All aboard the fairness merry-go-round
Fair is a tricky word, no more so than in a valuation context. Even if one ignores some of the obvious homonyms of fair, it is still capable of quite different interpretations. Is “fair value” a value which is equitable, impartial and unbiased? Is it a value which treats all interested parties equally? Or it is simply a value which appears reasonable alongside the prices being achieved for similar assets, perhaps as opposed to one that appears to be high or low?
In my recent blog When is Fair Fair? I examined a decision of the English Court of Appeal which held that the use of the adjective “fair” in conjunction with market value did not mean that the effect of market conditions unfavourable to the seller had to be ignored. It found that in the context of the case in question, the market in which the value had to be set was not a hypothetical one which could be deemed “fair” as in “fair” weather or a “fairway” in golf, but the actual market on the material date, complete with any storms, bunkers or other obstacles that might be seen as “unfair”.
At much the same time the Court of Appeal in the Cayman Islands was pronouncing on the meaning of “fair“ in the context of a merger under the Cayman Companies Law. While to many valuers the detailed legal issues of this case may seem beyond arcane, the debate on what constitutes fairness illustrates principles that should never be far from any valuer’s mind.
By way of background, the Cayman Islands is one of the leading offshore jurisdictions for merger and acquisition (M&A) activity. A significant portion of this M&A activity is related to the taking private of Cayman incorporated companies listed on US exchanges through a statutory merger regime. Any shareholder who is unhappy with the consideration offered as part of a merger may dissent and is entitled to payment of the “fair value” of its shares under Section 238 of the Cayman Islands Companies Law.
In the matter of Shanda Games Ltd*, a Chinese video games manufacturer listed on the NASDAQ exchange agreed a transaction in 2015 to take the company private. A minority of shareholders, together holding 1.64% of the issued shares, dissented from the sale. Last year, the Grand Court of the Cayman Islands determined a fair value for the dissenting shareholders’ shares that made no discount for their being a minority. Shanda Games Ltd (“Shanda”) appealed against this decision. The dissenting shareholders also cross appealed on certain other aspects of the Grand Court’s decision but in this blog I just focus on the minority discount point.
Back in 2015 I commented on another decision of the Grand Court in my blog Fair is Sometimes Unfair even in Paradise. This case, In the matter of Integra Ltd, also concerned the determination of fair value under Section 238, but it was agreed between the parties, based on certain Delaware and Canadian precedents, that no minority discount was applicable. This was accepted by the court. The matters in contention in Integra were the contrasting methods used by the experts for each side to determine the fair value of the dissenting shares based on a straight apportionment of the value of the company. However, the concensus in this case has now been overturned by the the decision in Shanda.
Shanda's principal contention was that the judge should not have followed the Delaware and Canadian jurisprudence but should instead have looked to the courts of England and Wales for precedents on how to apply fair value when dealing with the compulsory acquisition of shares. It had never been part of the public policy of the Cayman Islands or of England and Wales that there was anything unjust in the compulsory purchase of shares for less than the amount a shareholder would receive if the company's business was sold and the proceeds distributed pari passu. It also pointed to distinctions between the language of the relevant part of the Delaware legislation relied on by the dissenting shareholders and Section 238 under the Cayman law. There was no justification in the wording of the Section 238 for valuing the company as whole rather than the shares actually held.
In accepting Shanda’s argument, the Court of Appeal noted various distinctions between, on the one hand, the Delaware and Canadian authorities and, on the other, the Cayman Law. While there is no direct equivalent to Section 238 under UK law, there are parallel provisions in the Companies Act 2006 in relation to dissenting shareholders, which also appeared in earlier versions of the Companies Act and which have been the subject of litigation before the courts of England and Wales. In particular the Court of Appeal highlighted the judge’s comment in the case Re Grierson, Oldham & Adams Ltd  Ch 17, “In my judgment it is not unfair to offer a minority shareholder the value of what he possesses, i.e., a minority shareholding”.
The Court of Appeal also considered decisions stemming from the provisions in the UK Companies Act under which the court can order a company or its members to purchase the shares of a shareholder that it considers have been unfairly prejudiced by the actions of the company. It is the general rule that the court will direct that the shares be purchased at a discount reflecting the size of the holding, with the leading authority being the decision of the Court of Appeal of England and Wales in Strahan v Wilcock .
After consideration of the above, together with the awards of courts to dissenting or prejudiced shareholders in Bermuda and the British Virgin Islands, the Court of Appeal agreed that section 238 requires fair value to be attributed to whatever the dissenting shareholder possesses. If this is a minority shareholding, it is to be valued as such. If the shares have particular rights or liabilities attached, the shares are to be valued subject to those rights or liabilities. In its judgment the Court confirmed that the judge at first instance (and the judge in Integra before him) was wrong to hold that a minority discount should not be applied.
The main take away for valuers from this decision is that while the word “fair” may have comforting connotations of reasonableness, and accordingly be a favoured adjective in agreements or regulations that provide for a value to be determined, what is fair is rather more complicated in practice. Fairness can only be considered within the context of the factual matrix for which the valuation is required, and it is vital that the valuer understands this and clearly defines the appropriate parameters before preparing and reporting the valuation. It is also useful to reflect that it took the combined resources of the International Accounting Standards Board and the US Financial Accounting Standards Board some eight years to agree a common standard for “Fair Value Measurement” in financial reporting, and that the former’s IFRS 13 extends to over 45,000 words!
* In the Matter of Shanda Games Ltd CICA 12 of 2017