Shareholders at war - the case of Richard George v Robert McCarthy re Goss Interactive Limited.
The most common grounds for a section 994 action (conduct unfairly prejudicial to one or more shareholders) is exclusion of a shareholder in a quasi-partnership. In this case an additional facet was added in that Mr George complained of mismanagement of the affairs of the Company.
The first challenge for the Judge in this case was to determine whether Mr George and Mr McCarthy were in a quasi-partnership as defined by various authorities down the years. Mr George had to clear this first hurdle before the question of exclusion became of relevance. The question of alleged mismanagement then had to be examined.
If the business was a quasi-partnership and if Mr George was found to have been unfairly excluded, then an order for the purchase of his shares might be given. The same might apply if mismanagement was sufficient to be unfairly prejudicial.
The company was engaged in web and digital platform provision; 50% of the shares were owned by each of Mr George and Mr McCarthy. Tensions had been evident for many years. As long ago as 2005 Mr George had written acerbically to Mr McCarthy stating that their relationship was intolerable. He warmed to this theme, stating: "You are probably the most selfish person I have met and a complete idiot in dealing with people".
The strains in the relationship prompted Mr George to cease being managing director in 2007, to resign from his role as Chairman in 2011, to cease active involvement in 2012 and to move to Dubai that same year in order to engage in powerboat racing. He then returned to the UK in 2014, looking to engage with the company once more.
The comments of the Judge on the implications of the Shareholder Agreement were instructive. I have therefore quoted them in full:
“It seems to me to be clear that this Shareholders' Agreement negates the concept of a quasi-partnership as at that date. It self-evidently does not rely on a personal relationship involving mutual confidence, but instead seeks to set up a series of checks and balances which will expressly prevent the oppression of a minority by the majority. There is no room, in my judgment, for an equitable agreement or understanding to sit alongside this formal express agreement, nor is there any evidence of any unwritten agreement or understanding complementary to or conflicting with this written agreement.”
Very helpfully the Judge decided to make a decision on the valuation regardless of what his findings on exclusion might be. There were two business valuers both of whom had used EBITDA multiples as the main method in order to derive enterprise value. Surplus cash was then to be added in order to derive equity value. Both experts wisely agreed that the questions of quasi-partnership and mismanagement should be left to the Judge.
The two experts agreed that the past provided a stable platform of profits on which to build future profit expectations. They therefore based their EBITDA calculations on the averages for the last three years.
They made various normalisation adjustments relating to directors’ remuneration and other matters and the Judge decided on a maintainable EBITDA of £225,000. Various ranges of multiples were suggested by the two experts. One expert stated that the normal range would be from 4 to 5 and that multiples of 6 or above would only apply to companies that were achieving growth. The other expert relied on comparable transactions which indicated a multiplier of 7.
Judgements are often a matter of compromise. The Judge settled on an enterprise value of £1.45 million which equates to an EBITDA multiple of 6.44.
Surplus cash less deferred income was added to give a value for the entire equity of £2,200,000.
As the interest to be valued was 50%, and as a discount was appropriate the Judge stated that “the standard 20 per cent minority shareholder discount should be applied here, if a sale were to be ordered by the court.”
This level of discount needs to be compared with the 2015 case of Foulser and Foulser v HMRC in which a discount of 20% was applied to a holding of 51%. We can all recognise that there is a very significant difference in value between 51% and 50%. A further reference point is given in the case of Irvine v Irvine in which a holding of 49.96% was valued at a discount of 30%.
The Judge stated that Mr George believed that, as a 50% shareholder he had an absolute entitlement to return to active involvement with the company. The Judge did not find this to be so.
The Judge found Mr George to be an unreliable witness with his statements only being accepted if supported by documentation. Mr George’s position was also not helped by some of his actions before the Trial: he had acted in concert with a supposed buyer of the shares, with the clear aim of ramping up the value of the company and of his shareholding.
The Judge found no mismanagement; this was not a quasi-partnership; if there had been equitable considerations in place, Mr George had been in breach of them when he went to Dubai; his exclusion therefore did not amount to unfairly prejudicial conduct; in consequence his shares should be valued on a discounted basis.