Unfair Prejudice (Section 994): How the Buy-Out Price Is Set

When a shareholder dispute becomes a valuation problem

Most shareholder disputes in UK private companies do not end with a judgment on who behaved badly. They end with one shareholder buying out another, and the only question that genuinely matters is the price. Section 994 of the Companies Act 2006 gives a shareholder the right to petition the court where the company's affairs have been conducted in a manner unfairly prejudicial to their interests. In practice, the overwhelming majority of successful petitions produce the same remedy: an order that the respondent purchase the petitioner's shares.

That makes valuation the substance of the case, not an afterthought. The legal finding establishes the right to be bought out. The valuation decides what the case was worth.

The three questions the court has to answer

Every section 994 buy-out order turns on three valuation decisions, and each of them can move the final number by tens of percent.

1. What is the valuation date? The default position, from *Profinance Trust SA v Gladstone* [2001], is the date of the court order, not the date of the unfairly prejudicial conduct. But the court has a broad discretion and will move the date where fairness requires it - for example, where the respondent's conduct after the falling-out depressed the value.

2. Is a minority discount applied? In a quasi-partnership, normally not. Outside one, usually yes. This single decision routinely accounts for 30-45% of the answer.

3. What adjustments are made for the conduct complained of? Excessive director remuneration, diverted opportunities, related-party contracts on non-commercial terms - these are typically added back so the petitioner is valued out of the company as it should have been run.

A valuation report that does not explicitly address all three, with reasoning, is not a report a court can use.

Quasi-partnership: the concept that decides the discount

*Ebrahimi v Westbourne Galleries* [1973] established the idea of the quasi-partnership - a company formed on the basis of a personal relationship and mutual confidence, where shareholders expected to participate in management and where transfer of shares is restricted.

Where a quasi-partnership exists, the courts have consistently held that a minority shareholder unfairly excluded from management should be bought out on a pro-rata, undiscounted basis. The logic in *Bird Precision Bellows* [1984] is that the shareholder is not choosing to sell a minority parcel on the open market; they are being forced out of a business they helped build.

The indicators the court looks at:

• Was the company formed or continued on the basis of a personal relationship?
• Was there an understanding that all or some shareholders would participate in management?
• Are there restrictions on share transfer that lock a shareholder in?
• Did the shareholders behave as partners rather than as investor and manager?

Where none of these apply - a passive outside investor in an arm's-length company, for instance - the discount is far more likely to survive.

Worked illustration. A company with a defensible equity value of £5,000,000 and a 25% petitioner:

Same company, same date, same methodology. A £600,000 spread decided entirely by the characterisation of the relationship.

Conduct adjustments: valuing the company as it should have been run

Where the petition succeeds, the court values the shareholding in a company adjusted for the prejudicial conduct. The recurring categories:

• Excessive remuneration. A controlling director paying themselves £450,000 in a business where the market rate for the role is £150,000 has removed £300,000 a year of profit. Where that started after the dispute began, it is added back - and because value is a multiple of earnings, a £300,000 add-back at 5x is £1.5m of enterprise value.
• Diverted business. Contracts routed to a connected entity. Valued on the profit that would have accrued.
• Related-party terms. Rent to a director-owned property company above market, management charges to a parent with no substance, interest-free loans out to connected parties.
• Suppressed dividends. Where a dividend policy has been used to starve the minority while the majority extracts value through salary.

Each add-back requires evidence: comparable salary data, the actual contract terms, market rent evidence. An unevidenced add-back is a gift to the other side's expert.

Court-appointed expert or party expert?

Section 994 proceedings sit in the Business and Property Courts, under CPR Part 35 rather than the family rules. Two routes are common:

• A single joint expert, where the parties agree the valuation should be determined once and neutrally. Cheaper, faster, and increasingly encouraged by the court.
• Party-appointed experts, each producing a report, followed by a joint statement of agreement and disagreement under CPR 35.12, and concurrent evidence ("hot-tubbing") at trial.

Whichever route, the expert's duty is to the court and overrides any duty to the instructing party. An expert who reads as an advocate loses the tribunal, and a discredited expert report frequently costs more than the underlying dispute.

There is a third route that resolves most disputes without a trial: an independent expert determination under the company's articles or a bespoke agreement, where both parties agree in advance to be bound by a valuer's figure. It is materially cheaper than litigation, but the scope of the valuer's instructions has to be drafted with the same care the court would apply - valuation date, discount basis, conduct adjustments, treatment of shareholder loans.

The offer that ends a case: *O'Neill v Phillips*

*O'Neill v Phillips* [1999], the only section 994 case to reach the House of Lords, is the practical hinge for costs. If the respondent makes a fair offer to buy the petitioner's shares, the petition may be struck out as an abuse of process and the petitioner risks the costs of everything that follows.

A fair offer under *O'Neill* typically requires:

• Purchase at fair value, undiscounted where a quasi-partnership exists.
• Value determined by a competent independent expert if not agreed.
• Both parties given equal access to information and equal right to make submissions to the expert.
• The petitioner's reasonable costs to the date of the offer.

For a respondent, making a properly constructed offer early - grounded in a defensible independent valuation - is the single most effective way to cap exposure. For a petitioner, an incoming offer has to be assessed against a valuation, not against a feeling.

The five most expensive mistakes

1. Litigating for two years before anyone values the company. Positions harden around numbers that were never defensible, and the costs exceed the gap.

2. Confusing fair value with market value. They are different bases. Applying open-market discounts inside a quasi-partnership misstates the answer and signals partisanship.

3. Ignoring directors' loan accounts. A £300,000 credit balance is shareholder wealth outside the equity value; a £300,000 debit balance is an asset of the company. Getting the direction wrong is a common and material error.

4. Failing to evidence conduct add-backs. An add-back without market evidence behind it will be stripped out of the report at trial.

5. Ignoring funding. An order the respondent cannot fund produces a forced sale that destroys the value both parties were arguing about. A liquidity analysis - dividend capacity, debt capacity, buy-back feasibility - belongs in the report.

What a defensible section 994 valuation contains

• Stated valuation date, with reasoning on why that date is fair.
• Explicit position on quasi-partnership and its consequence for discounts.
• Methodology (earnings, assets or hybrid) with reasons for the choice.
• Normalised maintainable earnings, with every adjustment evidenced.
• Multiple derived from genuinely comparable UK SME transaction evidence.
• Conduct adjustments, quantified and separately identified so the court can accept or reject each one.
• Treatment of surplus cash, excepted assets, shareholder loans and net debt.
• Reasoned position on minority discount and DLOM, including the scenario where the court disagrees.
• Funding and liquidity analysis.
• CPR Part 35 statement of truth and expert declaration.

Where the leverage really sits

The parties who do well in shareholder disputes are the ones who obtain a defensible number early and negotiate from it. The number frames the mediation, informs the *O'Neill* offer, and gives each side an honest view of what trial actually risks. Almost every section 994 petition settles; the ones that settle well settle around evidence rather than around exhaustion.

If you are heading into a shareholder dispute - on either side - the valuation is not the last piece of work. It is the first.