Shareholder disputes: what is a minority discount and when is it applied?

Shareholder disputes can arise in private companies, particularly where there’s a breakdown in personal relationships between majority and minority shareholders.

One of the biggest hurdles in these disputes is valuing a minority shareholder’s interest when they want to leave the company or challenge unfair conduct. In these cases, a “minority discount” often applies, affecting the value of shares held by minority shareholders.

This article explores what a minority discount is, how it affects shareholder disputes and when it’s likely to be applied.

What is a minority discount?

A minority discount refers to a reduction in the value of shares held by a minority shareholder. This reflects the fact that minority shareholders don’t have control over the company.

Shareholders with control or majority stakes can influence key company decisions – such as dividend payments, company strategy and even the sale of the company – while minority shareholders typically can’t block actions taken by the majority or exercise meaningful control over the company.

Somewhat confusingly, a minority discount can also apply to a shareholder who owns more than 50% of the shareholding in a company. This is because a shareholding of 51% to 74% gives day-to-day control of a company, but 75% is needed to pass special resolutions.

An exact 50% shareholding can also lead to a majority discount, depending on the level of control it provides.

Minority discounts in shareholder disputes

Shareholder disputes often arise in private companies where ownership is concentrated between few hands and relationships between shareholders break down over time.

In these cases, the valuation of shares becomes a contentious issue.

When a minority shareholder is being bought out or wants to exit the company, the value of their shares will be assessed and a minority discount may be applied –  especially where the company is closely held, there’s no active market to determine the value of the shares or the company doesn’t operate as a quasi-partnership.

If the parties can’t resolve the issue between themselves, court proceedings may follow.

When is a minority discount applied?

Under section 994 of the Companies Act 2006, a minority shareholder can apply to the court if they believe their interests are being unfairly prejudiced by the actions of the majority shareholders.

Common examples include:

• Mismanagement or exclusion from decision-making
• Failure to pay dividends or provide financial information
• Dilution of the minority shareholder’s stake
• Mismanagement or diversion of company assets for personal gain by the majority shareholders.

If the court finds there has been unfair prejudice, it has the power to grant relief which includes a buyout of the minority shareholder’s shares.

The question then arises: should a minority discount be applied when valuing the shares?

Case law offers some guidance:

• O’Neill v Phillips is the leading case in respect of the valuation of shares in a quasi-partnership. It sets out the general rule that there should be no minority discount applied in such cases. However, the court said there may be rare cases with “special circumstances” where a discount is appropriate. An example of this could be when the minority shareholder deserved to be excluded from the management of the company due to their own behaviour
• For cases involving a non-quasi partnership, the initial case law following Phillips established that a minority discount should generally be applied unless there were special circumstances (e.g. Irvine v Irvine [2006] EWHC 583 (Ch)). However, case law then started to move towards an opposite view: in Re Blue Index Ltd, the court said the default position should be no minority discount, to avoid rewarding the oppressing majority. In Re Edwardian Group, the court held that it did not have an either/or choice between applying a discount or not applying one discount
• Re Dinglis Properties Ltd is an example of the current “half-way house” approach that the court adopts. The court said it must “try to arrive at a valuation method which is fair in light of the facts of the case” but also noted that outside quasi-partnerships, it’s rare for no discount to apply.

Therefore, while recent case law has set out general guiding principles, the application of these in particular cases will be very fact specific.

Courts aim to balance the parties’ competing interests and reach a fair outcome based on their relationship history.

As a guideline for how a minority interest may be valued in practice, the Association of Chartered Certified Accountants (ACCA) has prepared a Technical Factsheet for valuing trading companies, which includes a section on valuing minority interests. It sets out a series of factors that the valuer should consider, as well as potential levels of applicable discount.

Paragraph 6.1 of the Factsheet states:

“The following range of discounts might be considered to be a reasonable starting point in deciding on the level appropriate in any specific instance:

• Majority holdings in excess of 50% – a discount of 5% to 10%
• 50% interests – a discount of 15% to 25%, depending on the split of the other interests
• Interests of 26% to 49% – a discount of 30% to 40%
• Interests of 10% to 25% – a discount of 45% to 55%
• Interests of less than 10% – a discount of 60% to 75%.”

The Factsheet also outlines different scenarios that may affect the level of discount applied.

Conclusion

Minority discounts are an essential element of the valuation process in shareholder disputes.  While they’re often applied in non-quasi partnerships, this isn’t automatic – a common misconception among lawyers and accountants.

Courts will consider various factors, including the nature of the company, the circumstances of the dispute and the conduct of the majority shareholders, before deciding whether to apply such a discount.

Minority shareholders involved in disputes should seek expert legal advice to ensure their interests are properly protected, especially where there’s disagreement over whether the company operates as a quasi-partnership, as discounts usually don’t apply in those cases.