Natural Duvet & Pillow Company Ltd, Re

The petition was an unfair prejudice petition under section 994 of the Companies Act 2006 and the sole substantive issue at trial was the fair value of the petitioners 50% shareholding in The Natural Duvet & Pillow Company Limited (NDP) as at the Valuation Date of 10 March 2005. The court applied established valuation principles: fair value to the co-owner rather than open market value, no discount for a 50% holding and exclusion of events occurring after the valuation date, subject only to their use to test reasonable contemporaneous forecasts.

The court treated NDP as a going concern (on the basis that the supplier Zhejiang Liquiao Feather Company Ltd (ZLF) was not actively pursuing repayment) and took the companys statutory accounts for 2003 2005 as the starting point. Post-Valuation Date material (notably the 2006 accounts) and witness statements investigating alleged accounting irregularities were excluded by prior orders. The judge accepted the experts methodology of normalising historic figures and re-allocating a portion of NDPs costs to a related company (D&P) but adjusted the allocation methodology and included the 2003 (annualised) figures. Using the adjusted maintainable earnings of 3,600 and an accepted P/E multiple of 7 produced an enterprise value of 1,005,200, rounded down to 1,000,000; the petitioners 50% share was therefore valued at 500,000.

Background and parties:

• Petitioner: Ivan Ng, joint 50% shareholder and director of NDP.
• First respondent: Steven Crabtree, joint 50% shareholder and director; Duvet and Pillow Company Limited (D&P) was a separate company owned by Mr Crabtree.
• Third party: Zhejiang Liquiao Feather Company Ltd (ZLF), principal supplier and creditor of NDP.

Nature of the application: An unfair prejudice petition under s.994 Companies Act 2006. By prior consent order the parties agreed that Mr Crabtree would buy and Mr Ng would sell Mr Ngs shares at fair value as at 10 March 2005, that value to be determined by the court if not agreed.

Procedural posture and evidentiary limitations: The court proceeded under a series of orders: an agreed figure for the ZLF debt as at the Valuation Date; a buy/sell order dated 6 May 2010; and an order of 4 May 2011 limiting the trial to expert evidence and excluding witness evidence of disputed facts. The Court of Appeal dismissed an appeal against that restriction on 9 June 2011. As a result the valuation had to be determined solely on admissible expert evidence and on facts not in dispute.

Issues framed by the court:

• The correct valuation basis for the shares as at 10 March 2005 (co-owner value v open market value).
• Whether to exclude or to use post-Valuation Date information (particularly the 2006 accounts) and excluded witness evidence.
• How to calculate maintainable earnings: which years to use, normalising adjustments, and how to re-allocate NDPs operating costs to D&P.
• Whether to reflect the ZLF debt by treating NDP as having to pay commercial interest on it.
• The correct P/E multiple to apply.

Courts reasoning and conclusions:

• The court confirmed the valuation should be on the basis of value to the co-owner and that no discount should be applied for a 50% holding. Events after the Valuation Date were excluded except to the limited extent allowed by authority to test contemporaneous forecasts; reliance on post-2005 accounts to re-state earlier accounts was impermissible.
• The statutory accounts for 2003 2005 were the proper starting point. Because NDP was young and the 2003 accounts covered 17 months, the court annualised 2003 and used all three years to calculate maintainable earnings.
• The experts normalising adjustments were appropriate in principle. The court rejected the detailed retrospective re-statement exercise based on the 2006 accounts and excluded witness statements relied upon by one expert as inadmissible under the order of 4 May 2011.
• On allocation of costs to D&P the court rejected the granular year-by-year allocations that depended on excluded factual material and adopted a pragmatic approach, applying year-specific percentages of NDPs costs to be re-allocated to D&P of 15.2% (2003), 13.3% (2004) and 20.8% (2005).
• The court rejected the inclusion of a commercial interest charge on the agreed ZLF debt because there was no admissible evidence of an obligation to pay interest and the free credit from ZLF was a known and established feature of the business at the Valuation Date; the concern about the debt influenced the court only as a reason for modest downward rounding.
• Applying the adjusted methodology produced maintainable post-tax earnings of 43,600. The court accepted the primary experts assessment and adopted a P/E multiple of 7. Multiplying and rounding down produced a value for 100% of 1,000,000 and thus a 50% share value of 500,000.

This first-instance court determined the fair value of Mr Ngs 50% shareholding to be 500,000. The court reached this conclusion by valuing NDP to a co-owner as at 10 March 2005, using the 2003 2005 statutory accounts (with 2003 annualised), applying normalising adjustments and apportioning a proportion of NDPs operating costs to D&P (15.2% for 2003, 13.3% for 2004 and 20.8% for 2005), concluding maintainable earnings of 43,600 and adopting a P/E multiple of 7 to arrive at a rounded company value of 1,000,000 and a half share value of 500,000.

The judgment records interlocutory orders: (i) an order of Peter Smith J dated 25 November 2009 recording agreement that the ZLF debt as at 10 March 2005 was US$3,606,177.98 and granting judgment by consent in favour of ZLF for a stated sum; (ii) an order dated 6 May 2010 by consent that Mr Crabtree would buy and Mr Ng would sell Mr Ngs shares at fair value as at 10 March 2005; (iii) an order of Lewison J on 4 May 2011 restricting the trial to expert evidence and excluding witnesses of fact; and (iv) the Court of Appeal dismissed Mr Crabtrees appeal against inter alia the 4 May 2011 order on 9 June 2011. The present determination followed those interlocutory steps.