Articles of Association (Articles), put simply, constitute a company’s ‘rule book’.
On incorporation, newly formed companies require Articles – be it a bespoke set or standard model articles. A bespoke set of Articles may provide for, amongst other things, how shares are transferred in a company and the basis for their valuation if a price cannot be agreed. It is imperative that Articles are drafted accurately to ensure that in practice, they achieve what was originally envisaged.
In the recent case of Cosmetic Warriors Ltd & Anor v Gerrie & Anor , the High Court’s judgement reiterates the importance of clearly and unambiguously drafted articles of association (Articles) and in particular, the importance of carefully considering specific articles which are often overlooked on the basis of their ordinary and unassuming nature.
Before delving into the facts of this case, it will be necessary to explain and clarify a couple of pieces of legal jargon.
- Pre-emption rights these provide the existing shareholders of a company with a right to have first refusal on the issue or a transfer of shares.
- Minority shareholders these are the holders of shares who do not exert control over the company as a result of the size of their shareholding. A common issue for most minority shareholders is the fact they may be unable to approve or perhaps block certain decisions on their own as illustrated below.
Joe Bloggs has a 10% shareholding and Josephine Bloggs has a 90% shareholding in Company A. The directors of Company A propose to change Company A’s name to ‘MTG & Co’. In order to make this change, at least 75% of the holders of voting shares in Company A need to approve this resolution. Joe votes against this change but Josephine votes in favour. As Josephine holds more than 75% of the shares in Company A, the resolution to approve to change the company’s name to ‘MTG & Co’ has been passed – much to Joe’s disapproval.
Now, let’s putting this legal jargon into practice:
In the abovementioned case, Mr Gerrie and Ms Hawskley were both minority shareholders in each of the companies (Cosmetic Warriors Ltd and Lush Cosmetics Limited). In accordance with the procedures set out in the companies’ Articles, both Mr Gerrie and Ms Hawskley served notices on the two companies with a view to transferring their shares and thereby triggering each of the Articles pre-emption provisions.
One of the questions posed to the High Court was the basis on which the shares of Mr Gerrie and Ms Hawskley would be valued in view of their minority shareholdings – whether they would be valued per share (not taking into account their minority shareholdings) or as a block of shares (taking into account their minority shareholding and thus their lack of influence).
The High Court considered in detail the relevant wording:
“The “prescribed price” shall be such sum per share as shall be agreed between the Vendor and the Company failing which it shall be the median price of the prices as determined and certified in writing by two independent chartered accountants as being in their opinion the fair value thereof as between a willing buyer and a willing seller valuing the Company on a going concern basis… the said chartered accountant when determining and certifying the fair value of the Transfer Shares as aforesaid shall act as an expert…”
In agreement with Mr Gerrie and Ms Hawskley, the judge concluded that, the valuation of each of their shareholdings should be based on the fair value of each share, rather than their shares as a block.
Whilst this case may provide us with a useful indication as to how similar articles should be interpreted, this interpretation should not be regarded as a rule of thumb, each case will be determined on its own facts.
However, if we can take away arguably one of the most significant factors of this case it will be the importance of clear and unambiguous drafting which has been carefully considered. Mackrell Turner Garrett can assist you in drafting or amending bespoke articles of association to ensure that your position, whether as a director and/or shareholder of a company, is safeguarded by particular provisions in the Articles.
If you would like more information please contact Mireille Turner, Solicitor, in our Corporate Team on 0207 240 0521 or by email at email@example.com.