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Fong v Wong [2010] NZCA 301; [2011] NZCCLR 2 (16 July 2010)

Last Updated: 13 January 2012


IN THE COURT OF APPEAL OF NEW ZEALAND

CA46/2010

[2010] NZCA 301


BETWEEN NEVILLE FONG AND JUNE CHONG
Appellants


AND CHRISTOPHER SHANE WONG AND ANGELA KIM FONG
Respondents


Hearing: 20 May 2010


Court: O'Regan, Priestley and Ronald Young JJ


Counsel: P W G Ahern for Appellants
A F Grant for Respondents


Judgment: 16 July 2010 at 11.30 am


JUDGMENT OF THE COURT

  1. The appeal is allowed only to the extent set out at [41] of the Reasons of the Court.
  2. Counsel should submit an order for sealing to reflect that outcome.
  1. Leave is reserved to either party to apply in the event that clarification is required.
  1. The appellant must pay the respondent costs for a standard appeal on a band A basis and usual disbursements, discounted in each case by 20 per cent.

____________________________________________________________________


REASONS OF THE COURT

(Given by O’Regan J)

Introduction

[1] This appeal raises a difficult issue concerning the application of s 149 of the Companies Act 1993 to a sale of shares in a company by a director to a fellow director, in circumstances where both have access to all information that is relevant to the value of the shares.

Issue

[2] The focus of the case is on the transfer of a 32 per cent shareholding in Pavé Capital Ltd. A minority discount of 30 per cent was applied in the assessment of the fair market value of that shareholding. The High Court found that it was not appropriate to apply a minority discount in the circumstances of this case: the fair market value incorporating that discount was not a ‘fair value’ for the purposes of s 149.[1] The issue before us is whether the High Court erred in so finding.

Facts

[3] The appellants, Neville Fong and June Chong, are brother and sister. They are trustees of the Hobson Trust, and we will refer to them in this judgment as “Hobson”. The respondents, Angela Fong and Christopher Wong, are the daughter and son-in-law of Neville Fong. They are trustees of the Cobblestone Trust, and we will refer to them in this judgment as “Cobblestone”.
[4] In 2005 Hobson and Cobblestone established Pavé Capital as a vehicle for their intended investment activities. Hobson held 68 per cent of the shares and Cobblestone 32 per cent. The family connections between the parties was an important component of the venture: Mr Fong is a successful businessman and the venture was assisting his daughter and son-in-law to get into business.
[5] Pavé Capital made three major investments. In each case it acquired 75 per cent of the entity, with the remainder of the shareholding held by a senior executive of the company concerned, and the relationship between Pavé Capital and the executive regulated by a shareholders’ agreement. The three companies are KML Retail Management Services Ltd (KML), PAL Brands Ltd (PAL) and Pavé Consumer Brands Ltd (PCB). Mr Fong and Mr Wong were directors of Pavé Capital and of each of the companies in which it invested.
[6] A difference arose between Hobson and Cobblestone in July 2007, when Mr Wong wanted Pavé Capital to enter into a purchase transaction involving considerable debt funding, and Mr Fong rejected this. Cobblestone sought to buy Hobson out of its shareholding in Pavé Capital, but this was not agreed to. Mr Fong indicated that if he were to sell he would wish to sell in the open market, notwithstanding the pre-emptive rights which Cobblestone held under the constitution of Pavé Capital. Cobblestone was indebted to Hobson for around $500,000 and Hobson sought repayment. Eventually Cobblestone issued a share transfer notice under the constitution of Cobblestone triggering the pre-emptive rights in favour of Hobson.
[7] Negotiations followed aimed at a division of assets between the parties. It was agreed that Hobson would purchase Cobblestone’s shares in Pavé Capital, and that Pavé Capital would sell its 75 per cent interest in PCB to Cobblestone. Part of the arrangement was that Cobblestone would repay to Hobson on settlement the full $500,000 owed in respect of the loan. It was agreed that the price for the shares would be the “settlement value”, which was to be determined by Eric Lucas of PricewaterhouseCoopers (PwC). The valuation process provided that the shares were to be valued at “their fair market value” based on the financial accounts of Pavé Capital and the three subsidiaries as at 31 March 2008. Each party agreed to provide all requisite information to the valuer and to each other.
[8] PwC undertook the valuation process as mandated and issued a valuation report on 17 June 2008. PwC valued each subsidiary of Pavé Capital, and then calculated the value of Pavé Capital’s 75 per cent interest by first multiplying the total value by 75 per cent and then applying a 10 per cent discount. It said the discount was required to reflect the fact that a 75 per cent shareholder lacks outright control and needs to consider the existing rights of the 25 per cent shareholder. This was despite there being provisions in the constitutions of each subsidiary allowing Pavé Capital to force a sale of 100 per cent of the shares in the subsidiary if it wished to exit.
[9] Applying this methodology, PwC assessed the fair market value for Pavé Capital’s shares in the subsidiaries as follows:
[10] PwC then valued Pavé Capital by aggregating the above figures and adjusting for other assets and liabilities, giving a fair market value of 100 per cent of the shares in Pavé Capital of between $3,657,343 (low) and $5,918,593 (high). It applied the mid point of those figures, giving a fair market value of $4,787,968. The fair market value of Cobblestone’s 32 per cent interest was calculated by first multiplying that figure by 32 per cent and then applying a 30 per cent minority discount giving a fair market value for Cobblestone’s shareholding of $1,072,505. PwC recorded that the constitution of Pavé Capital required a 75 per cent majority to pass an ordinary or special resolution and to appoint or remove a director and gave each shareholder pre-emptive rights over the shares of the other. It acknowledged that this effectively gave the 32 per cent shareholder equivalent rights to a typical 50 per cent shareholder. But it said it would routinely expect to apply a 25 per cent discount in the valuation of a typical 50 per cent holding and that 30 per cent was appropriate in the present case.
[11] The key feature of this report for present purposes was PwC’s conclusion that minority discounts of 30 per cent (Pavé Capital) and 10 per cent (each subsidiary) were appropriate. The 30 per cent discount was strongly contested by Cobblestone, which believed that, given the nature of the business venture and the driver for the transaction, which was essentially a liquidation of the investments, no minority discount ought to have been applied to its Pavé Capital interest.
[12] In accordance with the process agreed between the parties, PwC was asked to reconsider its position but it declined to do so. It was put to PwC that the test to be applied ought not to have been “fair market value” but “fair value”, because a transfer at fair value is what s 149 required. In its revised report, PwC commented on this issue as follows:

We note that fair market value is a different standard of value to fair value, which is commonly used in arrangements between shareholders and private companies. Fair value, in this context requires an assessment of what the buyer gains and what the seller gives up, and an equitable sharing of gains and losses.

While we understand that one of the parties to the Deed now considers that “fair value” should be the standard applied the Deed and our engagement letter are explicit in requiring the standard to be fair market value. Application of the fair value standard is likely to result in different valuation opinions to those expressed in this document.

[13] The outcome was therefore that the fair market value of Cobblestone’s 32 per cent shareholding in Pavé Capital was $1,072,505. That is the price Hobson was required to pay. The fair market value of Pavé Capital’s 75 per cent shareholding in PCB was $1,222,888 (the mid point of the high and low values set out above).[2] That is the price Cobblestone was required to pay for those shares.
[14] Cobblestone resisted settling the transactions required by the deed of dissolution and Hobson sought summary judgment. Asher J dismissed the application for summary judgment.[3] He found that:
[15] Subsequently Cobblestone decided it would settle the transaction in accordance with the deed of dissolution at the values determined by PwC, and seek the difference between the PwC value and “fair value” under s 149(4) of the Companies Act.
[16] Cobblestone then sought advice from a share valuation expert, Mr Hagen. His opinion on the application of a 30 per cent minority discount to the valuation of the Cobblestones’ 32 per cent shareholding in Pavé Capital was as follows:

8. It is my opinion that the standard of “fair value” requires the valuer to ensure that it is the “value” itself that is fair as between the parties. This requires the valuer to consider both what the vendor gives up and what the purchaser acquires in the particular circumstances pertaining to the transaction.

9. I am not of the view that the standard of “fair value”, of itself, bars the application of a discount for minority shareholdings. For example, if there were a situation where a shareholder had acquired a minority interest which had a minority discount applied to it then on sale, under the “fair value” standard, it would seem quite reasonable that a minority discount should also apply. Furthermore if the shareholding was a small minority in a widely held company with no unusual rights then I would expect a minority discount to apply.

10. However that is not the case in this instance where the situation is more that of a partnership in corporate form, albeit the partnership interests are not equal. Here there are pre-emptive rights and the requirement for a 75% majority to pass even an ordinary resolution. In my opinion, in such circumstances it is not appropriate to apply a minority discount on the exit of a 32% shareholding selling to the only other shareholder and when no such minority discount was applied to the acquisition price or subscription price paid by that 32% shareholder.

11. Thus I would conclude that the “fair value” between the parties of Cobblestone’s shares in PCL should not include the 30% minority discount as was applied by PwC.

[17] Mr Hagen also suggested that a 10 per cent discount applied to the valuation of the 75 per cent shareholdings held by Pavé Capital in each of its subsidiary companies was inappropriate, given the rights that Pavé Capital had the right to force a sale of 100 per cent of the shares in each subsidiary. He expressed the view that the 10 per cent discount adopted by PwC should have been five per cent.
[18] The difference between the parties is significant. On Mr Hagen’s calculation, the fair value of Cobblestone’s 32 per cent shareholding in Pavé Capital’s is $1,632,522 (in contrast to PwC’s fair market value of $1,072,505). Mr Hagen’s calculation of the fair value of Pavé Capital’s 75 per cent shareholding in PCB is $1,256,150 (in contrast to PwC’s fair market value of $1,222,888).

Section 149

[19] Section 149 provides as follows:

149 Restrictions on share dealing by directors

(1) If a director of a company has information in his or her capacity as a director or employee of the company or a related company, being information that would not otherwise be available to him or her, but which is information material to an assessment of the value of shares or other securities issued by the company or a related company, the director may acquire or dispose of those shares or securities only if,—

(a) In the case of an acquisition, the consideration given for the acquisition is not less than the fair value of the shares or securities; or

(b) In the case of a disposition, the consideration received for the disposition is not more than the fair value of the shares or securities.

(2) For the purposes of subsection (1) of this section, the fair value of shares or securities is to be determined on the basis of all information known to the director or publicly available at the time.

(3) Subsection (1) of this section does not apply in relation to a share or security that is acquired or disposed of by a director only as a nominee for the company or a related company.

(4) Where a director acquires shares or securities in contravention of subsection (1)(a) of this section, the director is liable to the person from whom the shares or securities were acquired for the amount by which the fair value of the shares or securities exceeds the amount paid by the director.

(5) Where a director disposes of shares or securities in contravention of subsection (1)(b) of this section, the director is liable to the person to whom the shares or securities were disposed of for the amount by which the consideration received by the director exceeds the fair value of the shares or securities.

(6) Nothing in this section applies in relation to a company to which Part 1 of the Securities Markets Amendment Act 1988 applies.

The High Court decision

[20] In the High Court, Keane J noted that Asher J had stated that the common application of a minority discount in the calculation of the fair market value of a minority interest was not an invariable practice, and one exception was where a small private company was a quasi partnership. Keane J referred to a number of cases involving oppressed minority shareholders, in which it had been decided that no minority discount should be applied to the valuation of the minority shareholding. However, he concluded that Cobblestone was not an oppressed minority shareholder in this case, notwithstanding that Cobblestone had argued that Hobson had placed undue pressure on it to agree to the transaction evidenced by the deed of dissolution.
[21] Keane J then considered another exception, which had not been referred to in the judgment of Asher J. This is the situation where a minority interest has a strategic value to the majority shareholder, making a minority discount inappropriate. Keane J referred to the decision of the New South Wales Court of Appeal in MMAL Rentals Pty Ltd v Bruning.[7] In that case, the Court considered that an 18.75 per cent minority interest (which the 80 per cent shareholder had an option to purchase) had a special value because the acquisition of that interest by the majority holder meant that it would not be exposed to “greenmail” or to the nuisance value of the threat of minority oppression proceedings. So no discount should be applied when calculating the fair market value of the 18.75 per cent shareholding. The Court said the reference to “fair” market value suggested that the valuation should proceed on the assumption, which could be contrary to the facts of a particular contractual relationship, that there was no impediment to the process of bargaining either on the terms of availability of information or restraints arising from the characteristics of a particular vendor or purchaser. Thus, in a case involving the acquisition by a majority shareholder of the minority shareholding in a “majority controlled business requiring mutual co-operation and a level of trust”, a minority discount may not be appropriate when calculating the fair market value of the minority interest.
[22] Keane J found that the exchange of shares between the parties had to be at “fair value” in order to comply with s 149 of the Companies Act. He said that he also considered that PwC had been incorrect to discount Cobblestone’s shareholding to the extent of 30 per cent. This was because Pavé Capital was, like the company at issue in the MMAL case, a corporate partnership founded on the basis of a personal relationship involving mutual confidence. It rested on an agreement or understanding that the two shareholders would participate together in the business, and transfers of shares were restricted.
[23] Although Keane J did not consider that Cobblestone was an oppressed minority shareholder, he considered that a minority discount was inappropriate. The decisive factor in that regard was the fact that Pavé Capital’s constitution required a 75 per cent majority for ordinary as well as special resolutions and for the appointment and removal of directors. Thus, he said, the imbalance in shareholdings was irrelevant, and the shareholders “enjoyed equality of arms”.
[24] Keane J therefore accepted Mr Hagen’s evidence (which had not been challenged) as to the proper value of the shares. The fair value of the Cobblestone shareholding in Pavé Capital should be calculated in the manner undertaken by PwC, but without the application of the 30 per cent minority discount. The difference between that value and the fair market value determined by PwC was therefore payable to Cobblestone by Hobson under s 149(4). He also concluded that the sum which Cobblestone was entitled to receive from Hobson should be adjusted to reflect the fact that the fair value of the shares held by Pavé Capital in PCB should also be assessed on the basis that no discount was to be applied. The Judge’s decision that there should be no discount at all in the case of the PCB shares can be contrasted with Mr Hagen’s view that the discount factor should remain, but at a reduced level of five per cent.
[25] After Keane J issued his judgment, Cobblestone made an application to recall it. The recall application was based on the fact that the elimination of the 10 per cent discount in calculating the value of Pavé Capital and PCB should also have been applied to the calculation of the fair market value of its shareholdings in PAL and KMC in order to ensure that the value of Pavé Capital was calculated on a consistent basis. Having received submissions from the parties, Keane J did recall his judgment and issued a second judgment in which he ruled that there should be no discount in the calculation in the value of Pavé Capital’s interests in any of the three subsidiaries.[8]
[26] Hobson indicated during the hearing in this Court that it intended to appeal against the recall judgment, which it said reduced the return to it from the overall transaction by something in the region of $100,000. At the hearing we indicated that we would be prepared to consider any issues arising from the recall judgment at the same time as we dealt with the issues in the present appeal, and the parties accepted that offer. We received written submissions after the hearing on the issues arising from the recall judgment and we deal with those issues in this judgment as well.

The issue for decision

[27] As mentioned earlier,[9] the issue before us is whether it was proper to apply a minority discount to the calculation of the amount which Hobson would be required to pay to Cobblestone for Cobblestone’s 32 per cent shareholding in Pavé Capital. That issue needs to be seen in context. The case was not a judicial review of the PwC valuation. The only foundation for the Court’s jurisdiction to consider the issue was s 149 and its requirement that a sale or purchase of shares in a company by a director who holds non-public information about the company be at fair value.
[28] Section 149 applied in relation to the sale of shares in Pavé Capital because both Mr Fong and Mr Wong were directors. In the summary judgment decision, Asher J found that the fact they were acting in the capacity as trustees of Hobson and Cobblestone respectively rather than personally did not affect the application of s 149 and that issue was not raised before us. We therefore proceed on that basis. It also appears to have been common ground that the directors had material information about Pavé Capital in their capacity as directors, which would not otherwise have been available to them. In other words, there was no dispute that s 149 applied, and the issue before us was the impact that that section had on the transaction. Section 149 applied both to the sale by Pavé Capital of its shares in PCB to Cobblestone (because Mr Wong was a director of PCB) and to the sale of shares in Pavé Capital to Hobson.

The parties’ contentions

[29] The essence of the argument on behalf of Hobson is that all s 149 requires is that the price at which the director sells and/or buys shares is fair. The concept of “fair value” is not a term of art but rather a description of what is required, and compliance with the section is monitored after the event by a Judge considering whether, on an objective basis, the value is fair. Mr Ahern said that in a situation where both directors have the same information and they agree on a process on which all information is placed before a well qualified valuer and that valuer determines the fair market value for the shares, it is simply not open to a Court to say that the outcome has not yielded “fair value” for the purposes or s 149.
[30] On the other hand, Mr Grant argued that s 149 requires that the transfer price for the shares in Pavé Capital represent fair value, and in this case both PwC and Mr Hagen have said that the price that was determined by PwC was not fair value. Mr Grant accepted that it may well have been fair market value. But he said s 149 explicitly requires fair value and the unchallenged expert evidence from both PwC and Mr Hagen was that fair value was something different from fair market value in a case such as this.

Our approach

[31] We are not entirely convinced that fair market value and fair value really are different concepts. Given that “value” and “market value” are usually seen as synonymous, it is hard to see why there is any real difference between them. But the evidence before Keane J and before us was that there are two distinct concepts, and that if the experts had been asked to assess fair value rather than fair market value, a different result would have been obtained. We therefore deal with the case on the basis of the unchallenged evidence before the Court, that is that fair value is a different concept from fair market value.
[32] We do not derive much assistance from the cases relating to minority oppression in quasi-partnerships, because Keane J found there was no oppression in this case. Nor do we consider that the MMAL case provides much assistance to us. In that case, the Court was addressing what was fair market value, rather than fair value. It made findings about the “greenmail” possibilities and their effect on valuation. These findings would need to be the subject of evidence before us before we could determine that they were apposite to the present case.
[33] We see the case as being determined by an assessment based on the evidence before the Court as to whether the value to be paid by Hobson to Cobblestone for Cobblestone’s 32 per cent shareholding in Pavé Capital was fair value. We do not see how the High Court Judge could have gone behind the uncontested evidence of Mr Hagen and the view expressed by PwC in its report that an assessment of fair value would have yielded a different outcome from the fair market value assessed by PwC. Although PwC did not specify what that outcome would be, there was no challenge to Mr Hagen’s view that no minority discount would have been applied to the shares in Pavé Capital. That means we see the case very much in the same terms as Keane J did, though we emphasise that this is because of the evidence that was before the Court.
[34] We do not express any criticism of PwC for the application of a minority discount. We do not consider that Keane J ought to have said that PwC was incorrect to apply a minority discount even in the context of its “fair market value” assessment. It is true that there were aspects of the constitution of Pavé Capital which gave Cobblestone greater rights than would normally be expected of a shareholder with a 32 per cent shareholding, but there was no challenge from Mr Hagen or anyone else to PwC’s assessment of “fair market value”, and in those circumstances we consider it would not be appropriate to make a finding that PwC was wrong in that respect.
[35] Mr Ahern argued before us that it would be wrong to stipulate that a specific standard of “fair value” should be applied. Rather he said that the Court should stand back and assess whether, having regard to all of the circumstances and the knowledge of each party about the affairs of the relevant company, the outcome was fair. While we can see some attraction in that argument, it is difficult for the Court to make a finding, even on that basis, that the transaction as structured in this case led to a price that represented fair value when the unchallenged expert evidence from both experts indicated that this was not so. It seems reasonably clear that no one contemplated the effect of s 149 in the present circumstances and that the instructions given to PwC for the purposes of its valuations were not focused on ensuring compliance with s 149. One can only assume that if the parties had been aware of the requirements of s 149, PwC would have been asked to assess fair value rather than fair market value.
[36] On the facts of the present case and on the basis of the evidence that was before the Court, we conclude that Keane J was right to find that the outcome of the PwC fair market value valuation did not yield a result that constituted fair value for the purposes of s 149. In light of the unchallenged evidence from Mr Hagen that the fair value of Cobblestone’s shares in Pavé Capital involved no minority discount, we uphold the general approach taken by Keane J, of essentially adopting the PwC report but not applying a 30 per cent discount.
[37] In relation to the valuation of the shares in the subsidiaries the matter is more complicated. The only transaction to which s 149 applies is the transfer of shares in PCB from Pavé Capital to Mr Wong, who is a director of PCB. But the approach taken to minority discounts in relation to KML and PAL potentially affects the fair value of the shares in Pavé Capital which are to be transferred by Cobblestone to Hobson. Mr Hagen suggested that the 10 per cent discount applied and the valuation of Pavé Capital shares in those subsidiaries ought to have been reduced to five per cent, but Keane J decided, at least in the case of PCB, that no discount was appropriate.

Recall judgment issues

[38] In his recall judgment, Keane J addressed the issue of what discount should be applied for the purposes of valuing Pavé Capital’s shares in KML and PAL. It was not clear that that issue had been dealt with in the original judgment. In his recall judgment he ruled that the ten per cent discount “be set aside both for the purpose of fixing a fair value for Cobblestone’s minority interest in Pavé Capital and for Pavé Capital’s majority interest in [PCB]”.[10]
[39] In their submissions, both parties addressed the rights and wrongs of Keane J’s decision to recall the original judgment. We do not intend to engage with those arguments. The purpose of our agreeing to consider the competing positions of the parties on the outcome as recorded in the recall judgment was to cut through the procedural niceties and deal with the outcome, recognising that both sides had a right of appeal against the recall judgment and intended to exercise it.
[40] The issue for decision is whether the discount applied in valuing KMP and PAL should be reduced from the ten per cent applied by PwC and, if so, by how much? We think it is clear that there would be no logic in applying a different discount to Pavé Capital’s 75 per cent interest in KMP and PAL than to its 75 per cent interest in PCB. And we accept Mr Ahern’s submission that there was nothing before Keane J that provided an evidential basis for applying no discount. The only expert evidence before him as to the appropriate discount when assessing “fair value” was Mr Hagen’s, and he said five per cent was appropriate.
[41] PwC’s figure of ten per cent has to be seen in the context of its comment that its position would have been different if it had been asked to assess fair value.[11] On the basis of the evidence before us, we are satisfied that the discount in relation to PCB, KML and PAL should be five per cent. We allow the appeal against the original judgment as modified by the recall judgment to that extent.

Result

[42] In all other respects the approach taken by PwC was not disputed and ought to be adopted.
[43] In the result we allow the appeal only to the limited extent that the discount to be applied in the valuation of the three subsidiaries ought to be five per cent, rather than the 10 per cent reflected in the fair market value assessment made by PwC and the zero per cent applied by Keane J. We uphold Keane J’s finding that no minority discount should be applied in the assessment of the fair value of the shares in Pavé Capital. The amount for which Hobson is liable to Cobblestone under s 149(4) should be calculated accordingly.
[44] The parties are asked to submit an order for sealing which reflects this approach, and we reserve leave to either party to apply in the event that any clarification is required.

Costs

[45] Cobblestone has been largely, but not entirely, successful in this Court. Costs should follow the event. We award costs to Cobblestone for a standard appeal on a band A basis and usual disbursements, in each case discounted by 20 per cent to reflect the fact that Cobblestone was not entirely successful.

Solicitors:
Morrison Kent, Auckland for Appellants
Glaister Ennor, Auckland for Respondents


[1] Wong v Fong HC Auckland CIV-2009-404-2469, 16 December 2009.
[2] At [9](a).
[3] Fong v Wong HC Auckland CIV-2008-404-5547, 4 December 2008.
[4] Thexton v Thexton [2002] 1 NZLR 780.
[5] New Zealand Law Commission Company Law (NZLC PP5, 1987).
[6] At [542].
[7] MMAL Rentals v Bruning [2004] NSWCA 451; (2004) 63 NSWLR 167.
[8] Wong v Fong HC Auckland CIV-2009-404-002469, 14 May 2010.
[9] At [2].
[10] Wong v Fong HC Auckland CIV-2009-404-2469, 14 May 2010 at [9].
[11] See [12] above.

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