The promotion of investment in the South African markets is one of the objects of the Companies Act, No. 71 of 2008, as amended (Act). Section 163(1) of the Act promotes investment by providing minority shareholders with relief against conduct that is oppressive or unfairly prejudicial to, or that unfairly disregards, their interests. The principle of majority rule in company law means minority shareholders are at risk of oppressive or unfairly prejudicial conduct. Therefore, although the relief in section 163(1) of the Act is available to a majority shareholder, it will continue to be used mainly by minority shareholders; the wretched of the corporate earth.

There have been a number of reported judgments where our Courts have considered the scope and ambit of section 163 of the Act. This note does not traverse those judgments and controversies in some of them. It analyses the judgment in Omar v Inhouse Venue Technical Management (Pty) Limited (Omar case) and highlights challenges in the determination of the price of shares in circumstances where a Court has: (i) granted relief in terms of section 163(1) of the Act and (ii) ordered the other shareholders to purchase the shares of the aggrieved minority shareholder.

The essence of section 163 of the Act

In the majority of cases decided under section 163 of the Act, a minority shareholder applies to Court in terms of section 163(1) of the Act for relief on the basis that certain conduct of the majority shareholders is oppressive, unfairly prejudicial to, or unfairly disregards the interests of, that minority shareholder.

In terms section 163(2) of the Act –after considering the merits of the application in terms of section 163(1) of the Act– a Court may make any interim or final order it considers fit, including a variety of orders listed in section 163(2)(a) to (l) of the Act. Although an order for the purchase by majority shareholders of shares owned by the oppressed minority shareholder is not listed in section 163(2) of the Act, the Court may –based on the enabling wording in section 163(2) of the Act– use its discretion to grant such an order.

Section 163 of the Act is similar to section 252 of the Companies Act, No. 63 of 1973 (1973 Act). Cases decided under section 252 of the 1973 are therefore useful in the interpretation of section 163 of the Act.

Omar case – relevant facts

The facts in the Omar case were as follows: the applicant (Omar) was a shareholder in the first respondent (Inhouse), owning 45 % of the shares. The second respondent (Gearhouse SA) –a wholly owned subsidiary of Gearhouse Holdings Proprietary Limited (Gearhouse Holdings)– owned 50 % of the shares in Inhouse. Sandragasen Govender (the third respondent) owned the remaining 5 %. The fourth and fifth respondents (Lapis and Abbas) owned the entire issued shares in the capital of Gearhouse Holdings and were the only directors of Gearhouse Holdings and Gearhouse SA. Inhouse conducted a business similar to the business of Gearhouse SA, albeit at a smaller scale. Through their ownership of the entire issued shares in Gearhouse Holdings and being directors of all companies within the Gearhouse Group, Lapis and Abbas controlled the whole Gearhouse Group of companies, including Inhouse.

Lapis and Abbas used their positions as directors and ultimate majority shareholders of Inhouse to take decisions which advanced the commercial interests of the Gearhouse Group –which they controlled– to the detriment of Omar. The primary issues that caused the relationship breakdown between the shareholders of Inhouse related to: (i) the 50 % increase by Lapis and Abbas of rent that Inhouse paid to a company which was part of Gearhouse Group without the matter being considered by the directors of Inhouse and (ii) the increase by Lapis and Abbas of certain charges paid by Inhouse to Gearhouse Group for using the Gearhouse Group business infrastructure and personnel. As the relationship deteriorated, Gearhouse SA offered to acquire Omar's shares for R 2m. The offer was rejected by Omar. He argued that he could not establish whether or not the offer reflected the fair value of Inhouse without the financial information relating to Inhouse. The dispute reached its climax when Lapis and Abbas suspended Omar as the managing director of Inhouse and hauled him before a disciplinary enquiry without the matter being properly considered by the Inhouse board of directors.

Omar turned to the High Court for relief in terms of section 163 of the Act. The High Court had no difficulty finding that the conduct of Lapis and Abbas in the operation of Inhouse was unfairly prejudicial to Omar.

Gamble J granted the order sought by Omar that the other shareholders of Inhouse (Gearhouse SA and Govender) purchase Omar's shares proportionately "…for their fair market value as at 27 June 2014 which coincides with the time of Omar's suspension…" He also decided that a chartered accountant be appointed to value Omar's shares.

The interesting aspect of the Omar case is that in addition to the above, Omar innovatively requested the High Court to–

• declare that Lapid and Abbas, as directors of Inhouse– acted in contravention of sections 75 of the Act in respect of some of the transactions that caused the relationship breakdown; and

• order that the chartered accountant should –when determining the value of Omar's shares– make appropriate adjustments to factor the breach by Lapis and Abbas of section 75 of the Act.

    
The aforementioned requests were granted. In regard to the contravention of duties of directors, the Court said:

"It is conceivable…that had the decisions been taken in accordance with proper corporate governance while having regard to the prescripts of sections 75 and 76 [of the Act], the profitability of the company [Inhouse] may have been enhanced."

Valuation challenges

Under section 252 of the 1973 Act, the purchase of shares of an aggrieved shareholder by the other shareholders was a preferred oppression remedy. This trend will –as demonstrated in the Omar case– continue under section 163 of the Act because the purchase of shares of an aggrieved shareholder provides a clean break between the feuding shareholders.

The most difficult and contentious aspect of the order for the purchase of shares of an oppressed shareholder is the price of the shares and the method of determining such price. Judges have been said to be sophisticated technicians in law but self-proclaimed amateurs in commercial matters. In South Africa, to avoid involvement in commercial matters, Judges have consistently ordered the appointment of a chartered accountant to conduct the valuation. Whilst Judges determine some parameters within which valuation should be done, the methodology for such is left to an expert valuer. It is internationally accepted that the price for shares in the oppressive buy-out context should be a 'fair price; however, there are widespread disagreements regarding what 'fair price' means and how it is determined.

Meaning of fair price

The principle that shares in the oppressive buy-out c’ontext must be purchased at a 'fair price' was adopted by our Courts from the United Kingdom (UK); therefore, in South Africa, as in the UK, there is no legislative guidance on the meaning of 'fair price'. However, it has been opined that where shares of an aggrieved shareholder are to be purchased, 'a fair price is the value that his shares would have had if there had been no unfair treatment.'

The confusion about the meaning of 'fair price' has been compounded by the imprecise references by Judges and commentators to 'fair price', 'fair value' and 'fair market value' when dealing with the sale of shares in the oppressive buy-out context. Fair value means the price that would be received for an asset in an orderly transaction between market participants. Fair market value means the price at which an asset would be sold between a willing buyer and a willing seller and without any compulsion to sell or buy and both parties having reasonable knowledge of the relevant facts. Whilst the definitions of fair value and fair market value are similar, the valuation methodologies used in each determination are different.

In the Omar case, Griesel J ordered that Omar's shares be purchased at fair market valu;racyel Pont – Lynne and Nicholas tin,e as determined by a chartered accountant in accordance with the procedure set out in the Inhouse shareholders agreement. Although Griesel J did not explicitly indicate that the price for the shares must be a fair price, it may well be that he considered that the fair market value would be the fair price in the circumstances.

In Hickman v Oban Infrastructure (Pty) Ltd and Other (Hickman case) the phrases 'fair price' and 'fair market value' are used interchangeably.

In McMillan N.O. v Pott and Others (McMillan case) the Court decided that the shares of the affected shareholder be purchased at 'fair value'. There is no reference to 'fair price' or 'fair market value'.

The imprecise use of 'fair market value' or 'fair value' where reference to 'fair price' is intended may seem innocuous; however, it contradicts the well-established jurisprudence on oppression remedy buy-outs that shares must be purchased at a fair price having regard to the circumstances in each case. Further, our Courts do not do valuations themselves. The valuation exercise is referred to a valuation expert. Therefore, the imprecise use of 'fair market value' and 'fair value' in judgments may result in the valuation expert misinterpreting the valuation parameters set by a Court and determining a price that is not a fair price in the circumstances.

Ordinarily, where the 'fair market value' of shares is determined, the valuation expert applies a minority discount, liquidity discount and/or a marketability discount. The minority discount is traditionally not factored when shares are valued on the price per share basis, as opposed to the valuation of a specific tranche of shares.

Valuation experts use established valuation methodologies to determine value, depending on the circumstances. Internationally, Courts modify established valuation methodologies on a case-by-case basis to ensure that the fair price is determined and paid to an aggrieved shareholder. In the Hickman case, the Court decided that the price of the shares should not be adjusted by any discount for the reason that the shares in issue were a minority interest (minority discount). Similarly, in the McMillan case, the Court specifically said the 'fair value' determined should not factor any discount (i) for the shares representing a minority holding (minority discount) or (ii) on account of any contractual restrictions that might have been agreed between the shareholders.

Discounts and the Omar case

In the Omar case, Gamble J decided that a chartered accountant appointed to value the shares utilise the valuation procedure set out in the Inhouse shareholders agreement. The phrase 'fair market value' is defined in the Inhouse shareholders agreement as the price per share determined by the valuation expert acting as an expert and not as an arbitrator. Further, the Inhouse shareholders agreement specifically prohibited the factoring of a minority discount in the determination of the fair market value.

The Omar case and the Inhouse shareholders agreement are silent whether or not the marketability discount and/or liquidity discount had to be applied by the expert in the determination of the 'fair market value'.

It has been argued that discounts of any nature whatsoever are misplaced in Court sanctioned oppression buy-outs because they incentivise the oppressors of minority shareholders at the expense of the same minority shareholders. According to this argument, the oppressed shareholder must ultimately receive a pro rata share of the value of the company as a going concern because the exit is not voluntary.

Court sanctioned oppression buy-outs are meant to achieve equity between the parties. If conventional valuation methodologies are utilised and such use results in marketability, minority and/or liquidity discounts being applied, it would seem that the oppressor shareholder benefits at the expense of the oppressed shareholder by causing the forced exit and thereafter paying a discounted price. Whilst discounts may be entrenched in various valuation methodologies applicable to voluntary disposals, it must be recognised that a Court sanctioned buy-out constitutes an abnormal forced exit. Therefore, fairness dictates a departure from normal valuation conventions and the rejection of any discount in valuations involving Court sanctioned buy-outs. Indeed, in 1999, the Supreme Court of New Jersey (per Garibaldi J) decided that:

"There is … less consensus about whether discounts should be applied in oppressed shareholder actions.   Although other jurisdictions are divided, the majority reject the use of discounts for lack of marketability or liquidity, and minority discounts. Most of the cases deal exclusively with the minority discount and do not address the marketability discount; others do not distinguish the discounts." [Emphasis added]

When a Court decides that shares of an oppressed shareholder be purchased, it exercises its discretion in terms of section 163(2) to make 'any…order it considers fit'. Notwithstanding that discretion, a shareholder who applies for relief from oppressive or prejudicial conduct is required to assist the Court by formulating the relief sought. To avoid the valuation challenges referred to in this note, the relief must be formulated without confusing 'fair value', 'fair market value' and 'market value' with 'fair price'; on the basis that–

• the price to be determined is the fair price, being the value that the relevant shares would have attracted if there had been no oppressive or prejudicial conduct. It may well be that the fair price in the circumstances will be the fair market value or the fair value as understood in valuation parlance; and
• notwithstanding the valuation conventions, no discount should be applied by the expert involved in the determination of the fair price. 

If the issue of discounts is part of the relief formulated by an applicant, the Court will be obliged to address it. The Court may also have to determine whether or not a certain discount is necessary in the circumstances and provide reasons. This approach will ensure that valuation mechanics in the context of section 163 buy-outs are –as they should– within the confines of the relief sanctioned by a Court and are not left at the whims of valuation experts.

Conclusion

Notwithstanding that section 163(2) of the Act does not explicitly refer to the purchase of shares of an oppressed shareholder as one of the oppression remedies, the Omar case demonstrates that the buy-out remedy will continue to be a preferred remedy, as it was under the 1973 Act. Therefore, it is essential that in adjudicating matters involving section 163(2) and the buy-out remedy phrases like 'fair value' and 'fair market value' (and that member of their dynasty: 'market value') are not used imprecisely. The Court must exercise its discretion to ensure that the price at which the shares will be purchased is the fair price.

Further, applying minority, marketability and/or liquidity discounts in the determination of the price for the purchase of the shares of an aggrieved shareholder incentivises the oppressors of the minorities at the expense of the minority shareholders. Therefore, applicants seeking relief from oppressive or prejudicial conduct must –when formulating the relief– request that no discount be applied by the expert determining the fair price.

Written by Siyabonga Shandu, Director, Tony Tshivhase