It is generally accepted that when interpreting the relationship between two or more individuals it is better to be able to refer to a written Agreement than to try to infer the terms of a contractual relationship from the differing recollections that each party might have about any verbal discussions which took place.
Therefore, when shareholders form a company and go into business together, it is prudent for them to review their Articles of Association, or to enter into a Shareholders Agreement so as to create a greater degree of certainty in the ways that their relationship will work.
In the Articles of Association of a Company, or in a Shareholders Agreement, one of the key provisions can relate to the way that the valuation of the shares might be carried out in the event that one shareholder leaves. The case of Cream Holdings Limited - v - Davenport [2010] EWHC 3096 (Ch) is a good example of a situation in which it was difficult to interpret the valuation provisions, even though they had been reduced to writing and incorporated within the Articles of Association.
In that case, a Director (D) had been removed from the Company and had invoked the Share Transfer provisions, which stated that he was entitled to be paid the “fair value” of his shares. The Articles stated that the fair value was to be determined by a third party accountant and D nominated three potential firms of which the Company selected one. However, D then refused to sign the Letter of Engagement to that firm because he was concerned that the Company were not going to provide the accountant with all relevant documents and he wished to ensure that disclosure took place before the accountants were engaged.
When the matter was considered by the Court of Appeal, they decided that the wording of the Articles of Association meant that D was entitled to withhold his consent to the letter of engagement because the Articles stated that the agreement to appoint an accountancy firm would have to be an agreement between all three parties affected i.e. the Company, D and the accountancy firm.
The Company brought further proceedings to try to argue that the Court should require D to sign the accountant’s letter. It is important to note that by then the draft Terms of Engagement that were being proposed introduced a process which allowed D to state what documents he said he did not currently have and which he reasonably required in order to be able to properly make submissions to the expert accountant and allowed the Company to respond to this, so that the expert accountant could then determine whether and, if so, what further documents were to be disclosed. The Court did not accept that D’s remaining objections to the proposed Terms of Engagement were reasonable. Essentially, the Court found that the Company was not under an obligation under the valuation provisions to provide full disclosure prior to the appointment of the third party accountant.
The Court based its decision on an interpretation of the Company’s Articles within their commercial context. It was persuaded that D’s continued refusal to sign the letter was unreasonable when the Articles were looked at as a whole. It decided that it needed to interpret the Articles in such a way as to try to make them work rather than to leave the parties without any mechanism for valuing the shares, and it decided that D’s actions in withholding consent were unreasonable.
Summary and conclusions
The lesson of this case is that when drafting a valuation mechanism in a Shareholders Agreement or Articles of Association it is important to ensure that it can be made to work in all circumstances (ideally without the need for litigation!).