Calculating fair value – is it really fair?

The difficulties in determining what is meant by the phrase "fair value" have been highlighted by a recent decision of the Privy Council in the case of Shanda Games Ltd v Maso Capital Investments Ltd.

The case arose as a result of Shanda Games Ltd (Shanda), a Cayman Islands company, merging with Capitalcorp Ltd, as part of a transaction to take Shanda back into private ownership and remove its listing on NASDAQ.

Maso Capital Investments Ltd (Maso), a minority shareholder in Shanda, did not agree with the price offered for its shares in Shanda and objected to the merger in accordance with Cayman Islands company law. This law provides that an objecting shareholder is entitled to payment of the "fair value" of its shares. Where the company and the objecting shareholder are unable to agree what is a "fair value", the company can apply to the Grand Court in the Cayman Islands for a determination of the "fair value".

The lack of certainty as to what is meant by the phrase "fair value" saw the dispute start in the Grand Court in the Cayman Islands, be considered by the Court of Appeal of the Cayman Islands, and end up in the Privy Council, the ultimate court of appeal for the Cayman Islands comprising five judges from the UK's Supreme Court.

The Grand Court found that the correct interpretation of the concept of "fair value" was to value the shares on the basis of a pro rata share of the value of the whole of Shanda, with no minority discount. Shanda disagreed with this interpretation and so appealed to the Court of Appeal of the Cayman Islands, which ruled that, in fact, a minority discount should have been applied – a decision that was supported by the Privy Council.

The reasons why the decisions were reached go beyond the scope of this article (and involved interpretation of statutory provisions and a comparative analysis of various other jurisdictions). But the effect of a differing interpretation of two words had a considerable impact on the amount to be paid. Based on the decision of the Grand Court, Maso's interest was valued at around US$73.5 million. Based on the decision of the Court of Appeal of the Cayman Islands (and supported by the Privy Council), Maso's interest was valued at around US$57 million - a US$16.5 million difference.

Because this case looked at the meaning of "fair value" in the context of a statute, it was not open to the parties to agree in advance of any dispute what "fair value" should mean. This is, of course, not the same for private joint ventures or shareholders' agreements, or where management of a company hold shares in an employer – the concept of "fair value" can (and should) be defined in the relevant shareholders' agreement or articles of association. It is obviously better to set out what is meant by "fair value" at the outset rather than have a dispute about it later.

What's fair?

While Shanda Games Ltd v Maso Capital Investments Ltd looked at the meaning of the phrase "fair value" in the context of a Cayman Islands statute, it is a useful reminder that the different parties in a transaction can have very different expectations as to what a phrase means and how much the parties will be paid or have to pay where someone's shares are being bought for "fair value".

To give some certainty to the parties, we would expect the relevant agreements to set out what should be considered when determining "fair value", whether that is agreed between the parties or referred to a third-party expert for determination where the parties cannot agree.

Typical assumptions include:

• that the sale is on arm's length terms between a willing seller and a willing buyer;
• that the sale is of all the shares in the company;
• that the company is a going concern (provided that it is a going concern at the date of determination);
• the date on which the valuation is to be made;
• disregarding whether the shares being valued represent a minority or majority interest or, alternatively, considering what value would be paid for the shares if there had been a sale of all of the shares and the proceeds had been allocated through the distribution 'waterfall' in the articles (i.e. where different share classes are entitled to different amounts of any sale proceeds); and
• that the shares can be transferred without restriction and are not subject to any encumbrances.

A costly (lack of) assumption

The inclusion (or not) of a particular assumption can drastically alter the amount paid as "fair value", as was seen in the case of Doughty Hanson & Co Ltd v Roe decided by the High Court in England in 2007. Mr Roe left the private equity firm Doughty Hanson & Co Ltd and his departure was followed by a dispute as to the price to be paid for his shares, which (following his departure) had been determined by an accountancy firm acting as an expert.

The articles of association set out various factors for the expert to consider in making its determination. Unfortunately for Mr Roe, the articles did not make any assumptions as to whether the company would continue as a going concern, with Mr Doughty and Mr Hanson continuing their involvement in the business. The consequence of this was that the expert took into account that Mr Doughty and Mr Hanson may leave the business, reducing its overall value – and, as a result, the expert valued Mr Roe's shares at value of £9.3 million. This contrasts with Mr Roe's assertion that his shares would be worth in the region of £100 million – a considerable difference, caused by the absence of a simple assumption.

Lessons to be learned

So the lessons are simple: first, if the opportunity arises, set out what you – and the other parties – mean when referring to a definition or phrase; and, second, think carefully about what falls within that definition.  The alternative, as we have seen above, can be costly.