“FAIR VALUE” OR “EQUITABLE VALUE” By Roger Isaacs, Milsted Langdon
The term “Equitable Value” is seldom seen in English legal documentation but the increasing influence of the International Valuation Standards Council (“IVSC”) means that this is likely to change.
Legal documents including shareholders’ agreements and articles of association often refer to “Fair Value”. Typically Fair Value has been distinguished from Market Value or Open Market Value on the basis that Fair Value takes into account the possible existence of Special Purchasers, such as existing shareholders.
This concept takes into account both the value of the shares to the vendor and to the purchaser.
To illustrate this, consider a company with three shareholders. Suppose that two shareholders each owned 49% of the share capital and that the third shareholder owned the remaining 2%. A valuation of the 2% shareholding that recognised its value to the other shareholders would clearly result in the minority shareholding having a value above its pro-rata value.
In the absence of pre-emption rights, either of the 49% shareholders might reasonably be expected to be willing to pay a premium to acquire the 2% shareholding, ownership of which would result in conversion of a non-controlling 49% interest to a controlling 51% interest.
By contrast, the value of a 2% shareholding in a company with 50 shareholders each of which had a 2% stake would be much less than the value of the 2% interest in the first example. Increasing a shareholding from 2% to 4% would not result in any increase in control and therefore the shares in this scenario would have no greater value to the buyer than to the seller.
The recognition of Special Purchasers can therefore have a significant impact on valuation.
According to the IVSC, Fair Value is “the price a willing buyer would pay a willing seller in a transaction on the open market” or “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
Neither of these definitions mentions the respective interests of buyer and seller. Instead the relevant definition in the IVSC Glossary is “Equitable Value” which is defined 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.”.
In other words, the concept that has traditionally been known as Fair Value is now defined by the IVSC as Equitable Value. There is a risk that continued use of the term Fair Value in legal documentation could cause confusion or be misleading and a number of lawyers have therefore indicated that they intend to use the term Equitable Value in future in circumstances in which they would previously have used the term Fair Value.
Whichever term is adopted, it is perhaps now more important than ever to include a clear definition so that the intentions of the parties are clear.
Even if the term “Equitable Value” gradually replaces “Fair Value” there will be many thousands of agreements which have already been signed that refer to Fair Value. There is therefore clearly a risk that the IVSC Glossary may cause the exact opposite of what it intended to achieve, namely for there to be more scope for uncertainty, argument and litigation than before its definitions were introduced.
Roger Isaacs, Forensic Partner