• Chris Thorne

Fair is Sometimes Unfair, Even in Paradise:

Readers familiar with the International Valuation Standards (IVSs) will be aware that they contain a different definition of “fair value” to that which is used in both the International Financial Reporting Standards (IFRS) and US GAAP.

A vocal minority complain that having these different definitions promulgated by different international standard setters is confusing, and that since the accounting standards are required law in many jurisdictions, the IVSC should withdraw their alternative. Others even argue that the IVSC has no business defining or explaining valuation bases. However a recent court case that involved a company domiciled in a British Overseas Territory, the Cayman Islands, headquartered in Russia and listed in London illustrates both the validity and usefulness of the IVS definition in the international arena and that the IVSs have a purpose beyond just financial reporting.

In the Matter of Integra Group, the valuation methods and assumptions made by two leading experts recently came under scrutiny. The case, heard by the Grand Court of the Cayman Islands concerned the correct determination of the “fair value” of the shares in a business held by a group of shareholders who had dissented to a merger of two companies. The merger was the legal form permitted under Cayman law of what was commercially a management buyout (MBO). A group of funds based in Europe held about 17.3% of the company. They opposed the MBO and rejected the compensation offered by the company when it was approved, hence triggering the reference to the Court.

The Cayman Islands is of course a major global financial centre, and the domicile of thousands of companies and funds operating internationally. The international favour of the case was illustrated by the fact that the experts called to give valuation evidence by each side in the dispute were practitioners from Deloitte in London and Houlihan Lokey in Los Angeles respectively. The Court also heard evidence that similar statutory provisions for the protection of shareholder rights in the State of Delaware and Canada had been influential in the drafting of the Cayman law. Accordingly it considered it appropriate to consider evidence of case law and jurisprudence concerning fair value from these jurisdictions.

The Court heard that in the US “fair value” has a number of different meanings within the variety of courts but in the context of shareholder disputes the concept typically provides a minority shareholder the economic benefit it would receive were the business sold as a going concern in a hypothetical, arm's length transaction, with the resulting shareholders' equity value distributed on a pari passu basis. The Court also was referred to the judgment in Brant Investments[1] where in a dispute under the Canada Business Corporations Act it was held that:

“Fair value is a value that is "just and equitable": one which provides "adequate compensation, consistent with the requirements of justice and equity."

This evidence confirms that the accounting standard setters do not have a monopoly over “fair value”. The term is well established across different jurisdictions as meaning something quite different in contexts other than financial reporting. The experts in the Integra case agreed that the definition and explanation of fair value provided in the IVS Framework was relevant and helpful. The judge, The Hon. Justice Andrew J. Jones QC, seemed to concur and included the relevant text in his reasoned judgment. He further added that he found the IFRS definition that had also been referred to in evidence to be unhelpful and irrelevant. He agreed with the statement in the IVS Framework that IFRS fair value is generally consistent with the IVS definition of market value, which made it inappropriate in this case as would imply a discount for a minority shareholding, which neither expert considered appropriate.[2]

Where the two experts differed was in their preferred method. The judge noted that is well established in both the Canadian and Delaware jurisprudence that fair value should be proved by any techniques or methods which are generally considered acceptable in the financial community and are otherwise admissible in court. There was discussion of the applicability of the three basic valuation approaches discussed in the IVS Framework. Both experts agreed that the cost approach was inappropriate in this case. However, while one preferred to put most reliance on the income approach using the market approach as a cross check, the other relied mainly on the market approach.

The expert retained by the company preferred to rely on the market approach because the shares were listed on a leading stock exchange and therefore he considered the market price of the shares was the best starting point. From this figure he made adjustments to remove the “minority discount” implied in the share price. The expert retained by the dissenting shareholders preferred to use a discounted cash flow method based on management’s forecasts, but checking this with metrics obtained from analysis of comparable publicly quoted companies. The Court preferred the latter approach, principally because it accepted evidence that the market for the shares at the valuation date was insufficiently liquid for a valuation based on its quoted prices to be a reliable indicator of fair value.

The Court was also critical of the fact that the expert for the company had put forward a range of values rather than giving a specific figure, commenting that this was “not particularly helpful” from the Court’s point of view.

While any valuation or valuation approach endorsed by a court is dependent upon the facts of the particular case and the legal framework in which it takes place, this case demonstrates that valuation concepts transcend jurisdictional boundaries and that it is helpful to both litigants and courts to have these codified in the IVSs. And this is just as applicable to valuations for other purposes, such as to support secured lending. If the IVSs ever became limited to simply providing practice notes for valuations for financial reporting they would surely be neglecting some very important parts of their public interest remit.

[1] Brant Investment Ltd et al v. KeepRite Inc et al (1987) 60 OR (2d) 737, a decision of the Ontario High Court of Justice.

[2] This consensus regarding the lack of a discount for a minority shareholder was effectively found to be incorrect by the subsequent decision of the Court of Appeal In the matter of Shanda Games Ltd, discussed in "All aboard the fairness merry-go-round"

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