Introduction

Business valuers are often asked to estimate the value of interests in companies that do not represent the entirety of the company’s share capital.1 In those cases, the application of an appropriate valuation discount, which accurately reflects the attributes of a subject shareholding can be both a contentious and material issue, with the size (and application) of the assessed discount potentially having a large effect on the overall valuation of an individual’s interest.

Mostyn J’s recent judgment in Clarke v Clarke [2022] EWHC 2698 (Fam) represents, from a valuation perspective, an interesting departure from the strict reading of the assumptions that would normally underpin a Market Value estimate (and the valuation discounts that are typically involved). In this article, we explore the implications of the judgment and what it may mean for business valuations performed in the context of financial remedy proceedings going forward.

FZ v SZ, Market Value and a demonstratable injustice

Valuers sometimes refer to the assumptions that underpin the basis on which they perform a valuation as the ‘basis of value’ (or ‘standard of value’). One such common basis of value is Market Value, which, according to the definition provided by the International Valuation Standards (IVS) represents the estimated amount that would be exchanged between a willing buyer and willing seller in an arm’s length transaction, after proper marketing, where both parties have acted knowledgably, prudently and without compulsion.2

Importantly, Market Value does not reflect any attributes that might be valuable to a specific owner or purchaser. That is to say, the characteristics of the actual owner should be disregarded when performing a Market Valuation. It is exactly this issue that raises interesting questions when valuing interests in financial remedy proceedings.

As business valuers, the basis of value is often a point of instruction, although my understanding is that Mostyn J’s views, as set out in FZ v SZ [2010] EWHC 1630 (Fam), are instructive in this regard. In that case, he said (at [118]):

‘My view is therefore that present market value should be the usual measurement of value and that fair/hope/economic values should only be used in the exceptional case. I think that serious injustice would have to be demonstrated before departure from the usual rule was justified.’

Whilst departures from Market Value are explicitly acknowledged as being possible, it follows that, in most cases, the assumption for the purposes of a valuation in financial remedy proceedings is that the business interest is: (1) to be sold; (2) imminently (e.g. ‘after proper marketing’); and (3) to an unconnected third party. As a consequence of these factors, and from the perspective of valuation theory, it follows that a valuation discount should be applied to reflect these assumptions.

However, valuation discounts are difficult to estimate reliably as there is limited data on the sale of minority interests in private companies. This is because it happens so infrequently. It is more common for owners of small stakes in private businesses to realise the value of those interests either: (1) by retaining their interest and benefiting from the receipt of future dividends; or (2) for the whole company to be sold. If the whole company is to be sold, then no valuation discount would be applied, and the shareholder would receive their pro rata share of the proceeds of the sale.

Leaving aside for now any issue of a ‘demonstratable injustice’, this aspect raises an important question: is it appropriate (or fair), when assessing the value of a minority interest in financial remedy proceedings, to apply discounts, which can be material, in the scenario where either: (1) the interest is unlikely to be sold; or (2) it has been explicitly agreed that it will not be sold.

Clarke v Clark – a probabilistic departure?

In Clarke v Clarke [2022] EWHC 2698 (Fam), one of the issues that Mostyn J addressed was the applicability (and quantum) of valuation discounts. At first instance, HHJ Farquhar had applied a 15% discount (5% less than the discount suggested by the SJE) to the value of the husband’s 50% minority interest and consequently reducing its estimated value by approximately £140,000, whilst at the same time questioning whether Mr Clarke would, in fact, leave the business and realise his shareholding for at least 2–3 years.3

When dealing with this point, Mostyn J commented (at [17]) that:

‘Of course, it is perfectly true that were the respondent to seek to sell his 50% shareholdings … he would struggle to do so, and if he were able to find a buyer would have to sell at considerably less than the par value … So in that sense the 20% discount is logical. But it is also completely unreal because, in my judgment, on the evidence it was not possible for the judge to find that there were any likely circumstances in which the respondent would sell his shares other than in conjunction with his fellow 50% shareholder.’

Going on, Mostyn J stated (at [17]):

‘It is my opinion that the judge should have looked into the future, and asked himself whether it was more likely than not that a discount would be suffered. The answer to that question would, on the balance of probability, be no … It seems to me that the question is a binary one. Either the discount applies or it doesn’t. There is no room for a third way.’

Ultimately, Mostyn J concluded that the valuation discount, on the facts of the case, should be rejected as ‘highly artificial and highly improbable’.4 As a result, the effect on the estimated value of the husband’s 50% interest was considerable, increasing the value by approximately £140,000.5 Or, put another way, the valuation was increased by 15%.

In making its decision, the court specifically took into account the characteristics of the actual owner, Mr Clarke (and his relationship with his co-shareholder), when considering the question of how he might go about crystalising the value of his interest. This, from a valuation perspective, is a step away from Market Value, and might be said to reflect an alternative basis of value, such as ‘Equitable Value’, where the specific characteristics of the seller are considered and reflected in the valuation.

Also interesting is Mostyn J’s reference (at [17]) to both: (1) the likelihood of the business owning party actually suffering a discount (i.e. by way of a sale of their minority interest in isolation without the other shareholders as part of a wider sale of the whole company); and (2) being ‘satisfied the business was run as if it were a partnership’. Both those conditions being present, he concluded that no valuation discount should apply.

A matter of expert judgement?

So where does that leave valuations performed in financial remedy cases? Is it still the case that valuations should be performed on a Market Value basis? Or have we entered a brave new valuation world whereby, without either party first proving a ‘serious injustice’, the valuer can be instructed to value a business on alternate bases?

Whilst it will remain a factual and legal matter for the judge to be satisfied whether the business is ‘run as if it were a partnership’, following Mostyn J’s judgment in Clarke v Clarke, it may now be the case that it is helpful to instruct the business valuation expert to perform their valuation on both a Market Value basis, as well as any other basis of value that they consider relevant, reflecting their understanding of the facts of the case and the way in which the business has been managed to date.

This will, hopefully, allow the expertise and experience of the forensic accountant to be brought to bear so that you, the legal team, are able to express the arguments you consider necessary to accurately reflect the value of the interest.

Letter to the Editors from Roger Isaacs, Partner, Milstead Langdon and member of the Financial Remedies Journal Editorial Board

The Editorial Board of the Financial Remedies Journal is keen to foster debate. During the editorial process a point of divergence from the view expressed by Thomas Rodwell in his article above was noted by Roger Isaacs and he sets out his differing view in this short reply.

The foregoing article quite rightly raises the issue as to the importance of furnishing the court with as much information as possible so that it can understand the circumstances in which parties to family proceedings are likely, in practice, to realise their shareholdings.

Such considerations, for the reasons set out in the article, ought to be disregarded if a strict Market Value approach is taken. The real-world circumstances of the party to the proceedings and the interests of other shareholders, who may even be relatives, can only be taken into account if a valuation is undertaken using an Equitable Value approach. The reason for this is that the International Valuation Standards Council (IVSC) defines equitable value as ‘the estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties’ (emphasis added).

The lesson here is that family practitioners who instruct experts to opine only on Market Value should not be surprised if a strict approach is taken, resulting in a valuation that is, to quote Mostyn J in Clarke v Clarke ‘completely unreal’.

Such ‘unreality’ is an accepted and indeed a requisite feature of fiscal valuations prepared for tax purposes, but it is far less common in the context of financial remedies proceedings for the reasons that are so clearly and succinctly set out in the Clarke v Clarke judgment.