessary to deduct the amount of the company's net borrowings from the value of £2.85 million attributed to Quarry Walk Park as an asset. On this basis, it is submitted that the judge ought to have concluded that the fair price for the respondent's shares was £356,250.
34. The respondent submits that the judge was right not to deduct the company's bank borrowings or other liabilities from the value derived from the multiple of earnings, for the reasons he gave. The bank borrowings did not threaten the company's income stream and there was no reason why the company or any purchaser would pay off the bank borrowing on purchase of the shares. The bank borrowings at the valuation date could at best only be a snap shot and were material only to a net asset based valuation. Deducting bank borrowings from a multiple of earnings based valuation would involve mixing valuation methodologies in a manner that would inappropriately discount the company's goodwill and trading potential. Moreover, it might be the case, although it was impossible to know, that the increased borrowings were in part caused by the failure by the appellants to record all the revenue of the company. As to this last point, I should say immediately that there is no finding to this effect and, as it is a matter of pure speculation, it is not a factor on which reliance can now be placed.
35. The first task is to identify from the terms of the Order the basis on which the respondent's shares were to be valued for the purpose of their purchase by the appellants. An elementary point, almost too obvious to need mentioning, is that the appellants were to purchase the respondent's shares in the company. They were not to purchase any part of the company's assets. Paragraph 2 of the Order required the appellants to purchase "the Petitioner's shares in the Company between them at a fair value, being a rateable proportion of the total value of the Company" on a number of assumptions including "[w]ithout any discount to the value of those shares because they are a minority shareholding." Paragraph 3(1) referred to "the means by which the said value of the shares in the Company shall be determined". On behalf of the respondent, Mr Beresford accepted that this was the effect of the Order.
36. It would be possible, although highly unusual, for the court to direct in an order for the purchase of shares that the value of those shares was to be determined not by reference to the value of the issued share capital but by reference to the value of the business or other underlying assets of the company, determined on the basis of a business or asset sale. There is, however, no basis for interpreting the Order in that way. The only way of reading the reference to "the total value of the Company" in paragraph 2 is as a reference to the total value of the issued share capital of the company. The dichotomy, on which the Judge (and, it appears, Mr Handley) relied, between "the Company" and its issued share capital is, with respect to them, false. They can only, in my view, be read on the terms of the Order as one and the same thing.
37. It would be possible to provide in an order that the value of a company's share capital was to be valued not by reference to its market value but by reference to some other yardstick, but it would need clear words to do so. It is, I consider, impossible to read the Order as referring to anything other than the market value of the company's share capital. That is the clear effect of the second assumption in paragraph 2 of the Order, that the respondent and the appellants "are respectively a willing seller and willing purchasers operating at arms' length". In any event, in the absence of a clear indication to the contrary, the "value" of a marketable asset, in this case the shares of a company, can refer only to the price that would be received for it on a sale. It follows that I cannot agree with the Judge when he said that the instruction to the expert "to ascertain the price which a buyer with knowledge of all material facts would pay to the existing shareholders for 100% of the issued share capital" was not part of the Order or "reflected anywhere in his order whatsoever". On the contrary, it was in my view an essential part of the exercise required by paragraph 2 of the Order.
38. In reaching his view, the Judge attached some importance to the terms of the letter of instruction which (i) called for a valuation based on each of the five criteria stated in the letter and (ii) "also" required the expert to ascertain the price that a buyer would pay for the entire share capital "as part of your report". The form in which the letter was drafted cannot, however, alter the terms of paragraph 2 of the Order. The task of the expert, having produced the five valuations called for by the letter, was in effect to decide which of those valuations (or combinations of valuations) would form the basis of the price at which the share capital would hypothetically be sold. To an extent this is what Mr Handley did, with the assistance of Colliers, when he concluded at paragraph 6.5 of his report that the multiple of earnings method was the most appropriate. What he did not do in his report, but later addressed in his written answers to questions put by the appellants and in his oral evidence, was to identify on that basis the price at which the company's share capital would be sold as between a willing seller and a willing buyer.
39. Pausing there, the appellants have in my judgment made good the first and second submissions of Mr Shaw, their counsel, summarised in [33] above.
40. The critical question then arises whether, in valuing the share capital of the company, a deduction should be made for the company's net borrowings of approximately £1.4 million. Mr Shaw submitted that a purchaser of the company, as opposed to a purchaser of its property and business, would take the value of the lodge park as the starting point and then reduce it by the amount of the net borrowings to arrive at the price he would pay. There was, he correctly noted, nothing in the Order that stated or suggested that liabilities were to be ignored in arriving at the value of the company. It was not one of the stated assumptions. I have summarised in [34] above the submissions of Mr Beresford for the respondent on this point.
41. There is no a priori basis for determining whether, and if so to what extent, a sale of the shares of the company would be at a price that took account of the company's net borrowings. It certainly does not appear unreasonable that the price should be affected by the net borrowings but their impact, if any, on the price is a commercial matter on which the court needs evidence: see the contrasting conclusions of this court in Crabtree v Ng [2012] EWCA Civ 333 and Re Sunrise Radio Ltd [2013] EWCA Civ 667, [2014] 1 BCLC 427. Because both decisions turned on their particular circumstances and the evidence before the court in each case, there is no inconsistency between them. Indeed, Mr Beresford accepted that there was no heresy involved in deducting liabilities from a multiple of earnings valuation; it depended on the circumstances.
42. Fortunately, there is evidence on this issue in this case. As I have earlier mentioned, Mr Handley was asked about this by the appellants following delivery of his report. He said that it would not be unusual for a buyer of the entire share capital "to look to reduce the price he would be willing to pay (ie the original valuation figure) by the amount of any borrowings". Conversely, the company (by which I take it he meant the seller) would also look to increase the price for any non-trading assets, such as stock, debtors and pre-payments. This would be a matter of negotiation between the buyer and seller. His written answer concluded by saying that a buyer with knowledge of all material facts "would potentially look to reduce the valuation…by £1,400,000 to £1,450,000, but any 'realisation price' would obviously be negotiated between buyer and seller(s)."
43. Mr Handley gave oral evidence on this issue. There are times at which he says or agrees that the price would be reduced by the amount of the net borrowings, but that does not fairly reflect the overall effect of his evidence. He repeats a number of times, as he stated in his written answers, that the buyer would look to reduce the price by reference to the net borrowings and that it would be a matter of negotiation between the parties. The difficult question is to predict the likely outcome of such negotiations. This is necessarily very uncertain but Mr Handley agreed with the Judge that "if you are looking for something that is fair to both sides you would look for something in the middle, would you not?" Mr Handley replied "You would, yes. That would normally, in a deal situation, be arrived at by negotiation, yes."
44. Mr Beresford's submission that there would be no reduction in the price to reflect the net borrowings is untenable in the light of Mr Handley's evidence. Equally, in my judgment, Mr Shaw's submission that the price would be reduced by the full amount of those borrowings finds no real support in Mr Handley's evidence. His agreement that "it would be somewhere in the middle" may be imprecise but there is no reason to think that a more scientific answer could be given. Mr Shaw accepted, and Mr Beresford did not dissent, that this court must do the best it can on the available evidence.
45. In my judgment, the evidence justifies a conclusion that a price of £2.85 million on an earnings basis for the entire share capital would be reduced in the course of negotiation by half the net borrowings (£700,000) to arrive at a value of £2.15 million, giving a fair value for the respondent's shares of £537,500.
46. The appellants also appeal against the orders for costs made by the Judge. The sole basis for this part of the appeal is that the appellants had offered £400,000 for the respondent's shares in 2009. If the appellants had succeeded in their case on appeal that the price payable for the shares should be £356,250, there would be a clear basis for their appeal on costs. As it is, however, they are still required to pay significantly more than £400,000, and this part of their appeal must, in my view, fail.
47. As an alternative to upholding the order made by the Judge, the respondent served a respondent's notice advancing a case for a limited reduction in the price to reflect just the costs of servicing the net borrowings. This alternative case is not supported by the evidence. It is not addressed in Mr Handley's report or in the written questions put to him. Mr Beresford put it to Mr Handley in the course of oral evidence, to which Mr Handley replied only that it was "possible". When asked about it by the Judge, Mr Handley replied that it would be "unusual". In any event, it fails in light of the evidence of Mr Handley that supports the conclusion to which I have come on the appeal.
48. Accordingly, I would allow the appeal to the extent indicated above, and substitute £537,500 for £712,500 in paragraph 2 of the Judge's order as the price to be paid by the appellants for the respondent's shares.

LORD JUSTICE PATTEN:

49. I agree