By Wanissa Nemsi, Maxime Mekki-Kaddache and Ewa Lis, University of Montpellier, Centre du Droit de l'Entreprise, Program of Master 2 "Droit du Commerce International"
Overview
This Quick Counsel outlines recommended contract provisions on the valuation of shares to be used under French law as well as under other European laws.
Common provisions relating to the valuation of shares
Despite the existing variety of legal provisions relating to the transfer of shares and their valuation, a number of common provisions can be identified.
a) Provisions relating to the scope of application
- The provisions must specify cautiously the material scope of application of the clause, which is to say the operations for which the valuation will be needed. Most of the time valuation will be necessary in connection with a sale or a contribution. It can also be needed to fix the amount of an indemnification, for example in case of a squeeze-out. They also have to define the personal scope of application, more precisely the persons to whom the agreement should apply.
Moreover, the parties should also clarify the time scope of application of the provisions.
b) Provisions relating to the mechanism of valuation.
- The parties can agree in advance on the value per share. In order to be more effective it is possible to provide for an initial price and a possibility to update it to accommodate extraordinary events (for example a fixed price and an annual update). Another possibility is to provide a fixed formula to determine the value of shares. This formula will be applied by the parties themselves or by a third party such as an expert. Such a third party should be agreed upon in advance or, in the absence of agreement, appointed by the court.
c) Provisions relating to the expert appointment method
- The simplest way is to designate by name the expert, that is to say, one person that will determine the valuation. Even if it can be difficult to find an agreement on the identity of the expert, this method avoids any future dispute. If the parties cannot agree on the identity of the expert it can be easier to define the qualifications this expert must have. It is also possible to contemplate an appointment mechanism. This mechanism must establish the situations in which it will be triggered, the date of appointment and the person who will designate the expert (the judge, the first party to make a request,...).
d) Provisions relating to the valuation method
- The value the expert must determine has to be clarified. It can be the market value (highest price obtainable in the market), the net asset value or the investment value (the company's forecast earnings). The valuation method may command the expert to take into consideration some additional information to be used as a discount or as a premium. It is also possible to limit the maximum value or the minimum value to be found. An earn-out clause can be included in order to adjust the value of the shares according to the future earnings of the company. It is important to specify the period taken into account for the valuation, which is not necessarily the same date as the one of valuation. It may be appropriate to use the last tax year. The French "Cour de cassation" held, on September 16, 2014, that when the bylaws do not stipulate at which date the value of the shares must be determined, it shall be at the closest date to the future sale.
e) Provisions relating to the authority of the valuation
- The parties may provide for the relationship between the value and the price. It is to be remembered that they are not necessarily the same (for example, the price could be a percentage of the value), though in some cases they could be. The price is just an application of the value within a contractual context.
f) Provisions relating to the valuation proceedings
- A calendar must be set up: this clause shall clarify when the expert has to be appealed and the time he will have to comply with his obligations. Usually, a duty of cooperation is provided and remedies can be foreseen for the non-compliance with this duty. The French Court of Appeal of Versailles held, on September 27, 2005, that the expert is not forced to respect the rule of audi alteram partem (adversarial principle). The expert should also explain his decision in order to make it more transparent. Nevertheless, a clause of the contract may require it. The allocation of the expert fees has to be determined. In a ruling on October 22, 2013, the Court of Appeal of Paris held that if a dispute arises on the valuation, the party who will pay the fees was the one ordered by the court to bear the costs of the court proceedings. It is reasonable to establish an incident settlement mechanism. In order not to waste time and avoid additional problems, it is prudent to insert a clause forbidding the valuation to be subject to appeal.
French legislation relating to the valuation of shares
In France, the valuation of shares is associated with article 1843-4 of the French Civil Code. The article provides for a court appointed expert mechanism in case of a disagreement on the value of shares.
Over the years, the French "Cour de cassation" has given this article a more significant application. At first, the article was meant to only apply in cases where other articles referred to it. Most of the time, these articles dealt with situations where the shareholder was forced to sell his shares. Eventually, the third party designated in application of this rule, was able to fix the price of sale without taking into consideration the terms provided by the parties, the bylaws or by the shareholders' agreements.
In 2007, the "Cour de cassation" even stated that article 1843-4 was a mandatory rule. It held that the designation of the expert was compulsory in case of disagreement between the parties on the price of the shares.
An ordinance of July 31, 2014 has modified this article 1843-4. The parties' provisions now bind the expert. This reform was highly needed and is a relief for business lawyers. However, this new article does not apply to all situations. Indeed, this new legislation only expressly applies to transfer of shares contemplated by law or bylaws.
Approach in other European jurisdictions
a) In England
In England, contractual provisions nominating an expert have been used for many years in connection with share valuation under shareholders' agreements. The effect given to the clause will entirely depend on the contract. This was confirmed in Premier Telecoms Communications Group Ltd and (2) Darren Michael Ridge v Darren John Webb [2014] EWCA Civ 994. The Court of Appeal ruled that expert valuations are generally intended to be binding on the parties. If the parties want the court to have control over the performance of the expert, they should make it clear in the terms of the expert's appointment.
Furthermore, in the case Socimer International Bank Ltd v Standard Bank London Ltd [2008] EWCA Civ 116, the Court of Appeal confirmed the limitations of the expert discretion. The key matter was whether the discretion of expert in providing the valuation was limited, as the contract was silent on this matter. The court ruled that the discretion of the expert was not absolute. It was limited by concepts such as "honesty, good faith and genuineness and the need for the absence of any arbitrariness, capriciousness, perversity and irrationality." The valuation can be therefore challenged on the basis that the expert failed to comply with these standards. Finally, even if the parties expressly provide that the discretion of the expert was to be absolute, the court may imply terms limiting this discretion.
b) In the Netherlands
In the Netherlands, article 2:192 of the Dutch Civil Code provides that the price the shareholder is to receive for its shares must be equal to a price determined by one or more independent experts. Nevertheless, the bylaws may provide for a different valuation method. The price will be determined in accordance with the criteria provided that:
c) In Spain
In Spain, the freedom of contract prevails. Still, the difference must be made between the transfer of shares between living shareholders, and upon death. We will focus here on transfer of shares between living parties.
Concerning limited liability companies "sociedades de responsabilidad limitada" for which the shares cannot be freely sold on a market, under the article 107 paragraph 1 of the "Real decreto legislation 1/2010, de 2 de julio, por el que se aprueba el texto refundido de la Ley de Sociedades de Capital", the valuation of shares must respect the rules established in the bylaws. If no rule relating to the valuation of shares is provided by the bylaws, article 107 paragraph 2 (a) states that the price of the shares will be the one decided by the parties. Besides, the other shareholders of the company have a pre-emptive right if they want to buy the totality of the shares offered for sale (c). If it is a free of charge or a transfer other than a sale (d) the price will be the one agreed upon by the parties, or, if there is no agreement, the reasonable value of the shares at the date the will to transfer was notified to the company (this "reasonable value" will be fixed by an auditor different than the statutory auditor of the company).
Concerning corporations for which the shares can be freely sold on a market (for example the stock exchange), the "Real decreto legislation 1/2010, de 2 de julio, por el que se aprueba el texto refundido de la Ley de Sociedades de Capital" refers to the Spanish Civil Code. Article 1447 of the Spanish Civil Code states that the price must be certain. It is certain enough if it refers to another certain item or is fixed by a determined person. Article 1448 states that the price is also certain enough if it refers to a market or stock exchange at a determined day, or if it is a percentage of this price.
CONCLUSION
Contract provisions relating to the valuation of shares are similar in many jurisdictions and freedom of contract generally prevails. Nevertheless, some European states have particular ways to handle disagreements arising from the valuation of shares or the absence of provisions organizing the valuation of shares. Overall, it is generally advised to provide for the appointment of a third party that will fix this value in case of difficulties.
ADDITIONAL RESOURCES
IBA's Guide on shareholders agreements http://www.ibanet.org/LPD/Corporate_Law_Section/Clsly_Held_Growing_Busi_Entprs/shareholderagreements.aspx
Pierre Mousseron, "Les conventions sociétaires" (2014), LGOJ, p.316 - 335.
Clarke Hunter and Ken Potter, "Legal and practical issues for business valuation in shareholders agreements and minority shareholder rights" (1997), p.6. http://www.nortonrosefulbright.com/files/business-valuation-in-shareholders-agreements-and-minority-shareholder-rights-pdf-78kb-67505.pdf
Valuation of shares under Dutch law http://www.eversheds.com/global/en/what/articles/index.page?ArticleID=en/global/netherlands/en/flex-bv-implementation-of-a-more-flexible-corporate-law-applicable-to-dutch-bvshttp://www.dutchcivillaw.com/legislation/dcctitle2255aa.htm
Valuation of shares under English law http://www.ashurst.com/publication-item.aspx?id_Content=3630